What is fuelling the FMCG rally? - Views on News from Equitymaster

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What is fuelling the FMCG rally?

Aug 22, 2012

Even as economic uncertainty continues to loom, the FMCG sector remains a darling of the stock-market. The BSEFMCG index currently commands steep valuations of 47 times its trailing 12 months (TTM) earnings ending June 2012. In contrast, the broad market represented by SENSEX is trading at 23 times its TTM earnings.

As more investors flock to the FMCG sector as a defensive measure, FMCG stocks continue to reap huge investment returns. Blue-chip stocks like Hindustan Unilever (HUL), Nestle, Dabur, Colgate, Britannia and Glaxo SmithKline Consumer yielded over ten-fold jump in return for every rupee invested (One rupee test) during the period FY10-FY12. Clearly, the FMCG sector is being lapped up by the investor community.

Warren Buffet, the guru of value investing believed that the best way to test the investment potential of a stock is to determine the return earned by shareholders on every rupee invested. In other words, have these stocks generated at least one rupee for every rupee invested? This is measured by the increase in market cap relative to the increase in net worth.

The table below shows that FMCG companies have done very well with the "one rupee test", which is why investors are willing to wager on this defensive bet?

One Rupee test on FMCG companies (standalone)
 Increase in networth in Rs m (A)Increase in Market Cap in Rs m (B)Value created for every Re 1 invested (B/A)
(Rs m)FY05-FY10FY10-FY12FY05-FY10FY10-FY12FY05-FY10FY10-FY12
Britannia-13012371710032562 26.3
Godrej Consumer77761694663026826498.14.8
Glaxo Smithkline Consumer*37571842397785219510.528.3
Source: Ace Equity
* Results follow calendar year

A critical evaluation of the table also shows that post 2010, the returns fetched on most FMCG stocks have declined in comparison to returns earned during the 2005-10 period. Dabur, Godrej Consumer and Marico have been in an expansion mode and as a result their value appreciation has been modest.

However, Glaxo SmithKline Consumer posted a steep jump in the "one rupee test" value in the FY10-FY12 period, and has been an exception in being higher than that for the FY05-FY10 period. FMCG behemoth, HUL, has continued to fetch over 40 times higher return for every rupee invested. The company has witnessed robust rise in its topline, and strong earnings growth since FY10. This has been the result of the return of pricing power and the company's renewed focus on the high margin personal care segment.

Another reason that the FMCG sector may be high in terms of value created is that market perception itself may be driving more and more investors to this industry viewed as "defensive". In this context, Benjamin Graham points out that the return earned on the stock of a company is a sum total of the real return, rate of inflation, and the return based on the market perception.

FMCG companies have been clocking double-digit sales growth despite price hikes. There does not seem to be any meaningful slowdown in consumption patterns. This pricing power has enabled them to maintain, and in some cases, even improve their profitability. Firm interest rates, high inflation and government policy paralysis do not seem to have affected the FMCG sector. At the same time, other sectors such as automobile, capital goods, power, infrastructure, realty and banking have been reeling under the challenging conditions.

And this weakness in other sectors has in turn further added to the charm of investing in the FMCG industry.

In our next article, we shall discuss whether the FMCG sector still holds steam or has sector peaked and is ripe for a correction.

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.

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