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

Anubhav Sahu Moneycontrol Research

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
Source: BSE, investing.com, Moneycontrol Research

FMCG stocks trades at a beta to Sensex
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 (%)
Source: AceEquity, Moneycontrol Research Note: FMCG stocks include HUL, Nestle, GCPL, Dabur, Britannia, Emami, Colgate, Bajaj Corp

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
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.