Consumption based stocks - Business Line

With the economy growing at 8-9 per cent, consumption is likely to remain a dominant theme in the markets. And the domestic consumption story is one of the few ideas that professional investors are almost unanimously positive about.

The domestic consumption story is one of the few ideas these days that professional investors are almost unanimously positive about, with concerns of a possible US economic slow-down, volatile commodity prices, pricing regulation and rising interest rates affecting sentiment in just about every other sector.

The universe of stocks that benefits from the consumption theme is no longer restricted to the FMCG sector but has expanded to include retailing, media, tourism, alcoholic beverages, automobiles, telecom and housing. The performance in the stock market over the past year has, however, been mixed, with some of the obvious beneficiaries of consumption, such as FMCG, retailing and hotels being the under-performers.

The media and housing sectors, where more options have emerged in the listed space in the last two years, have received most of the attention. Here is an overview of the consumption space and a clutch of recommended stocks for those who wish to ride the theme.

Dominant theme

With the economy growing at 8-9 per cent, consumption is likely to remain a dominant theme in the markets. And even if the stock market lets you down, take comfort from the thought that the job market certainly will not. HR consulting company Hewitt Associates expects Indian salaries to rise 14.5 per cent in 2007 — the same as last year. Higher disposable incomes may ensure that the spending spree continues.

India currently enjoys the strongest consumer confidence in the world. Four times in a row, it has topped AC Nielsen's Consumer Confidence Index, a half-yearly survey that gauges consumers' confidence in the job market, status of their personal finance, their willingness to spend, spending habits/intentions and their current concerns. From among 46 countries, Indians were found to be most bullish on job prospects and the state of their personal finances.

The strong double-digit volume growth seen in everything, from FMCGs to automobile sales, also points to the spending wave and, in our view it would take higher interest rates to slow down spending dramatically.

Stocks that benefit from the domestic consumption would, therefore, serve as good defensive picks and are likely to outperform the market in the medium term. We, however, take a more positive view on sectors where spending is not credit-dependent, such as FMCG, food and apparel retailing and entertainment (multiplexes, broadcasting).

Also, given the increased competitive activity across sectors, an inflationary environment and the fact that growth will have to come on a higher base, the execution challenges will be significant. A cherry-picking strategy in stock selection may be more appropriate. Given the volatility in the market, investors may use price declines linked to market weakness to accumulate these stocks rather than invest a chunk at one go.

Sector view

FMCGs: If you had loaded up on FMCGs in May 2006 as a defensive strategy, it would have backfired. Despite healthy balance-sheets, double-digit growth rates and aggressive acquisitions, investors have given the sector a go-by. In fact, quality stocks have shed 15-30 per cent from their peak levels. The stiff valuations that had prevailed earlier appear to have been a factor behind the underperformance. The average FMCG stock is now at a 25-30 per cent premium to the market (down from historical levels).

Our outlook for the sector remains positive. Volume growth across categories is strong. FMCG majors are likely to effect further price hikes to partly offset rising input costs, having largely maintained prices over the last three years in light of the higher competitive activity.

Given the comfortable cash position and the low gearing, interest rate hikes are unlikely to affect these companies. Recent numbers suggest that acquisitions in new markets/product lines are also beginning to pay off.

Hindustan Lever and Marico are our top picks for the sector.

Retail: The sector is now buzzing with investment activity, with the entry of big players such as Reliance, Birlas and Bharti-Wal-Mart.

However, we believe that most of the opportunity lies outside the listed space as new entrants snap up smaller players and foreign retailers strike partnerships with local outfits.

This year might also see the likes of Subhiksha and RPG tapping the primary market.

While there is room for four-five players, margins in the medium term are likely to be under pressure on the back of rising real-estate rentals and labour costs, and pricing pressure.

For leading retailer Pantaloon, staying at the top may mean sacrificing some margins in the medium term as it expands at a frenetic pace.

A hold strategy appears appropriate right now for current listed players. The long-term outlook for the sector, however, remains intact.

Media: The sector has caught the fancy of investors over the last year as a beneficiary of India's unique demographic profile.

The re-rating in broadcasting has come on the back of implementation of the conditional access system as well as the increasing advertising spend by marketers as they target young viewers.

The print media has also got its fair share of attention, with a growing community of discerning readers.

It has been a particularly big year for entertainment, with a series of blockbuster movies. The interest in multiplexes has, however, waned.

Valuations in the media sector remain at high levels given that it is still in its infancy. Stocks might pause for a breather till greater clarity emerges on the impact of CAS on viewership. The series of new channel launches also threatens to shake up market share figures. Adlabs Films appears well-placed to benefit from spending on entertainment with its integrated presence in film entertainment. Among multiplex majors, Shringar Cinemas looks attractive from a valuation perspective.

Automobiles: Moving on to bigger spend categories, automobiles sales have recorded robust growth rates in recent years. Although traditionally an interest-rate sensitive sector, double-digit growth rates should sustain. Two-wheeler sales are likely to be more sensitive to interest rate hikes than passenger vehicles. Maruti Udyog, which has been an under-performer, is our top pick.

The stock trades at attractive valuations. Increasing traction in compact car sales and launch of new models are likely to drive revenue growth.

Hotels and tourism: Hotels have notched up spectacular growth rates over the last couple of years on the back of a supply shortage.

While a key driver of demand has been the increase in tourist arrivals buoyed by a strong business environment, domestic travel too has played a role in increasing occupancy rates across hotels. Hotel stocks have also underperformed since the May correction. Concerns of fresh supply lowering occupancy rates in some pockets could explain the correction of stocks such as Hotel Leelaventures or Taj GVK.

Indian Hotels would be our top pick in this space. Its range of properties and its foray into the budget segment make it best placed to benefit from domestic travel.

Market-linked price weakness may be used to accumulate the stock.

Recommended picks: Hindustan Lever, Marico, Adlabs films, Shringar Cinemas, Maruti Udyog and Indian Hotels