Broking firm Nomura believes that over the next few quarters, the growth outlook for consumer companies in India continues to remain strong. Volumes are likely to remain buoyant in the medium term, concerns such as delay in monsoons and economic slowdown notwithstanding

In 2012, the consumer sector has been the best performing sector in India, with the FMCG (fast moving consumer goods) index up 35.8% YTD (as of 14^th September) compared to the benchmark Sensex +19%. This outperformance of 16.8% has been on account of continued delivery on the operational front from companies across the sector as well as a risk-off environment, where defensive sectors have been the flavour with investors, according to a report by Nomura Equity Research. This is also reflected in the performance of other defensive sectors such as pharmaceutical companies, which has also had a strong run with the healthcare index at +28.3%, outperforming the Sensex by 9.3%.

Nomura believes that over the next few quarters, the growth outlook for consumer companies in India continues to remain strong. Unlike its previous expectations, the global brokerage firm is yet to witness any meaningful slowdown or trading down in the staples sector. The on-the-ground feedback and company commentary suggest that volumes are likely to remain buoyant in the medium term, concerns such as delay in monsoons and economic slowdown notwithstanding.

Stocks of Consumer companies are trading currently at an average of 27x FY14F P/E, higher than the long-term average of around 24x. Nomura expects valuations to remain at current elevated levels in the near to medium term due to: a) continued strong growth, and b) prevailing risk-off environment.

In the current environment, the brokerage prefers companies with a history of consistent delivery. ITC is a top buy in the large cap space where mid-teens EBIT growth in the key cigarette business is seen continuing in the next few years. Nomura has upgraded Hindustan Unilever to a neutral on the back of continued strong operational performance. Among the mid-cap names, it prefers GCPL, as its performance across geographies has been robust. It also recommends Jubilant Foodworks despite its high relative valuations. We believe its earnings will continue to surprise the street positively.

Among the stocks in the coverage universe, we see that the outperformance Vs the

Sensex is across the board with United Spirits the top performing stock and Nestle India being the only underperformer. United Spirits is +88% YTD (on the back of a sharp move in recent months on news reports of an M&A deal with Diageo; Source: The Economic Times,

25 April 2012). On the other hand, Nestle, where underlying performance on the volume front, has been underwhelming, has underperformed the Sensex.

Even when we look at valuations of the consumer companies against the Sensex, the premium is at multi-year highs. The consumer sector trades at a 117% (as of 14 September 2012) premium to the Sensex compared to the long-term average of 73%. This premium has moved up from 100% at the start of the year, which indicates that even if we see this on a short-term basis, valuations across the consumer sector have seen a significant re-rating, says Nomura Equity Research.

The brokerage believes tat one of the key reasons for this re-rating has been the consistent track record across companies in terms of delivery on operational performance. If we look at volume growth performance over the last few quarters, companies across the sector have shown consistent delivery in terms of volume growth, which investors have rewarded with higher multiples.

It can be noted that this performance has been delivered across a full cycle. If we look at sector performance since the financial crisis in 2008, we see that sales growth has been fairly robust, despite the swings in commodity prices and threat of softening demand over the past three to four years. The only quarter where sales growth was sub-10% was in 2008, in the first quarter after the financial crisis.

FY12 saw a significant level of pricing action across categories, particularly as companies tried to balance the increasing commodity costs with price increases. A look at some of the key segments, such as soaps, detergents and shampoo, indicates that the pricing action is now showing signs of slowing down. This trend is likely to sustain in the near term, as commodity cost pressures have eased significantly. Pricing is also a function of the demand situation and inflation, both of which have seen a slowdown in recent months. In FY13F, the majority of the impact on revenue growth will be in the form of volume growth with price/mix element being a smaller contributor.

A look at EBITDA margin trends across the consumer sector shows a significant level of variation across the time period. This is a reflection of two key variables: first, the commodity price trends and, second, the investment in advertising and promotion (A&P) in the sector. Over the past few quarters, there has been a recovery in EBITDA margins led primarily by softening of commodity costs.

However, there have been some recent spikes in commodity costs particularly in commodities such as maize and wheat, which should temper some of the margin performance for food companies as well as in pockets of HPC categories such as oral care. Copra prices are still down substantially y-o-y, which should continue to benefit Marico into FY13F. Barley and milk prices being relatively stable are a positive for Nestle and GSK Consumer, opines Nomura.

Nomura Equity Research has upgraded Hindustan Unilever to ‘neutral’ from ‘reduce’ and raise its target price to Rs527 from Rs327 on the back of structural improvements in the business. It believes HUL has turned a corner and valuations are likely to sustain at higher levels than the long-term average in the near term.

While the regulatory environment has been uncertain, with large increases in excise duty in both FY10 and FY12 budgets, ITC has been able to pass on these price increases to consumers and deliver robust revenue and earnings growth. This has been the case for the last six to eight years, and ITC will continue to deliver mid to high teens earnings growth, even if there remains some uncertainly on the regulatory front. Given this resilience which the company has demonstrated, ITC should continue to be a core holding in the Indian consumer sector. Nomura reiterates ‘buy’ with an increased target price of Rs310.

Godrej Consumer Products (GCPL) has delivered strong operational performances both on the domestic and international front over the past couple of years. The performance to continue in the medium term, with management focused on delivering volume growth ahead of industry. International business is now a substantial part of the portfolio, where the inorganic route has worked well for GCPL. The agency maintains a ‘buy’ rating with an increased target price of Rs800, on the back of increases in our earnings forecasts as well as P/E multiples.

Jubilant Foodworks delivered strong same-store-sales growth (SSSG) of 29.6% for FY12. With penetration of pizza still low and consumption in major cities continuing to hold up, Nomura believes SSSG will continue to be in the 20% range over the next couple of years. The company has guided for 18%-20% SSSG for FY13, which could be conservative. The launch of Dunkin Donuts will likely add another leg of growth in the medium term.
 

Nomura maintains ‘buy’ with an increased target price ofRs1,490, implying 20.6% upside.