Consumption trends remain weak across categories, with revenue growth for discretionary companies at 20-year lows in real terms. FMCG companies are faring slightly better but face further risk from the deepening rural and low end consumption down cycle. We are particularly cautious on the smaller FMCG firms, where the market is extrapolating recent commodity-led strength in earnings, that are unsustainable, in our view.
Consumption slowdown—percolating across categories: Revenue growth for consumer companies has been under pressure for several quarters, with deflationary trends now setting in along with weak volume growth. In real terms, though, FMCG segments seem to be faring better than discretionary categories, where growth has now dropped even below historical lows. While one might wish to bank on the resilience of FMCG, past data suggests that nearly all consumer companies suffer badly in a prolonged slowdown of the kind we are witnessing now. In the backdrop of a weakening rural and low end consumption cycle, risks to FMCG growth seem significantly high. On the other hand, discretionary consumption is unlikely to worsen from here, although we are yet to see strong signs of recovery—a good festive season being the only bright spot at the moment.
Commodity gains—not entirely sustainable: Benign commodity prices have boosted profitability for consumer companies. This is particularly true for paints and the smaller FMCG firms, that have grown earnings far ahead of the sector in recent quarters. Margin gains in paints could likely sustain given the nature of the industry. However, we are particularly cautious on the margin trajectory for the smaller FMCG companies, as we expect them to pass on the benefits of benign commodity especially in the light of a weak demand.
Rich valuations—holding on to hope: Despite the growth slowdown, valuations continue to be high. However, earnings expectations have been tempered across the sector, more so for discretionary companies and to a lesser extent for the large staples companies. Expectations over the next few years (FY15-18e) are now considerably lower than historical growth rates. The smaller staples firms, however, are clear outliers. The market is extrapolating the recent strength in earnings over the next few years. We believe these run the most risk of disappointment and remain negative on Marico and Godrej Consumer. We continue to prefer discretionary companies and maintain Buy on Jubilant and Titan.