Jyothy Labs

Small obsessions look to be adding up to big gains. After the big Budget disappointment, most things 'consumer' look bright and beautiful and along with them so do the fortunes of the fast moving consumer goods (FMCG) sector. And what adds to the supplying businesses' lustre is their classic 'cash flow positive' character and relatively low capital hungriness.

In the current market scenario, companies making chips, beverages, detergents, razors, soaps, toothpaste and creams, promise much. Every man woman and child needs these products and demand is constant. Juxtaposed against the uncertainty in all other sectors, FMCG looks set to dominate.

We enumerate here the overall factors that impinge on the sector and what makes buying into FMCG stocks worthwhile.

FMCG Overview

The sector is the fourth-largest in the economy and had a market size, despite the slowdown, of $25 billion (Rs 120,000 crore) in retail sales in 2008, having grown consistently over the last 3 years — compounded annual growth rate (CAGR) was 20 per cent (6% between 2001-05). What is more, the sector is poised to grow at a 10-12 per cent rate for the next 10 years. It’s set to reach $43 billion (Rs 206,000 crore) by 2013 and $74 billion (Rs 355,000 crore) by 2018, a study by FICCI-Technopak stated.

The power-packed figures, however, are not expected to add wings to FMCG companies. AC Nielsen data shows that the sector grew 16.2 per cent year-on-year (YoY) during April-May 2009, which is lower than the 19 per cent reported for last year.

WHY FMCG

Sure, on the stock markets, FMCG companies' shares are not the most popular, even though they will never fall as sharply as those from other sectors. Simply stated, FMCG stocks are not the stock of choice in a bull run because they don’t generate superlative profits for investors.
But, in a volatile world, what FMCG stocks have become is a bulwark against uncertainty. Albeit its heyday may be over — in the 1990s it was one of the biggest wealth creators — yet they still must form a good chunk of any investor's portfolio.

Here's why: BSE FMCG index fell from 2,319 points on December 31, 2007 to 1,987.38 on December 31, 2008, a fall of 14 per cent. In the same period, Sensex fell by 52 per cent from 20,286.99 to 9,647.31 points — this was the time of the slowdown squeeze.

In fact, during the global meltdown, the sector showed resolve, with Hindustan Unilever (HUL) delivering a gain of 17 per cent — when everyone else was down by 50 per cent or more. Companies like Marico, Dabur, Godrej and HUL logged double-digit growth over the last three years — the first three by about 20 per cent and the last by 14 per cent.

This kind of guarding of capital and generating of gains during a downfall, caught the eye of the mutual fund industry, with all 12 companies on FMCG index between December 2007 and March 2009, except Colgate-Palmolive, Tata Tea and Ruchi Soya, seeing a rise in funds' holdings — funds’ stake in HUL rose 85 per cent, Dabur 143 per cent and United Spirits 337 per cent.
The first of the 5 stock selections is highlighted here. Over the next few days we will reveal the rest one by one.

The numbers are eye-catching, but the same can be said of real estate and pharma, but are they really so scintillating for stocks?

Hindustan Unilever

Hindustan Unilever (HUL), a Rs 6,009 crore company, is a stock for all seasons and bucking the bear market is one of its specialties.

India's largest FMCG company’s links with the country go as far back as 1888, but it was established here officially some 75 years ago. Chances are that you may not have heard of the company, yet its brands are omnipresent: Brooke Bond, Lux, Kissan, Surf, and more — 700 million consumers use its products.

The stock over the decades has been backed by steady offtake as the rest of the companies and sectors in the economy battled the boom and doom periods as they came and went. Its resultant ability to generate topline and profit growth has kept it as a favourite with all those looking to safeguard their investments and post profits too.

