Fall in raw material costs to impact FMCG earnings

Analysts expect earnings growth to accelerate in the coming quarters and gross margins to increase

Contrary to expectations, consumer stocks have continued to do well, despite the rebalancing of portfolios and consequent sell-off by foreign portfolio investors. The CNX FMCG Index is up nine per cent over the past three months, while the National Stock Exchange’s Nifty is up 15 per cent in the same period.

The sector, which has seen a slowdown in demand, is benefiting from several tailwinds, say analysts. While rural markets are showing some signs of revival, the sharp fall in input prices is expected to shore up earnings.

Over the past few months, prices of agricultural commodities and oil derivatives have declined, which would have a positive impact on the gross margins of consumer staple companies. If the commodity index falls further, analysts expect the consumer companies to cut prices and do more promotions to lure consumers. While analysts fear this might lead to a heightened competition, the gains from lower input prices outweigh the risks at this point. In this scenario, Morgan Stanley envisages a revenue growth of four to six per cent and domestic earnings growth of 8-12 per cent over the next few quarters in its bear case analysis for the consumer staples that it tracks. In a bull run, the brokerage expects a domestic earnings growth to be strong at 25 per cent.

From a valuation point of view, analysts believe the stocks already have priced in these gains and, therefore, a further upside might be capped. Kotak Institutional Equities says, “The recent rally in stock prices of consumer staples suggests a large portion of the potential benefits from lower commodity prices is already in the stock prices.”

However, there is a contrarian view on valuation of consumer stocks, too. Consumer stocks have risen by a phenomenal 140 per cent over the last four years. While a large part of the increase in stock prices is driven by earnings, a portion of this is also driven by an expansion in their price/earnings (valuation) multiples. JM Financial suggests that on an average, three-fourth of the return has been earnings-led and the balance on account of PE-multiple expansion. On a weighted average basis, consumer stocks are trading at a 22 per cent premium to the five years average. And, if ITC is excluded from the list, then the sector is trading at a 34 per cent premium. While stocks that command a hefty premium face the risk of compression in their multiples, others like ITC might be safe.