A closer look at Raw Material trends and impact on staples :: JPMorgan

 Raw material price trends. Most of the raw materials that we follow
have been either stable or moderating over 3m/6m/12m period. Palm oil
and Crude, however, have started to inch up over the past month. Agri
commodities like sugar and wheat have been benign. On a y/y basis,
most commodities (wheat being an exception) are either stable or lower.

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 Impact on earnings. We try to assess the earnings sensitivity of
consumer companies to decline in key commodities like palm oil,
crude/edible oil derivatives, copra, sugar and wheat. Assuming there is
no change in volumes and product realizations, a 1% decline in raw
materials mentioned above could impact companies’ earnings by ~0.2-
0.7%. Most companies engage in some kind of hedging practices, which
will likely influence the impact and timing to some extent. Companies
more sensitive to decline in agri commodity prices are Nestle India, GSK
Consumer, HUL, GCPL, Marico (NR) and Dabur. Companies more
sensitive to decline in crude oil prices are HUL, Dabur and GCPL.
 We expect gross margins improvement to continue in 1HFY14
supported by moderate RM inflation outlook. On a y/y basis, rupee
depreciation is also likely to turn benign as base effect catches up. Gross
margin expansion surprised on the upside for most staple companies over
Mar’13 qtr led by benign RM inflation (steep decline for palm oil and
largely stable crude oil prices). Margins for food companies (Nestle India
and GSK Consumer) further benefited from higher realisations
 Much of the gross margin gains will likely be utilised for higher
brand investments. We have already started to see this with step up in
A&P spending by HPC players in FY13 offsetting some gross margin
gains. A lot will also depend on the pricing power of the companies.
Categories like soaps & laundry are witnessing more of the RM benefits
being passed to consumers in slowing volume growth environment;
however, segments like skin care, household insecticide and some
packaged foods could hold on to pricing better.
 Sector picks. Consumer staples sector has been a key outperformer YTD
with MSCI Consumer Staples index generating 15% returns supported
by relatively strong earnings delivery. Sector is currently trading at
higher end of its valuation band at 32x one yr forward P/E (25/35%
premium to its past 3/5 yr-average). We believe further re-rating is
unlikely from current levels and we prefer companies with higher
earnings surprise prospects, pricing power and/or limited competitive
risks. Our preferred picks are ITC (OW), Dabur (OW), UNSP (OW) and
GCPL (OW).