Rural push won't lift FMCG much; buy ITC, HUL: StanChart

Rural demand for consumer goods has been growing for some time now and a good monsoon will only boost the rural economy further by 1-2 percentage point, says Sanjay Singh, Director, Standard Chartered. The main slowdown which is in urban areas won't see any change. Rural segment sales contributes 35% to aggregate sales in FMCG sector.

Also Read: Rupee may hit 62/$ if Q2 GDP above 5%: StanChart Bank
In the largecap FMCG space, he likes both ITC and Hindustan Unilever (HUL), but prefers ITC over HUL. In the midcap space, he is bullish on Britannia on the back of soft agri commodity prices. Standard Chartered has buys only on two of the 15 stocks it covers. Below is the verbatim transcript of Sanjay Singh's interview on CNBC-TV18 Q: I was going through your report and I was quite interested with regard to your comments on the monsoon as well as the elections. You don't see them as a big trigger?
A: Rural has been doing well for some time although it has corrected a bit from around 20 percent plus growth to around 14-15 percent. So rural anyway was doing well so just a good monsoon will not probably change the fortunes completely of the sector because the main slowdown is in urban and there we see no change. So while rural may improve by 1-2 percentage points, urban remains pretty poor and hence urban is 65 percent of sales. So 35 percent is only rural. So it is not going to change things meaningfully.
Also we need to see exactly the monsoon has been good but there have been patches of excess rains and poor rains. Some crops in Gujarat, Maharashtra have not done well, some crops in Bihar, West Bengal have not done well. The first advance estimates was not too great. So we actually need to see what happens till we actually get more firm numbers which is the second and third advance estimates for the kharif crop. But bottom idea is agriculture is 12 percent of GDP, rural is 35 percent of FMCG sales. Rural anyway has been doing good so will it change the fortunes completely, no.
What we need is the consumer sentiment to improve because of better jobs, more pay hikes etc which is a function of the economy and hence we don't see any meaningful change in demand in the neat term. Interesting even if economy improves in FY15, we only see demand improving in FY16 for staples not for discretionary because consumer staples fall with a lag and then again improves with a lag because behaviour in stables doesn’t change overnight and hence our call is that even if economy improves in FY15, we would see uptick of back to 20 percent levels top line only in FY16 if at all economy improves in FY15. Q: So is your call that as a sector FMCG is an avoid and will there still be exceptions within that sector where you have a buy?
A: One cannot avoid the sector today from an institutional perspective because it is 12 percent of the weight of the index. So from a large cap perspective we like both ITC and Hindustan Unilever (HUL) but we prefer ITC over HUL. Valuations in ITC have corrected now to 25-26 times one year forward which is even cheaper than many of the midcap names. Hence ITC is a favored pick in large caps. But still it is not scorching return, it is about 10-15 percent returns from a 12 month perspective but it is more of a relative call to the sector.
In midcaps we like Britannia which has been our top pick in the last 8-9 months. The stock has been pretty much scorching in the last six months but there is still some steam there because be sugar prices have softened. Even edible oil which has run up a bit it has still not gone through the roof. So agri commodities are soft and Britannia’s fortune pretty much depends on that. Hence we believe that Britannia could push that 10 percent margin boundary here and there. Our official estimate is still 9 percent EBITDA margins. So there could be upside to our numbers. Valuations while not cheap it is not crazily expensive at 25 times one year forward. Hence we see that there is a possibility that Britannia could still surprise on the upside. Of course the larger part of the cream is gone but still it can do well from here.
We have only two buys out of the 15 stocks we cover so pretty much pessimistic at this point in time but some stocks like Dabur does look decent given the fact that a large proportion of sales come from rural. They are doing some rural distribution activation but that is more towards, the downside is not there but really there is no meaningful upside in any of the stocks from our perspective.