The company is doing well enough during the current market rally too. Over the April-June quarter, its stock has risen by as much as 12.79 per cent, while that of Sensex has risen by 46.37 per cent. Not only has it been fighting market turbulence well in 2008, it has also been able to take advantage of the current situation, fighting off volatility to post perceptible gains.
The enhanced performances have been courtesy the company looking to take the battle to the mid-sized and small companies that had virtually uprooted it from the hinterland, causing the company's volumes and profits to dip. The effect has still not worn off as can be seen from the fact that its sales growth is muted in April-June quarter at 13 per cent QoQ and 6.6 per cent YoY.

However, since April 2008, the volume growth rate has been falling and jumped into the negative in the quarter ended March 2009 with the company reporting a de-growth of 4.2 per cent YoY.

But its profits after tax were up 10.3 per cent YoY (32% QoQ) over the June quarter. Its earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) indicates that the gain has been to the extent of 11.6 (YoY) per cent (17% QoQ). The company closed the fiscal ended March 2009 with 15.5 per cent growth in net sales, an operating profit margin of 14.5 per cent and a net profit growth of 15 per cent.

One of the big reasons helping the company stay at the top has been the 70 bps YoY fall in raw material cost that helped boost operating margins by 78 bps.

The challenges from large rivals have remained a constant, but where HUL is really losing out to is in rural markets to mid-size companies that have put in shade most of its products. However, aside from the ramped-up spend on advertising and distribution in rural areas, the company has an unrivalled brand power as well as a vast distribution network that will help keep it at the top.
At the current market price of Rs 260 the stock trades at 23.8x and 21.1x its FY2010E and FY2011E EPS of Rs 10.9 and 12.3 respectively.

Stock Views on BHEL, Hindustan Unilever, Pfizer

Emkay on Hindustan Unilever, target of Rs 305

Emkay Global Financial Services has maintained its buy rating on Hindustan Unilever with target price of Rs 305 in its research report.

"HUL implemented price cut of 4%-20% on select brands and product categories. The price cuts are implemented either directly (20% price cut on Wheel Active Blue) or indirectly through weight changes (4.2% weight increase in Lifebuoy and 6.7% - 8.3% weight increase in Wheel Green). Considering above mentioned price cuts on select brands, total blended price reductions is approximately 1.2%. This translates into net cost saving of Rs 5,301 million compared to Rs 7,637 million earlier and additional EBITDA margin of 2.9% versus 4.1% earlier."

"Recent price reductions ratify our call that consumer staple companies will retain some savings to improve margin profile and intensify advertisement activities and utilize the balance for price reductions to benefit consumers. The recent price reduction on select brands is in-line with expectation. Despite adjusting the above price actions, HUL can implement incremental price reductions of 3.1% without impacting FY10E earnings estimates and intensify advertisement activities. Our earnings forecasts for CY09E remain unchanged at Rs 11.7/Share. We maintain our BUY rating with target price of Rs 305," says Emkay Global Financial Services' report.

IIFL on BHEL, target of Rs 2585

IIFL has recommended a buy rating on Bharat Heavy Electricals with a target price of Rs 2,585 in its research report.

"Higher-than-expected 34% YoY growth in 4Q gross revenues was reassuring after the execution slip in 3Q. However, our fears of a muted guidance for FY10 revenues came true. The 16.3% YoY growth in gross revenues implied by MoU target of Rs 320 billion under ‘Excellent’ rating is below our estimate as well as consensus. The muted guidance reflects constraints on accelerated execution, as was evident during our recent visit to a project site. We cut our FY10 and FY11 earnings estimates by 5% on lower revenue estimates. Order coverage ratio of 4.6x provides unmatched earnings visibility in the Indian capital-goods universe, but valuations, at PE of 18.7x on FY10ii and 15.5x on FY11ii, leave little room for slippages."

"Bharat Heavy Electricals’s 4Q gross revenue growth of 34% YoY helped the company beat the FY09 MoU targets by 1.8%. However, EBITDA margin likely contracted by 300bps in 4Q, against our estimate of 240bps contraction. BUY", target price of Rs 1,585," says IIFL's research report.

