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India Consumer
Market Still Too Optimistic
Sustained cost pressures, heightened competitive
intensity and risks to revenue growth drive our
below consensus earnings estimates for HPC
companies in India. We downgrade Dabur to EW
and reiterate UW on HUL.
2011 is different from 2008, in our view. In 2008,
companies raised prices ahead of cost increases and
did not lower prices in line with subsequent falls in raw
material prices leading to significant margin expansion
of ~160bps in F10. For 2011, price increases appear to
be lagging cost pressures while competition continues to
be intense. We believe it will be difficult for the
aggregate sector margins to rise even when input costs
eventually decline; we forecast marginal decline in
aggregate sector margins (ex ITC) in F2012 versus
market expectation of over 50bps increase.
What prevents us from turning more positive:
Rising raw material costs: Our MS Input Cost Index is up
23% in Q4F11 vs. Q4F10 and up 14% YoY in FY11.
Price increases lag cost pressures: Our proprietary
research suggests HUL has made only ~25% of the
price increase necessary to offset cost pressures.
Sustained competitive intensity: We are seeing
consumer companies in India increasing investment
behind brands through new product launches and
aggressive marketing initiatives especially in skin, hair
and food & beverage categories.
High inflation expectations: Consumer sentiment in India
appears strong, but if inflation persists, we see risk to
consensus and our revenue growth estimates.
MSe below consensus earnings expectations: The
stocks are discounting a rapid fall in input costs and
subsequent increasing in F2012 margins; we think this is
too optimistic in the current inflation scenario amid
limited pricing power. Our earnings estimates for HUL
and Dabur are ~5-7% below consensus. On rolling 12m
earnings, HUL is trading at 27.4x (versus long term
average of 25.9x) and Dabur trades at 24.8x (versus
long term average of 20.3x).
Investment Case
Key Debate: Margin progression in F12 for domestic
consumer companies.
Market View: Markets are focused on Revenue growth and
seem to view current cost and competitive pressures as only
cyclical speed bumps in the promising Indian consumption
opportunity. Stocks are discounting a rapid fall in input costs
and subsequent increasing in F2012 margins
Our View: 1) 2011 is different from 2008 when Indian
consumer companies often made price increases ahead of
cost pressures and did not lower prices in line with
subsequent falls in raw material prices, driving significant
margin expansion. In the current round of input cost inflation,
price increases are calibrated and they continue to lag input
cost pressures. 2) Competitive intensity is likely to sustain, It’s
driven by players with deep pockets and long-term
commitments to Indian markets. We are seeing consumer
companies in India increasing investment behind brands
through new product launches and aggressive marketing
initiatives especially in skin, hair and food & beverage
categories 3) Market expectation for earnings for domestic
consumer companies may be aggressive, we believe. Even if
inflationary cost pressures alleviate, margins are unlikely to
expand in the current environment of intense competition.
4) Consumer sentiment in India appears strong, but if inflation
persists, we see risk to consensus and our revenue growth
estimates
Where we could be wrong: We may be proven wrong if 1)
consumer markets in India expand rapidly allowing new
players to compete across product categories. 2) Companies
shift focus to revenue growth and are able to manage near
term profitability through potential sharp fall in input costs.
However, even if our concerns eventually prove exaggerated,
based on current pricing power, margins are unlikely to
expand meaningfully and current valuations leave little room
for outperformance, in our view.
We downgrade Dabur to EW with a target price of Rs105
(Rs115 earlier) and reiterate our UW rating on HUL with a
target price of Rs223 implying a 21% downside from current
levels. HUL has underperformed ITC by ~18% over the past 3
months and we expect this underperformance to continue. We
recommend ITC over HUL and a basket of stocks that are
levered to disposable income growth with relatively low
competitive intensity. Nestle, United Spirits and Cox & Kings
(all OW) are our top picks. We await a better entry opportunity
in GCPL (EW).
Input cost pressures continue to rise: MS Input Cost Index
(ICX) rose 23% in Q4F11 vs. Q4F10 with edible oils, copra,
menthol and coffee prices driving the index higher YoY,
despite some moderation in prices in March 2011. MS ICX is
up 14% YoY in FY11e. MS HUL ICX is up 19% YoY in 4Q and
is up 9% YoY in FY11e. Though Palm oil prices have
moderated sequentially in Feb & March (down 15% in 2
months), prices are up ~55% YoY in Q4F11), both soda ash &
LAB prices have moved up sharply in the last couple of
months. Soda ash prices are up 65% since December 2010,
while LAB is up 17%.
Price increases continue to lag cost pressures: Our
proprietary research on company-specific input cost
pressures and product price increases indicate that HUL has
made only ~25% of the price increases necessary to offset
cost pressures.
