X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Food stocks - Are high PEs justified? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Sep 17, 2012

    Food stocks - Are high PEs justified?

    This is the first of a series of articles that analyzes some expensive stocks in specific sectors to understand if the valuations are justified.

    There are two ways in which one can make money from investing in stocks. One is by way of dividends earned, and the other is appreciation of share prices. Stocks are valued on the basis of price to earnings multiples (PE or price to earnings ratio). Stocks with a higher PE are said to be relatively more expensive than their peers.

    Why do stock prices go up? One reason of course is the fundamentals of the company - but this is not the only reason. At times, speculation and other factors also contribute to changes in stock prices.

    We examine whether these high PE stocks deserve such high valuations based on their fundamentals, or have speculation or one off events driven these valuations up.

    Specifically, in this article, we focus on consumer goods food companies. We shortlisted companies with a 10 year track record of profitability, and a return on equity of 10% in each of the past 10 years.

    The companies with the highest PEs, (in descending PE order) are Sanwaria Agro Oils Ltd., Nestle India Limited and Glaxosmithkline Consumer Healthcare Ltd.

    Key financial parameters for 3 highest PE companies
      Sanwaria Agro Oils Ltd. Nestle India Limited GSK Consumer
    TTM PE 55.2 43.5 31.5
    Average Profit Margins (in %)      
    Operating Profit 5.0 19.0 19.0
    Net Profit 2.7 12.0 11.0
    RoE (in%) 32.4 96.1 24.3
    Average debt to equity (x) 1.6 0.1 0.0
    Average dividend payout (%) 13.0 74.0 40.0
    Average PE (x) 22.0 32.0 20.0
    Note: Numbers are for last 10 years except TTM PE.
    TTM: Trailing Twelve Month

    Let's look more closely at the reasons for the strong PEs for these companies.

    Sanwaria Agro Oils is in the business of edible oils produced from soyabean and other minor oil seeds, and sold under the brand names of Sulabh, Narmada and Sanwaria. The company also produces soya lecithin and soyabean meals for cattle feed. Soyabean has many health benefits because of its ability to lower cholesterol levels, and prevent heart diseases, diabetes, osteoporosis and other illnesses. With these many benefits, soybean's global demand is also increasing.

    This has helped Sanwaria post an average sales growth of 20% over ten years. However, sales and net profits have been very volatile, including showing a drop in one year. The company has very low operating margins ranging from 3% to 8%, and net profit margins have been even lower. The dividend payout ratio has also been disappointing at 10-13%. As a result, RoE has also been inconsistent over the years.

    All this makes us wonder if the company's high multiple is based on fundamentals, and if yes, is the high PE justified?

    Nestle India has the second highest PE.

    We know that FMCG companies are considered to be relatively safer investment bets since their earnings do not fluctuate too much with changes in the economy. Of late, with a rise in disposable incomes of rural Indians, the FMCG companies have been doing very well.

    This gives Nestle a distinct advantage because of its brand equity, wide range of products from milk and milk products to coffee to noodles, and wide distribution network. The company's earnings have increased during the past few years. Operating margins and net profit margins have been consistent at 19% and 12% over the same period. Further, the company's average dividend payout of has been around 74% in the last decade. Continuously rising net profits have increased shareholder wealth with RoE averaging more than 95%. These fundamentals and results have improved investor confidence and thus the hike in stock prices and high PE multiples.

    Glaxosmithkline is in the fast growing segment of malt beverages with a 70% share in volume terms. Its products include Horlicks, Boost, Viva and Maltova. There has been increased awareness of healthcare in the country, and this has higher sales of health drinks which now contribute to 85% of the company's total revenues. Net sales have grown robustly by12-15% over last 10 years and dividend payout has been 40% on an average. Operating and net profit margins are averaging 19% and 11% respectively. In terms of other financials, the company's debt levels have always remained at comfortable levels. Despite stiff competition from other players such as Bournvita (Cadbury), Complan (Heinz) and Milo (Nestle), GSK Consumer has been able to maintain its leadership position. The company's high PE seems to be because of the scope of malted beverages in a growing Indian economy, and the company's proven sound fundamental performance over the years.

    Conclusion

    We believe that, based on the company's fundamentals, Sanwaria Agro Oils's high PE of 55 is not justified. For the other two companies, Nestle and GSK Consumer, even though the fundamentals are good, their current PE multiples of 43 times and 32 times are far higher than their historical (10 year average ) PE of 32 times and 20 times respectively. It is possible that due to uncertain economic conditions, investors have in fear moved to these two "defensive" stocks and so raised their PE multiples to unreasonable levels.

    Investors should dig deeper to understand the causes for company valuations being high, and carefully evaluate whether the PEs warrant investing in or not.

     

     

    Equitymaster requests your view! Post a comment on "Food stocks - Are high PEs justified?". Click here!

      
     

    More Views on News

    GSK Consumer: On the Recovery Path (Quarterly Results Update - Detailed)

    Jun 20, 2017

    While GSK consumer reported muted revenue growth, volumes are seen to be recovering.

    ITC: Demonetisation woes pull down business growth (Quarterly Results Update - Detailed)

    Feb 8, 2017

    ITC Ltd has announced third quarter results of the financial year 2016-2017 (3QFY17). The company has reported 4.7% YoY and 5.7% YoY growth in revenues and net profits respectively. Here is our analysis of the results.

    ITC: A Decent Quarter Amidst Challenging Environment (Quarterly Results Update - Detailed)

    Dec 7, 2016

    ITC has announced second quarter results of the financial year 2016-2017 (2QFY17). The company has reported 8% YoY and 10.5% YoY growth in revenues and net profits respectively.

    ITC: Numbers Go Nowhere in FY16... (Quarterly Results Update - Detailed)

    Jun 8, 2016

    ITC declared results for the quarter and year ended March 2016. During the year, the company's net revenues and profits rise by 1% YoY and 3% YoY respectively.

    GSK Consumer: A Forgetful Year (Quarterly Results Update - Detailed)

    Jun 1, 2016

    GSK Consumer Healthcare announced its results for the quarter and year ended March 2016. During the quarter, sales and profit came in lower by 9% YoY and 8% YoY respectively.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    COMPARE COMPANY

    MARKET STATS