ITC is now among cheapest FMCG stocks

Indicating the polarisation of the stock market, country largest FMCG maker ITC is now trading at an all-time high discount to its smaller peers in the benchmark Nifty. Hindustan Unilever (HUL) and Asian Paints are now trading at more than twice the price to earnings multiples of ITC. The tobacco to FMCG major is now trading at 26x its net profits in the trailing 12-months. In comparison, HUL now commands a valuation ratio of 53.5x while Asian Paints has become one of the most expensive stocks in the index with a price-earnings multiple of 55x. (See the chart).

The valuation gap has opened in the last few quarters and in the past the valuation of the companies used to move in tandem. Historically, ITC has always traded at a discount to its peers but it was as never as large as its now. For example, in January 2014, ITC was trading at 30.6 times its trailing 12-months earnings, around 10% discount to Hindustan Unilever P/E multiple 33.8x and nearly 30% discount to Asian Paints’ earnings multiple of 39.7x.

ITC lower valuation is due to the hangover of its slow-growing tobacco business and losses that it incurs on its fast-growing non-tobacco FMCG business. Besides ITC has one the highest free-float (non-promoters’ holding) among its peers and leading to more shares available for trade that acted as a brake on spike in valuations. ITC remains the largest (by revenue) and the most valuable consumer goods company in the market, followed by HUL and Asian Paints respectively.

The analysis is based on the month-end market capitalisation and trailing-twelve month’s net profits of these three companies beginning January 2008.

The valuation gap is however now at eight year high as investors booked profits in ITC and shifted their money to its peers including HUL and Asian Paints. “The outlook has turned bearish on ITC as indirect taxes and regulations on cigarettes –ITC cash cow tightened in last few quarters. HUL and Asian Paints are pure-play consumer companies and face no such as headwinds and command premium valuations,” says Devang Mehta, Sr VP and head equity sales Anand Rathi Financial Services.

Some experts see it as a sign of market polarisation where winners take all while losers are pushed to the margins. “The market is highly polarised right now and investors are willing to give record valuations for quality stocks that seems to offer better growth prospects,” says Nitin Jain, CEO global asset and wealth management Edelweiss Capital.

The polarisation is not unique to FMCG but is playing in sectors such as automobiles, apparels, consumer durables and transportation sectors. “The valuation gap between market favourites’ and the rest has reached all-time high and may see insane to some investors. But this is how markets operates,” adds Nitin.

For some this is inevitable in the market where lots of money is chasing an ever shrinking number of growth stories. “Lot of fresh money has entered Dalal Street in last 18-24 months but pool of investment-worthy stocks has actually shrunk due to lower than expected economic growth and poor corporate earnings. This has led to a situation where winners are treated like rock stars and losers are punished equally hard,” says Chokkalingam, founder & CEO Equinomics Research & Advisory.

In the long-term however there is not much to choose between the three companies. In last five year (20 quarters) ending March 2015, ITC net profit earnings grew the fastest followed by Hindustan Unilever and Asian Paints.

Given this current gap in the valuation may sustainable for long as most sectors and companies go through a growth and earnings cycle. This raises the down-side for investors who continue to stick with winners and completely ignore losers.