India - FMCG:: Who gains if RM cost reduction sustains? ::IIFL

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Costs of commodities, especially crude oil and palm oil, have
corrected meaningfully in the past few weeks. We would wait
for the corrections to sustain before factoring them into our
estimates. However, if there is a sustained reduction, the key
beneficiaries would be home and personal-care companies
that have high pricing power and would not need to
undertake price cuts. In our recent detailed FMCG sector
report, The hyper-competition threat, we highlighted the
following home and personal-care companies with high
pricing power: Emami, Godrej Consumer and Marico. These
companies could see sustained margin gains if commodity
costs settle lower. Hindustan Unilever (HUL) would also gain
in the near term, though intensified competition in
detergents and soaps would force price cuts and higher
marketing spends.
Crude, palm oil prices come off significantly: The c15% fall in
crude prices over the past few weeks would reflect in crude
derivative prices if crude prices remain at the current level. Prices of
key FMCG derivative inputs, LAB and liquid paraffin, rose
significantly, by 25-40%, in the past six months. Prices of packaging
material did not rise as fast, increasing only 5-15% in this period,
despite it being a crude derivative. Palm oil is also down c16% from
the March quarter 2011 average; this would put downward pressure
on other edible oils and copra.
Home and personal-care companies could gain – Emami,
Marico, HUL key beneficiaries: Crude derivatives or oils form a
significant portion of raw material for all home and personal-care
categories; their prices increased significantly over the past six
months. These commodities contribute the most to raw material
costs of soaps, detergents and hair-oil categories. Packaging costs
did not rise substantially over the six-month period and hence, price
correction could be smaller than that for other crude derivatives. We
expect the soaps, detergents and hair-oil categories to benefit the
most from easing of commodity costs. Emami, Marico and HUL have
the highest share of crude linked commodity costs at 40-60% of
their total raw material mix.
High pricing power key to sustained margin gains – Emami,
Marico, GCPL best positioned: Companies with high pricing power
would not need to pass on price cuts in line with reduction in costs;
hence, in the event of fall in commodity prices, margin gains would
sustain. Emami, Marico, Colgate and Godrej Consumer, with
relatively higher pricing power, would be able to sustain their margin
gains if commodity prices remain low.
HUL would gain in the near term, but benefits unlikely to
sustain, owing to competitive intensity: Proportion of crudelinked
raw material cost is one of the highest for HUL. Thus, it would
gain in the near term if these costs fall. However, in the soap and
detergent categories, competition would intensify from aggressive

competitors such as P&G and ITC and unorganised players that
typically halt operations in a scenario of higher commodity prices.
Thus, HUL would need to pass on most of the correction in the form
of price cuts. It would also need to increase advertising and
promotion spend. HUL was able to lower advertising and promotion
spend in the past two quarters, with competitors’ spend also being
lower.


Correction to reflect in P&L with lag of at least a few months:
Even a sustained fall in costs will take at least 2-3 months to reflect
in P&Ls, as most companies have minimum forward covers of that
duration. Most companies have indicated that they are not carrying
larger-than-normal inventory or forward covers.