The combination of very high inflation and high economic growth that we are currently witnessing is producing some strange outcomes. One of these is the fact that at a time when sales of essential consumer goods like toothpaste, detergent and soaps are hardly growing, sales of more expensive (and seemingly less essential) goods like coffee, alcohol, therapeutic hair oil, hair dyes, motorbikes and cars is booming. What explains this paradox and is this something you can profit from?
Our research shows that whilst the bifurcation of the “consumption” story (between sluggish demand growth for daily essentials versus booming growth in what we call “aspirational” products) is very clear at present, this trend is not new.
In fact this story has been gradually coming to the fore over the past four decades. Data from the Government shows that whilst in the 1960s, Indians devoted nearly 70% of their expenditure to essentials, that figure is now just below 50%. Logic suggests (and data broadly corroborates this) that most of this 20% of re-allocated consumer expenditure has gone toward non-durables (such as white goods, electronics, motorbikes and cars) and towards seemingly less essential purchases like hair dyes, therapeutic hair oil, coffee, booze, etc.
Clearly, as the Indian consumer’s income rises further, data from more developed nations suggests that the orientation of his consumption basket will turn increasingly in favour of products that satisfy his aspirational needs i.e. the need to the signal to the world that he is affluent enough to move beyond a basic consumption basket. The Korean consumer, for instance, spends only 20% of his wallet on essentials versus 50% for the Indian consumer. If we follow the path of countries like Korea the potential for producers who can cater to the aspirational needs of a young and upwardly mobile nation is huge.
To understand whether you can profit from this structural trend, our Economist, Ritika Mankar, divided the consumer facing stocks in the BSE 500 into separate baskets and then analysed their performance. She found that:
In terms of top and bottom line growth, the FMCG sector has been a relative underperformer over the past decade as opposed to Consumer Durables and Auto. Even more interestingly, aspirationals have clearly outperformed essentials in terms of top and bottom line growth over athe past decade. In particular, the profitability of aspirational product firms grew at a faster pace (31% per annum) as opposed to those offering essentials (14% per annum).
With regards to investment returns, just as Consumer Durables and Auto stocks have comprehensively outperformed FMCG stocks over the past decade, aspirationals have outperformed essentials. The outperformance of aspirationals over essentials is to the tune of 0.3% per month although these returns have come at the cost of the higher volatility associated with aspirational stocks.
Finally, and this is the bit that fascinates me, inspite of all this, aspirational stocks are available at lower valuation multiples than the stodgy well known FMCG names who prices seem to be propelled by rocket fuel (or is risk aversion?) at present. By and large, most of the better known FMCG names are trading in FY11 P/E multiples between 27-35x. That does not make any sense to me given that these companies are highly unlikely to grow earnings at anywhere approaching 30% per annum.
On the other hand, a range of aspirational stocks can be found at mid-teens P/E multiples. Obvious plays on affluence on like Exide Industries, Hero Honda and Maruti Suzuki and Whirlpool are all available on at around 16-17x FY11 earnings. Now, as fundamentals oriented analyst who swears by his DCF models, it is not my place to make investment recommendations based on grotty P/E multiples but there does seem to be something wrong with our stockmarket which values yesterday’s consumption stories at a 100% premium to stocks which might come to define an emerging nation’s changing consumption habits.
In a country where nominal GDP is likely to grow at close to 20% in most years, many companies which are plays on our aspirations to live a better life should be able to grow earnings are 30% per annum year after year. It makes sense for these companies to have P/E multiples close to 30x whereas the companies flogging tea, toothpaste, soap and detergent to us should probably trade at somewhere around 20x i.e. in line with nominal GDP growth.