While consumer stocks are trading at multi-year high valuations, Nomura Equity Research believes that investors continue to favour them due to their defensive nature

Consumer stocks continue to outperform with the BSE FMCG index up 5% in August versus the Sensex’s gain of 2%. While these stocks are trading at multi-year high valuations, Nomura Equity Research believes that investors continue to favour them due to their defensive nature. Recent first quarter FY13 results indicate the trend of rising gross margins which is a positive sign, but some of the gains are being reinvested in the form of higher advertising and promotion (A&P) spending. Recent interaction with companies suggests underlying demand continues to be strong and there have been no visible signs of demand slowdown from most of the companies, according to Nomura analysts.

On the suppliers’ side, Nomura evaluates input costs to be stable, with copra prices showing a significant 35% decline on a y-o-y (year-on-year) basis. Palm oil prices are down 4% y-o-y, while linear alkyl benzene (LAB) prices are up 5% on a y-o-y basis. However, the depreciating rupee has been a negative and this has impacted the commodity costs of companies over the past couple of quarters.

Nomura expects gross margins to continue improving on a y-o-y basis in 2QFY13F.

While volume growth in the June quarter results has been stable, the key surprise has been on gross margins. The benefits on gross margins have been invested back into A&P by companies across the sector. Nomura expects to see similar trends in second quarter FY13, although A&P spending could see increased momentum across the sector.

Although there is near-term caution on the sector in the stock market, Nomura finds that valuations are at multi-year highs in consumer stocks. They have underperformed the Sensex in the first couple of months of CY12, but have outperformed since 1 April 2012. The sector average is now about 30.5 times the one-year forward P/E (price-to-earnings ratio), which is much higher than the long-term average of around 24 times one-year forward earnings (based on Nomura estimates). It is expected that valuations would remain at current elevated levels in a risk-off environment, but over the medium term, valuations would revert to the long-term average.

On the consumer market side, there have been headline price increases as well as by grammage reduction (reduction in pack sizes), according to Nomura analysts. Some recent examples of price increases include:

• Price increases have been pushed through on Tide Plus detergent with the pack now priced at Rs294 for a 3.5kg pack versus Rs280 earlier (an increase of 5%). The price of a 6kg pack has also increased from Rs462 to Rs498 now (an increase of 7.8%).

• In oral care, Pepsodent has seen a 9.4% increase on the 150gm pack from Rs64 to Rs70 now. Close-up has seen a 3% increase on the 150gm pack from Rs66 to Rs68 now. Dabur Red has also seen a price increase of 3.1% from Rs65 to Rs67 now.

• In the shampoo segment, Sunsilk has seen a 2.9% price increase from Rs105 for a 200ml pack to Rs108 now.

Simultaneously, promotional offers continue to be visible across various segments, as observed by Nomura. The intensity is highest in the packaged food segment this month. Promotions in oral care have also been rising, especially in the ‘sensitive’ segment. Some of the promotions across segments that are prominently visible across shelves are indicated below.

•Rs15 off on Kelloggs Extra Museli pack of 550gm across all three variants.

• Saffola Oats has a “200gms pack free with a 1kg pack” as in-store promotion

• Britannia cheese singles pack, which has a maximum retail price (MRP) of Rs261, is now at Rs219 as in-store promotion.

• Breakfast box with Horlicks 500gm pack and two bowls with a 1kg pack.

• Kelloggs Oats 1kg pack for Rs105 versus Rs129 MRP.

• Horlicks Chocolate 1kg pack for Rs285 versus MRP of Rs312.

Nomura analysts observe that within the consumer pack, United Spirits (UNSP), Godrej Consumer (GCPL) and Jubilant Foodworks have been the biggest outperformers so far this year in the stock market. ITC has had a good year and has gained momentum post the budget. Hindustan Unilever (HUL), which underperformed in the earlier part of the year has had a solid month +11% and is now +30% for the year versus the FMCG index by 34% YTD (year-to-date). Finally, over the past one month, mid-cap names such as Marico and Dabur have underperformed the FMCG index, by 4% each.