Consumer Stocks Underperform But Only In Short Term

Consumer Stocks Underperform But Only In Short Term 

FMCG and consumer stocks have underperformed benchmark indices year-to-date. However, Karan Bhojwani finds out that they are fabulous long term bets for patient investors 

India has lost the tag of being “fastest growing economy in the world” for the past several quarters. From a peak of 8 per cent, GDP growth recently nearly halved to 4.5 per cent in September 2019 quarter (Q2FY20): slowest growth in six years. This along with 45-year high unemployment rate is a serious concern for quite some time. 

On the contrary, Indian equity market is soaring with key benchmark indices making all time highs. Sensex managed to close above 41000 for the first time on 29th November. Many market experts said that the market has already discounted the sluggish economic growth and hence the exuberance. 

Various sector stocks are showing signs of recovery. Nifty 50 is up by nearly 1.2 per cent in November while Nifty realty, Nifty PSU, Nifty Metal, Nifty Services, Nifty Bank and Nifty Pharma are up by 3.2 per cent, 4.1 per cent, 2.5 per cent, 2.8 per cent, 4.7 per cent and 2 per cent respectively. The synchronised rally in the beleaguered sectors is a sign of sectors bottoming out.

Asia is on track to form 50 per cent of global GDP by 2040 and drive 40 per cent of the world’s consumption, representing a real shift in the world’s centre of gravity. 

Mckinsey Global Institute 

On the other hand, consumer (automobile, healthcare, textiles, aviation) and FMCG stocks are showing signs of underperformance. Nifty FMCG and and Nifty consumption is down 4.8 per cent and 3.2 per cent respectively. 

FMCG and consumer stocks have been darling of investors during tough times. In other words, they are perceived as defensive bets. For most of 2019, investors lapped up these stocks. As a result, valuation of FMCG and consumer stocks have come to uncomfortable levels especially when volume growth for most companies has been subdued due to stress in rural India. Stocks such as Hindustan Unilever, Nestle, Britannia, Dabur, Colgate, Godrej Consumer, Marico and Tata Global Beverages are trading at premium valuations. 

Says Shardul Kulkarni, a long term investor, “Half of my portfolio is exposed to FMCG and auto stocks. My view has consistently been that India is a great consumption story. I am not sure how to deal with these stocks. While FMCG stocks have run up a lot recently, auto stocks have expectedly underperformed due to sluggish demand.” 

Moderation in volume growth for the third consecutive quarter on one hand and continued high valuation on the other is expected to affect performance of FMCG and consumer stocks in the near term. 

However, in the long term, consumption theme has rewarded investors and beaten the benchmark indices (See table below) by a huge margin. Between the two, FMCG stocks have performed the best. 

If we look at the broader picture, Asia is expected to drive 50 per cent of global consumption growth in the next decade. Over the past couple of decades, the global poverty has dropped in Asia and in India as well. More than 1.2 billion people have emerged as the consuming class and have started discretionary spending. 

This economic success story applies to India as well. Consumer spending is expected to increase with softening interest rates and various incentives announced by the government to boost consumption. 

Thus, the robust story for FMCG and other consumer stocks is intact for the long run. However, one will need to have an investment horizon of atleast five years for FMCG stocks and a decade for consumer stocks, the data shows. 

Conclusion 

FMCG and consumer stocks are fit only for long term investors as they are usually low beta stocks. The beta for Nifty consumption index is less than one. For short term investors, FMCG stocks may disappoint as other sector stocks may bounce back at a rapid pace on smallest good news on the macroeconomic parameters. 

Various measures taken by the government including the recent corporate tax rate cut is expected to help consumer companies offset margin concerns and improve earnings growth. The money saved from lower tax outgo is expected to be used for improving market share and entering new categories. 

After witnessing sluggishness in CY19, there is good probability of a revival in rural demand in CY20 post monsoon and expected expansionary government policies.

The sector has been going through a challenging phase in the last few quarters due to the slowdown in the economy. However, many FMCG companies have reported better than expected net profit growth despite sluggish revenue growth. Nevertheless, growth has slowed definitely and it is visible very much in the earnings of the companies compared to previous years. Consumption has definitely seen a slump primarily led by rural areas given that growth in this region has come down from double digits and now stalled at 5 per cent. Though various measures from government including corporate tax cut and RBI may show some effect in H2FY20, hope for this sector as the top taxpayer has suddenly waned away. 

- Mustafa Nadeem, CEO, Epic Research

Outlook on Consumer Stocks 

Volume growth reported in 2QFY20 was in low to mid single digit for most FMCG companies barring paint companies, which witnessed high single digit to low double digit. Rural India was impacted more due to liquidity issues and economic slowdown. Rural growth was reported at 0.5x of urban growth. The floods in most parts of India also led to sales disruption. Most of the consumer companies barring those involved in food business reported growth in gross margins led by benign commodity inflation. A part of the savings on gross margins were spent on advertisements, trade promotions and discounts to support weak demand. EBITDA was boosted due to adoption of IND AS 116 accounting standard. Bottom line for most of the consumer companies further got a fillip due to corporate tax cuts announced by the government. The management of the consumer companies are confident of a better second half led by low interest rates, government stimulus and good monsoon. Consumer stocks are witnessing correction considering their expensive valuation and moderation in growth. Until the Indian economy witnesses a broad based recovery, consumer stocks shall command a premium due to their high cash flow generation, healthy balance sheet and visibility on growth (although slow compared to the past). On a long term basis, we maintain positive view on the consumer sector. 

Jaipal Shetty, Analyst, Bonanza Portfolio