FMCG sector: Premium valuations justified

Companies to benefit from last year?s tailwinds, as select commodity prices have fallen

The last one year has clearly been one of consumer stocks. Even as this financial year 2011-12 (FY12) started with tremendous cost pressures, consumer companies have delivered growth through volumes and value. Commodity prices for most fast moving consumer goods (FMCG) companies rose at the start of FY12, forcing them to undertake calibrated price hikes to offset the pressures. While the price rises are beginning to impact volumes of some players in the FMCG segment, analysts believe FMCG stocks will continue to fare well in FY13.

This is evident even now, when the market has switched to a ‘risk on’ mode in 2012. Given the price increases undertaken last year and the subsequent fall in prices of select commodities, analysts believe pricing for some companies is running ahead of cost inflation, while it’s in line for others. Companies which have increased prices and are now seeing input prices cooling are likely to enjoy higher margins due to the tailwind benefits.

A section of analysts, therefore, believes the premium valuations of FMCG companies are still justified. Esprito Santo Securities believes the benefits of recent price increases, the rupee’s appreciation and a softening of some key commodities will create a more benign environment, at least in the first half of FY13. However, high crude prices and liquidity driving up overall commodities prices remain a key risk.

Despite the tailwind benefits, analysts believe volume growth will be crucial for consumer companies in FY13. In a note on Hindustan Unilever, Edelweiss Securities says Hindustan Unilever’s growth trajectory would continue to be led by a growth in prices. “The growth quality would be similar to the December quarter (more price and less volume).” Despite the commodity prices cooling, analysts don’t expect companies to pass on the benefits to consumers. In fact, most FMCG companies are likely to increase advertising and promotion (A&P) spends. In order to prevent erosion in their brands, companies will have to start investing in A&P again, believe analysts. HUL, for instance, is likely to increase adspends in the personal care space but may cut back in the soaps segment.

Competitive intensity is expected to play a role in the A&P strategy of companies. For instance, the last one year has seen competition ease in the detergents market. However, analysts expect some of the competitive intensity to return this year and affect segments like oral care (Proctor and Gamble is expected to enter the category) and food business. Analysts at Esprito Santo have assumed A&P investments for Nestle to continue at 4.4 per cent in both 2012 and 2013 to factor in new product launches and match competitive intensity. For Colgate-Palmolive, they have assumed A&P investments to continue at high-teen levels in FY13 and FY14. Reduction in competitive intensity would give an upside to most FMCG stocks.