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Pakistan Consumer: Profitability down 16% YoY in Sep 2018

• Pakistan consumer companies (Staples & Discretionary) posted 16% YoY decline in profits, steepest in last five quarters, mainly due to poor performance of consumer staples. Staples profits fell 23% YoY in Sep 2018 Qtr (excluding PKGS). Our analysis is based on sample of listed firms with market capitalization of US$200mn and above.
• While overall sales grew by 4% YoY (staple sales flat) in Sep Qtr 2018, profits were down owing to contraction in gross margins which fell by 314bps YoY to 27%. Staples and discretionary GP margins fell by 259bps and 271bps to 34% and 15%, respectively.
• While EFOODS and PMPK in staples sector (excluding PKGS) posted more than 70% decline in profitability, major dent in staples earnings came from NESTLE and PAKT (cumulatively 49% and 59% of our sample’s profit & market capitalization, respectively), whose earnings fell 30% and 22%, respectively.
• We have excluded PKGS from our analysis due to its consolidation effect, which led to a considerable fall in its gross margin on the back of higher cost of production of its subsidiary company (Bulleh Shah Packaging). This coupled with higher financial and other charges of Bulleh Shah weighed heavily on PKGS’ consolidated profits, down 85% YoY in Sep Qtr 2018.
• Profitability of NESTLE in Sep Qtr was marred by contraction in gross margins, down 197bps YoY to 32% and higher financial charges, up 71% YoY. Former due to higher input & energy costs and increase in commodity prices while latter owing to uptick in interest rates (+275bps in 2018YTD), we believe.
• PAKT on the other hand witnessed significant contraction in gross margins, down 595bps YoY to 49% during the outgoing quarter. This coupled with higher distribution expenses led to 22% decline in bottom-line. We attribute pressure on margins to higher input costs and recent hike in excise duty which also affected the company’s volumetric sales as the company had a portfolio wide increase in cigarette prices, thereby widening the price gap with cheap duty evaded cigarettes. To note, illicit sector market share stood at 33.2%  as of Aug 2018.
• In discretionary space, INDU reported profitability decline of 3% YoY mainly due to contraction in gross margins, down 297bps YoY to 14%. However, margins fared better than expectations despite significant PKR depreciation since Dec 2017 (~28%) as the company was able to maintain its gross margins up until last quarter. While THALL on the other hand reported YoY profitability growth of 19%, mainly owing to 19% increase in revenues and almost stable margins.
• A cautionary stance in consumer space is advised as consumer purchasing ability will be limited owing to inflationary pressure and weak macroeconomic variables in short to medium term. Moreover, higher input costs will likely keep producers’ gross margins in check while advertisement and promotional campaigns will keep pressure on their bottom-line, we believe.