Friday, June 7, 2013

Is There a Price Bubble Building in Consumer Stocks?

All the time, I get the question consumer stocks are trading at such rich valuations and is there a bubble building up there? I did a post on same topic in 2011 here.

“Stay away” from these is the advice from some of the analysts. Graham worshippers and “Value investors” say these stocks are absolute no-no, and cannot be justified anyway you look at them.

There can be no two opinions about ultra-expensive valuations of consumer plays. At the same time, it can be intriguing to see every other investor taking shelter in these names despite such pricey tags. 

I, however, think it is important to appreciate the overall landscape in which consumer facing stocks are being evaluated by the markets:

  1. Infra companies pack has been a disaster in their capital allocations and many of their acquisition and other decisions haven’t been financially prudent. Government alone cannot be blamed for policy paralysis and their sorry state.
  2. Cash flows in power and capital goods companies are unreliable, or missing in some cases. Well established names of yesteryear are languishing at lows. A recent article on BHEL gave insight into the real situation, so much for a Navratna enterprise.
  3. PSU stocks have not come out of overhang of OFS and dilutions, the woes of fundamentally strong companies like Coal India, NMDC and MOIL etc in mining sector are well known. Oil & Gas sector has some minor positive with reduction in diesel subsidy but it will take long before that makes any real impression on the stock prices.
  4. Auto majors like Maruti have to stop production for a couple of days every now and then to cool off the supply mismatch. Entry of one Honda has changed the 2-Wheeler market dynamics for our Bajaj auto and Hero.
  5. Pharma is a mixed bag. For an ace like Sun Pharma, we also have to live with a Ranbaxy that acts as dampener. Still, market is giving high multiples to well performing Pharma guys so long as they are performing.
  6. Banks are somewhat of a divided house where many PSU banks are saddled with asset quality issues and trading well below book. Private peers are already priced in overvaluation zone in excess of 2-3 times book.
  7. IT with some exceptions (HCL Tech, TCS, Mindtree) have failed to live upto promise of  volume growth. The stock uptick seem to be on account of currency moves rather than real operating performance.
  8. No point discussing about real estate and the likes.
All the above tentativeness in market leaves us with consumer facing businesses in FMCG and Consumer durables. Yes, we are talking about the likes of Nestle, HUL, ITC, Colgate, Britannia, Bata, Asian Paints, Berger Paints, Pidilite, Dabur, Emami, Bajaj Corp, GSK Consumer, Tata Global, Godrej Consumer, Marico, TTK Prestige, Hawkins, P&G, Gillette and so on.

Now, question is what is distinguishing these from the rest:
a.  Consistent cash flows, debt free (most of them), incremental capex is funded internally, no dilution,  high capital return ratios and decent pay-outs.
b.     Market very well knows that Nestle cannot grow at 30%+ anytime in near future but still gives it PE of 40. Such companies are like oasis in desert where “Predictability of Earnings” is the real PE decider not just the earnings growth.
c.   Domestic consumption stories are here to stay. A large middle class and growing number of consumers add to it. They can reduce some discretionary spend in inflationary times, ultimately that has to be realized in the market. After all, Chinese folks may not succeed selling hair oil and toothpaste in India.
d. Established consumer companies have strong brand power, distribution network and geographical penetration. Most of this is irreplaceable moat.
e.   Gestures from the parent shareholders to hike their stakes even at current levels like in GSK Consumer and HUL boosts market sentiment for investors (why will promoters not raise their positions when they have business growth compared to home turf, they take away high royalty payments of 1-3% and of course the dividends).
f.     In this kind of scenario, where do you think an emerging market fund looking to put money to work in India will invest, if not in these consumer stories?

In short, these consumer stories may have their ups and down and occasional performance blips. Broadly, this theme will continue to deliver earnings and premium multiples accorded by the market may not significantly shrink going forward. These are uncertain times and the way macro-economic scene is panning out, there may be bouts of sustained selling. That will again make participants look for defensives. 

No wonder, consumer facing businesses will keep the markets interested!

1 comment:

  1. Oil also has been hurt by a strengthening dollar, he said. Because crude is bought and sold in dollars, a barrel of crude becomes cheaper if the dollar moves higher.
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