In a shout out to the consumption theme and its valuations in the Indian stock market, I want to look at what the numbers tell us for this sector. The listed FMCG universe that I track consists of about 30 companies with the largest being HINDUNILVR with a mkt cap of about 380K Cr and the smallest is SKMEGGPROD with a mkt cap of about 100 Cr. For our purposes, I will narrow this further down to companies with more than 3K Cr mkt cap which yields 18 companies.
The immediate thing that stands out is the large ROE that this list enjoys – ROEs can be volatile year over year, so I look at 5 Yr averages of each company. If I take the average across the list, this number is 35%. What this means is that a company from the list accrues Rs 0.35 to its book value every year for every Re. 1 that it already owns in the book at the beginning of the year. The outlier of course is also the biggest company in the list – HINDUNILVR with average 5 Yr ROE of 83%. Huge profitability in this group with features like asset light models, -ve working capital, outsourced manufacturing, B to C business models, leverage over distribution networks, sticky brand building and moat building opportunities, customer mind share, relatively high entry barriers, expensive advertisement et al.
The other remarkable thing that stands out is how the market values this list intrinsically. On average across the 18 companies in the list, the market is assigning 23% of the market cap to the current Earnings Power Value in perpetuity without taking growth into account. There is also very little variance in this number - almost all companies are painted with the same brush stroke of 20-24% when it comes to this component of value. The market is assigning almost 3/4 of market cap to growth in general. When I think of this group, the products that come to mind are consumer staples – think hair oil, tooth paste, insecticides, shaving blades, detergents etc. Essential things, almost commoditized. Yet the group gets FAANG-type valuations. The average TTM P/E across the group is 50. If this were a developed market would the same group enjoy these kinds of valuations? I don’t think so. India is different in terms of the penetration of these products and the population. Yet, 77% to growth seems too high. As India gets richer and consumption pivots from needs to wants, would these valuations hold true? The one developed world parallel that comes to mind is Coke, where there is almost a century worth of brand recognition incorporated in the valuation – stuff which is not built overnight. As Coke matured as a company, the P/E fell into the 20-30 handle.
To me, this seems to be a case of TINA – there is no alternative - there are very few companies like these in the Indian market with characteristics like stable demand, high profitability, relatively simple businesses to understand which will not so easily be disrupted, and a proxy to the Indian consumer with rural and urban footprints providing protection from economic cycles. In short there is a behavioral bias from the investor community to own these businesses rather than analyze them from the growth perspectives fundamentally. Every quiver could have an arrow like this.
Obviously some companies in the list look cheaper than the other – like Emami which has come off recently due to issues like promoter pledges and diversification into other businesses. The moot point is would you buy any of these companies now? With tight liquidity in the rural marketplaces and slowing consumption, these stocks could fall more. The other point is – can we avoid having a stock from the list in our portfolio – ideally no. I think that in the medium term, these stocks will continue to enjoy high valuations – new industries are not getting created in India overnight which enjoy high levels of ROE, so for the foreseeable future the FMCG basket will remain overvalued. Tactically though, we could wait for these stocks to come off before taking a plunge.