FREE

FMCG: Q3FY20 preview - No signs of recovery

Volume growth recovery not visible yet

Overall consumption trends continued to remain weak, , in Q3FY20, with most staples players reiterating Q2FY20 commentary: a) Consumer sentiment remains weak with no early signs of recovery, b) rural growth moderates further, and, c) Food categories remain resilient compared to HPC segments. Moreover, delayed winter and anti-CAA protests, especially in North East India impacted certain categories/markets during the quarter. We expect volume growth for staples players to remain subdued in Q3FY20E too, with no signs of recovery despite the festive period. Within our coverage universe, HUL (indicated further moderation in rural markets and delayed winters), Marico (decline in hair oil segment) and Jyothy Labs have indicated volumes growth moderation due to weakness in rural markets. We expect Dabur (superior execution), Nestle (higher urban skew and presence in food segment), and GCPL (recovery in HI) to outperform with mid-single digit volume growth. We estimate 4% volume growth for HUL and Colgate, 1% volume decline for Marico and 2% growth in ITC’s cigarette volumes in Q3FY20E.

Input costs largely benign on yoy basis, uptick in palm oil and crude will be key monitorables

Input cost environment remained favourable for HPC players in H1FY20, led by benign crude/crude-linked commodities (PE, LLP) and palm oil prices. However, input costs have begun to firm up, given the sharp uptick in palm oil prices through Q3FY20 and of crude, more towards the end of Q3FY20. However, benefit of forward covers and low-cost inventory is likely to keep gross margins stable during the quarter. On the agri commodity front, copra prices were flattish yoy in Q3. However, Marico’s gross margins (factoring 320bps yoy expansion in Q3FY20E) will continue to benefit from low-cost inventory. However, gross margins of food players like Nestle could remain under pressure (factoring ~190bps yoy decline), impacted by higher milk and SMP prices, in our view.

GCPL, Dabur, Nestle and HUL likely  to perform better

Ex-ITC, we estimate Q3FY20E sales and EBITDA (including IND AS impact) growth of 4.1% and 9.3% yoy, respectively, within our coverage universe. HUL’s volume growth (at 4% yoy) too is expected to moderate sequentially, resulting in 4.5% yoy revenue growth, but, benign input cost, and control over other overheads should help the company achieve 15%/16% yoy EBITDA/PAT growth, respectively – highest in our coverage universe.

For Dabur too we have factored in ~4.4% revenue growth (5% domestic volume growth), which, coupled with moderate margin expansion will likely result in 10%/9% yoy EBITDA/PAT growth, respectively. GCPL will continue to outperform with 6% domestic volume growth (on expected recovery in HI segment) and recovery in Africa business. However, price cut in soaps will likely offset the positive, resulting in flat revenue growth. Despite decent performance in the international segment, EBITDA/PAT growth is likely to be flattish, considering the high margin in the base quarter.

While we expect Nestle’s volume-led revenue growth to continue, input cost pressures could result in low EBITDA growth of 2.6% yoy. With decline in volumes, we expect Marico’s revenue to decline by 1% yoy, however, benign input cost could result in EBITDA/PAT growth being higher at 10%/8.4% yoy, respectively. For ITC, we have factored in ~2% volume growth from cigarettes, which, coupled with price hikes and moderating costs could cause cigarette EBIT to post 7% yoy growth.

Recovery in jewellery division sales to drive earnings growth for Titan

We expect 9% revenue growth, led by 11% yoy growth in jewellery sales (wedding season demand), partially offset by flat sales in watches and 2% growth in the Eyewear business. Gross margin expansion could cause EBITDA growth to be higher at 18.7% for the quarter, despite higher promotions/consumer offers.

Our view

Overall, demand environment remains weak, with no signs of revival seen at the beginning of H2FY20. Given the challenging environment and with input costs inching up, we would stick to companies with better execution capabilities. HUL (ability to outperform peers in an uncertain environment), Nestle (highest skew towards urban consumption, strong NPD) and Dabur (power brand architecture and rural distribution expansion to aid growth) remain our top picks.