 "Consumer stocks’ valuation at new high")
Investors continue to bid up stock prices of consumer goods companies, despite a sharp slowdown in earnings growth for the sector. On an average, these companies are now valued at nearly 37 times their trailing 12-months net profit, up from a price-to-earnings (P/E) of 28 times at the end of March 2016.
In the same period, the sector’s net profit grew at the slowest pace in four years, increasing by 3.5 per cent in FY17, compared to a growth of 10.6 per cent in FY16. The return on equity (RoE) also continues to slide and hit a 10-year low of 16.7 per cent in FY17. Adjusted for RoE, these companies are now thrice as expensive compared to valuations at the end of March 2014.
The result has been a steady rise in the valuation premium of consumer companies over the broader market. The premium over the benchmark S&P BSE Sensex is now at an all-time high of 14 points. The earlier high was 11.3, at the eve of the previous market peak in March 2015. The 30-stock Sensex is currently trading at 22.7 times the underlying trailing 12-months earnings of the index companies, unchanged from the P/E multiple of 22.6 at the end of March 2016.
The analysis is based on annual profit and loss accounts of 169 companies across sectors such as automobiles & ancillaries, cement, consumer durables, fast moving consumer goods, media & entertainment and retailers. These together reported a net profit of Rs 78,700 crore in FY17, on revenues of Rs 10.96 lakh crore. Based on Friday’s price, their combined market capitalisation stood around Rs 29 lakh crore.
Some of the top stocks in the sample are ITC, Maruti Suzuki, Tata Motors, Bajaj Auto, Hero MotoCorp, Havells, Eicher Motors, Asian Paints, Colgate, Nestle, Bosch, MRF, ACC, Hindustan Unilever, Zee Entertainment, Page Industries, Motherson Sumi, UltraTech Cement and Shoppers Stop. Together, these companies now account for nearly 34 per cent of the combined market capitalisation of all BSE 500, BSE Mid-Cap and BSE Small-Cap companies, ex-financial and oil marketing companies. In comparison, these consumer companies accounted for 25 per cent and 23 per share of the universe of combined net profits and net sales in FY17, respectively.
Analysts attribute this to investors’ expectation of a cyclical recovery in revenue and profit growth of consumer goods companies in FY18, besides higher liquidity on the bourses.
“There is a widespread belief that consumer companies will report a faster growth in top line and bottom line in FY18, after a poor show last fiscal. Growth is likely to be led by higher government spending in the rural and farm sector, boosting rural demand for everything from passenger cars to packaged food to personal care products,” says Dhananjay Sinha, head of research at Emkay Global.
Kotak Institutional Equities’ Sanjeev Prasad raises the issue of liquidity driving stock prices. “It seems to us that the sole investment thesis in some cases is liquidity, which is quite bizarre. We can only hope that fundamentals improve sufficiently to support the valuations of stocks,” he wrote in a recent report on equity valuation.
The improvement in earnings growth, however, has to be in the high teens to justify the current rich valuations of companies.
“There could be an upside in earnings growth during the second half of FY18 if the monsoon is good, resulting in better crop harvest. However, I doubt if the growth would be high enough to justify the current valuations of top consumer companies,” says G Chokkalingam, managing director, Equinomics Research & Advisory.
For the bulls, consumer goods companies reported an uptick in FY17 revenue growth, with combined net sales of the sample companies up 5.9 per cent year-on-year, as against 1.5 per cent growth a year before. This is, however, attributed to higher price realisations rather than volume growth. “FY16 was a year of deflation, with companies forced to take price cuts, depressing top line growth. It reversed in FY17 and companies took price hikes to compensate for higher input cost,” says Chokkalingam. According to him, volume growth remains in low single digits across most consumer goods categories, with few chances of it moving higher anytime soon. “This calls for a more reasonable valuation of 25-27 times the trailing earnings, a significant cut from the current levels,” he adds.
