Kotak Institutional maintains cautious view on FMCG Sector

In an interview to CNBC-TV18, he said, "Apart from Hindustan Lever and ITC we would relatively prefer Godrej Consumer , Glaxo and Marico ."

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Below is the edited transcript of the interview with Latha Venkatesh and Reema Tendulkar. Also watch the accompanying video.

Q: Do you expect relative outperformance in this sector or do you think that along with the rest of the market, we are going to see some kind of necks?

A: We do not really see too much of earnings risk for the sector as a whole for the next one year. There are two basic assumptions which we have made. One is that the commodities would behave not been too inflationary from hereon because incrementally it looks to be very difficult for most companies to take further price increases because the demand scenario particularly on the discretionary side is definitely not improving.

Secondly, if you go by small trends which came out from the first quarter performance, some of the volume growth seems to have been lesser there than what the companies have delivered in FY11. So if you look at the overall earnings growth, risk looks limited assuming that commodities do not get further inflationary from here.

However, since the sector has been perceived as a safe haven, what we are finding is that the valuations have gone up indiscriminately across the sector even for companies which have not really done well in earnings. There is risk for those companies going through a correction but I wouldn’t say that sector is really bad at this point of time.

Q: Given the current valuations of VIP and Jubilant Foodworks – where do you stand on both these stocks?

A: We don’t cover VIP so we do not have a view on that. We have a sell rating on Jubilant that is purely on valuations for the company. The company has turned about 20% compounded growth in the same-stores in the last eight years. In the last downturn, this company had a zero percent volume same-store growth and a 6% reported same-store. Last year they had more than 40% same store growth and in the first quarter it was about 37%.

We are looking at a company which seems to be cyclical in terms of performance, so economic performance does impact them. The valuations currently is supported by the performance. It is a question in terms of when the demand conditions could potentially turn for them. In that sense, we find that the valuations were extremely rich for the company even though the performance in the near term continues to be good.

Q: Between ITC and HUL which one would you prefer? Even on these two do you see valuations at an exorbitant level that they would require some scaling down?

A: We like both the stocks. We upgraded Hindustan Lever four months back. We had a long standing negative view on the stock. We find Hindustan Lever as a turnaround story here –  the performance of the commodity end of their businesses (soaps and detergents) gets impacted by movement in commodity to a larger extent. But the personal care part of the business has got pricing power and advantage of low penetration. Structurally the good part of their business is growing very well.

The company is investing in lot of new categories which can create tail winds for the future. This is because in our view, of these new categories are better gross margins that the blender gross margins for the company has got currently. Focus on volumes investment for the future could be a turnaround story for HUL, one could look from a two - three year view so, we are definitely positive on that. We have been positive on ITC for a long time and continue to be so. Both the stocks are not really gone into the zone where I would call it exorbitant valuations as yet.

Q: What is the other list of FMCG companies or personal products stables that Kotak is recommending at this juncture?

A: Very few of them because we have a cautious view on the sector. Apart from Hindustan Lever and ITC we would relatively prefer Godrej Consumer , Glaxo and Marico .