Multi-year high margins lend comfort to Dabur

Demand and sales improvement expected to continue

The Dabur stock recorded a 52-week high at ~382.3 in Wednesday's trade, after the company posted its highest operating profit margin of 23.9 per cent, up 206 basis points (bps) year-on-year (y-o-y), in the March quarter. This was led by cost management and an improved product mix.

Operating expenses (excluding finance costs and depreciation) as a proportion of sales fell to 76 per cent, among its lowest; it was 78 per cent in the year-ago quarter. A fall in cost of raw material consumption propelled the gross margin, which expanded by 167 bps to 50.7 per cent. The management foresees a stable gross margin in 2018-19. It believes price hikes, if required, will help neutralise any inflationary pressure.

Adjusted for the goods and services tax related-impact, sales increased by about 10 per cent over a year before in the quarter, and supported the margin performance (standalone sales were up 5.2 per cent). A recovering rural economy supported sales and pushed domestic volumes by 7.7 per cent.

Although the low base of the past year helped, given the 2.4 per cent volume growth in the March 2017 quarter, the latest figure is higher than 6-7 per cent anticipated by analysts. Dabur earns 40-45 per cent of its domestic revenue from rural areas. Since its domestic business accounted for a little over 70 per cent of total revenue in the quarter, a rural recovery should be beneficial.

"We are witnessing early signs of revival in consumer sentiment, especially in rural India. Rural demand has been growing at a faster pace," said Sunil Duggal, chief executive officer.

Even as advertising spend was benign (up 2 per cent y-oy) and aided margins, Dabur gained market share in 70-75 per cent of its domestic portfolio in the quarter. Its consumer care business, accounting for 82 per cent of revenues, grew by 8.2 per cent. Almost all consumer care categories such as oral care, hair care, skin care and others posted more than 8 per cent rise in sales. The management said its honey business, hit by Patanjali, grew by 23.7 per cent, and should soon be at its peak. Despite a faster increase of 21.6 per cent over a year in tax expenses, consolidated net profit jumped 19 per cent y-o-y to ~3.97 billion in the fourth quarter.

Sales performance is likely to improve, with an expected rise of 8-10 per cent in volumes in the AprilSeptember period and then accelerate. "Favourable monsoons and a likely stimulus by the government as part of its overall thrust on rural growth is expected to boost rural demand. We will continue to invest in our brands to tap the growth opportunities and deliver profitable volume-led growth," added Duggal.

Overall, the management's optimistic commentary should auger well for the stock in the near term and support its rich valuation, analysts say. We have not changed our strategy in six months. In UTI Mastershare, we follow a 'growth at reasonable price' approach. At times market might underestimate long term-growth potential and value stocks accordingly. Our focus is to look for such opportunities.

One such recent example could be our investment in information technology (IT). Six to eight months ago, we went overweight on the segment. The sector was available at an attractive valuation of 15 to 17 times price to earnings (PE) multiple; the benchmark index was around 26x. The other major change in the past few months has been in the financial services, where we had an overweight exposure to retail banks and non-banking finance companies (NBFCs) for past two to three years. We started increasing our exposure to private corporate banks where valuations looked attractive, assuming the normalisation of earnings over the medium term.

Do you still see pockets of value and growth in the large-cap segment?

The consumer discretionary sector has seen steady growth and is likely to continue. I am positive on automobiles and consumer durables. Affordability has gone up and cash flows have started to improve, especially in rural areas. Beside having aspirations, consumers are not much leveraged. This augurs well for the consumption story. Commodity prices have been strong, especially crude oil. The energy sector does hold value in this backdrop. Though the metal sector can be a bit volatile, the valuations are reasonable.

How comfortable are you with the overall market valuation?

The valuations were stretched in January. Despite the correction, these are still not in a comfort zone. High valuations were partly on account of expected growth in corporate earnings, which the indices were supposed to deliver. The S&P BSE Sensex is trading at 23 times trailing PE, though mid-caps are still at higher multiples. Given the past history of earnings growth delivery, one needs to be cautious while investing. The pace of downgrades seen earlier has gone down. The consensus 25 - 27 per cent growth estimate for FY19 earnings could get corrected, as a number of variables could trigger this.

How do you see the markets over the next 12 months?

The best of the macro-economic environment, inflation, current account deficit (CAD) and fiscal deficit, is behind us. On the other hand, the micros (fuel consumption, car volumes and discretionary demand) are improving. Given the inflation pressure, there are chances that the rupee becomes volatile and interest rates stay firm. Monetary tightening by the global central banks, crude oil prices, geopolitical tensions (if any) and upcoming state elections are some factors that can lead to volatility in the markets. However, if the earnings deliver, we can sustain the current valuations.

Could the volatility trigger a slowdown in domestic fund flows into equities?

Domestic flows have been strong in the past two to three years. Market returns in the past have attracted a lot of retail (individual) investors. However, the fact that the correction or volatility might not have been understood by those who have started investing recently, the quantum of flow into the equity segment could be volatile. With more investors understanding their asset allocation needs for achieving long-term financial goals, flows will become steadier.