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FMCG stocks: What's cooking? 
(Mon, 27 Sep Pre-Open) 
 
Indian markets maintained their winning streak, as they emerged the second best performer among key global markets last week. This was the second straight week of outperformance by India. The Sensex closed with gains of 2.3%, only bettered by the US markets that closed with 2.4% gains. Within India, FMCG stocks led the gainers pack by a wide margin. The BSE-FMCG index gained 5.3% during the week. Indian markets maintained their winning streak, as they emerged the second best performer among key global markets last week. This was the second straight week of outperformance by India. The Sensex closed with gains of 2.3%, only bettered by the US markets that closed with 2.4% gains. Within India, FMCG stocks led the gainers pack by a wide margin. The BSE-FMCG index gained 5.3% during the week.

Source: BSE

So what's cooking in the FMCG sector? Why have the stocks from this sector become the darling of the markets? Seeing the above chart, it gets clear that FMCG stocks have outperformed the Sensex stocks over the past one year as well, and that too by a handsome margin. Now, even despite this outperformance, stocks from this sector continue to be in the limelight.

One big reason we can attribute this to the recent decision by some leading FMCG companies to raise prices of their products. This has been done to offset the rise in input costs. While many companies are taking price hikes, there are others who are reducing their pack sizes without raising prices.

India's largest FMCG player, Hindustan Unilever (HUL), for instance, has raised prices of its flagship brands Rin and Lifebuoy over the past few days. And then, HUL's closest competitor P&G India has also effectively followed by upgrading its detergent brand Tide by launching Tide Plus at a higher price.

We believe these and other FMCG companies have no choice but to raise product prices to avoid taking a hit on their margins. For the consumer, however, this just adds to the inflation she is facing due to the rise in the prices of food items.

Source: BSE; P/E-Price to earnings, P/BV-Price to book value

As far as investors in FMCG stocks are concerned, they must take note of the above chart that compares the valuation ratios of these stocks versus the broader markets. So while the BSE-Sensex is currently trading at 23.8 times trailing 12-months earnings, the BSE-FMCG index is trading at 32.3 times. While there are reasons to justify the premium paid to FMCG companies given their stable business and strong return ratios, the current premium over Sensex companies does not seem justified.

We believe the valuations of FMCG stocks (as a basket) have run ahead of their fundamentals. This is also given that the negative impact of the current price will be seen in the coming quarters when volume growth could slow down. Apart from that, FMCG companies' margins are also likely to come under pressure given that rising competition will continue to drive them to spend more and more on advertising.

Also, while a good monsoon can lead to higher demand for FMCG products, especially from the rural markets, the current valuations more than justify any increase in profits due to this. Given this, investors need to be very careful with their investments in FMCG stocks. Sticking with quality companies with sustainable competitive advantages is the key here.

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Jul 21, 2017 10:02 AM

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