Hem Securities on Pfizer, target of Rs 935

Hem Securities has initiated a buy rating on Pfizer with a target of Rs 935 in its research report.

"The company has posted the compounded annual growth rate of 48.42% in bottom line in last four years and is expected to maintain its growth in coming years. The company was well placed to benefit from the growth of Indian Pharmaceutical market, that is expected to grow at 11-12%. It is expected to be valued at USD 20 billion by 2015. The stock at the current market price of Rs 597 will trade 12.27 times to its earnings of Rs 48.67 (TTM) and 1.90 times to its book value of Rs 314.52 and is expected to provide huge upside potential in long-term. We initiate a ‘BUY’ signal on the stock at the current levels with a target of Rs 935 in the long -term investment horizon with an appreciation of 56.62%," says Hem Securities' report.

Stock views on Nestle, Sun Pharma, Glaxo smithkline Pharmaceuticals, Castrol, BOC India, Godrej Consumer Products, Hindustan Unilever, Hero Honda

CADILA HEALTHCARE


Cadila Healthcare, one of the five largest drug makers in India, may have been the top performer (64.51%) during the bear run, but analysts are cautious on this low volume stock at current market valuation. They believe though the stock is a safe bet in the current environment, and has good domestic business, technically it looks weak below Rs 225.


HERO HONDA MOTORS


In the last nine months, two-wheeler maker Hero Honda has outperformed market expectations with volume growth of 11.1% year-on-year, against a flat growth of 1.9% for the rest of the two wheeler industry. The key reason for the over-achievement has been the company’s strong rural franchise, lower input costs, and lower discount offerings. In fact, the share of volumes from rural India has gone up from 40% a year ago to more than 50% at present. Though concerns remain over — less correlation to broader markets, falling interest rates and raw material cost — a major section of brokers are bullish on the scrip. What makes the stock attractive is the company’s significantly reduced dependence on financing with only 15% of the vehicles sold on finance. This protects the company against the current tight credit cycle.


HINDUSTAN UNILEVER


India’s leading fast moving consumer goods company, Hindustan Unilever (HUL) is expected to benefit from the sharp drop in commodity prices this year. HUL has been formidable in this space in the last nine months. The company, in fact, recorded its fastest growth in 10 years, growing volumes despite aggressive price increases. Currently, rural areas contribute 45% of HUL’s sales, which analysts feel will remain a strong growth driver in FY10. Although the stock is a defensive bet and has limited upside, analysts are positive on the business. The operating margin for the company is expected to improve in the quarters ahead as the benefits of lower material prices kick in. Even though the pace is expected to decelerate, HUL’s revenue will grow 15.6% y-o-y in the current financial year.


GODREJ CONSUMER PRODUCTS


Analysts count on Godrej Consumer Products to ride on its strong brand image in new markets following its acquisition of five companies in the hair care and personal care space. The sharp fall in palm oil prices, a key raw material in soap manufacturing, coupled with price hikes at the start of the year, believe analysts, will lead to margin expansion. A strong balance sheet is expected to enable organic as well as inorganic growth. The stock has low volumes, but looks technically strong.


BOC INDIA

BOC India, the arm of BOC Group, the second largest industrial gases company in the world, has recently won a 15-year gas supply contract from SAIL. The company plans to invest around Rs 500 crore in a new air separation plant and ancillary equipment to meet the growing demand for liquid products in eastern India. The stock, one of the star performers during last year, lies low on the wish list of analysts. Falling global demand of the product coupled with low volumes doesn’t make it a winning stock. Further, it looks technically weak and we will suggest investors to sell at every rally.


CASTROL INDIA


One of the best dividend paying stock, Castrol India has good numbers to boast of due to high volumes and improved price realisations. Analysts are neutral on this oil lubricant firm, though it can turn out to be a dark horse in 2009. The company’s sound business model and stable financials make it an attractive long term investment. Strong brand equity of Castrol products has enabled it to churn out good cash flows year after year. Even amid a decline in the automobile sector, analysts say the company’s lubricants will have a large potential market to tap.



