May 29, 2013 03:50 PM IST | Source: CNBC-TV18

How FMCG pack looks after Q4 earnings: Nomura analyses

Manish Jain of Nomura India has a bullish view on the food sector for almost two years now. “I would still prefer something like a Nestle over something like Britannia. Nestle has a much wider product portfolio and valuations over there are much better now,” he told CNBC-TV18 in an interview.

Manish Jain of Nomura India has a bullish view on the food sector for almost two years now. "I would still prefer something like a Nestle over something like Britannia. Nestle has a much wider product portfolio and valuations over there are much better now," he told CNBC-TV18 in an interview.

On ITC, he has a buy call with a target price of Rs 390. “From a two-three year perspective, one year perspective also it will continue to do well,” he says.  

He holds a "neutral" view on Colgate for now, citing headwinds in the near-term. "You will obviously see promotional cost going up. They have already started showing in the results. You have already seen two straight quarters of profit after tax (PAT) decline from a company like Colgate which is a bit perplexing and that will continue," he says.

Below is the verbatim transcript of his interview to CNBC-TV18

Q: Britannia came out with absolutely mind boggling numbers and along with the strategic change which you would expect on the back of the management that Britannia announced?

A: Food sector in general is something that we have been very bullish on for a very long time now, almost two years now. From a longer term perspective we continue to like food companies versus non food companies in general. I think the terminal growth rate over here is much higher. If you look at amongst the food companies, that we like and that we don’t like, I would still prefer something like a Nestle over Britannia. That is largely because it’s a longer term call. However, Nestle has a much wider product portfolio. Valuations I think over there are much better now especially the fact that stock has not done too much over here.

I don’t remember when was the last time when we actually had Nestle at sub 30 price-earnings (P/E) multiples available to us. Somewhere people have written the company off. Britannia on the other hand what surprises me the most over here even though we don’t officially cover, it is that despite being a food company, if you look at outside their biscuits portfolio, they have actually not done too much in terms of innovation and success. As the breakfast cereals and all that they launched have actually not been doing too much.

Second is that the profitability there has been a bounce back and people expecting 40-50 percent Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) growth over the next couple of quarters. However, clearly if you look at most of the other companies, they make somewhere close to 18-20 percent EBITDA margins even in the worst case.

Nestle right now is making 23-24 percent EBITDA margins. These guys make 6-8 percent EBITDA margins. In the near term I agree there is bounce back, there is strategy change so you would want to be in Britannia, it looks good. But from a longer term perspective, I would still prefer somebody like Nestle. I think the quality of management shows the commitment to India in terms of the research and development (R&D) capabilities that they have put up. Innovation pipeline is now picking up, valuations are much more reasonable.

After a lull of six-eight quarters I think growth to pick up now. They are doing the right things now. So, I would much rather pitch Nestle against Britannia right now.

Q: What about the frontline Fast-moving consumer goods (FMCG) stocks? ITC post its numbers had a smooth run. It hit that lifetime high of somewhere around Rs 350. Quarter after quarter, it has been delivering. How much more of an upside do you see for a stock like ITC and would you recommend it now?

A: I would recommend ITC at any price point. I don’t think valuations matter. The thing is where else in the world would you get a monopolistic business which is regulated in nature, high barriers to entry. Management in the company has 80 percent market share in value terms in the business which is delivering 17-18 percent EBIT growth quarter after quarter.

I think from a two-three year perspective, one year perspective also it will continue to do well. Our target price on the stock is somewhere close to Rs 390 right now. So clearly, it has a decent upside. I would continue to recommend buying it. The way I look at ITC is slightly different. The biggest concern people seem to have on ITC and this is a question we get always is their terminal growth rate on the cigarette business, what would you put it at. That is something that I think is clearly a number which is underestimated.

If you look at most of the global companies, even in developed markets like US, UK - they are still delivering positive EBITDA growth despite volume decline. I don’t think why ITC can’t replicate it over here because the pricing power is clearly very enormous. So, good quality management in the core business is doing really well. Best of all is that the FMCG business, the personal care business has now broken even. It is a first year of profit where they have delivered. It is also one of the fastest growing companies in the personal care space.

Six percent plus market share in the skincare business is doing well, food is much in profit. So, clearly it has done well on all fronts and it’s a stock which I would buy now and I would recommend it at any given price point. I don’t think valuations in ITC would matter at all.

