See risk reward for Marico; Espirito downgrades Nestle

Espirito Santo Securities has downgraded the consumer goods sector recently. Nitin Mathur of Espirito Santo justifies the reason for the downgrading citing slowing GDP and wage inflation. Although, the volume growth reported by staple companies remains strong, discretionary growth is starting to show signs of slowing down, added Mathur.

Besides, Mathur sees more risk-rewards for Marico in comparison to other companies. Espirito Santo has also downgraded Nestle to 'sell' and expects further downside in the stock. He also believes that decoupling of consumption and the investment cycle will end. 
Also read: FMCG shrs hit new high; Is a correction around the corner? Here is the edited transcript of the interview on CNBC-TV18. Q: You are one of the few on the street who actually downgraded the consumer sector. Can you just give us the rationale behind this considering it’s the toast of the market at this point?
A: Sure I think one of the concerns that we had was about the negative real wage inflation as well as lack of employment opportunities in urban India. We have analyzed BSE 200 wage inflation data. We think it is in the negative territory. We have analyzed online job portals data and we think it is not at all good to occupy the new working population coming into the workforce.
Moreover, if you look at the RBI consumer confidence data, it keeps deteriorating from quarter to quarter. Overall, we believe that lack of inclusive growth in the economy is going to hurt consumption and the virtuous cycle of growth that we have seen in the past can turn vicious from here. Q: When you speak to the FMCG and consumer companies that you cover, do you get a sense that they are worried about dipping consumption at all? Many of them reported decent numbers for Q1, didn't they?
A: If you look at the absolute volume number, it is good. I am not saying that is not good but if you look at from where it is coming from and the valuation multiples that the consumer companies are commanding, I think it is not at all impressive. Now we are hearing stress from several companies across discretionary spending.
If you look at same store sales growth for Jubilant Foodworks, it is coming down. If you look at the commentary from TTK Prestige it is tapering down. The growth numbers are actually tapering down, if you look at packaged food category and chocolates. These growth numbers are still there but, these are not at all impressive as you would expect them to be at such a nascent stage of evolution. Q: You have a sell on ITC but your report also claims that the least amount of impact on consumption would be on tobacco. Are you that concerned in terms of valuations for ITC that you wouldn’t have a long call on it?
A: Valuation is just one part of the whole debate. The second part is that tobacco as a category is defensive but, if you look at cigarettes it is just 15% of tobacco consumption. Moreover, we would never assign FMCG style defensive multiples to any company which is exposed to regulatory risk like ITC is. Our key argument for a sell rating on ITC is that valuations are just not in the range where the risk rewards would be favorable from here.
_PAGEBREAK_ Q: Would you have any contrarian or any outperformer in the FMCG sector at all, any buys?
A: Given the current market conditions I think we are still confident in putting money on Marico. We think pricing is running ahead of cost inflation. Moreover the categories that Marico operates rank lower in our slowdown vulnerability index and we see more risk rewards in Marico than any other consumer sector in our coverage universe. We have just downgraded Colgate Palmolive and Hindustan Unilever to neutral and we have been maintaining a buy on it for quite sometime now. Q: Nestle which is trading at crazy valuations, you have a neutral on that?
A: I have a sell on Nestle. I have recently downgraded Nestle to a sell and it is more to do with the categories that Nestle is operating into. Milk products as well as packaged foods rank very high on our slowdown vulnerability index and hence, we are cautious on this company especially given the valuation multiples that the company was commanding in the past and still continue to command. We see further downside on Nestle from current market price. Q: Any other strong buy or sell?
A: What we are arguing is that the decoupling of consumption and investment cycle won't last forever. In fact, if you look at data from 1960 onwards, the consumption growth has had a very strong correlation with the investment growth cycle. But, what we have seen in last four years is that the investment growth has tapered off while consumption continues to stay steady.
The initial signs are already indicating that the consumption cycle has to come down significantly and just follow the investment cycle or investment cycle has to pickup substantially from the current levels. Hence, the overall macro view and we have more neutrals to negative as compared to buy.