GLAXOSMITHKLINE PHARMACEUTICALS


Analysts have a favourable recommendation for Glaxo smithkline Pharmaceuticals, which is one of the fastest growing players in this segment over the past few years. Better cost-effectiveness over the years have reflected in the company’s improved net profit margins. The margins have increased from 16.5% in 2003 to 25.3% in 2007. The pharma company has clocked a 10% growth in revenues at Rs 473.9 crore for the September 2008 quarter, as compared with Rs 428.7 crore in the previous corresponding quarter. Aggressive product launches this year, sitting on huge cash amount on books, strong domestic presence and attractive valuations makes it a company to watch out for.



SUN PHARMACEUTICAL INDUSTRIES


Sun Pharma has one of the low-risk business models among the Indian peers with a strong presence in central nervous system, pain management, ophthalmology, cardiovascular and respiratory segments. It is one of the fastest-growing companies in the domestic pharmaceutical market. Having facilities approved by the United States Food and Drug Agency for controlled substances in regulated markets, analysts feel the company has an edge in the niche controlled substances market. The high margin, strong earnings growth, low risk revenue model and strong balance sheet make it a good defensive bet. With no significant forex hedges, Sun is likely to reap major benefits of the sharp depreciation of the rupee against the US dollar.



NESTLE INDIA


Changing consumer preferences from unpacked/ unbranded foods to branded packaged foods is expected to provide the $70 bn Indian food processing industry a robust growth opportunity. According to analysts, Nestle, with its strong presence in milk and milk-based products, beverages, prepared dishes, chocolates and confectionery and baby foods segment, is the best play as it garners more than 90% of its revenues from domestic business. Nestle has a strong product portfolio with some of the best-known brands globally, such as Nescafe, Maggi, KitKat, Polo and Milo, which are amongst the top 50 brands in India. The company will also benefit from the sharp drop in commodity prices. The operating margin of the company is expected to improve in FY10 as benefits of lower raw material prices set in.

Emkay Global views on BHEL, HUL, ICICI Bank

Emkay Global on ICICI Bank - Target Rs 720

Emkay Global Financial Services has recommended a buy rating on ICICI Bank, with price target of Rs 720, in its report. "ICICI Bank reported net profit of Rs 12.7 billion, in line with our estimates. However, the operational performance was weaker with less than expected growth in NII and sharp dip in the fee income. The core operating profit declined by 9.2% yoy and 26.4% qoq. We maintain our BUY recommendation on the stock with price target to Rs 720," says Emkay Global Financial Services' research report.


Emkay Global on BHEL - Target Rs 1450

Emkay Global Financial Services has recommended a buy rating on BHEL, with price target of Rs 1450, in its report. "BHEL Q3FY2009 net profit at Rs 7.9 is sharply below our expectations primarily because of slower than expected topline growth - 16.7% yoy growth in gross turnover to Rs 64.5 billion (our estimate Rs 69.56 billion). On the order flows management said that for FY2009 it expect fresh order inflows of close to Rs 600 billion as earlier expectation of Rs 500 billion. Also the management expects benefits of falling commodity prices to be witnessed from Q4FY2009. In order to factor the earnings downgrade, we lower our price target for BHEL from earlier Rs 1520 to Rs 1450, Buy" says Emkay Global Financial Services' report


Emkay Global on HUL - Target Rs 305

Emkay Global Financial Services has maintained its buy rating on Hindustan Unilever with a target of Rs 305 in its research report. "In Q4FY09, HUL reported a robust 16.8% yoy growth in its revenues to Rs 43.1 billion. Lower interest income and other income in the quarter resulted in 19.2% yoy growth in adjusted net profit to Rs 6.1 billion. We maintain our earnings estimates for CY08E and CY09E at Rs 9.3 and Rs 11.7. We maintain our ‘BUY’ rating with price-target of Rs 305, valuing HUL at 26X CY09E earnings i.e. average of 10-year long-term and 5-year short-term multiple," says Emkay Global Financial Services' research report.

