Monsoon and Patanjali Don't Influence Our Valuations of These Stocks

Apr 27, 2016

In this issue:
» Mergers & Acquisitions on a roll in 2016
» How have businesses fared across the diversified Tata Group
» ...and more!
Madhu Gupta, Research analyst

As large parts of India continue to battle water shortages and drought, the Indian Meteorological Department's forecast of an above average monsoon has come as a huge relief.

It has also rejuvenated stock markets that had been falling since the start of 2016.

Stocks with a rural focus are suddenly in the limelight. Among them, FMCG companies, which are less capital intensive and better cash generators than fertilizer and two-wheeler companies, have caught the investors' fancy.

It is widely perceived that good rains will translate into better agricultural production. This means more farm income in the hands of rural consumer, which in turn will drive demand for consumer goods.

In urban India, the interest rate cut and payouts from the Seventh Pay Commission are expected to spur demand. This spells good news as most of the FMCG companies are struggling with single-digit sales growth.

But is this seemingly favourable demand push reason enough to buy FMCG stocks at this juncture?

A look at the valuations shows otherwise. Most of the FMCG stocks continue to trade at expensive valuations.

Sample this: While the Sensex has been trading at trailing twelve-month PEs of 19.7 times, the BSE FMCG index has been trading at 46.5 times.

Still room for returns?
Company NameTTM PE
Britannia Industries Ltd.48
Colgate-Palmolive (India) Ltd.39
Dabur India Ltd.54
Godrej Consumer Products Ltd.64
Hindustan Unilever Ltd.48
Marico Ltd.47
Nestle India Ltd.100

Source: Ace Equity

And the reason for the lofty valuations is partly because of the defensive halo surrounding their businesses. During the last two years of economic downturn, FMCG companies have managed to post decent growth in earnings despite sluggish offtake.

Cheaper agri commodities and lower prices for crude derivatives have come as a blessing in disguise for FMCG companies. This has enabled them to pass on the benefit to consumers in the form of price cuts and to invest in brand building through increased ad spends.

But with input prices heading north, the margin expansion benefit may not be available in the future. Moreover, the competitive intensity in the industry has increased with the entry of Patanjali Ayurved in a big way.

Capitalising on the growing demand for natural herbal products, Patanjali has been on a launch spree. Healthcare supplements, dental care, hair oil, cosmetics, packaged foods, and cooking oils - the group has introduced its products in most of the large FMCG categories.

And to distribute its products across the country, the company has tied up with Big Bazaar and other retailers. It has also priced its products at a significant discount to established brands and is aggressively advertising them.

The strategy has met with success with Patanjali reportedly doubling its sales in the first ten months of FY16. Even players in dental care, hair oils, and health supplements are beginning to feel the competitive pressure. The group is targeting to increase its turnover from Rs 20 billion in FY15 to Rs 70 billion by FY17.

While the group may be reaping the benefits of its initial foray, retaining its clout through repeat customers may not be easy considering the wide product baskets of FMCG biggies. However, direct sourcing of inputs from farmers and a strong rural push through competitive pricing give Patanjali an edge over the established players.

In a nutshell, rising competitive intensity is likely to keep ad spends high in the FMCG industry. But this time, the cost-benefit savings from low input prices may not accrue to keep earnings intact. Therefore, the present high valuations of FMCG stocks may not completely justify the demand potential arising from a bumper monsoon.

Radhika and her ValuePro team have a distinctly different way to overcome such valuation risks to FMCG stocks. Instead of estimating the volatility of earnings on year-on-year basis, the team looks at the intrinsic value of the stocks. Exactly the way Buffett would do it. And that makes it easy to gauge the valuations at which such stocks would be attractive, irrespective of the cyclical and competitive risks.

Do you agree that a stock-specific approach guarantees strong returns in the long term? Let us know your comments or share your views in the Equitymaster Club.

In case you wish to know more about how at Equitymaster we evaluate and value business, you can get a Free hard copy of a Limited Edition 220-Page Book, where we have revealed it all.

02:32 Chart of the day

The first three months of 2016 has already seen a lot of activity as far as IPOs are concerned. But the buoyance does not stop there. If the first quarter of 2016 is anything to go by, mergers & acquisitions (M&A) activity in India could very well be robust for the full year too. As per an article in Livemint, the construction sector was the most active in terms of deal-making and accounted for 43% of the value of all the deals closed. This includes the cement sector and the big deals done by UltraTech Cement and Birla Corp. Both of them acquired cement capacities of Jaiprakash Associates and Reliance Cements respectively.

The consolidation in the cement sector is not surprising given a scenario of a supply glut and weak demand, all of which has taken a toll on the performance of cement players. There could very well be more such consolidation going forward too. In all in the construction space, seven transactions worth US$3.5 billion were announced in the first quarter compared to two deals worth US$266 million in the same period last year.

