Analysts recommend FMCG stocks despite near-term challenges

Despite near-term headwinds of rising input costs and the possibility of lower demand for products owing to the impact of the second wave on both rural and urban India, analysts remain bullish on stocks of fast-moving consumer goods (FMCG) companies. They expect the index to outperform peers in the second half of the financial year 2021-22 (FY22).

In the past year, prices of key commodities, such as groundnut oil, mustard oil, vanaspati, soy oil, sunflower oil, and palm oil have shot up in the range of 20 per cent-60 per cent, shows data.

The FMCG sector macros, against this backdrop, have further deteriorated, say analysts. This is because of weakness in consumer demand, as well as likely margin pressure due to elevated crude oil, palm oil, and global food prices. “The weakness in IIP consumer goods may remain for the next few months, given the high unemployment level,” wrote Pankaj Chhaochharia and Dhirendra Tiwari of Antique Stock Broking, in a recent report.

Companies, analysts feel, will be able to pass on the sharp rise in raw material (oil) prices over time.

Consumers, on their part, will continue to buy essentials — such as biscuits, tea, sugar, noodles, soaps and shampoos. They may, however, defer purchase of high-end products in each of these categories for now. Cushioning the blow to consumption, according to them, is the third consecutive year of normal monsoon. This will aid farm produce, keep inflation under check, and help revive the economy after the recent lockdown.

“The full 'pass-on / transmission' may not be immediate, as companies also understand the impact of Covid on rural and urban India. It may happen gradually over time. People will still continue to buy essentials, but the demand for highend products may get hampered. A normal monsoon will help,” says G Chokkalingam, founder and chief investment officer, Equinomics Research.

At the bourses, the Nifty FMCG index has been an underperformer so far in FY22, slipping 0.1 per cent as compared to a rise of around 5 per cent in the Nifty50. Among individual stocks, performance has been polarised with Godrej Consumer Products, Marico, United Spirits and Colgate-palmolive (India) rising 9 per cent to 16 per cent during this period, while Britannia Industries, Hindustan Unilever (HUL) and ITC slipping up to 6 per cent.

“India’s consumption story has just started, given demographics, per capita income, penetration level, and shift to the organised sector. We will see inflation rise in some years but FMCG companies have levers of pricing power along with product mix and will be able to pass on most of it to consumers.

Volume may slow for one or two quarters due to the impact on rural areas but demand should come back post monsoon. In addition, given youth aspirations, preference for brands will remain,” says Mahesh Patil, chief investment officer at Aditya Birla Sun Life AMC.

Even if the overall FMCG sector was to underperform, going ahead, analysts at Jefferies believe absolute returns offered by the sector could still be strong. A common concern, they say, is also the high valuation multiples that FMCG companies trade at (40-60x), which could come down, going forward.

“An uptick in GDP growth will likely percolate to consumer demand and accelerate penetration growth, premiumisation and shift to branded products in key FMCG categories. Thus, absolute FMCG earnings growth, too, could accelerate in such an environment, even though relative performance appears weaker on earnings growth. While FMCG companies do trade at a multiple, which is at a premium to its own historical average, its valuation premium versus the Nifty has come off to a near five-year average now,” they said in a recent report.