Nifty FMCG gains 6% in 3 sessions: Is the sector set for a turnaround?

FMCG stocks have staged a robust comeback in recent sessions, with many previously sidelined stocks beginning to show strength. This resurgence is driven by several positive factors that have bolstered investors' optimism towards FMCG stocks.

Even amid Monday's market meltdown, the FMCG sector weathered the storm as it finished the session with a nearly 1% gain, even as the frontline indices experienced one of their bleakest intraday drops in four years.

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Overall, in the last three sessions, the Nifty FMCG index has gained 6.40%, with 6 out of 15 constituents, including United Spirits, Godrej Consumer Products, Colgate-Palmolive, Marico, Dabur India, and Britannia Industries, touching new 52-week highs with gains ranging between 4% and 8%. 

What led to the rally?

The spike in FMCG stocks was fueled by the positive forecast for monsoon rainfall, which is anticipated to strengthen rural recovery. Improved macroeconomic conditions and price reductions by FMCG companies instilled investor confidence in the potential for increased volume in the rural sector. 

The sector had previously experienced sluggish growth due to macroeconomic obstacles and price hikes, leading to FMCG stocks underperforming in comparison to the broader market. In addition, the recent drop in crude oil prices has further benefited the FMCG sector. 

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Moreover, the stocks also saw a positive reaction following the Lok Sabha election results, as investors anticipated the government's emphasis on consumption, especially in rural areas, which could further drive volume growth.

Analysts believe that the anticipated new coalition government (comprising the BJP and its allies) may prioritise rural spending over capital expenditure, marking a departure from previous strategies.

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Prime Minister Narendra Modi's Bharatiya Janata Party (BJP) won 240 seats on its own, falling 32 seats short of the 272 required to form a majority government. Although the BJP-led NDA is expected to form the new government, there may be a slowdown in decision-making and further reform efforts. 

Potential policy shifts are anticipated, with a renewed focus on the rural and lower-end economy due to the stagnation in rural spending, according to the analysts. 

"As against expectations of exit polls, the BJP has underperformed the most in the three biggest states, viz., Uttar Pradesh, Maharashtra, and West Bengal. All three states have a predominance of rural and agri-voters."

"In addition, state elections in Maharashtra are scheduled in less than six months. This makes us wonder if the new BJP government will take this voter feedback and dilute its unequivocal supply-side policy-making style to also accommodate the rural and agri-push to address this political reality," said global brokerage firm CLSA in its recent report. 

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The brokerage remained "overweight" on consumer staples and said ITC was its preferred pick in the sector. CLSA is also positive on banks, IT, and insurance companies.

Earnings cycle will see an upward trend

Domestic brokerage firm Motilal Oswal said that FMCG sector's valuation has seen a consistent re-rating over the last 10–15 years. It said that the sector was trading at around 30x P/E during 2014, but it has since undergone a re-rating, with the multiple increasing to more than 40-45x after 2019. 

However, over the past 2–3 years, the sector’s valuation has remained relatively stagnant. In fact, some stocks have experienced a correction in their valuations during this period. 

The sector (excluding ITC) has largely witnessed a de-rating in valuation over the past two years. Most of the stocks have generated returns below their earnings growth as the quality of earnings (volume-led) was lacking. During the same period, new consumer companies in the discretionary sector reported a high earnings trajectory, resulting in a re-rating of their valuations, it noted. 

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The brokerage pointed out that several FMCG stocks over the last three years, (excluding ITC, Tata Consumer, and Varun Beverages) have experienced a valuation correction, including Dabur, HUL, Marico, and P&G. Some of the discretionary stocks have also seen corrections recently, such as Asian Paints and Pidilite.

It said that an above-normal monsoon, rural pickup, distribution expansion, seasonal benefits (summer/winter portfolio has favourable base) and steady raw material prices provide visibility on the earnings acceleration in FY25. 

It believes that, in line with the earnings uptrend, the valuation will also see rerating and will be close to the last five-year average valuation multiple.

The brokerage maintained its ‘overweight’ rating on the staple sector and continues to prefer HUL, GCPL and Dabur as its top picks.

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According to the brokerage, HUL's valuation at 49 times FY26E EPS appears reasonable when compared to its five-year average P/E ratio of 60 times based on one-year forward earnings. As for GCPL, the brokerage views its valuation as expensive; however, it expects the company's earnings to outperform its peers.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.