Delayed Demand Recovery, Rising Input Costs To Hit Consumer Sector In 2017
FMCG index set to retreat for the first time since 2008.
Major Indian equity indices have been in a consolidation phase for two years now but Indian consumer indices are set to outperform these benchmarks. Good monsoons, after two successive years of drought, had brought cheer to the consumption sector in India. But that turned out to be short-lived with the demonetisation of high-value bank notes pushing earnings recovery by at least two quarters as per consensus estimates.
The Nifty FMCG Index which had posted gains of 8.5 percent in 2016 before the November 8 announcement, is now looking at a potential decline of over 2 percent by the end of the year. The index is now set to retreat for the first time since 2008 breaking a seven-year gaining streak.
Impact Of Demonetisation On Income
The demonetisation of old Rs 500 and Rs 1,000 notes is likely to adversely impact revenue of FMCG companies for no longer than two quarters, according to most reports released by brokerage firms. UBS’ initial estimates released in the last week of November suggest a drop of 4-5 percent in volumes for consumer staples in the third quarter of financial year 2016-17. Goldman Sachs in its December 9 report has cut revenue estimates for the stocks it covers by 2-14 percent for financial year 2016-17. However, most analysts prefer to wait until the end of December to provide concrete estimates for this financial year.
Rising Inputs Costs Are A Concern
India’s consumption sector has been aided by soft agri-commodity prices and crude oil-linked raw material costs for over one year which has led to substantial expansion in gross margins. This trend has been reversing over the past three months with appreciation in prices for wheat, barley, sugar, palm oil and several edible oils. Nomura, however, says that this may also result in more pricing power for these companies.
With this rise in input prices, we estimate price-led growth to return as small regional players in highly penetrated segments die out and overall competitive intensity reduces, a key positive for market leaders present in the food and beverages and home and personal care space.Nomura Global Equity Research (December 21)
Pricing Remains Benign But Ad-Spends To See Sharp Cuts
Earlier in the month, Religare Securities in a report had said there was no material change in pricing environment for products across categories which remained benign. Promotions too remained elevated. But Credit Suisse expects to see sharp cuts in advertising spends eventually.
Most companies are likely to pull back ad spend until they see consumer demand and channels normalizing. It may not be possible to pull down very near-term advertising as the slots are booked in advance. However, we believe some discretionary spend that is on spot rates will be pulled down and new spend will he sharply cut.Credit Suisse Report (November 23)
Despite Correction, Sector Valuations Remain Rich
Nifty’s FMCG index has retreated by over 10 percent since November 8. Despite the fall, most fast moving consumer goods companies trade at expensive valuations. Kotak Institutional Securities pegs the sector’s price to earnings ratio at 31 times for financial year 2017-18 with the ratio at 35 times times ITC is excluded. Not only is the sector expensive on an absolute basis but it is also at a premium when compares to Nifty 50’s forward price -to-earnings of 18 times.
