Searching for value? Keep an eye on consumer product stocks as they correct

Publish Date: September 25, 2018

With the stock market seeing some long due correction, many quality stocks are available at a discount. Since the Indian economy is driven by domestic consumption, investors with a shorter investment horizon have often found consumer stocks to be slightly expensive. Now with the sharp correction, pockets of value may be slowly emerging. We believe that investors should definitely keep an eye on consumer product stocks as they correct more. Read on to know what our stance is on the sector and which stocks we prefer.

Tempting opportunity

Consumer product stocks are directly linked to consumption. So, unless something drastically changes, consumers keep on buying those products and help the businesses of the companies involved. Thankfully, consumer mentality is not as fickle as the stock market is! These are some of the reasons why consumer product stocks have been selling like hot cakes.

Given the recent sharp correction, you may think that consumer stocks are now cheap. Don’t make that mistake, though. Most of the names in our coverage universe are still up substantially on a calendar year to date (CYTD) basis (several up 20%+). Very few stocks in the sector have seen any meaningful correction in forward earnings multiples.

The weighted average of 12-month forward multiples (excluding ITC) in our coverage universe still stands at a rich 45 times. This level is broadly where it was towards the end of Dec 2017. This means, investors like you should be on watch. Wait for the stocks to become more attractive.

Related read - Why are consumer sector stocks falling: 4 things to know

Pricing power

The growth expectations from the consumer products sector are quite high, and understandably so. There are signs of improved volume growth. However, risks remain. The pressure caused by raw materials (RM) can be a source of discomfort. Plus, competitive intensity is also on the rise. While consumer product companies have to deal with these risks on a regular basis, the question is about being able to hold and grow margins.

Both RM and competition could test the companies’ capacity to keep expanding margins at the super-normal pace. Investors have seen the consumer product companies do so in the past few years. So, some expectation of a redux would be there. We believe the sector enjoys pricing power. But the steady rise in fuel prices can put pressure on household budgets. Under such a situation, exercising the pricing power would have some consequences like volume growth.

Related read - Godrej Consumer Products divests 100% stake in UK business: Things to know

Diverging show

Not all consumer stocks are moving in the same manner. Investors may like to look at the underlying factors that are driving this divergence.

For example, Jubilant FoodWorks is the best performer based on CYTD performance with a 45% return (as on 24 September 24). The stock has enjoyed a combination of a sharp increase in 12-month forward earnings-per-share (EPS) expectations and a decline in forward price-to-earnings (P/E) multiples. We have a 'Buy' rating on the stock.

In the case of Dabur, the strong (27% YTD gain) drivers are different. Earnings multiples have expanded and so have forward EPS expectations.

We remain cautious overall. ITC, Britannia, Nestle, Jubilant FoodWorks, and Colgate remain our preferred picks.

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