Fundamentals strong, but valuations too high

For premiums to sustain, FMCG earnings growth must pick up in coming quarters

The BSE Fast-Moving Consumer Durables (FMCG) index fell 4.2 per cent in the last two sessions, on worries that valuations for the sector that has had a good run so far are in the bubble territory.

The FMCG index surged over 19 per cent in 2018 (till August), outpacing the 13.5 per cent rise in the Sensex.

While most analysts believe the fundamentals continue to be strong, the concern is largely on absolute valuations and the premium the sector gets, as compared to the broader markets.

Valuations of consumer firms are now upwards of 55 times the one-year forward earnings estimate.

The same is reflected on the premium, as compared to overall markets. According to analysts at CLSA, the FMCG index’s valuation premium to the Nifty is at an all-time high of 160 per cent, compared to the last 10 years’ average of 110 per cent (lowest premium was 20 per cent).

Interestingly, valuation premiums of Indian subsidiaries — compared to their global parents such as Colgate, Hindustan Unilever, and Nestlé — are also at peak levels.

Typically, valuation multiples should justify the earnings growth potential but currently this is not the case yet.

SBICAP Securities in a recent report indicated that average FMCG sector multiples (excluding ITC) have moved from 27 times over FY08-13, to 42 times over FY14-18, despite a deceleration (from 16 per cent to 12 per cent) in compound annual growth rate of earnings during the same period.

While valuations are high, analysts reiterate that growth prospects, too, are strong and concerns on that count are unfounded.

They believe that earnings growth of consumer companies will be strong, led by a revival in the rural economy and market share gains on the back of the goods and services tax implementation.

Further, higher spending with Assembly elections around the corner is also expected to be a trigger.

Sunil Jain, head of research at Nirmal Bang Securities, says that the correction in the FMCG index was due to high valuations, with fundamentals and growth potential remaining intact.

Jain does not see major corrections in FMCG stocks, given investors are looking to increase their positions in defensive stocks.

How the earnings growth pans out over the next couple of quarters, and management commentary, will be crucial for the sector to hang on the current premiums.

Thus, investors have to be selective while taking an exposure to the sector.