Add ITC, Jyothy Labs to your portfolio: PINC Research

PINC Research has come out with its report on FMCG space. The research firm recommends to buy ITC.

Selective Picks:

• India's past 5 years average GDP growth was at ~8.6% which was way ahead of ~5.5% GDP growth in the last 5 decades. India's key states Maharashtra, UP, AP, TN, West Bengal and Gujarat have contributed well towards India's robust growth. These 6 states contribute >50% to the Indian GDP and grew by >13% in the past 5 years.
• Urban India growth is marked by rise in urban population mix which stands at 30% as compared to 18% in 1960. Besides, there is a significant expansion in upper urban income mix to 36% in 2010 from 17% in 2002. Such favourable transformation is supporting FMCG companies from premiumisation perspective.
• Rural market is being driven by growth in non-agriculture income, better MSP rates, higher education and the Government's emphasis on rural development programmes. Large rural population provides consistent volume growth for FMCG companies.
• FMCG categories, with low per capita and low penetration level i.e. skin care, shampoo, oral care, deodorant and packaged juices are the opportunities for FMCG companies. While categories like soaps and detergents which have high penetration level can also show healthy growth due to their low per capita consumption.
• International business is an opportunity for the long term growth potential for domestic FMCG companies. Entrance into new geographies provides growth scope for the established brands/power brands. However, we expect initial cost would impact the profitability of domestic players in the near term.
• We evaluate the competitive strength of FMCG companies based on our 'RIVER' analysis through which HUL, Nestle, Dabur and ITC are the foremost rankers.

Sector Valuation:

FMCG sector, in the current global financial turmoil, converted into a preferable bet for the investors which resulted in 35% outperformance of BSE FMCG over BSE-Sensex in the past 12 months. FMCG sector trades at ~27x P/E on 12-month forward earnings which is ~13% higher than its past 5 years median P/E. FMCG sector valuations are at 118% premium over BSE-Sensex (above +2 standard deviation) as compared to the 5 year average premium of 70%. FMCG valuations are very expensive and we believe going forward growth in net earnings would play a key role in the stocks' performance. At the current juncture, we prefer stocks on their relative traits where earnings growth and valuations both are at attractive level.

Recommendation:

We initiate coverage on ITC (BUY) and HUL (REDUCE) while update on Nestle India (SELL), Dabur (ACCUMULATE), Colgate (REDUCE), Marico (REDUCE) and Jyothy Labs (BUY).

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