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Margin headwinds
Crude based chemical prices and palm oil prices have moved up by 2-
55% over the last six months. While P&L impact is usually felt with a lag,
we note that the sector hasn’t seen any major product price hike since
Aug’10. We believe that the Hindustan Unilever’s aggressive growth
stance implies that its margins are at a higher risk. Historical analysis
does not give us any comfort on HUL’s ‘inflation hedging ability’. We
continue to prefer ITC and Godrej Consumer as our preferred picks.
Rising input costs create margin headwinds
After moderate cost inflation over the last 6 quarters (RM costs up 30 bps), the tide
has turned around on the input prices. Palm oil prices have risen 55% in the last 6-
months and current prices are already ~8% higher than the 2008 peak.
Prices of crude based chemical prices (LAB, Polyethylene, PET) are up 2-25% over
the last 6 months. Prices of agri commodities viz. Milk, and wheat etc have
witnessed only a moderate rise over the last 6 months (decline in case of sugar).
Competitive pressure imply a limited pricing power
While the input prices have been moving up rapidly, the brand-owners have taken a
very few product price hikes. Given the fact that RM costs account for 35-50% of
net sales, we estimate that the companies will need to take 3-5% weighted average
product price hike; much higher for soap business.
While the higher input costs would feed thru into P&L completely only after 2
quarter’s lag (due to inventory effect & the forward cover), we note that except
Marico, none of the companies have taken any meaningful product price hike since
July’10. Possibility of a negative margin surprise exists even in 3QFY11.
Historical analysis highlights that HUL is no inflation hedge
Our analysis of 6 periods of rising inflation in the last decade reveals that Godrej
Consumer and Marico have outperformed in 5 out of those 6 and HUL has
outperformed only once.
Fundamentally, we note that the consumer sector can become an inflation hedge
only competitive pressures ease, in which case, the players could also lower the
advertisement and promotional (A&P) expenditure as a % of net sales which is near
its all time high. But this appears unlikely in the near-term.
Prefer ITC and Godrej consumer as preferred picks
We continue to like ITC and Godrej Consumer as the preferred picks. We note that
ITC does not face any specific input cost pressure aside from the potential hike in
the excise duties in the upcoming budget.
Godrej consumer is already down 8% over the last two months on higher palm oil
prices and is now the cheapest FMCG stock under coverage.
We would avoid Hindustan Unilever as the company’s aggressive stance to gain
volume growth / market share could adversely impact its margins negatively
Our analysis of 6 periods of rising inflation (highlighted by blue bars in the
chart above) in the last decade reveals that Godrej Consumer and Marico
have outperformed in 5 out of those 6 and HUL has outperformed only once.
Fundamentally, we note that the consumer sector can become an inflation
hedge only competitive pressures ease, in which case, the players could also
lower the advertisement and promotional (A&P) expenditure as a % of net
sales which is near its all time high. But this appears unlikely in near-term.
We however note that in case of mid caps, there have been positives like
market share gains etc. which may have also helped the stock performance
given the superior earnings growth. However, with market share base
becoming high, significant upsides from share gains in case of mid caps may
be limited in our view.
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