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Q: Did you manage looking at Colgate’s numbers yesterday? It came out during market hours. Considering that the strong or hefty valuations of around 35-40 times that it trades at. Do you think that there could be some amount of earnings per share (EPS) downgrades which could come in now that there is that threat coming in from Procter & Gamble (P&G) entering into the toothpaste market into India? What would your on Colgate be?

A: I agree. There was little bit of inherent contradiction in yesterday’s numbers. While I was very heartened to see double digit volume growth coming through in a category like toothpaste which has 91 percent penetration in the urban markets. It is quite credible the way they have done it. 55 percent market share to hold on against a guy like Lever is something quite credible.

So, they have really done well over there. You have got to give it to them. But yes, from a near term perspective, I agree with you that there are headwinds. You will obviously see promotional cost going up. They have already started showing in the results. You have already seen two straight quarters of profit after tax (PAT) decline from a company like Colgate which is a bit perplexing and that will continue.

With P&G entering, I wouldn’t have been so worried about Colgate had they been entering with a brand like Crest which is relatively unknown entity but Oral-B will be stiff competition especially to guy like Colgate in the premium and semi-premium segment. Oral-B has established credible brand equity in the market today thanks to their toothbrush franchise. It is going to be a bit tough. Combine that with the fact that the valuations are rich.

I would want to be an underperformer in this stock but I think I will continue to hold that neutral view. As I don’t see multiples contracting anytime soon because of two reasons. One is volume growth is coming through quarter after quarter and that’s something that they have demonstrated globally everywhere even in a country like Brazil where they held on to market share. They held on to volume growth despite P&G’s entry over there. So they have done that. I think they will do it over here. They are much more proactive over here.

Secondly, most of the multinational companies’ (MNC) multiples will continue to hold where they are given the fact that what GSK consumer did, what Unilever did. I don’t see multiples contracting because of those two reasons so I will be more equal weight on Colgate right now rather than underweight.

Q: I don’t know if you track the paint companies but this quarter was slightly different because most of the paint companies reported a disappointment this time be it Asian Paints, something like Kansai Nerolac, etc, what would you do with that space now? Any recommendations?

A: We track Asian Paints. That’s something that we look at actively and others also we have looked at. So, I agree with you. I have looked at the results of Kansai Nerolac, I have looked at the results of Akzo and Asian Paints obviously and you are right, numbers are disappointing. What was disappointing was from a full year perspective, the volume growth in the paints business for Asian Paints was about 7.5 percent so this is like the lowest that I have seen them deliver in a long time now.

So, clearly a disappointing. I think it has more to do with macro headwinds. Painting is discretionary spends. It’s a big ticket item spent and it is more of an urban phenomena. So, given the fact that you are not doing too well right now both in terms of urban income as well as macro economic headwinds being there, I do see a couple of challenging quarters coming through over here - those challenges are going to continue to remain.

On the other hand, what is positive is the titanium dioxide prices which have kind of corrected quite significantly, almost 25-26 percent from the peak. Second is that Asian Paints in particular has taken a price hike despite titanium prices correcting. So you will see margins sitting at all time highs this year. Profitability is definitely going to improve. International business from their perspective is going to remain steady.

So clearly, this is a stock which I will hold on to. I will not be selling despite volume growth weakness because what we have seen in Asian Paints is that even if you go back in history and if you look at 2009, the rebound happened much sharper. From nine percent volume growth for full year 2009, it bounced back double digits fairly quickly so that rebound can happen.

It’s a great company, great promoters, amazing quality of management, the innovation capabilities are probably the best that I have seen in the whole of consumer space. So from a longer term perspective I would buy it regardless of valuation. I don’t think that matters at all and from a near term perspective I will hold on to it despite the macro headwinds because I believe that in the second half you will see a bounce back happening.

Q: Would you be recommending investors to tender into the Hindustan Unilever (HUL) open offer which kicks off on June 21st?

A: It is a double-edged sword. At 32 times valuations are very compelling to tender it out, but if you want to sell it you can sell it at Rs 590 in the market today. The thing the open offer price looks very attractive from the date of announcement, but if you go back in history and if you look at the prevailing prices of HUL in October-November it is not a very great price, because the stock was almost Rs 550 then, so you are giving a 10 percent premium to that price.

That is the way I look at it. Somewhere down the line when you like somebody like GSK Consumer and what is the valuation over there and what is happening over there you are effectively asking people to exit HUL. At 75 percent holding for Unilever in HUL you effectively will have no liquidity left in the stock. If I were an investor the way I look at it I would want a much higher valuation in this name over here at this exit option. So clearly it is a double-edged sword, but if I had shares I would not be tempting in.

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