Are consumer durables the new darling?

Last year was a year of hope. Amid Modi's wit and charm, India’s economy was expected to return to its days of high octane growth. While everything on the Street was making money in FY15, one sectoral index rose above the rest – S&P BSE Consumer Durables. The index returned 60%. The only exception was healthcare which returned 71%.

Cut to FY16, the market sentiment has changed. Capex revival seems far away, while weak demand has put corporate balance-sheets under stress. Defensives like FMCG, IT and pharma are also facing headwinds from certain sector-specific factors like weak rural demand, growth saturation in US generic drug market and pricing pressure in the IT sector. Of the 11 BSE sectoral indices, eight have given negative returns in the range of 5% and 34% while the Sensex has corrected 8%.

But one thing hasn’t changed: the love for consumer durables. Even as bearish sentiment has taken over most of the market, the BSE Consumer Durables index has once again outperformed with year-to-date gains of about 16%. What is it about this sector that has been attracting investor interest? More importantly, can this defiance continue?

For starters, some experts are of the view that the under-penetrated white goods market is on the verge of a cyclical upturn. “The Indian white goods market is under-penetrated. The market size currently at $5.4 billion could grow approximately six times to $30 billion if India can reach penetration levels of SE Asian countries,” analysts at Deutsche Bank observe in a client note titled Multi-year Potential Growth Story.

Over the next two to five years, the analysts forecast an industry growth of 8-12%, with organised players outperforming. “Consumer sentiment is turning at the margin with lower inflation and reducing consumer finance rates (high correlation to volumes),” says the report adding that government initiatives on power, housing, and smart cities could increase demand exponentially.

Sudip Bandyopadhyay, CEO of Destimoney Securities, believes that there is huge pent-up demand in the sector. “The Seventh Pay Commission is a big positive for consumer discretionary and can uncork some of this latent demand”, he adds. The Seventh Pay Commission recommends a 23.5% one-time overall pay increase and a 3% annual salary increase. These recommendations which will take effect from January 1, 2016, would affect the 4.2 million central government employees and 6.2 million pensioners.

Market players add that the heavy discounts offered by online shopping portals during the festive season is helping widen the consumer durables market. “With improvement in the economy, more disposable income at hand and promotions from retailers and companies, the consumer appliances industry is expected to witness growth in both value and volume terms. Sales via internet retailing and appliance specialist retailers will help the overall consumer appliances market to grow,” the management of Bajaj Electricals observed in the company’s FY15 annual report. It then seems urban consumers will be the real drivers going forward given that rural consumption is likely to remain muted owing to two consecutive rain-deficit monsoons.

Will all this add up to stock performances? As growth pockets in markets shrink, stocks that continue to deliver growth have shot up beyond what fundamentals can justify. Valuations thus look really steep for companies to leap from here. Take the case of Symphony. The stock was among the best performers in FY15, but at 38X FY17 earnings, the valuation of the company now seems stretched. According to a fund manager, the company has shown growth but the valuation is too steep.

AC-maker Hitachi is also trading at a high valuation of 40X FY17 earnings riding on last year’s (FY15) superlative performance when earnings grew 866% YoY. While maintaining a ‘neutral’ outlook on Hitachi, Milan Desai at Angel Broking observes, “… steady economic growth will lead to higher disposable incomes in the hands of the consumers, thus triggering higher demand for room ACs. Also the company will benefit from the improved demand from the commercial/institutional clients for its ductable ACs.” After a 8-fold surge in FY15, the stock might have just hit a wall and is down 8% year to date in FY16.

Another home appliances company Whirlpool has supportive fundamentals but may again be a tad costly. “Whirlpool has a capital-efficient model with low capex (about 3% of sales), low royalty (0.9%), and dominant positioning with distributors (negligible working capital). Hence, current ROCE is good (20%), and incremental ROCE could be significant,” say analysts at Deutsche Bank. Analysts estimate the company’s earnings per share to rise 22% CAGR over 2015-18, while the stock trades at 28X FY17 earnings.  Again, a case of growth lagging behind valuation.