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Pakistan Consumer: Profitability up 2% YoY in Jun 2018

• Pakistan consumer companies (Staples & Discretionary) posted profitability growth of 2% YoY in Jun 2018 quarter vs. decline of 12% YoY in Jun 2017. However, this growth in Jun 2018 was primarily due to strong performance from Tobacco companies (PAKT & PMPK) which recorded outstanding profitability growth of 132% YoY.
• Our analysis is based on sample of listed firms with market capitalization of US$200mn and above. We have excluded National Foods (NATF) and Thal Limited (THALL) from our sample as they have not yet announced their Jun 2018 results.
• If we exclude Tobacco companies from our sample, profitability of consumer firms declined by 11% YoY during the outgoing quarter vs. 14% YoY growth in Jun 2017 reported by the same sample firms.
• While revenues of consumer companies grew by 19% YoY in Jun 2018, contraction in gross margins, down 234bps YoY to 22% and higher distribution and financial charges, up 8% and 29%, respectively contained bottom-line growth to 2%.
• Delving into the numbers of sub-sectors of consumer companies, staple firms witnessed sales growth of 7% YoY (excluding PKGS as its sales were up 96% YoY due to consolidation effect) in 2Q2018, mainly led by higher sales from Tobacco companies (PAKT and PMPK). In our staple space (excluding PKGS), PMPK and PAKT recorded highest sales growth of 58% and 26% YoY, respectively during the outgoing quarter. This was owing to cut in Federal Excise Duty (FED) on cigarettes falling in lower slab in Budget FY18, which led to higher volumetric sales. Excluding PKGS, PMPK and PAKT, staples sales were only marginally up YoY.
• Sales of dairy producers (NESTLE and EFOODS) remained weak in 2Q2018 as EFOODS sales declined by 12% YoY while NESTLE sales were marginally up. Dull sales were on the back of stiff competition in packaged milk industry, especially Tea-whitening segment. 
• Sales of discretionary sector were up by an excellent 32% YoY with INDU recording highest sales growth of 43% in 2Q2018, followed by 35% growth recorded by PSMC. Stellar growth in revenues of INDU and PSMC was on the back of higher volumes and increase in prices.
• Consumer sector margins during the outgoing quarter contracted by 234bps to 22% in 2Q2018 mainly due to decline in margins of discretionary firms (down 196bps YoY to 11%). In discretionary, only INDU managed to sustain its margins at previous levels of 17% while HCAR and PSMC margins contracted by 521bps and 271bps YoY to 9% and 5.7%, respectively. 
• Staples margins were down 16bps to 35% in 2Q2018. However, excluding PAKT (margins up 3.6ppts to 48%) and PMPK (margins up 3.4ppts to 41%), sector margins contracted by 166bps to 32% mainly due to decline in NESTLE and PKGS margins. PKGS had lower margins as a result of higher cost of production of its subsidiary Bulleh Shah Packaging.
• While discretionary sector profitability remained almost flat YoY in 2Q2018, INDU posted phenomenal earnings growth of 50% thanks to stable margins. On the other hand, staples sector posted profitability growth of 3% YoY in 2Q2018 mainly due to strong performance from Tobacco companies. Excluding tobacco, staples profitability declined by 19% YoY owing to lower profits posted by NESTLE and PKGS. NESTLE earnings declined (-25% YoY) due to pressure on margins which contracted by 370bps YoY to 35% as a result of rising input costs while PKGS profits were down (-51% YoY) largely due to consolidation effect of its subsidiary Bulleh Shah Packaging.

Sector Outlook

• External account situation of the country continue to post challenge to the new Government as Current Account Deficit (CAD) in Jul 2018 clocked-in at a whopping US$2.2bn, higher than street consensus.
• Pakistan’s Consumer Confidence Index (CCI) declined by 2% during 1H2018 while Current Economic Conditions (CEC) index declined by 8%, according to joint survey conducted by Institute of Business Administration (IBA) and State Bank of Pakistan (SBP). However, Expected Economic Condition (EEC) index improved by around 4%, which we believe due to expectation of new Govt. to manage the fiscal and external imbalances.
• We believe that the required measures to curtail the external account i.e further currency devaluation and monetary tightening among others are expected to curtail overall aggregate demand (we expect GDP growth to be 4.7% in FY19 compared to 5.8% in FY18), which will affect consumer purchasing power going forward.
• Dairy producers continue to face challenging environment as new entrants have entered the industry which is affecting producers ability to pass on rising input costs. EFOODS which used to enjoy leadership position in Tea-whitening category through its flagship ‘Tarang’ has suffered a major blow owing to increased competition.
• We advise our investors to remain cautious in consumer space as we believe that weak macroeconomic variables will limit consumers ability to spend in the coming quarters while increasing competition is likely to push producers to spend more on their advertisement and promotional campaigns, thereby putting pressure on the bottom-line.