FMCG to remain pricey for a long time despite coronavirus outbreak

Amidst growth concerns in other sectors, better earning visibility and cash surplus position provide comfort

At a time when most sections of the market are bearing the brunt of Covid-19, the fast-moving consumer goods (FMCG) sector, too, has witnessed a correction in valuation to its 5-year mean.

However, the sector is still trading at a 115-per-cent premium to the frontline indices. Over the last month, the Nifty FMCG index, which has been flat, has outperformed the Nifty, which has declined over 16 per cent.  The price-to-earnings (P/E) valuation of the FMCG index, at almost 29x, is among the highest within sectoral indices. If analysts are to be believed, FMCG’s valuation premium vis-à-vis leading indices will continue in the near term, despite muted economic activity.

Though much of last month’s outperformance was led by the Hindustan Unilever stock, others like ITC, Nestlé, Britannia, Colgate, and Dabur have added to gains.

Not only has the likely pressure on earnings for the automobile, hospitality, aviation, banks, and NBFC sectors has made FMCG a safe haven, but even the earnings visibility for the sector is better. 

 

 

According to a JPMorgan report, “The valuation divergence (between consumer staples and leading indices) is likely to stay with premium multiples (of FMCG) being attributed to earnings resilience and better visibility on long-term growth potential.”

Besides essential or the daily-use nature of products, likely margin support from benign input prices and cost-efficiency measures will confine the impact of the crisis on overall earnings. How individual firms manage their distribution (given the labour shortage) would be a key differentiating factor.

Though distributors may demand extended credit period amidst the liquidity issue, G Chokkalingam, founder and managing director of Equinomics Research and Advisory believes that given the supply-driven business of FMCG, which results in higher realisation and zero-debt position, managing working capital is unlikely to be a challenge for the companies. In fact, many FMCG companies have surplus cash and bank balance in their books (after accounting for debt), which itself provides significant comfort in the current situation.  However, near-term earnings impact will vary depending on the product mix and export dependence.

With expectations of low income, demand for discretionary/non-essential items will remain low. Further, a partial or complete lockdown in key overseas markets such as South Africa, Indonesia, and Bangladesh will further dent the top line.

Thus, firms with higher revenue share of essential items and lower revenue contribution by overseas markets are expected to perform better, say analysts. Most sectors will limp back to normalcy over the next 2-3 quarters, believe experts, indicating that FMCG companies with better visibility will remain in demand.

For now, Hindustan Unilever, Britannia and Nestle are some analysts top pick in the FMCG space.