Competitive pressures continue to be intense: Consumer
companies in India are increasing investment behind brands
through new product launches, aggressive marketing
initiatives and re-launches. Some recent activities in the
market include: 1) HUL’s launch of fruit juice and soya based
beverages; 2) Coca-Cola’s Minute Maid brand extension to
fruit juices; 3) P&G is offering Pantene sachets now at Re1 (vs.
Rs1.5 earlier); and 4) Garnier’s launched Light Ultra, a
fairness cream designed and developed in India.
According to Business Line, HUL’s market share in Shampoo
segment declined by 130 bps for Jan-Feb 2011 even as P&G
gained 240 bps. As consumers evolve, increasingly more
categories and sub segments will likely emerge within the
staples space. Unless incumbents are able to match new
product development and category evolution, it will be difficult
to maintain market share, in our view.
MSe below consensus: Market expectations, in our view,
are anchored to a rapid fall in input costs and consequent
rising margins for F12 – assumptions we find aggressive in the
current inflation scenario amid limited pricing power. Our
earnings estimates for HUL and Dabur are 5-7% below
consensus for F12.
Inflation – Key Headwind for Consumption in India: Our
Macro team expects inflation to remain high in 2011.
Consumer sentiment in India appears strong yet if inflation
sustains, consumer adjustment thereon will likely constrain
consumption growth, we believe. Market and indeed our
expectation for revenue growth may prove to be aggressive.
Over the past 16 quarters, aggregate operating margins for
Indian consumer stocks have exhibited a strong negative
correlation with the WPI inflation index.
How do the stocks perform? We identify five period of rising
inflation over the past decade. Contrary to market perception,
we observe that home growth FMCG companies in aggregate
perform better than large multinationals during these periods.
The following disclaimer is required: Morgan Stanley is
currently acting as financial advisor to The Procter & Gamble
Company ("P&G") with respect to P&G's announced merger
of its Pringle's business into Diamond Foods, Inc. ("Diamond")
pursuant to a split-off.
The proposed offer is subject to the consummation of the
exchange offer to exchange shares of P&G for shares of
Diamond, required regulatory approvals and other customary
closing conditions. This report and the information provided
herein is also not intended to provide advice with respect to
the exchange offer, (ii) serve as an endorsement of the
exchange offer, or (iii) result in the procurement, withholding
or revocation of a tender in the exchange or any other action
by a security holder.
P&G has agreed to pay fees to Morgan Stanley for its services,
including transaction fees that are subject to the
consummation of the proposed transaction.
Please refer to the notes at the end of the report.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Consumer
Market Still Too Optimistic
Sustained cost pressures, heightened competitive
intensity and risks to revenue growth drive our
below consensus earnings estimates for HPC
companies in India. We downgrade Dabur to EW
and reiterate UW on HUL.
2011 is different from 2008, in our view. In 2008,
companies raised prices ahead of cost increases and
did not lower prices in line with subsequent falls in raw
material prices leading to significant margin expansion
of ~160bps in F10. For 2011, price increases appear to
be lagging cost pressures while competition continues to
be intense. We believe it will be difficult for the
aggregate sector margins to rise even when input costs
eventually decline; we forecast marginal decline in
aggregate sector margins (ex ITC) in F2012 versus
market expectation of over 50bps increase.
What prevents us from turning more positive:
Rising raw material costs: Our MS Input Cost Index is up
23% in Q4F11 vs. Q4F10 and up 14% YoY in FY11.
Price increases lag cost pressures: Our proprietary
research suggests HUL has made only ~25% of the
price increase necessary to offset cost pressures.
Sustained competitive intensity: We are seeing
consumer companies in India increasing investment
behind brands through new product launches and
aggressive marketing initiatives especially in skin, hair
and food & beverage categories.
High inflation expectations: Consumer sentiment in India
appears strong, but if inflation persists, we see risk to
consensus and our revenue growth estimates.
MSe below consensus earnings expectations: The
stocks are discounting a rapid fall in input costs and
subsequent increasing in F2012 margins; we think this is
too optimistic in the current inflation scenario amid
limited pricing power. Our earnings estimates for HUL
and Dabur are ~5-7% below consensus. On rolling 12m
earnings, HUL is trading at 27.4x (versus long term
average of 25.9x) and Dabur trades at 24.8x (versus
long term average of 20.3x).
Investment Case
Key Debate: Margin progression in F12 for domestic
consumer companies.
Market View: Markets are focused on Revenue growth and
seem to view current cost and competitive pressures as only
cyclical speed bumps in the promising Indian consumption
opportunity. Stocks are discounting a rapid fall in input costs
and subsequent increasing in F2012 margins
Our View: 1) 2011 is different from 2008 when Indian
consumer companies often made price increases ahead of
cost pressures and did not lower prices in line with
subsequent falls in raw material prices, driving significant
margin expansion. In the current round of input cost inflation,
price increases are calibrated and they continue to lag input
cost pressures. 2) Competitive intensity is likely to sustain, It’s
driven by players with deep pockets and long-term
commitments to Indian markets. We are seeing consumer
companies in India increasing investment behind brands
through new product launches and aggressive marketing
initiatives especially in skin, hair and food & beverage
categories 3) Market expectation for earnings for domestic
consumer companies may be aggressive, we believe. Even if
inflationary cost pressures alleviate, margins are unlikely to
expand in the current environment of intense competition.
