Marico:: Building in near-term stress:: Enam

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Building in near-term stress
Marico issued an investor update, cautioning investors against
excessive earnings forecast. The mgmt continues to remain
optimistic of the long-term growth prospect of the biz but wishes to
highlight short-term pains, especially over the next 1/2 qtrs.
Key takeaways from the investor update:
􀁺 “Copra’s bull run denotes a structural upward shift; may need
to reset the rules of the game” – The bull run in copra started in
May’10. Demand-supply imbalance & speculative interests have
resulted in ~83% increase in prices during CY11. We believe this
move is not structural in nature, similar to 2008, and prices
could soften in the flush season of Feb’12. Given the recent
decline in vegetable oil prices, we believe the demand-supply
imbalance in Copra will also be restored.
􀁺 “May not take any further increase in retail prices as it may
impact volume growth” – Despite the 32% YTD price hike in
Parachute (~30% of sales), there has been a shortfall in covering
cost inflation. Further price increases in the segment is fraught
with risk of muted volume growth, which is still in the nascent
stage of recovery. Hence, a cap on price hikes will impact margin
recovery in the short run. We have build in 13% vol. growth in
FY12E (vs. 11% in FY11) for the domestic business; while we
have factored in a 125 bps YoY decline in EBITDA margin for
FY12E due to input cost pressure.
Use this continued weakness as an entry opportunity
In view of the near-term pain and continued high input prices, we
have lowered our earnings ests by 8% for FY12E & 7% for FY13E.
Consequently, the TP has been lowered to Rs 140 (earlier: Rs 156).
The 12% price correction, on cautious guidance from mgmt, has not
yet brought the stock to attractive levels. But we believe, further
correction from this point on or weak Q2FY12 should be used as an
opportune entry point. We maintain our HOLD rating.


Parachute (~30% of sales) volumes are expected to be steady in FY12E: Despite the 32%
YTD price hike in Parachute, 1QFY12 volume grew 10% YoY. The volume growth is
expected to remain steady as: (1) consumer preference remains sticky amongst hair oil
categories i.e. Coconut, Amla, Cooling & Almond; (2) Parachute still is the cheapest hair oil
amongst other hair oil categories; (3) the absolute price increase of Rs 7 for a 100 ml pack
(earlier priced at Rs 20) is not significant in the context of monthly grocery budget. In our
opinion, Parachute volume is expected to grow by 11% YoY in FY12E, in-line with 10%
volume growth in FY11.


􀁺 Copra prices likely to trend lower (~40% of RM cost): Copra prices has corrected 10%
from its Jan’11 peak but is still ~83% higher YoY for CY11. The surge in demand for
coconut oil could be attributed to a switch of Palm kernel oil users to coconut oil (for
cooking purpose), as the price differential between the two has narrowed down, even
though supply of copra has been steady. Similar demand-supply imbalance was
noticed in 2008 when crude oil peaked at USD 147. We believe there is a high
probability that this temporary imbalance will be reset in H2FY12E, as coconut oil
premium to palm kernel oil is close to the historical low (refer chart). Edible oil prices
are trending weak, with Sunflower oil (􀂾 3%) & Palm kernel (􀂾 22%) having corrected
from their recent peak in Jan/Feb’11. We have modeled a 230 bps decline in gross
profit margin (to 40.5%) for the domestic business in FY12E. Further, we believe there
remains a probability of margin improvement in H2FY12E.