Emkay FMCG

Update
Sector
Research “Holding” gain
March 6, 2009

History indicates that, there is lag-effect of 2 quarters to effect adjustment in

Pritesh Chheda, CFA valuations for any reversal of trend in earnings growth momentum. We have
pritesh.chheda@emkayshare.com anecdotal evidence in consumer staples, which clearly highlights lag time of 2
+91 22 6612 1273 quarters for re-rating or de-rating of valuations. This observation COMPLEMENTS
our argument mentioned in ‘Drawing Parallels’ – ‘Consumer staple are likely to post
Sachin Bobade robust earnings growth in FY10E with probable earnings surprises in Q110E and
sachin.bobade@emkayshare.com Q210E’. Thus, we believe that consumer staples are ‘SAFETY HARBOR’ in current
+91 22 6624 2492 uncertain times and investors can take shield under the ‘SAFETY HARBOR’ until
Q210E. Further, consumer staples are not likely to undergo de-rating – even if
earnings spring negative surprise in Q110E and Q210E, going by historical
HUL
behavior during trend reversal. We maintain our BUY rating on Hindustan
Unilever and Asian Paints and ACCUMULATE rating on Godrej Consumer and
(%) 1M 3M 6M 12M
Marico.
Absolute (8) 3 (2) 5
Rel. to Sensex (1) 7 74 104
Consumers are defensive play in bear market- a flight to safety
The economic downturn alongside equity meltdown in FY01-03 Period (From April 2000
APL
to March 2002) clearly highlighted the shining silver stones within the scattered particles
(%) 1M 3M 6M 12M of Indian equity market. During this period, the broader index (BSE-200) fell by 36.8%,
Absolute (5) (15) (39) (37) but consumer staple universe posted a decline of meagre 6.4%. Quite clearly the
Rel. to Sensex 2 (12) 8 22 consumer staple sector outperformed BSE-200 with huge positive divergence of 48.1%.
The outperformance of consumer staple was supported by (1) growing institutional
Marico participation and (2) robust earnings performance, especially higher than BSE-200
(%) 1M 3M 6M 12M earnings growth. Amongst the lead performers were Asian Paints and Nestle India with
Absolute (1) 15 (3) (8)
relative outperformance of 95.4% and 116.5% respectively. Barring Tata Tea with
underperformance of -30.2%, all companies in consumer staple universe outperformed
Rel. to Sensex 7 19 73 77
BSE-200.
GCPL Consumer staple outperformed BSE-200 by 48.1%
(%) 1M 3M 6M 12M Return For April 2000 to Absolute Returns Relative to BSE 200
Absolute (5) 7 (3) (8) March 2002 Period (% 1 – Year 2 - Year 1 - Year 2 – Year
Rel. to Sensex 2 11 73 78 Terms)
Asian Paint 33.2 23.5 24.0 95.4
Colgate Palmolive -8.8 -2.9 -15.1 53.6
Dabur India -8.7 -32.1 -15.0 7.3
Hind. Unilever 3.0 -7.6 -4.1 46.1
ITC -14.5 -5.2 -20.4 50.0
Marico 13.1 6.4 5.3 68.3
Nestle India 1.2 36.9 -5.8 116.5
Procter & Gamble -11.3 -13.8 -17.4 36.3
Tata Tea -27.6 -55.9 -32.6 -30.2

Consumer Staple Universe -1.9 -6.4 -8.7 48.1

Source: Capitaline, Emkay Global

Emkay Research 6 March 2009 1

 FMCG Sector Update

… Attract institutional interest in bear market- thanks to lack of

investment options
Consumer staples emerged as preferred investment avenues for the wholesale money
or institutional money in FY00-03 Period. The flight to safety philosophy coupled with
conservatism approach and lure to protect principal had drawn institutional interest
towards consumer staple. Consequently, institutional holding in consumer staple
improved by 280 bps from 52.2% in March 2000 to 55.0% in December 2002 whereas,
institutional holding in BSE-200 remained almost unchanged during the same period.
This trend reversal happened during 5-year bull market phase of FY03-08 Period - with
institutional interest drifting in favor of high growth sectors. But, institutional activity in
January 2008-February 2009 indicates renewed preference for consumer staples –
thanks to un-certainty around and risk averseness.
Preference for consumer staples in uncertain times
35%

58%
Holdings Slashed In Consumer
Consumer Staple Universe Staple - In Favor Of Other Sectors -
Attracted Institutional Thus BSE-200 Attracting Interest
Interest In The Bear Market
- Cleary Evident
30%

55%
Resumption Of Interest In
Consumer Staple - Post The
Fall Out Of 5-Year Bull Run
25%

51%
200003 200203 200403 200603 200803

BSE- 200 FMCG

Source: Capitaline, Emkay Global

Consumer staple valuations are resilient in the bear market

The preference for consumer staples is largely led by safety of principal on the back of
resilient valuations. We have witnessed this in FY00-03 Period with valuations of
consumer staple showing resilience despite the gloom-doom in broader market. Our
consumer universe reported 27% decline in 1-year forward PER multiple from 30.0X in
March 2000 to 21.3X in April 2002. But, adjusting for the market meltdown in February
2000 and June 2000 period, the valuations of consumer staples were resilient with 1-
year forward PER in the range of 20X – 23X. Whereas, valuation of BSE-200 were on
downward trail with 1-year forward PER falling by 54% from 17.4X in March 2000 to
8.0X in April 2002. This clearly explains the relative outperformance of consumer
staples in FY00-03 Period.

