Religare: FMCG- Rising input costs to dampen prospects

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FMCG
Rising input costs to dampen prospects
We expect our FMCG coverage universe to report sales growth of 17.9% YoY in
Q3FY11, led largely by volumes. Operating margins, however, are projected to
decline 40bps, as input costs have inched up and brand building expenses remain
high due to strong competitive intensity in the sector. Adjusted PAT for our
coverage universe is likely to grow by 14.8% YoY. We maintain our positive
stance on ITC, Asian Paints, Dabur and Marico in staples and United Spirits
(UNSP) and Radico Khaitan (RDCK) in the alcoholic beverages space. We have a
SELL on Nestle, Emami, Colgate and GSK Consumer & Healthcare.

Overall, we maintain our cautious view on the Indian FMCG sector as its rich
valuations overshadow our optimism over the growth momentum in urban and
rural spending. High valuation multiples, following the outperformance over
the last two years, leave little scope for further upsides, in our view. Moreover,
as price hikes lag input costs increases, gross margins in the sector will likely be
pressurised. We advise buying on declines in strong business models and prefer
large cap stocks. We recommend selling mid caps on further rallies as
valuations appear heady and already factor in the strong growth.

Sales growth at 18% YoY for the quarter: We expect sales growth of 17.9% YoY
for our FMCG universe during the quarter, led by Godrej Consumer Products
(GCPL), United Breweries (UBBL), Emami, Britannia and Nestle. GCPL is likely to
report a 75.8% YoY increase in its topline mainly on account of inorganic growth
driven by Godrej Household Products (GHPL) and other global acquisitions.
Asian Paints, after a sluggish Q2, is expected to bounce back with a 20% growth,
while Hindustan Unilever (HUL) is likely to report a 9.5% growth on higher
volumes. ITC is set for a 17% growth in sales, with cigarette volumes likely to get
back to the positive territory from this quarter.

Operating margins to decline YoY: The operating margin for our FMCG universe
is likely to dip slightly by 40bps YoY, allowing for EBITDA growth of 15.8% 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
expected to report an 110bps decline in operating margins on account of higher
A&P expenses. We expect the sector to report an adjusted PAT growth of 14.8%
for the quarter. UBBL, RDCK, GCPL and Nestle are projected to report strong
PAT growth, whereas HUL’s profits are likely to remain flat YoY.

Valuations near top end of historical bands: FMCG stocks are trading near the
top-end of their historical valuation bands in terms of absolute P/E multiples. On
a relative basis, the sector is trading above the long-term average premium to the
market, though not at the top end. However, we expect market earnings growth
to accelerate; this would lower the likelihood of sector outperformance.