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Consumer Goods Q3FY18 Preview - Favourable base led recovery

Consumer goods – Favourable base and demand recovery to drive earnings

We expect the FMCG sector (within our coverage universe) to report strong 8-16% volume growth in Q3FY18 benefiting from a favourable base, GST-led rate cuts and a sequential demand recovery. We estimate such growth even though some disruption in channels is expected to continue, especially in Home & personal care (HPC) categories, due to GST rate changes in November. While prices of select commodities (crude oil, LAB) are seeing some uptick, favourable price/mix and moderation in palm oil prices could result in stable to marginal improvement in gross margins for HPC players (HUL, Jyothy Labs, GCPL). While inflation in agri-commodities (copra) could adversely impact gross margins of Marico, moderation in milk and skimmed milk powder (SMP) prices will benefit food players like Nestle and Parag Milk Foods, in our view. With channel and GST-led disruption now behind us, we expect companies to increase investments in core brands and new launches, resulting in a gradual increase in advertising spends. However, benefit of operating leverage, GST-led savings as well as focus on driving cost efficiencies could result in EBITDA margins to improve in Q3. Overall, for Q3, we estimate sales, EBITDA and PAT growth of 12%, 21% and 21% yoy, respectively, for stocks within our coverage universe (ex-ITC). Baring Marico (where profitability is likely to be impacted most due to steep inflation in copra prices), we expect double-digit earnings growth for our consumer staples coverage universe in Q3FY18E.

Alcoholic beverages – Better quarter for IMFL than for beer

We expect improved comparable volume growth for IMFL players, aided by favourable base and receding impact of highway ban/GST-led disruption. Gross margins of IMFL players will sharply expand from improved mix, price hikes and favourable input cost scenario. For beer companies, minimal sales in Maharashtra for almost two months will impact sales and margins. United Spirits will likely post 8% yoy volume decline, impacted by operating model changes and the highway ban but the benefit of mix, price hikes and lower cost structure will result in 350bps EBITDA margin improvement. For United Breweries, we have factored in 5% yoy revenue growth with flat volumes impacted by limited sales in Maharashtra. With sale in Maharashtra now back to normalcy, we expect Q4FY18 to register strong growth.

Retail – A mixed bag

Apparel retailers had a strong October and December in the base with the demonetization impact being more in November. We expect a 5% Like to like (LTL) growth for Shoppers Stop and estimate 100bp margin improvement on overhead costs savings and superior product mix. For jewellery retailers, festive season demand, suspension of PMLA Act coupled with market share gains will drive revenue growth in Q3FY18. We expect Titan’s revenues to grow 14.5% yoy and expect jewellery revenues to increase 15% yoy (retail sales will continue to be high, however, primary sales are likely to be lower due to higher franchisee billing of Rs2.5bn in Q2FY18). Revenue growth in the Watches & Eyewear segment is expected to improve, aided by festive demand as well as benefit of reduction in GST rates. This growth coupled with benefit of operating leverage, could result in relatively higher EBITDA and PAT growth of 21% and 23% for Q3FY18, respectively.

Paints – Stable volume growth, margin pressure due to higher input costs

The impact of demonetisation on paint companies’ volume growth was not as severe as for FMCG players, given the former’s simplified distribution structures. We expect Q3FY18 volume growth to sustain at Q2FY18 levels on stable demand and factor in high single digit to low double digit decorative volume growth across paint companies. Furthermore, benefit of price hikes (~5.7%) in March and May will continue to aid overall revenue growth. While inflation in input costs (solvents, monomers) will continue to impact gross margins, benefit from strong leverage and control over costs will aid EBITDA margins during the quarter. We expect Asian Paints to report 15.5% revenue growth, led by low double-digit decorative volume growth and Kansai Nerolac to report strong 16% revenue growth, led by continued volume outperformance in the decorative segment and improved pricing in the industrial segment.