FMCG Sector Preview – Q3FY15 :: HDFC Securities

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Sector Preview:
No material change in demand environment; Y-o-Y revenue growth to remain soft, though could be slightly better than Q2, as we expect marginal
uptick in volume growth
Y-o-Y sales growth of FMCG companies in Q3FY15 could continue to remain soft, as there has not been any material change in the demand environment over the last
quarter. The gap between urban and rural growth continues to shrink, with rural growth persistently moderating. However, we expect the growth to be slightly better
than the previous quarter, since we expect a marginal uptick in the volume growth (expected to be company specific) due to improving consumer sentiments & declining
inflation (larger revival is expected in urban India). Consumer sentiments have started showing signs of improvement. However, early arrival of Festive season this fiscal
could negatively impact the growth to some extent in Q3. Companies like Dabur, Marico & Emami could witness healthy volume growth of 8-9%, while volume growth
for Colgate & HUL could be around 6%. Growth for Tata Global Beverages & Nestle could continue to remain subdued. ITC could also witness volume growth revival in its
non-cigarettes FMCG business, through its cigarettes business is likely to witness a sharp decline in volume growth (~6-7%)
Gross margins & OPM (Y-o-Y) to expand on the back of declining material cost
We expect most the FMCG companies to report an expansion in their gross margins on the back of decline in the raw material prices. Prices of some key inputs like
Crude, Palm oil, Menthol, LLP, TiO2, LAB, HDPE, VAM, etc have softened during the quarter (on Y-o-Y) and this is likely to benefit most of the FMCG companies. Lower
price of PFAD could benefit Godrej Consumer & HUL. However, the benefit would not be substantial as the companies are holding some inventories at higher prices.
Hence, the full benefit of input price correction would be visible from Q4FY15 onwards. Companies like Marico could witness margin contraction due to rise in the copra
prices (~38% Y-o-Y) during the quarter. Tea prices have also increased marginally on Y-o-Y basis.
Though lower material prices would result in OPM expansion, it would be limited and lower than expansion in gross margins, as we expect the companies to reinvest
some gains in their businesses as promotional spends to improve their volume growth. We expect the Ad spends to increase during the quarter on an overall basis.
Sector valuations not very cheap; likely to be market performer
The FMCG sector has underperformed the BSE Sensex in Q3FY15, rising by 1.8%, compared to 3.3% gains reported by BSE Sensex. The sector witnessed a decent rally
from mid Oct till first week of December 2014, but thereafter has witnessed profit taking. There are expectations that FMCG companies could report slightly better
numbers in Q3 compared to previous quarters due to improvement in consumer sentiments and falling inflation (which is expected to revive volume growth). Also the
profitability of the companies is expected to improve on the back of decline in the raw material prices.
We expect Q3 numbers to be in line with the street expectation and don’t see any positive surprises. Also the full benefit of the raw material price correction could be
visible from Q4FY15 onwards. Hence the margin improvement in Q3 is likely to be limited. We are cautiously optimistic on the overall sector and expect the sector to be
market performer due to its rich valuations. ITC has a substantial weightage (along with HUL) in the overall FMCG index. Companies like Nestle & HUL are already trading

at a significant premium. While HUL has been outperforming, ITC has underperformed on concerns of another round of possible hike in excise duty on cigarettes in the
upcoming union budget.
Better than expected Q3 and expectations of better numbers in Q4FY15 and in FY16 (due to revival in spending power) could result in a near term upside in the FMCG
stocks. However, expensive valuations are likely to cap the upmove. However, we also expect the downside to be limited in the event of negative surprises in Q3.

LINK
http://www.hdfcsec.com/Share-Market-Research/Research-Details/StockReports/3010669