Kotak Securities:: Consumer products India --Play it safe, still.

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Consumer products
India
Play it safe, still. We reiterate our cautious view on the consumer sector as
highlighted in our report ‘Play it safe’ dated October 1, 2010. The street appears
oblivious to potential earnings risks due to input cost inflation in a heightened
competitive environment, apart from potential deceleration in consumer demand
growth. A sector P/E multiple of 25XFY2012E provides no buffer either. We cut
earnings by 5-25% for FY2012E in our coverage universe and have no BUY
recommendations. Stocks with high earnings risk include HUL, Jyothy, Marico and TGB.
Our preferred picks are Asian Paints, Dabur, ITC and GSK Consumer.
Themes for FY2012E
We look at the major themes that will govern FY2012E, (1) gross margin pressure is a reality—
companies faced with high earnings risk are HUL, Jyothy, Marico, TGB, (2) impact of food inflation
on consumer demand is underestimated, particularly for the urban poor, in our view, (3) continued
interest of MNCs in India doesn’t augur well for incumbents and for profitable growth of the
sector and (4) cut in adspends could likely support margins, but not enough to support earnings
growth. Stay with companies with market leadership and reasonable pricing power.

Consumer demand is not parabolic!
In the backdrop of soaring food inflation, we note that incremental rural spends, including NREGA,
have likely plateaud—for the time being—which is an incremental negative for rural spends and
for the sector.

We highlight that the past three years have seen a confluence of factors which have likely aided
incremental spends on consumer products, (1) higher outlay on NREGA, (2) wealth effect due to
higher land prices, (3) benefits of farm loan waiver and (4) some benefits of the sixth pay
commission.

As we look into FY2012E, we highlight that most of these positive factors are in the base and
lower incremental spends has a potential to hurt demand for consumer products.

Any buffers? Yes, cut in adspends possible but not probable
Most companies are operating at peak adspend levels and could likely make up for the hit in gross
margins with savings in adspends. However, considering the increasing brand proliferation (5,000
new HPC brands, 900 new F&B brands in the past three years), we assign low probability for
companies’ ability to cut adspends without hurting their market shares and market positions.

3QFY11 preview—good volume growth (selectively) and gross margin pressure (everywhere)
Key considerations for Dec 2010 quarter would be good volume growth in discretionary segments
and gross margin pressure everywhere (unlike the Sep 2010 quarter). We expect sector sales
growth of 16% yoy (14% in Sep 2010, marginally higher in Dec due to seasonality), driven by
trade and consumer promotion-led volumes. We expect EBITDA margin contraction of 60 bps led
by HUL, GCPL, Marico, Dabur, TGB, and Jyothy. Performers likely to stand out are APNT, GSK, ITC,
and Titan. A late Diwali this year has likely aided discretionary spending in the December quarter.