4) Consumer sentiment in India appears strong, but if inflation
persists, we see risk to consensus and our revenue growth
estimates
Where we could be wrong: We may be proven wrong if 1)
consumer markets in India expand rapidly allowing new
players to compete across product categories. 2) Companies
shift focus to revenue growth and are able to manage near
term profitability through potential sharp fall in input costs.
However, even if our concerns eventually prove exaggerated,
based on current pricing power, margins are unlikely to
expand meaningfully and current valuations leave little room
for outperformance, in our view.
We downgrade Dabur to EW with a target price of Rs105
(Rs115 earlier) and reiterate our UW rating on HUL with a
target price of Rs223 implying a 21% downside from current
levels. HUL has underperformed ITC by ~18% over the past 3
months and we expect this underperformance to continue. We
recommend ITC over HUL and a basket of stocks that are
levered to disposable income growth with relatively low
competitive intensity. Nestle, United Spirits and Cox & Kings
(all OW) are our top picks. We await a better entry opportunity
in GCPL (EW).
Input cost pressures continue to rise: MS Input Cost Index
(ICX) rose 23% in Q4F11 vs. Q4F10 with edible oils, copra,
menthol and coffee prices driving the index higher YoY,
despite some moderation in prices in March 2011. MS ICX is
up 14% YoY in FY11e. MS HUL ICX is up 19% YoY in 4Q and
is up 9% YoY in FY11e. Though Palm oil prices have
moderated sequentially in Feb & March (down 15% in 2
months), prices are up ~55% YoY in Q4F11), both soda ash &
LAB prices have moved up sharply in the last couple of
months. Soda ash prices are up 65% since December 2010,
while LAB is up 17%.
Price increases continue to lag cost pressures: Our
proprietary research on company-specific input cost
pressures and product price increases indicate that HUL has
made only ~25% of the price increases necessary to offset
cost pressures.
Competitive pressures continue to be intense: Consumer
companies in India are increasing investment behind brands
through new product launches, aggressive marketing
initiatives and re-launches. Some recent activities in the
market include: 1) HUL’s launch of fruit juice and soya based
beverages; 2) Coca-Cola’s Minute Maid brand extension to
fruit juices; 3) P&G is offering Pantene sachets now at Re1 (vs.
Rs1.5 earlier); and 4) Garnier’s launched Light Ultra, a
fairness cream designed and developed in India.
According to Business Line, HUL’s market share in Shampoo
segment declined by 130 bps for Jan-Feb 2011 even as P&G
gained 240 bps. As consumers evolve, increasingly more
categories and sub segments will likely emerge within the
staples space. Unless incumbents are able to match new
product development and category evolution, it will be difficult
to maintain market share, in our view.
MSe below consensus: Market expectations, in our view,
are anchored to a rapid fall in input costs and consequent
rising margins for F12 – assumptions we find aggressive in the
current inflation scenario amid limited pricing power. Our
earnings estimates for HUL and Dabur are 5-7% below
consensus for F12.
Inflation – Key Headwind for Consumption in India: Our
Macro team expects inflation to remain high in 2011.
Consumer sentiment in India appears strong yet if inflation
sustains, consumer adjustment thereon will likely constrain
consumption growth, we believe. Market and indeed our
expectation for revenue growth may prove to be aggressive.
Over the past 16 quarters, aggregate operating margins for
Indian consumer stocks have exhibited a strong negative
correlation with the WPI inflation index.
How do the stocks perform? We identify five period of rising
inflation over the past decade. Contrary to market perception,
we observe that home growth FMCG companies in aggregate
perform better than large multinationals during these periods.
The following disclaimer is required: Morgan Stanley is
currently acting as financial advisor to The Procter & Gamble
Company ("P&G") with respect to P&G's announced merger
of its Pringle's business into Diamond Foods, Inc. ("Diamond")
pursuant to a split-off.
The proposed offer is subject to the consummation of the
exchange offer to exchange shares of P&G for shares of
Diamond, required regulatory approvals and other customary
closing conditions. This report and the information provided
herein is also not intended to provide advice with respect to
the exchange offer, (ii) serve as an endorsement of the
exchange offer, or (iii) result in the procurement, withholding
or revocation of a tender in the exchange or any other action
by a security holder.
P&G has agreed to pay fees to Morgan Stanley for its services,
including transaction fees that are subject to the
consummation of the proposed transaction.
Please refer to the notes at the end of the report.
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