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Consumer Goods Q2FY19 preview - First signs of cost pressure to weigh on margins

Consumer goods –  Demand environment stable, input costs inching up

FMCG companies started FY19 on a healthy note, with an uptick in volume growth in 1QFY19, aided by pick up in underlying demand and a favourable base, given the destocking prior to GST implementation in 1QFY18.  With underlying demand trend stable, we estimate mid-to-high single-digit volume growth within the FMCG sector (our coverage universe) in Q2FY19. Volume growth seems moderate compared to 1QFY19, as the base has begun to normalise (2QFY18 saw restocking post GST implementation) since this quarter. Rising input costs especially crude and crude-linked commodities (LAB, PE, LLP) led to an inflationary trend, which could sequentially impact gross margins. However, selective price hikes, focus on premiumisation and benign palm oil prices (down ~18% yoy) should offset the impact from gross margins for HPC players. Agri commodities like copra have seen price moderation, which should aid gross margins for Marico on a sequential basis. Also, prices of milk and skimmed milk powder (SMP) remain benign, which will continue to benefit food players like Nestle, in our view. We do not expect advertising spends to moderate, despite the inflationary trend in input costs, driven by improving demand and likely price increases. Pace of new launches too is expected to increase, as we expect investments behind core brands to continue.. For stocks within our coverage (ex-ITC), we estimate sales, EBITDA and PAT growth of 11%, 14% and 14% yoy, respectively, for Q2FY19. We expect Nestle and HUL to outperform with strong 31% and 18% yoy earnings growth, respectively, during the quarter led by consistent volume growth and continued improvement in in operating margins.

Alcoholic beverages – Healthy volume growth; mixed margin trajectory

We expect Alcoholic beverage players to report strong volume growth on a favourable base (highway ban impact in July/August 2018), stable demand scenario as well as continued benefit of route-to-market change in UP. Gross margins of IMFL players should continue to expand on improved mix, price hikes and stable input costs, though extent of expansion will moderate, as favourable scenario is now in the base too. Higher barley costs will result in higher cost inflation for beer companies as compared to Q1. We estimate of 8% yoy volume growth in United Spirits, aided by a double-digit volume growth in Prestige & Above segment. While price/mix benefit will aid gross margins, however, EBITDA margins will be lower due to higher A&P spends and a high base, resulting in 5% yoy EBITDA growth. Lower interest cost would translate into 11% yoy PAT growth. For United Breweries, we have factored in 10% volume growth on a favourable base and stable demand in key markets. However, margin expansion looks unlikely, considering that higher input costs are partially offset by price hikes and a favourable state mix. We have factored in flat EBITDA margin and expect lower interest cost to drive 23% yoy PAT growth.

Retail – A mixed bag

We are factoring in mid to single-digit LTL sales growth for Shoppers Stop, which coupled with improved mix and cost control measures should result in 10%/35% yoy EBITDA/PAT growth. Titan’s jewellery division is likely to see strong revenue growth on a favourable base in July, continued market share gains from new launches and extended diamond-studded activation. We have factored in 27% revenue growth (30% sales growth in Jewellery business) and EBITDA/PAT growth of 20%/19%, respectively, for 2QFY19. SSSG growth to moderate for Shankara Building Products, largely on account of seasonality as well as impact of heavy rains in South India (Kerala/Karnataka). While the retail business is expected to post 30%+ revenue growth, channel/enterprise business should see muted performance, owing to lower credit business. Further weaker margins and higher interest costs will result in PAT to remain flat for the quarter.

Paints – Volume trajectory remains healthy, higher input cost to curtail earnings growth

We expect double-digit volume growth for paint companies in the decorative segment, aided by a stable demand environment as well as benefit of recent cut in GST rate for paints.  Further, price hikes in Mar 2018 (1.4%) and May 2018 (2.0%) will continue to propel overall revenues. While input costs are firming up on account of higher crude prices, as well as rupee depreciation, benefits from price hikes will curtail the impact on gross margins. We expect Asian Paints to report 13% yoy revenue growth, led by double-digit volume growth in the decorative segment. Berger Paints and Kansai Nerolac (KNPL) too are expected to report 15% and 16% yoy revenue growth, respectively, on continued volume outperformance in the decorative segment. However, Berger & KNPL will likely report lower PAT growth compared to Asian Paints, due to margin pressures in the industrial business.