Is It A Good Idea To Book Profits In FMCG Stocks?

FMCG stocks have inched up and major FMCG players have reported decent growth in earnings. Amir Shaikh explains why it may not be a good idea to book profits in FMCG stocks. 

FMCG companies reported double digit volume growth in Q1FY19 also due to the effect of a favourable base year ago. 

FMCG is one of the best performing sectors in India. The strong performance of the FMCG companies is something that investors have relished all these years. FMCG stocks have had their fair share of underperformance in the past few quarters due to demonetisation and roll-out of the Goods and Services Tax (GST). While most FMCG stocks have delivered volume growth after a major hiccup, the stocks prices are reflecting the growth delivered in recent quarters. 

While investors are expecting steady growth in the coming days in FMCG sector, the pertinent question in the minds of several investors at this juncture is – “Should I book profits in the FMCG stocks?” 

The valuations are not cheap for the set of large FCMG stocks at this point of time, except for ITC. Britannia, Asian Paints, Hindustan Unilever, Godrej Consumer Products and Nestle are some of the major FCMG players that are currently trading at 41-56 times their FY20 estimated earnings. 

Traditionally, FMCG sector is considered safe, and as growth was seen in the FMCG sector, investors showed confidence in the FMCG stocks recently. Domestic institutional investors have shown preference for this sector recently. 

Owing to its durable growth story, the FMCG sector has been a favourite of both the retail and institutional investors alike. This led to an increase in the demand for quality FMCG stocks. 

Going ahead, the increase in demand for consumer goods from the rural markets is expected to continue. Also, the recent hike in minimum support price for kharif crops, farm loan waivers and good monsoon will play a significant role in fuelling the demand in rural markets. This will further add to the revenues of the FMCG companies. Investors will also be waiting to see how the demand will be affected by the pre-election stimulus. The margins are under pressure for several FMCG companies due to increasing raw material prices. Hence, some of these companies may increase prices of their products to protect margins. 

Investors will have to watch carefully if the FMCG companies resort to price war to improve market share or they maintain higher prices to protect margins. Price war may trigger some selling in FMCG stocks, but we do not see it as a possibility. 

Harendra Kumar,
Managing Director, Institutional Equities, Elara Capital 

"Volume growth for market leaders has started showing an uptick"

What is your outlook on the FMCG sector? 

The sector has revived in the last three quarters as volume growth for all large market leaders has started showing an uptick (run-rate at least >10% YoY compared to low single digit earlier). In our opinion, large players (Nestle, Britannia, Hindustan Unilever, ITC, Dabur, Marico) have replaced indirect distribution (wholesalers) with direct distributors – hence they have overcome the problem faced by trade channels due to cash crunch (demonetisation) and GST. 

Also, for the last 3 quarters now, all companies catering especially to North India have started seeing a growth in rural markets as well. Hence, we remain confident that the sector will be achieve 10-15% volume growth across categories. 

FMCG stocks have moved up nicely. Do you think it is good time to book profits in FMCG stocks? 

Market leaders like Nestle, HUL, ITC, Britannia, ITC, GCPL, Marico, Dabur will continue to remain expensive as they all are on track of their declared strategies. Also, the FMCG stocks are expensive due to the TINA (There is no alternative) effect and cash generating nature, which has led them to trade at much higher premium (2x-3x market multiple). 

How are FMCG stocks valued right now? 

FMCG stocks are trading at 1-year forward P/E multiple in the range of 30x to 50x – depending on the penetration levels of their respective categories and growth opportunities in terms of up trading the consumers. 

They are all in margin expansionary mode as well due to cost rationalisation in terms of strategic sourcing, and launching of only margin accretive products (Nestle – Nescafe RTD, Maggi Hot heads, Surf Excel liquid detergent, Surf Excel Quick Wash, multiple benefits creams under Ponds and Lakme, etc, anti-hair fall oils are all at 2x/3x the price of base prices). 

Conclusion:- 

Many among the major FMCG players are expected to do well in the coming quarters. The demand uptick is visible for the FCMG companies. FMCG sector is considered defensive and hence it is expected to do well even in a volatile market situation. Select FMCG stocks are expected to do well owing to the uptick in demand. We do not think the time is ripe for profit-booking in FMCG stocks owing to the demand uptick in general and the pick-up in rural demand for majority of the large FMCG players in the sector. The margins are expected to remain intact and the earnings may improve going forward. Considering the defensive nature of the sector, in spite of rich valuations, it may not be advisable to exit FMCG stocks at this juncture.