FMCG: consumption growth robust but are high valuations about to get in touch with reality?

The packaged consumer goods sector’s sky- high valuations have appeared unrealistic for long, this column having written on it as well. The S&P BSE FMCG Index trades at a price-to-earnings multiple of 52 times its trailing 12-month earnings and this despite the index falling 4% this week so far. For these valuations to sustain, earnings growth has to step up in the coming quarters.

Market research agency Nielsen Co. said the sector’s sales grew 10.9% in the June quarter. This was better than the high single-digit growth the agency had projected in end-May, when it had released the March quarter figures (sales grew by 11.3%).

That growth surpassed its expectations is a bit surprising. The agency has revised its growth estimate for 2018 as well, to 12-13% or nearly as much as it grew in 2017. Earlier, it expected growth to be a bit lower than 2017.

Another aspect Nielsen highlighted was that sales growth in rural markets recovered. The rural to urban sales growth ratio is at 1.28 times, slightly higher than the 1.26 times of the March quarter. This means not only was overall growth higher, but rural markets did better.

The industry’s growth momentum is supported by the 8.6% growth in private final consumption expenditure—what households spend—in the June quarter. While the kharif crop is a bit below last year, the government’s support measures in the run-up to the general election should keep farm income in good spirit.

What could upset the growth apple cart? If final crop output declines or if the government’s price support programme underperforms, rural growth could stumble. Inflation is another risk. So far, food prices have been keeping a low profile but crude oil-based costs of derivatives have risen. A falling rupee is also bad news, as prices of several inputs are referenced to the landed cost of imports.

Still, companies have been tentative about passing on price hikes, given the government’s anti-profiteering regulatory sword hanging over them. If costs increase sharply but companies go easy on price increases, that could affect margins.

While the sales growth situation looks promising for companies, this needs to trickle down to higher profit growth. About half of most FMCG (fast-moving consumer goods) companies’ sales go towards meeting input costs. Advertising and promotion costs may remain high as a proportion of sales, as companies move to capitalize on higher growth. It is fixed costs such as employee costs and other expenses (to an extent) that should moderate as a percentage of sales. Although, some companies are changing their operating structure to benefit from the goods and services tax, and this is leading to one-time costs.

If sales growth keeps up a healthy pace then fixed costs get spread over a larger revenue base, profit growth should accelerate. Signs of this should become visible in the September quarter results. That may then provide some explanation as to why sky-high valuations are persisting. If earnings don’t show the momentum that valuations are demanding, then shares could tumble. The sector index has been falling for the past two days, perhaps as investors size the risks of rising crude oil prices and a weak rupee. Or, high valuations and turbulent macro conditions are giving investors an excuse to move some of those gains to the bank.

source: livemint


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