Consumer Staples - The 'party' is over - Ambit

The current valuations of FMCG stocks—37.2x one-year forward P/E, at ~35% premium to their historical three-year averages—do not reflect the likely moderation in earnings growth in the near term (to 15% EPS CAGR over FY13-15E from 18% EPS CAGR over FY08-13). Whilst we do not doubt the secular growth trend of the Indian consumption story, the rising competitive intensity and saturating penetration in few product categories would adversely affect the earnings growth and valuations of FMCG firms. Lack of further softening in raw material costs is a nearterm negative catalyst for these companies. We advise investors to SELL the frontline FMCG stocks (excl ITC, NOT RATED) and invest in discretionary consumer stories (such as TTK and Asian Paints) owing to the latter's relatively higher EPS growth and cheaper valuations.

Deflating growth rates for staples companies: Penetration levels (at 80-90%) are approaching saturation levels in product categories such as oral care, soaps, detergents, skin creams and hair oils. Furthermore, competitive intensity is rising quickly (owing to new entrants and promotion-led push from incumbents) in categories such as oral care, chocolates, noodles, premium edible oils and cosmetics. Thus, revenue growth could moderate (to 15% over FY13-15 vs 19% over FY08-13) and EBITDA margins could contract, thereby pulling down the EPS CAGR (by 500bps over FY13-15 vs FY08-13) for the frontline FMCG stocks covered in this note (HUL, Nestle, Colgate, Marico, GCPL, Dabur, and GSK Consumer).

HUL and Nestle better placed than the rest: HUL and Nestle are the best placed in the FMCG sector, given HUL's ability to leverage on its size to ride a wave of consumption evolution across most product categories and Nestle's dominant presence in less-penetrated, rapidly-growing and entry-level aspirational categories. HUL's and Nestle's consistent strategy of dividend payouts/share buybacks alongside consistent reinvestment into the core business give them a further edge over competition. Colgate, Marico, GCPL, Dabur and GSK Consumer are intermediately placed.

No more support for punchy valuations: Given punchy valuations, we initiate coverage with a SELL stance on each of these stocks. Our DCF-based valuation implies a 10-30% downside for most (as we model near-term earnings estimates factoring in lower growth and more importantly no more softening in raw material costs). We believe investors should move their consumption-focused investments to discretionary consumption stocks in paints, light electricals and apparel, as the rising disposable incomes in India would increase the depth and breadth of consumption to newer categories. We recommend investors to switch into high-quality discretionary names like Asian Paints, TTK Prestige and Bata.

Source : Equity Bulls

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