Emkay Research 6 March 2009 2

 FMCG Sector Update

Consumer Staples - 1-year forward PER at 20-23X BSE-200 - 1-year forward PER decline by 54%
39

18
Relatively Stable
Complete Collapse

12
25
11

6
199803 199909 200103 200209 200403 200509 200703 199803 199909 200103 200209 200403 200509 200703

FMCG PER BSE 200 PER

Premium to market multiple in the range of 1.5x – 3.4x

3.6
2.3
1.0

199803 199909 200103 200209 200403 200509 200703

FMCG Multiple To BSE 200 Multiple Average

Source: Capitaline, Emkay Global

Support from robust earnings growth

We view that valuations and earnings performance are hand-in-glove. Thus, resilient
valuations are backed by robust earnings growth. Even, flight to safety in FY00-03
period to consumer staples was amply supported by robust earnings growth. Our
consumer staple universe maintained the earnings growth momentum despite weak
macro economic fundamentals and meltdown in equity market. The universe reported
healthy earnings growth in the range of 15%-36% in March 2000 to April 2002 period-
more important a consistent earnings performance. The earnings performance had
surprises with 40% growth in June 2001 and 12% growth in December 2001, but no
decline recorded in above time period. On the contrary, growth engine of BSE-200
spluttered in March 2000 to April 2002 period with earnings decline in September 2001
(-12.9%) and December 2001 (-13.7%) and muted earnings performance in January
2001 (5.7%), June 2001 (3.3%) and March 2002 (1.5%).

Emkay Research 6 March 2009 3

 FMCG Sector Update

Consistent earnings performance in March 2000 to April 2002 Period BSE-200 growth derails in March 2000 to April 2002 Period

20% 40% 60% 80%

45%

18
31
Consistent
29%

Collapse

12
13%

16

6
-3%

-20% 0%
200003 200109 200303 200409 200603
200003 200109 200303 200409 200603
-19%

0
Earning Grow th PER Earning Grow th PER

Source: Capitaline, Emkay Global

Earnings not the sole trigger for re-rating or de-rating of

valuations
Earnings performance solely triggers the re-rating and de-rating of valuations? It’s an
ordinary popular delusion and we view it otherwise. The analysis of valuation trends of
consumer staple over longer-time period highlights the presence of other factors
alongside earnings performance. For example, slowdown in earnings momentum w.e.f
June 2002 was not reflected in the corresponding valuations with immediate effect.

Similarly, resumption of earnings growth momentum in March 2005 after muted

earnings performance in June 2002 to December 2004 was not accompanied by
corresponding upgrade in valuation with immediate effect. Thus, above anecdotal
evidence clearly hints at presence of other factors alongside earnings performance for
re-rating or re-rating of valuations.

Earnings not the sole trigger for re-rating or de-rating of valuations

Earnings Derailed- But No Earnings Are Not Sole Drivers Resumption In Earnings Momentum –
45%

Immediate Impact On Valuations For Valuations But No Immediate Effect On Valuation

33
22
15%

11

200003 200109 200303 200409 200603

-15%

PER Earning Grow th

Source: Capitaline, Emkay Global

Action starts with lag of 2 quarters, either re-rating or de-rating

The valuation does not adjust to the earnings performance with immediate effect owing
to external factors at play. But, the valuation adjusts to change in earnings momentum
with lag effect. It is largely linked with confirmation for reversal in mean trend of
earnings performance. We have strong anecdotal evidence to highlight the lag-effect
between mean reversal of trend in earnings and corresponding valuations. The
anecdotal evidence (1) consumer staple universe recorded slowdown in earnings
growth momentum in June 2002 and de-rating of valuations happened in December
2002 – lag effect of 2 quarters and (2) consumer staple resumed earnings growth

Emkay Research 6 March 2009 4

 FMCG Sector Update

momentum in March 2005 and re-rating triggered in September 2005 – lag effect 2
quarters. Thus, above evidence clearly indicates that action w.r.t de-rating or re-rating
of valuations occurs with lag effect of 2 quarters. Thus, we conclude that valuations are
not adjusted on first signs for reversal of earnings growth momentum.

