Consumer Products: Where are the price increases? : Kotak Sec

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Consumer products
India
Where are the price increases? The Street appears oblivious to potential earnings
risks due to input cost inflation in a heightened competitive environment. The Street
was expecting price increases by consumer companies in 2HFY11E, but we note that
the increases has been far and few. The past three years have seen a confluence of
factors which have likely aided incremental spends on consumer products. However, as
we look into FY2012E, we highlight that most of these positive factors are in the base
and lower incremental spends have a potential to hurt near-term demand for consumer
products. Our preferred picks are ITC, GSK and Titan.
Price increases are not in sight!
We reiterate our ‘Cautious’ sector view as (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.
While the Street was expecting price increases by consumer companies in 2HFY11E, we highlight
that the increases has been far and few. Few examples are the ~30% price hike in Parachute by
Marico, ~7% increase in Rin by HUL (in South and West India) and ~4-5% hike in HUL and GCPL
soaps portfolio.
Consumer demand is not parabolic!
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, (4) some benefits of the sixth pay commission
and (5) higher minimum support prices for agricultural produce. As we look into FY2012E, we
highlight that most of these positive factors are in the base and lower incremental spends have a
potential to hurt demand for consumer products.    
Consumer market is fragmenting...
Given the long-term attractiveness of Indian consumer categories, brand proliferation has been
accelerating, in our view. There are ~5, 000 new Home & Personal Care brands (including variants)
and ~900 new Food & Beverage brands launched in the past two years. In turn, this proliferation
raises adspends. Incumbents, particularly, are compelled to spend more to maintain their market
shares and relative market positions.
… and the leader has limited pricing power
Historically, HUL's pricing power had high correlation with inflation—this seems to have broken
down in CY2010. Hence, it will be dangerous to extrapolate the pricing power argument as the
competitive context has changed (1) P&G and L’Oreal are actively focusing on the Indian market,
(2) the erstwhile smaller Indian competition is not small anymore (Godrej which was one-twentieth
of HUL in 2000, is today one-fifth, Dabur is one-fifth from one-tenth, Nestle is one-fourth from
one-eighth)


Relative price/relative performance of the sector makes us cautious
Our analysis of relative earnings and the relative price between the sector and BSE-30 Index
indicates that either the sector valuations are running ahead of fundamentals or we could
see significant earnings upgrades. We believe it is the former. Exhibit 1 shows the consumer
sector (KIE coverage universe) relative price and earnings momentum versus BSE-30 Index.
Relative price is the index of our consumer sector coverage versus BSE-30 Index; relative
earnings are the indexed earnings of our consumer sector coverage versus BSE-30 Index
(with April-1993 as Base 100).