Risk reward turns favourable in these 3 FMCG stocks; should you buy?

Market beta (sensitivity to broader index) of various FMCG stocks are well below one, which means they decline or rise less in times of market wide correction or upsurge phases, respectively

October 19, 2018 / 01:30 PM IST
 
 
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The recent decline in FMCG stock has taken market participants by surprise. The BSE FMCG index has corrected by about 15 percent in the last one-and-a-half month, in line with midcap performance but underperformed the benchmark index. The recent correction offers investors a reasonable opportunity to increase exposure to the consumption space. Historically, FMCG stocks have provided a decent diversification benefit as investors flock for earnings with high visibility during the time of market stress. In this context, we highlight a few stocks which investors can keep on their investment radar.

BSE FMCG index performance versus Sensex and BSE Midcap
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Source: BSE, investing.com, Moneycontrol Research

FMCG stocks trades at a beta to Sensex
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Source: AceEquity

FMCG stocks: A quality defensive put for investors

Market embarked on a mild risk off phase earlier this year on the back of a US-China trade war, higher interest rates in the US and rising oil prices. The BSE FMCG index has outperformed the Sensex by 5 percent and BSE Midcap index by 19 percent from budget day (February 1). The last 15 years data, since the inception of BSE FMCG index, reveals that consumption stocks tend to outperform benchmark indices in times of market stress. Market beta (sensitivity to broader index) of various FMCG stocks are well below one, which means they decline or rise less in times of market wide correction or upsurge phases, respectively.

FMCG Earnings versus Nifty earnings growth (%)
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Source: AceEquity, Moneycontrol Research

Note: FMCG stocks include HUL, Nestle, GCPL, Dabur, Britannia, Emami, Colgate, Bajaj Corp

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Reason for their relatively lower volatility and limited sensitivity to broader index is governed by their consistent earnings growth and strong balance sheet. That’s why they command a higher trading multiple. Hence, we suggest investors look at Dabur, Britannia and Emami.

Dabur: Broadening growth drivers

Dabur has consistently witnessed an improvement across most categories last year. In the case of oral care (17 percent of Q1 FY19 sales), the company has consistently increased its market share. Competitive intensity has apparently decreased in some categories, where Patanjali Ayurved was a core challenger, such as the healthcare segment (around 25 percent of sales). The company posted 23 percent value growth in the healthcare segment in Q1 led by a 27 percent sales growth in Chyawanprash and Dabur Honey.

The beverages segment (foods category constitutes 22 percent of sales) was recently impacted by high competitive intensity, which the management countered by promotions and new launches. The home care segment (Odonil, Sanifresh) is on a recovery track after an industry-wide weakness in H2 FY19. However, hair care (23 percent of sales) is one category which requires a close watch as the company pursues a volume driven low price strategy amid heightened competition.

The stock is currently trading at 34 times FY20 estimated earnings, which is at a steep discount to the market leader. We expect improving growth outlook led by rural demand, falling competitive intensity and improvement in international businesses.

Price-to-book ratio versus 3-year average return on equity
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Source: AceEquity, Moneycontrol Research

Britannia Industries: Benefits from ramp-up in distribution and moderate input cost

Last quarter, its domestic business benefitted from ramp-up of its distribution network, with a focus on direct reach, improved rural demand and higher growth in northern states. Its direct reach has increased by over 2.5 times in the past four years. At present, its direct reach is about 1.84 million outlets (versus 1.55 million in FY17), which is 37 percent of total outlets. The management has a series of product innovations and launches on anvil.

However, as the company is in the process of executing various product launch campaigns, marketing spending would inch up in the near term. On the raw material front, prices of most ingredients are not concerning, except for the minimum support price (MSP) hike in wheat. The management said it has secured its raw material supply and is covered on the pricing side till January next year. However, it has indicated a price hike in the last quarter of FY19.

Increased emphasis on cost efficiency, along with the continuing premiumisation, is expected to support margin in the context of intensified competition.

The recent price correction of about 20 percent provides an interesting entry level for investors. The stock is currently trading at 45 times FY20 estimated earnings, which is still a premium to the sector average, but factors in higher earnings growth on account of product and distribution expansion. Prevailing moderate input cost (food prices) is expected to aid margin expansion in the medium term.

Emami: One of the cheapest in the diversified FMCG universe

Among diversified FMCG companies, Emami is one of the cheapest stocks (trades at 26 times FY20 estimated earnings). In recent times, a few factors have turned in its favour, with higher exposure to rural sales (around 50 percent of sales), improving growth contribution from wholesale channel (constitutes 40 percent of sales), revival of Kesh King portfolio and recovery in Zandu Pancharishta sales.

In the near term, the stock may be impacted by higher input cost (surge in mentha prices: around 30 percent quarter-on-quarter), leading to moderation in margin. Key monitorable remains sustained growth from the wholesale channel, which was severely impacted last fiscal.

A large part of the risk enumerated has been factored in the price. Investors can start looking at the counter, given stabilisation in its distribution strategy, improving innovation pipeline and product launches, and broadening product category with improved growth prospect.

For more research articles, visit our Moneycontrol Research page
Anubhav Sahu is Principal Research Analyst, Moneycontrol Research. He has been writing research/recommendation pieces on Chemicals and Pharma sectors along with Equity strategy themes. He has previously worked with Credit Suisse and BNP Paribas.

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