Best FMCG Stocks To Buy

Acquisition spree in FMCG sector: GCPL – (BUY, TP-Rs650), Jyothy Lab – (BUY, TP-Rs300) & Marico – (SELL, TP-Rs125)

Executive summary of the major trends in the sector

Managements of many FMCG companies are bullish about the prospects of consumer staples since it’s a defensive sector. The main fundamental driver for this sector is domestic consumption which has remained intact despite destabilizing macroeconomic factors like slowing growth, high inflation and rupee depreciation. All the stake holders of the industry are currently scouting for inorganic growth in India and also internationally. For FMCG companies, one prefers to buy growth through strong brands and wide reach since it’s riskier to develop a brand in-house, test market the product and then continuously invest behind brand building to create market presence. The strike rate of a successful brand is abysmally low at 10%. Valuations in India have already sky-rocketed because of positive fundamentals like demographic dividend; high disposable income, low category penetration and high working age population which is willing to experiment. For these reasons, it has practically become unviable to acquire suitable companies in India at a decent price. Many companies have hence forth ventured overseas in countries where the socio-economic factors and customer demands are similar to that in India, which in turn will ensure a steep learning curve for them.

We have analyzed the acquisitions made in the sector based on valuations of the target companies, sources of funding the deal, potential synergies of the acquisition and management track record in the past of integrating two businesses.

Based on the above evaluation, we strongly push GCPL as the best in the sector in terms of integration and carving out synergies and we have a BUY rating on the stock with a target of Rs 650.

We are also positive on Jyothy Labs as it has shown early signs of stabilizing Henkel’s performance and has now a bigger portfolio with strong brands to market in India. We have a BUY rating on the stock with a target price of Rs 300.

On the other hand, we believe that Marico did a very expensive acquisition at 5x sales– Paras Pharma, in which we do not see any significant synergies in terms of distribution or manufacturing. The acquisition has also come at a time when the company is reeling under the pressure of copra prices (200bps wiped off from gross margin in F12). We reckon the already declining return ratios will remain muted in the next 4-5 years because Marico will invest strongly in advertising Paras’s products and building the brands. We have a SELL rating on the stock with a target price of Rs 125.