India Consumer Two to Buy and Two Less ::Morgan Stanley Research

India Consumer
Two to Buy and Two Less
Preferred
Stock selection has proved important in the Indian
consumer segment to generate outsized returns. As
macro tailwinds wane, we believe the key is to
remain focused on earnings growth and the
visibility thereof. We expect investors to pay a
premium for operating margin expansion hereon.
Industry fundamentals are deteriorating… The
tailwinds of past 18 months seem to be waning. These
include input costs, competitive intensity, share gains for
large consumer companies in India vs. regional players,
pricing power and product mix improvement. Our F14
bear case for the consumer segment incorporates low
pricing growth amidst sluggish volume growth driving
single-digit revenue growth. This suggests lower-
than-expected margin expansion as gross margin
flexibility is offset by higher ad-spends/promotions.
…ITC (OW) and Dabur (OW) are stocks to own…
where consensus has increased earnings estimates
YTD, albeit marginally. We expect ITC and Dabur to be
key beneficiaries of our stock selection criteria, with
F14e earnings growth likely above the industry average.
Although multiple expansion may be limited hereon,
both stocks should track earnings growth, in our view.
…Titan (UW) and JUBI (EW) are less preferred: YTD,
consensus earnings estimates for Titan have been cut
by 9% and for JUBI by 19% – and both have
underperformed the Sensex by 13-14% YTD. We
remain concerned about revenue growth (sluggish SSG
for F14e), low productivity of new stores added, and
operating margins that may be materially weaker than
consensus estimates (inferior product mix, weak operating
leverage, and increased sales promotions). We believe
that recent sluggish growth trends in the case of JUBI,
and policy changes in the case of Titan, may compel
long-term investors to re-think their investments

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Indian Consumer – Stock Selection Key to Generating Returns in F14
Industry fundamentals seem to be deteriorating....
• Input cost trends are moderating: On a sequential
basis, all consumer companies are witnessing
moderation in input costs (Exhibit 1). However,
recent INR depreciation trends will likely crimp the
consensus outlook for material F14 gross margin
expansion.
• Relatively stable cost environment is good news for
the industry: A sharp fall in input costs amid sluggish
volume growth may catalyze aggressive price-led
competition across product categories, we believe.
• Competitive intensity may rise: Consumer
companies in our coverage remain focused on
‘growing ahead of market’. In an environment of
relatively sluggish volume growth (Exhibit 2), the
initial reaction would be to increase advertisement
and sales promotions. This may catalyze another
round of elevated competitive intensity.
• Weak pricing: With input costs moderating amidst
relatively sluggish volume growth, pricing growth is
likely to remain muted for the next 2-3 quarters, we
believe. Any increase in input costs will be offset by
lower promotions, we believe.
• Product mix: Anecdotal evidence and channel
checks suggest that there are initial signs of
consumer down trading emerging, even as volume
growth in high-margin categories, such as skin
care, remains under pressure.
• Margin expansion could be lower than expected: In
the event that volume growth trends remain
sluggish, the combination of weak pricing and
product mix deterioration can drive margin
expansion lower than our, and, indeed, market,
estimates, we believe.
Strong performance for India consumer staples over past
18 months… Following strong broad-based industry
performance in 2012 (14% outperformance of MS India
consumer coverage vs. Sensex), the segment again
outperformed by 10% in 1H2013. However, trends with
individual stocks have been mixed (Exhibit 5). Stock selection
has proved important to generate outsized returns, and we
expect this to continue through F14.
…however, industry fundamentals seem to be
deteriorating… These include input costs, competitive
intensity, share gains for large consumer companies in India
vs. regional players, pricing power and product mix
improvement.
… With the following as our bear case scenario… With
waning macroeconomic tailwinds and increased competition
from regional/unorganized players, we expect volume growth
in most consumer categories to be relatively sluggish. This,
combined with weak pricing power and anecdotal evidence of
consumer down trading, could imply single-digit revenue
growth for the industry. In addition, operating margin
expansion may be lower than our and market estimates.
Management of large consumer companies remains focused
on ‘growing ahead of market’. In an environment of relatively
sluggish volume growth, the initial reaction would be to
increase advertisement and sales promotions. This may
catalyze another round of elevated competitive intensity, we
believe.
…leading us to focus on these key themes:
• Businesses entrenched in high-growth categories
• Businesses facing low competitive threat and with
relatively niche-oriented product offerings
• High visibility for long-term earnings growth