FMCG - Re-rating Party is Passé - Performance to Drive Stock Return - Karvy

Unlike large-caps, most of the mid-cap consumer companies have delivered significant improvement in their performance despite economic slowdown. Ahead of the market expectation, most of them have beaten their own past performance and net earnings growth, which resulted in outperformance of the sector. The FMCG companies under our coverage have run-up by ~40% (average) in past 12-months. Currently, the sector trades at 140% premium (>2 standard deviation of the past 10-years) over Sensex P/E and trades at ~32x on 12-month forward earnings, which is at its highest levels. We continue to be positive on account of our expectation of maintaining such high net earnings growth, going forward. We initiate coverage on ITC, HUL, Nestlé India, Dabur, Colgate-Palmolive and Marico while update on Jyothy Labs.

Sector to Sustain Earnings Growth above Sensex Earnings Growth: The arguments that the defensiveness of the sector has evaporated - amid cyclical policy actions on domestic front and concerted actions by the European & US central banks - are short term phenomenon in our view. We believe high valuation is sustainable going forward, as this rally couldn't only be attributed to weak macro factors. In our view, stable inputs costs, strong rural wage growth, volume trends despite high inflation, market share gains from unorganized sector, high pricing stability and good product mix will sustain the sector's earnings growth above the Sensex earnings growth in next 2 years.

Earnings Trend Remain Robust: We expect most consumer companies to sustain their earnings growth momentum over the forecasted period, supported by gain in market share and softer raw material prices. We expect the universe of stocks covered by us to report 18.1% earnings growth during FY12-15E against the 2-Yr & 5-Yr trailing growth of 18.5% & 16.7%, respectively.

Mid-cap Companies under our Coverage to Outperform Large-cap Counterparts: Growth has been driven by volumes, penetration and price hikes and we believe that the mid-cap consumer companies are in a better position to meet the increased growth expectations. We expect the mid-cap companies in our universe to register 19.8% earnings growth during FY12-15E as compared to 17.5% earnings growth by large cap consumer companies.

We prefer ITC in Large-cap and Dabur, Marico & Jyothy Labs in Mid-cap Space: The large-cap consumer companies are currently trading at a P/E multiple of 25.3x of 24-month forward earnings and mid-cap consumer companies are trading at 25.9x. In mid-cap, companies like Dabur, Marico & Jyothy Labs are at attractive valuations of 21.2x, 21.2x and 16.2x of 24-month forward earnings and offers a decent upside in the mid-cap space at 12-16% from the current levels.

Source : Equity Bulls

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