Citi :FMCG/ Consumer: 2011 Sector Outlook

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Looming Margin Pressures; Valuations Near Peak Levels
 Revenue growth moderates sequentially — Revenue growth for FMCG
companies is moderating and there are signs of down-trading in a few
categories as the consumer’s wallet share increases towards the purchase of
food items, rather than staples. Admittedly, food inflation has come off
sequentially, but still remains high, unlike trends seen in earlier good
monsoon years.


 Increasing margin pressures — Companies have started selectively
increasing product prices, following the inflationary commodity cost
environment – no deceleration in competitive intensity. We reckon gross
margins could continue to deteriorate as pricing power may be limited in an
environment where food inflation is in double digits. Firming input costs on
last year’s low base, coupled with structurally higher A&P will keep operating
margins under pressure going forward.
 Valuations: Expensive, but not yet at peak levels — The consumer sector is
trading at a one-year forward P/E of ~26x; ~15% lower than past decadal
peak. Margin of safety is better from a relative perspective – valuations are
in line with the historical premium (~50%) vs. market.

 Prefer ITC & Asian Paints — We are more cautious on the sector, given
healthy sector outperformance (16% YTD vs. broad market), slightly
stretched valuations and looming margin pressures. We prefer companies
with strong revenue growth, limited competition and better pricing power –
ITC and Asian Paints are our preferred picks. Nestle India is our top Sell on
rich valuations.
 Retail Cyclical Upside – Pantaloon is well positioned — PRIL is well
positioned to benefit from the healthy growth in urban consumption. Samestore
sales (SSS) growth in value & lifestyle retailing has been rising both
sequentially and on a Y/Y basis – SSS for lifestyle retail growing at 20%+;
value retail growing at 12-13% A combination of growth, scarcity premium
and competitiveness should help sustain the premium valuations. Leverage
benefits from lower finance costs, SG&A overheads & better inventory
management should drive operating margin expansion going forward. We
expect ~120bps EBITDA margin expansion to ~9% between FY11-13E.