Financials better proxies to play consumption theme

As volume growth remains muted for consumer goods firms and their rich valuations are also being questioned, scrips of retail-fronted banks and NBFCs make more sense

The popular belief is that the pay commission and pension payouts will help consumption-focused stocks such as Hindustan Unilever (HUL), Marico, ITC and Titan. Such companies would certainly gain from increased consumption due to the payouts, as well as an uptick in rural demand, led by a good monsoon.

However, from an investors’ perspective, many experts believe financials are better bets, replacing the FMCG (fast-moving consumer goods) names. Retail (individual lender)-oriented banks and non-banking financial companies (NBFCs) are reckoned as better strategies to benefit from the consumption thrust; they also have reasonable valuations. Among these, Bajaj Finance, M&M Finance, LIC Housing, HDFC Bank and IndusInd Bank could be considered.

There are three key reasons for the shift in preference. First, volume growth for consumer staples was muted for most companies in 2015-16. The June quarter, first one in FY17, was no exception for ITC, HUL, Marico and Dabur. So, earnings have also been muted for some quarters.

Under these conditions, experts are challenging the high valuations these stocks are trading at. While these have moderated from all-time highs, stocks of HUL, Marico, Dabur and Titan trade as 35 to 45 times their price to earnings (PE) ratio, based on their FY17 estimated earnings. When seen against the expected Sensex PE of 17-19 times in FY16, experts say the high valuations are not justified.

“There are many grey shades in terms of valuation for consumer staples and we need to figure out how much money we can pay for those stocks,” says the fund manager at a large equity fund. With this issue hovering, he is currently underweight on the sector.

Surendra Goyal, head of India equity research at Citi, agrees with this. “In an environment where volumes and price hikes have been muted and valuations at the level where they are, it is difficult to be constructive on the sector,” he says.

This is where the private banks or NBFCs score better. They have also demonstrated strong loan book growth, helping to expand their profits. Take HDFC Bank, which has 53 per cent of its loans in the retail lending segment. While its loan book rose 23 per cent over a year in the June quarter, its retail loans expanded 25 per cent.

So, too, with Bajaj Finance, a highly retail-oriented NBFC, with deep penetration in various product categories — consumer durables, personal loans, home loans and even e-commerce purchases. Its loans expanded by 40 per cent over a year before in the June quarter and it expects the pace to sustain in the medium term.

Experts say with deeper penetration of credit cards, home loans, automobile loans and personal loans, banks and NBFCs will gain more as the consumption increases. Also reassuring in the case of Bajaj Finance and HDFC Bank are that the valuations have improved (to 3.8 times the FY17 price to book value for HDFC Bank and to six times for Bajaj) and their asking rates are expected to remain attractive, owing to the rich reward potential.

It is also the case with IndusInd Bank, M&M Financials and LIC Housing Finance. “Growth is not a question for retail banks and, hence, their valuations appear justified,” says Dipen Seth, head of research, Kotak Securities. As growth and valuations remain reasonable, experts feel a shift in preference from consumer stocks to financials might be more rewarding to cash-in on the consumption theme.

Finally, data suggest household savings increase in line with pay commission or pension payouts. A report by PhillipCapital notes that higher salaries lead to higher savings (about two per cent rise in the savings rate). “During the sixth (earlier) pay commission payout (in 2008-09), the rate of saving increased to 24 per cent (from 23 per cent in FY08) and to 25 per cent in FY10,” the report says. Higher saving helps banks strengthen their deposit base.

However, a caution from Ajay Bodke, chief portfolio manager at brokerage Prabhudas Lilladher. “Retail banks and NBFCs derive their underlying value of assets from the value of consumer staples and durables. So, if the volume growth and pricing power of consumer companies remain muted for a long period, financial institutions might also see a moderation in their loan growth,” he says.