There is significant over-valuation in Consumer Staples, at a time when consumption growth must fall to bridge the Balance of Payments deficit . We therefore cut 1.5pp from Staples from our model portfolio. CS India consumer analyst Arnab Mitra downgraded HUL and Britannia last Tuesday.
Even as India’s P/E premium to Global/EM indices has broken through the last seven year’s range, within the market Staples are near a record premium to the index . 64% of Staples stocks are trading
2 standard deviations above the mean P/E.
Sales growth of consumer firms has seen multiple tailwinds: GST rate cuts have helped formalisation and lowered prices, boosting volumes; state governments have added `1.6/`1.2 trn to wages/ pensions in FY18/19. These trends are peaking however, even as consumption gets pressured by a weak Rupee.
We add weights to Utilities which are now at a record discount to the market, and to Energy, which should benefit from a weaker rupee. Our model portfolio is up 9.8% CYTD, outperforming the benchmark by 1.5%.
As highlighted in our recent note , while the Indian market’s valuation premium to Global/EM indices has broken through the last seven year’s range, within the market Staples are near a record high premium to the overall market , and 91% of Staples stocks are trading more than 1 standard deviation away from their average P/E.
Consumption as visible in the revenue growth of listed companies in India has benefited from multiple tailwinds: GST rate cuts have brought down pricing (this has helped volume growth) and also boosted formalisation; state pay commission implementation raised wages and pensions by Rs 1.6 trn last year and by Rs 1.2 trn this year; and the low base of Jun-17 quarter also helped reported growth.
However, the unsustainable Balance of Payments deficit necessitates a drop in imports/consumption. As a weaker Rupee drives up local prices, we expect volume growth to slow. This, when the sector is at extreme valuations sharply increases the risk of underperformance. As CS India consumer analyst Arnab Mitra cuts ratings on HUL and Britannia we cut Staples weight by 1.5pp.
We increase weights on Energy and Utilities. The discount to market P/E for Utilities is now at a record low , and P/E multiples on Powergrid and NTPC have halved in the last eight years. Energy is likely to benefit from the weaker rupee, along with Metals and IT, on which we maintain our Overweight ratings.
Since our last update in late June, our Overweight on metals and corporate lenders (SBI, ICICI) has helped the model portfolio, whereas the Underweight on NBFCs (mainly through Bajaj Finance), Cement and Pharma has hurt. We maintain those positions.