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India Consumer
2QF11 - Sluggish Revenue
and Operating Profit Growth
Maintain Cautious Industry View: We see a
disconnect between industry fundamentals (where
intense competition threatens to disturb market share
equilibrium across categories) and the sector valuations
of Indian consumer companies, which are their highest
in four years (27x 1-yr fwd earnings vs. 4-yr average of
22x). The forward P/E for FMCG companies has
increased 14% in the past year. At current valuations,
we prefer stocks geared to disposable income growth
and where earnings are likely to surprise on the upside,
led by product mix driven margin expansion. United
Spirits and Nestle remain our top picks.
Morgan Stanley India Consumer (ex-ITC) delivers
adjusted net profit growth of 8% in Q2F11: Overall,
our consumer companies reported revenue, operating
profit and net profit growth of 18%, 15% and 17% vs. our
expectation of 18%, 14% and 13% respectively.
Key highlights from the Q2F11 result season:
1) Domestic FMCG sales (ex-ITC) grew by 12% YoY.
Nestle was the only company that surprised positively.
Ex-Nestle, domestic FMCG revenues grew by 9%
2) Gross margins contract by 110bps (Ex ITC) during
the Q2. Our proprietary input cost index has risen 7.4%
YoY in 1H11, with prices of palm oil up further 11.7%
over the past month. Higher input costs in an already
intensely competitive environment will continue to erode
operating margins of the HPC companies, we believe.
3) Operating profit margins declined by 120bps
(Ex ITC) even as reported advertising & promotion
expense to sales declined by 40bps during the quarter.
In our view, promotions were lower during the quarter in
response to rising input costs, while advertising
expenses continue to remain at elevated levels. Most
companies mentioned in their commentaries that they
had not witnessed any reduction in competitive intensity
and that managing cost increases was the key challenge.
HUL, Marico and Tata Global Beverages disappointed
with a decline in EBITDA in F2Q11.
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