For instance, the management of India’s largest FMCG company — Hindustan Unilever (HUL) — during a Q1 analyst call said, “Looking ahead, we expect near-term demand to remain subdued, given the macroeconomic conditions.”
The question is, will this lead to a significant correction in FMCG valuations? Analysts believe that might not be the case.
According to Dhananjay Sinha, head of strategy and chief economist at IDFC Securities: “Major sectors such as automobile, non-banking financial companies, steel and metal, among others, are going through stress. Thus, investors are shying away from them and FMCG is perceived as a relatively safe sector. We do not see sharp valuation correction in the FMCG space, despite lack of visibility of near-term demand recovery.”
In fact, even after six months of moderation in consumption, the average current valuation of major FMCG players is still 12-13 per cent premium to their own historical average one-year forward valuations in the past five years. This clearly indicates that FMCG is being considered the most defensive bet; the situation though in other major sectors is far worse.
This is also reflected in the 2020-21 earnings estimates of the FMCG sector, which is at a 168 per cent premium to broader markets, compared to 124 per cent for the trailing 12 months.
Though some expect demand to recover in the second half of the financial year, a lot will depend on factors such as monsoon and rural spending. One of the key reasons for the slowdown has been weak rural consumption. HUL highlighted that rural growth is now on a par with urban growth. Earlier, rural was growing around 1.3-1.4x faster than urban. Thus, companies with higher rural exposure could see more pain if the situation does not improve.
In Q1, barring Dabur and United Spirits, all other consumer staple companies, which have declared results so far, reported a deceleration in volume growth on a sequential basis. And the volume offtake could remain poor in the ensuing quarters on the back of weak consumption. Thus, how the companies control their advertising and promotional spending and their impact on profitability will be key. In Q1, benign input costs and new lease accounting standard — IndAS 116 — offered strong margin support to the companies.
Overall, investors, who can stomach some risks, can bet on FMCG on a selective basis. Experts believe the valuation correction risk for FMCG could be high if other sectors see some recovery. On the basis of Q1 numbers so far, HUL and Dabur are analysts’ top picks in the FMCG space.
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