2 quarters lag in valuation downgrade 2 quarters lag in valuation upgrade

2 Quarters Lag For

40%

50%
40

40
Rating Upgrade
15%

15%
20

20
2 Quarters Lag
For Rating
Downgrade
200403 200503 200603 200703
200003 200103 200203 200303
-10%

-20%
0

0
Earning Grow th PER Earning Grow th PER

Source: Capitaline, Emkay Global

Complement our view stroked in ‘Drawing Parallel’

We highlight our arguments in ‘Drawing Parallel’ ‘All companies under coverage i.e.
Marico, Godrej Consumer, Asian Paints and Hindustan Unilever are WELCOMING
FY10E/CY09E with promise of robust earnings growth and likely breach of linear trend
in earnings growth in FY10E – especially in Q110E and Q210E’. We forecast an
enabling and conducive environment for consumer staples in FY10E.
Our analysis for adjustment of valuation with lag effect complements our conclusion
mentioned in ‘Drawing Parallels’. Considering this, we believe that consumer staple is
not likely to undergo de-rating despite muted earnings growth in Q110E and Q210E.
Though, we expect robust earnings performance, any negative surprise will not
translate in de-rating of valuations in Q110E and Q210E, but would trigger in Q310E
and Q410E. We believe that consumer staple is ‘Safety Harbor’ until Q210E.
Consumer is ‘Safety Harbor’ until Q210E, barring negative
surprise in volumes
We view that consumer staples are ‘Safety Harbor’ in current uncertain times. Investors
can take shield under the ‘Safety Harbor’ until Q210E despite any negative surprises in
earnings in H210E. Though, we forecast robust earnings performance for consumer
staple amidst enabling environment, volume growth can yield negative surprise to
earnings. Any sharp deceleration in volume growth could trigger earnings revision and
de-rating in valuations. This will lead to under performance of consumer staples on both
absolute and relative basis. Thus, volume growth will decide the course of valuations
and have to be monitored closely. We have forecasted robust earnings growth for HUL,
Asian Paints, Marico and GCPL at 26.2%, 15.6%, 17.9% and 18.3% with volume
growth of 5.0%, 8.7%, 7.5% and 7.4%.
*We have considered following FMCG companies - part of BSE – 200 index: Asian Paints, Colgate
Palmoliv, Dabur India, Hind. Unilever, ITC, Nestle India

*We have considered 122 companies which are currently a part of BSE 200 index

Emkay Research 6 March 2009 5

 FMCG Sector Update

HUL
Net EBITDA AEPS EV/ Div Yld RoE
YE-Mar Sales (Core) (%) APAT (Rs) EBITDA P/BV (%) (%) P/E
FY2007 124,110 15,954 12.9 18936 6.8 25.4 19.3 2.7 62.8 33.7
FY2008 139,134 19,033 13.7 19189 8 21.5 33.2 4.6 84.1 28.8
FY2009E 165,187 22,182 13.4 20254 9.3 18.4 29.5 3.7 126.3 24.7
FY2010E 186,913 28,574 15.3 25568 11.7 14.7 25.8 4.6 140.4 19.6

APL
Net EBITDA AEPS EV/ Div Yld RoE
YE-Mar Sales (Core) (%) APAT (Rs) EBITDA P/BV (%) (%) P/E
FY2007 36,700 4,856 13.2 2868 29.9 14 9 3.1 40.3 24.2
FY2008 44,043 6,598 15 4327 45.1 10 7.1 1.3 49.2 16
FY2009E 53,700 6,530 12.2 4162 43.4 10.1 5.4 1.3 36.6 16.7
FY2010E 58,693 7,529 12.8 4786 49.9 8.8 4.2 1.4 32.5 14.5

Marico
Net EBITDA AEPS EV/EBITDA Div Yld RoCE
YE-Mar
Sales (Core) (%) APAT (Rs) (Rs) P/BV (%) (%) P/E
FY2006 11462 1354 11.80% 891 1.5 26.6 13.2 1.1 23.7 38.4
FY2007E 15569 1990 12.80% 1129 1.9 19.1 18.7 1.1 24.4 31.8
FY2008E 19067 2380 12.50% 1692 2.8 16.3 11.4 1.1 32.7 21.2
FY2009E 22558 2859 12.70% 1853 3 13.3 7.9 1.3 30.1 19.4
FY2010E 25602 3307 12.90% 2184 3.6 11.2 5.8 1.4 30.6 16.5

GCPL
Net EBITDA AEPS EV/ Div Yld RoE
YE-Mar Sales (Core) (%) APAT (Rs) EBITDA P/BV (%) (%) P/E
FY2007 9,515 1,800 18.9 1392 6.2 16.3 23.2 3 114 20.2
FY2008 11,040 2,229 20.2 1592 7 13.3 16.4 3.2 92.7 17.7
FY2009E 13,691 1,901 13.9 1594 6.2 15.7 5.1 2.9 25.1 20.2
FY2010E 15,191 2,229 14.7 1886 7.3 13 4.5 3.4 26.4 17.1

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Emkay Research 6 March 2009 6