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Consumer Staples
Equity Research
Margin pressure unlikely to ease given input costs and competition
Cost pressures remain high for FMCG companies
We observe limited relief from cost pressure in key cost items for FMCG
companies. After some respite in July, prices of PFAD, LAB, and coffee
have firmed up in recent weeks. On a yoy basis, prices of PFAD, LAB and
coffee are up 24%, 29% and 67%, respectively, thus far in 2QFY12
compared to 2QFY11. This has led to most companies taking price hikes in
detergents, soaps, and coffee by 10%-30% over the past twelve months.
Cost pressures leading to tough tightrope between volume growth
and margins
While price increases partly mitigate cost-push inflation, the recent investor
release by Marico indicates consumer companies are faced with a choice
between protecting operating margins and retaining customer franchise. We
believe persistent price increases could hamper volume growth and lead to
down-trading, as observed in late 2008. Marico indicated that it is becoming
increasingly difficult to pass on further price increases to customers as they
also face pressure from inflation and high interest costs. In addition, HUL cut
prices of 3.8 kg pack of Surf Excel Blue by 21% (as reported by CNBC TV18
on Sept. 13), indicating competitive action to gain market share as this price
action is not accruing from lower raw material costs, in our view.
Inflationary pressure increasing distribution costs as well
We also expect inflation – especially in fuel and labor – to affect
distribution costs. Our visits to Coimbatore and Ahmedabad indicate
pressure on distributors’ profitability as they also face increased pressure
from higher interest costs. Recent media articles (eg, Business Standard,
Economic Times, Sept 4) indicate companies are offering slightly better
terms to distributors to help promote their products more effectively.
Current valuations offer little room for error
Current sector valuations, at 31X FY12E EPS, imply optimal demand and
potential margin expansion should cost pressures ease. However, we believe
intense competition could mean that lower input costs will need to be
passed on to customers more quickly, thus limiting margin expansion. We
reiterate our Sell rating on HUL and Nestle as we believe valuations are
factoring in expectations of strong earnings growth. Key risks: upside –
sudden decrease in input costs, drop in competitive intensity; downside –
sustained copra prices, significant down-trading
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Consumer Staples
Equity Research
Margin pressure unlikely to ease given input costs and competition
Cost pressures remain high for FMCG companies
We observe limited relief from cost pressure in key cost items for FMCG
companies. After some respite in July, prices of PFAD, LAB, and coffee
have firmed up in recent weeks. On a yoy basis, prices of PFAD, LAB and
coffee are up 24%, 29% and 67%, respectively, thus far in 2QFY12
compared to 2QFY11. This has led to most companies taking price hikes in
detergents, soaps, and coffee by 10%-30% over the past twelve months.
Cost pressures leading to tough tightrope between volume growth
and margins
While price increases partly mitigate cost-push inflation, the recent investor
release by Marico indicates consumer companies are faced with a choice
between protecting operating margins and retaining customer franchise. We
believe persistent price increases could hamper volume growth and lead to
down-trading, as observed in late 2008. Marico indicated that it is becoming
increasingly difficult to pass on further price increases to customers as they
also face pressure from inflation and high interest costs. In addition, HUL cut
prices of 3.8 kg pack of Surf Excel Blue by 21% (as reported by CNBC TV18
on Sept. 13), indicating competitive action to gain market share as this price
action is not accruing from lower raw material costs, in our view.
Inflationary pressure increasing distribution costs as well
We also expect inflation – especially in fuel and labor – to affect
distribution costs. Our visits to Coimbatore and Ahmedabad indicate
pressure on distributors’ profitability as they also face increased pressure
from higher interest costs. Recent media articles (eg, Business Standard,
Economic Times, Sept 4) indicate companies are offering slightly better
terms to distributors to help promote their products more effectively.
Current valuations offer little room for error
Current sector valuations, at 31X FY12E EPS, imply optimal demand and
potential margin expansion should cost pressures ease. However, we believe
intense competition could mean that lower input costs will need to be
passed on to customers more quickly, thus limiting margin expansion. We
reiterate our Sell rating on HUL and Nestle as we believe valuations are
factoring in expectations of strong earnings growth. Key risks: upside –
sudden decrease in input costs, drop in competitive intensity; downside –
sustained copra prices, significant down-trading
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