Transportation was another sector which attracted interest as eleven deals were made worth US$732 million during the first three months.

Of course, as the chart clearly shows, a strong first quarter does not necessarily ensure a very strong year. For instance, the first quarter of 2015 saw deals worth US$7.8 billion, much higher than the US$3.5 billion of 1Q2014. However, on a full year basis, 2014 emerged as the better year.

So it will be interesting to see if the M&A momentum in the first quarter of 2016 will carry on for the rest of the year as well.

2016 Looks A Strong Year for Mergers & Acquisitions


The Tata Group of companies encompassing industries such as steel, power, automobiles hotels, IT, etc are some of the most respected not just in India but the world. Indeed, in a 2012 Equitymaster survey on the Most Trustworthy Indian Corporate Group, the Tata Group claimed the top spot. Clearly, the quality of Tata's management and their ethical standards is beyond doubt.

But do all the Tata companies make for good investments? One way to look at this is to see how Tata Sons (holding company of the Tata Group) has fared. And the results are not that great.

Indeed, as reported in an article in the Business Standard, while Tata Sons has been aggressive in supporting the growth ventures of various companies in the group, the returns from its incremental equity investments in the past decade have been negligible. The only notable exception to this is Tata Consultancy Services (TCS).

Thus, in the past 10 years, Tata Sons' equity investment in key listed group companies (excluding TCS) grew at a compounded annual rate (CAGR) of 22%. In comparison, its dividend income from this investment grew at a CAGR of only 5.7%. That's not all. If you consider Tata Sons' equity stake in listed companies (excluding TCS), the dividend yield is a paltry 0.7%. In contrast, the BSE Sensex 30 companies currently offer a dividend yield of 1.5%.

Of course, Tata Sons rationalises this by stating that its investments are for the long haul. And given that quite a few of the industries where Tata companies operate are cyclical, the returns would vary not just across sectors but also across periods of time.

Our view is that from an investment perspective, not all Tata companies are necessarily robust businesses however well respected the management is. Further, some of the Tata Group businesses are simply better than the others. TCS is without doubt one such solid business. But what about the others?

I and my ValuePro team have been reviewing all Tata companies (Subscription required) to gauge which ones are good enough to make into the ValuePro portfolios. And we will be exploring this theme further in the coming months as well.


And talking about business performance, public sector banks (PSBs) in India with mounting bad loans have been the worst performers in recent times. There has been an ongoing debate whether to infuse further capital in their operations or merge them with larger banks. But as the government's earlier bail-outs have not really changed their poor fundamentals, merger seems to be a better alternative. However, Vivek Kaul has discussed the futility of the exercise in his article.


After opening the day on a flat note, Indian equity markets remained volatile and are trading in the green. At the time of writing, BSE Sensex was trading higher by 43 points and NSE-Nifty was trading up by 60 points. Mid cap and small cap stocks were trading higher by 0.3-0.4% each.

04:55 Today's investment mantra

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."Warren Buffett

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst) and Radhika Pandit (Research Analyst).

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2 Responses to "Monsoon and Patanjali Don't Influence Our Valuations of These Stocks"

bm shah

Apr 27, 2016

I have nothing for or against Patanjali, but like many whom I know have questions about it. These are:
1. When Patanjali is so much against western/established medicines, why is it still using western terms like cholesterol, etc to promote its products. It should use Charak's/Patanjali's findings or terms to promote its products.
2. Why is Patanjali resorting to negative methods by saying there is poison in the western or established products. It should promote its products by proving positive aspects of its products. A Yoga guru should know and practice what Yoga has taught him, that self restraint, truth in talking about Patanjali products.
3. Does Patanjali really has large factories shown in its ads?
4. How has Patanjali got funds for creating assets (perhaps ~8000 crores)which has achieved sales of Rs 2000 crores in a short time?
5. When Patanjali claims to be so desi, why it is using automatic machines invented in western countries?
6. Are Patanjali products really cleared by fssai or they will become another cases falsification?
7. Why Patanjali selling west invented products like noodles? It should stick to traditional Indian foods. Patanjali noodle entry seems to be an opportunity grabbed by Patanjali post Maggi episode.
8. Is Patanjali a pvt or public ltd company? Does it have any share holding to have thousands of crores of assets? Is it registered under co act? Who are promoters of the company?
9. Are Patanjali products time-tested & scientifically tested to compete with those which are?
Companies like Patanjali are sending message to the world that Indians are contradicting people. On the one hand they want outsiders to invest in India bringing new technology, products and on the other hand they want to drive them out.
It seems that Patanjali will nullify all efforts of PM to launch India with outer world.



Apr 27, 2016

This is an excellent piece by Madhu Gupta revealing the high valuation of leading FMCG companies citing genuine doubts about the sustenance of such valuation.
Equally interesting is the coverage of Tata companies in general.

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