At a time when the entire market is bearing the brunt of coronavirus, the fast-moving consumer goods (FMCG) sector too witnessed a valuation correction to its 5-year mean.
However, the sector is still trading at 115 per cent premium to the leading indices such as Nifty50. In fact, with around 10 per cent fall over a last month, the Nifty FMCG index has outperformed the Nifty50's over 28 per cent fall during the same period. At these levels, the price-to-earnings (PE) valuation of the BSE FMCG at almost 29x is among the highest within sectoral indices. And, if analysts are to be believed, FMCG’s valuation premium vis-à-vis leading indices would persist in the near term despite muted economic activities.
While the expectations of earnings pressure for key sectors such as automobile, hospitality, aviation, banks and non-banking finance companies, among others, is making FMCG a safety heaven for investors, the earnings visibility for the latter is also relatively better.
According to a JP Morgan report, “The valuation divergence (between consumer staples and leading indices) is likely to stay with premium multiples (of FMCG) being attributed to earnings resilience and better visibility on long-term growth potential.”
Besides essential or daily-use nature of products, likely margin support from benign input prices and cost efficiency measures would confine the overall earnings impact of the on-going covid-19 crisis. How the individual companies manage their distribution (given the labour shortage) would be a key differentiating factor.
Though distributors may demand extended credit period amidst the liquidity issue, G Chokkalingam, founder and managing director of Equinomics Research and Advisory believes that given the supply-driven business of FMCG, which results in higher realisation and zero debt position, managing working capital is unlikely to be a challenge for the companies. In fact, many FMCG companies have surplus cash and bank balance in their books (after accounting for debt), which itself provides significant comfort in the current situation.
However, earnings impact would vary from company-to-company depending on the product mix and export dependence, which investors have to be mindful of.
With expectations of low income levels amid the on-going covid-19 outbreak, demand for discretionary/non-essential items would remain under pressure. Also, a partial or complete lockdown in key overseas market such as South Africa, Indonesia, Bangladesh, etc. would further dent the top-line of companies. Thus, companies with higher revenue share of essential items such as hygiene products/food products and lower revenue contribution by overseas market are expected to perform better, say analysts. Even after the lockdown is lifted, most other sectors will only be limping back to normalcy over the next 2-3 quarters, believe experts.
For now, Hindustan Unilever, Britannia and Nestle are some analysts top pick in the FMCG space.