Are FMCG Stocks Overvalued?

Despite clocking single to low double-digit growth, FMCG stocks are trading at high multiples

Published 5 years ago on Oct 25, 2018 2 minutes Read

Vinit Sambre, head-equities, DSP MF

FMCG stocks have been trading at very high valuations for the past year but with the broader correction their valuations have also corrected and thrown up buying opportunities. For the past few years, FMCG companies have seen volume growth of 7-9% but because of their cost rationalisation initiatives, premiumisation of products and overall deflationary environment, there was margin improvement. Post demonetisation and GST, FMCG companies didn’t take price hikes and passed on the benefits of lower tax rate. However, we are witnessing inflation in the input side of the business; hence the real test now will be hiking prices. Also, when inflation pressure builds in an economy, consumers tend to cut their discretionary spend rather than non-discretionary spend. So, FMCG category will be better off as compared to others in a rising inflationary scenario. There could be some impact on volume growth, but that impact is likely to be compensated by price increases. Hence, we believe because of price hikes, these companies will be able to register decent sales momentum, and these companies should be able to sustain double-digit growth rate.

Amit Mantri, fund manager, 2Point2 Capital PMS

Even before the recent deterioration in the macro condition, FMCG stocks were significantly overvalued. These companies are now no longer in their high growth phase and are barely able to grow earnings at a low double-digit growth rate. These growth rates don’t deserve P/E multiples of 40-50x. The argument that these companies have very strong moats, cash flows, and high ROCE is valid, but to justify very high P/E multiples, there has to be very strong underlying growth. A 40x P/E implies 20%+ earnings growth for a very long period which most of these FMCG companies are unlikely to achieve. FMCG valuations seem to have a large disconnect between the growth rate implied by valuations versus the actual growth rate. These companies seem to be valued on non-fundamental factors such as perception of being “defensive” plays, MNC parentage premium, etc. We believe that eventually over the long term even FMCG stocks will be valued according to fundamental factors i.e. long term cash flow generation. As cost of capital rises globally and domestically, these expensive stocks might see a significant P/E de-rating.