Religare Research: FMCG: Volumes growth strong, profitability to be under pressure

FMCG: Volumes growth strong, profitability to be under pressure
We expect our FMCG coverage universe to report sales growth of 18% YoY in
Q2FY11, led largely by volumes. Operating margins are projected to decline by
90bps, as input costs have inched up and brand building expenses remain high on
account of strong competitive intensity in the sector. Adjusted PAT for our
coverage universe is likely to grow by 12.3% YoY. Although the sector has
witnessed a re-rating and companies are currently trading at peak valuations, we
continue to prefer select stocks with strong business models. We therefore
maintain our positive stance on ITC and Marico which remain our top picks. We
have a SELL on Emami, Britannia, Colgate and GSK Consumer & Healthcare.
Volume growth momentum to continue in Q2FY11: We expect volume growth
to remain strong for most of the companies under our coverage led by an upturn
in macroeconomic conditions, higher disposable income in urban areas, strong
rural demand on the back off a bumper rabi crop, good monsoons this year and
lastly due to price cuts effected in certain segments over the past 6–9 months.
The pricing power of most companies is likely to be limited to some categories
on account of strong competition prevalent in the sector, and hence growth in
FY11 is likely to remain largely volume based.
Sales growth at 18% YoY for the quarter: We expect sales growth of 18% YoY
for our FMCG universe during the quarter, led by Godrej Consumer Products
(GCPL), Jyothy Labs, Britannia, Asian Paints and Emami. GCPL is likely to report
a 62% YoY increase in its topline mainly on account of the inorganic growth
driven by Godrej Household Products (GHPL) and other global acquisitions.
Nestle and Dabur are expected to clock a 21% and 18% YoY growth in sales
respectively, while Hindustan Unilever (HUL) is likely to report 9% growth led
by volumes. ITC is set for an 18% growth in sales, with cigarette volumes likely
to decline 2–3% on the back of a ~16% price increase to counter the hike in
excise duty in the union budget.
Operating margins to decline YoY: The operating margin for our FMCG universe
is likely to dip slightly by 90bps YoY, allowing for EBITDA growth of 13.1% YoY.
Most of the companies are likely to report a contraction in operating margins led
by a gross margin decline as input commodity costs have inched up. HUL is
likely to report a 140bps decline in operating margins on the back of higher A&P
expenses. We expect the sector to report an adjusted PAT growth of 12.3% for
the quarter. Emami, GCPL, Jyothy Labs and Nestle are projected to report strong
PAT growth, though HUL’s profits are likely to decline marginally YoY.
Key issues to watch for: The key factors to monitor would be: 1) the current
sustainability of volume growth, 2) increase in input commodity costs which may
hurt gross margins going forward, and 3) increase in A&P costs which is likely to
dampen profitability of most players.
ITC and Marico remain our top picks: Valuations for the sector are near peak
levels on an absolute basis and are also slightly higher than the long-term
average (40% premium to market) on a relative basis. While we do not expect a
re-rating from current levels, we would recommend selective plays, namely ITC
and Marico. We have a SELL rating on Emami, Britannia, Colgate and
GSK Consumer.