Can FMCG stocks outperform the index next year? Abneesh Roy answers

“In tea prices, in the last four-five quarters, there has been a deflation and that is why Tata Consumer, a key tea company, saw its gross margins expand by 300-400 bps. A lot of that flows towards the EBITDA margin also. I think that same thing will happen for Hindustan Unilever, Britannia, Nestle and Asian Paints,” says Abneesh Roy, Executive Director, Institutional Equities, Nuvama Wealth Management

While the going seems to be good and we are banking on a rural recovery, the management commentary also has been cautiously optimistic. At the same time, you have got that big tailwind of commodity cost cooling off but FMCG has always been about valuations. Where do you find comfort in recommending a fresh buy?
We are quite positive on the sector but we are selective. Currently two-three things are very important to track. One, of course, is rural recovery. As of now, there is no big recovery but the worst is behind for the sector because last year, the rural slowdown started in the second half and so the base became favourable.

Second thing is because commodity deflation is there in a lot of categories, companies will give back grammage. In the last two years, in the lower unit packs, there was a big issue because when companies cannot increase pricing, they cut down on grammage.


When you do that, your volume growth gets impacted. Now the reverse is going to happen. The second theme is definitely where deflation is higher and we are seeing palm oil prices fall to almost half. So biscuit companies, noodle companies and soaps categories will benefit. Similarly, crude oil is now at a one-year low. That will also benefit in terms of the packaging cost and some of the categories like detergent, paint and to an extent adhesives, we will see that benefit coming.

Third, of course, is where the market share growth is happening, where R&D capability, innovations are happening. Put together, we like Britannia, HUL, Nestle and Dabur in the staple space.

In discretionary stocks, we like Asian Paints. Just look at the valuations in these four-five companies. You will miss out on earnings trajectory and EPS improvement which is going to happen over the next two years because most of the pain of rural slowdown and commodity inflation is now behind us.

We will see that the next one or two years could give 15-17% CAGR. Some of these stocks are at a 52-week high but let us take Britannia for example. Yesterday they announced a JV with Bel SA. They are trying to replicate their biscuit strategy in cheese also by getting the core domain R&D capability and a good brand like a Laughing Cow. We see market share gains of Britannia continuing. Britannia, HUL and Nestle will remain in the top tier in terms of volume and sales growth going ahead also. So we remain positive.

When you are talking about 15% to 17% return, do you expect FMCG stocks to outperform the index next year?
We have a case study available with us. In tea prices, in the last four-five quarters, there has been a deflation and that is why Tata Consumer, a key tea company, saw its gross margins expand by 300-400 bps. A lot of that flows towards the EBITDA margin also. I think that same thing will happen for Hindustan Unilever, Britannia, Nestle and Asian Paints.

For example, Asian Paints from peak have lost 1,000 bps gross margin. Of course, now the mix would be a bit different. I would say that the EBITDA margin expansion for all these companies starting in Q3 and Q4 will be more pronounced. The EBITDA growth will be quite decent and definitely it will be beating more sectors.

Second, all these companies have hardly any debt and so the other concern which a lot of other sectors have is the rising interest rate. All that does not really impact these companies. These are extremely cash rich companies. In fact, their other income will go up because of the higher rate.