Stock views on ONGC, Hindustan Unilever

MORGAN STANLEY on HINDUSTAN UNILEVER

MORGAN Stanley reiterates ‘overweight’ rating on HUL as it believes that investors are likely to be positively surprised by the company’s structural growth story and turnaround in business fundamentals. The FMCG sector is at an inflection point and a sharp reduction in input costs is likely to benefit consumers as well as companies. HUL is not witnessing any exceptional uptrading or downtrading across its product portfolio. Industry volume growth in soaps and laundry is flat due to steep price hikes, but consumers have still been resilient. Revenue growth in FY10 is likely to be lower as it will be largely volume-led. HUL has geared up to respond to volatility in input costs and has shortened its response time and planning cycle.

INDIABULLS on ONGC

INDIABULLS has recommended a ‘hold’ rating on ONGC. During Q2 FY09, the company’s standalone net sales increased 12.9% y-o-y to Rs 17,410 crore. While the surge in global crude oil prices and the weakening rupee were expected to drive ONGC’s financials, its performance was dented by the excessive subsidy burden (Rs 12,670 crore) it had to shoulder in order to limit the losses of OMCs. As a result, ONGC’s standalone adjusted net profit declined 5.7% y-o-y to Rs 4,810 crore. Due to the global economic crisis, oil prices have fallen by more than 60% from their peak of $147/bbl in mid-July to the current lows of $50/bbl. This is mainly due to dampening fuel demand from the major consuming nations. The IEA has lowered its oil demand forecasts by 500,000 bopd for the second half of ’08 and by 400,000 bopd for ’09. Thus, with reducing demand, Indiabulls expects oil prices to be under pressure till FY10, thereby adversely affecting the company’s net realisations. However, Indiabulls believes that once the global economy revives, demand for crude oil and natural gas will recover, mainly due to increased demand from developing economies such as India and China.

Stock Views on Glodyne Technoserve, HCL Technologies, ITC

Reliance Money on Glodyne Technoserve - Target Rs 815

Reliance Money has maintained its buy rating on Glodyne Technoserve with a target of Rs 815 in its September 22, 2008 research report. "At the current market price Rs 683, Glodyne is trading 11x FY09E and 6x FY10E. We maintain BUY, with a revised 12 months target price Rs 815; we had earlier given a target price of Rs 784. On our revised target price stock will be valued at 13x FY09E and 8x FY10E," says Reliance Money's research report.

Reliance Money HCL Technologies - Target Rs 248

Reliance Money has recommended a hold rating on HCL Technologies with a target of Rs 248 in its September 22, 2008 research report. "Industry headwinds have taken its toll on the stock performance of HCL Technologies and it has corrected by almost 25% in the last 5 months. We expect HCL Technologies revenue and net profit to grow at a CAGR of 24% and 32% over FY08E-10E. HCL technologies stock trades at a P/E of 10x FY09E and 9x FY10E earning. We continue to recommend a HOLD on HCL Technologies with a reduced target price of Rs 248, at our target price the stock will be valued at 11x for FY09E and 9x FY10E earning," says Reliance Money's research report.

India Infoline on ITC - Target price Rs 214

India Infoline has recommended a buy rating on ITC with a target price of Rs 214 in its September 22, 2008 research report. "In the coming quarters, we believe the higher cigarette prices would get successfully absorbed by the industry and ITC's cigarette volume decline would significantly reduce. Outlook for the non-cigarette businesses such as hotels and paper remains positive with continued demand buoyancy while the FMCG - others segment is expected to turn profitable by FY10. With the entry into the personal care category, we expect ITC to become a tough competitor for Hindustan Unilever and Godrej Consumer Products. Also, strong cash flows from cigarette business can be invested in advertising heavily to build the personal care portfolio in the initial stage. We recommend a buy with a target of Rs 214," says India Infoline's research report.