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FMCG: Q2FY20 preview - Further deceleration in volume growth

Volume growth to moderate further

With no signs of recovery in consumption, most staples players have indicated moderation in category growth, with volume growth expected to slow further qoq in Q2FY20E. Among players with higher skew towards rural markets, HUL indicated sharper deceleration in rural (compared to urban), in contrast to Dabur, which expects its rural business to register faster growth, largely on internal initiatives. Baring Godrej Consumer (GCPL), we expect volume growth for all companies within our coverage to moderate at low to mid-single digit (4-6%) in Q2FY20 versus Q1FY20. We expect Dabur, GCPL and Nestle to lead the staples pack with ~6% volume growth, followed by Marico with 5% volume growth. For HUL and Colgate we estimate 4% volume growth and for 3% for ITC’s cigarette segment, in Q2FY20E.

Input cost scenario benign, Marico key beneficiary; margin pressure in Nestle to continue

Input cost environment remains favourable for HPC players, given the moderation in crude (down 18% yoy) and crude-linked commodity (PE, LLP) prices, as also benign palm oil prices (down ~8% yoy). Lower input prices should support gross margins, though a high base and consumer offers could curtail yoy expansion. Agri commodity like copra has seen price uptick on a sequential basis, but is down ~14% yoy, which we believe will continue to aid Marico’s gross margins (factoring 350bps yoy expansion in Q2FY20E). However, gross margins of food players like Nestle could remain under pressure (~150bps yoy decline), impacted by higher milk and SMP prices, in our view.

Gross margin expansion, control over costs and IND AS benefit to aid EBITDA growth

Competitive activity in terms of consumer offers/promotions remains high, especially in categories like oral care, foods and soaps. We expect advertising spend as a percentage of sales to increase 50-90bps yoy for Marico, Dabur and Colgate, given the investments these companies have made behind new launches. For GCPL the adspends are lower as base quarter had higher investment behind new launches.  Benefit of favourable input cost, relatively lower increase in adspends, IND AS 116 and focus on cost efficiency should aid EBITDA margin expansion of most companies within our universe, baring Nestle.

Marico and HUL will likely continue to outperform.

Ex-ITC, we estimate Q2FY20E sales and EBITDA (including IND AS impact) growth of 5% and 14% yoy, respectively, for our coverage universe. Despite expected moderation in volume growth, we expect Marico to report strong 26%/18% yoy EBITDA/PAT growth, supported by benign input cost-led benefit. HUL’s volume growth too is expected to moderate sequentially, but, benign input cost, lower A&P and control over other overheads should help the company achieve 18% yoy EBITDA growth. For Dabur too, we have factored in ~7% revenue growth (6% volume growth), which coupled with moderate expansion in margin will likely result in 9%/6% yoy EBITDA/PAT growth. GCPL is expected to be one of the few companies to report higher 6% volume growth on expected recovery in HI segment. However, price cut in soaps and weak performance in Africa will likely offset the positive, likely causing 1% yoy revenue decline. However, lower A&P spend and margin expansion in the International business will likely boost EBITDA growth at 13% yoy in Q2FY20E. While we expect Nestle’s volume-led revenue growth to continue, input cost pressures could result in EBITDA growth being lower at 4% yoy. For ITC, we have factored in ~3% volume growth from cigarettes, which, coupled with price hikes and moderating costs could cause cigarette EBIT to post 6.9% yoy growth. ITC, HUL, Nestle and Colgate are likely to see sharp jump in yoy PAT growth, fuelled by lower tax outgo due to cut in corporate tax to 25.2% from 31-34% currently.

Muted jewellery division sales & adverse impact of hedges to drag Titan’s earnings

We expect flat revenue, led by 2% decline in jewellery sales (fall in consumer demand), caused by surge in gold prices and adverse impact of hedges matured in Q2. Sales growth in watch segment is expected to moderate to 7% yoy, with the Eyewear segment expected to post 28% yoy growth, led by promotions. Negative operating leverage could lead to 4% yoy EBITDA (IND AS) decline.

Our view

HUL (ability to outperform peers in an uncertain environment), Nestle (highest skew towards urban consumption, strong NPD) and Titan (market share gains in jewellery segment continues) remain our top picks. We continue to like Marico (urban portfolio doing well, coupled with deflationary input cost environment) and Dabur (power brand architecture and rural distribution expansion to aid growth).