2011 Outlook: FMCG (Stable, rich valuations at 80% premium to Sensex): ICICI Securities

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FMCG (Stable, rich valuations at 80% premium to Sensex)
Neutral
The FMCG sector witnessed a spate of new launches and acquisitions in
2010 contributing to the sector’s phenomenal topline growth of ~15% led
largely by volumes. Robust GDP growth estimated at ~8.75% in FY11,
increased income in rural areas, growing urbanisation and changing
lifestyle of consumers would be key growth drivers for companies. With
demand shifting from need based to want based we believe personal care
and home care categories would lead the growth momentum with ~20%
and ~15% growth, respectively, in CY11.

⇒ Increasing commodity prices such as crude (from $74/bl in May 2010
to $90/bl in December 2010), copra (| 3450/qtl in January 2010 to |
5600/qtl in December 2010) and sugar (| 24 per kg in May 2010 to | 31
per kg) that constitute key raw materials for FMCG and paint
companies would bring down the margins to ~17% in FY11E from
~20% in FY10. The impact in H1CY11 could be considerably less as
the price increase taken by companies would help. However, H2CY11E
could be considerably impacted. Also, the increase in advertisement
costs by 150-200 bps in FY11E on the back of increasing competition
would pressurise margins further

⇒ Rural demand constituting ~35% of sector sales (FY10) is expected to
increase its pie to ~45% in FY11E. The growth in rural market sales in
FY10 stood at ~18% outpacing the urban market sales growth of 12%.
Hence, with the increase in minimum support prices for agricommodities
and good monsoons in CY10, we believe the contribution
from rural consumers would continue to lead the growth momentum
for the companies

⇒ Currently, the BSE FMCG index is trading at 32.7x with YTD upside of
26.7%. Hence, with the FMCG P/E of 1.8x to that of the Sensex P/E, the
valuation for the sector seems to be expensive with the sector’s
historical premium being ~0.4-1.2x. Though we believe revenue
growth will continue its uptrend in CY11, margin pressure and high
valuations could keep the premium capped. Hence, we remain neutral
on the performance of the sector. However, we recommend selective
stocks that have higher growth potential (Dabur, ITC) and relatively
attractive valuation (Marico) to be the preferred picks.