Even as India faces a more-than-60-percent chance of having a below-normal rainfall or a drought this year, it should not deter value hunters from continuing to look for bargains in the fast-moving consumer goods (FMCG) sector.
For, according to a report by Nomura, the sector's demand relies more on broad economic growth, which appears to be turning up, rather than the vagaries of the monsoon or even growth in the agriculture sector.
The Indian meteorological department recently forecast a 33 percent probability of rainfall being below normal (90 percent to 96 percent of long-period average) and a 30 percent probability of a drought (less than 90 percent of LPA.
The weak rainfall forecast in part stems from the more than 50 percent likelihood of El Nino, which is known to disrupt weather patterns across the globe, taking place in the Pacific Ocean taking place.
Also read: El Nino on the way? Here's one way to invest it
Weak rainfall can potentially impact the FMCG sector in two ways: by raising input prices and thus impacting margins or by impacting the spending power of the rural economy (which is a key constituent of sales for the sector, and is, to some extent, agrarian).
But analysts at the firm dug into data from the past 15 years to look at the potential impact of disruptive weather patterns on consumer demand as well as input prices.
The study found out that monsoons were significantly deficient in six years since FY98 but sales growth for the sector followed a largely secular trend, falling about 15 percent levels in 1998, falling to about 0 percent growth in 2002-03, and then coming back up to 15 percent levels since (while falling off slightly in 2013).
"We observe that rainfall and FMCG sector growth only have a correlation of about 20 percent," the report says.
The correlation between agriculture growth and FMCG sector growth is also weak – only 26 percent, it finds. "There have been large variations in agricultural sector growth over the past 15 years -- largely on account of rainfall. But this volatility has not had as much of an impact on FMCG sector growth largely because of the nature of the products."
If the monsoon season is poor, input prices could see an upward bias. "Recent comments by Nestle , at its analysts meet, suggest a significant increase in milk, wheat and green coffee prices. If the monsoon is poor, and crops are impacted, we could see a spike in other input costs as well," the report says.
But it sees limited impact to margins in case of a moderate price rise because of FMCG companies' ability to pass on cost increases to consumers.
Valuations
According to the report, valuations for the FMCG sector (29.3 times forward earnings) are trading above the five-year average of 27.6 times but well below last year's peak of 35.5 times.
Nomura's top picks in the sector are ITC and Godrej Consumer Products while it believes valuations are stretched in the case of Hindustan Unilever and Colgate .
ITC stock price
On April 28, 2014, ITC closed at Rs 342.05, down Rs 1.55, or 0.45 percent. The 52-week high of the share was Rs 380.00 and the 52-week low was Rs 285.40.
The company's trailing 12-month (TTM) EPS was at Rs 10.61 per share as per the quarter ended December 2013. The stock's price-to-earnings (P/E) ratio was 32.24. The latest book value of the company is Rs 28.04 per share. At current value, the price-to-book value of the company is 12.20.
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