Bumper quar­ter driven by low base

The Hitavada - - BUSINESS -

WE THINK it is go­ing to be the tough­est quar­ter for the sell-side com­mu­nity to de­ci­pher un­der­ly­ing de­mand trends. This is be­cause most com­pa­nies are likely to re­port bumper num­bers ow­ing to: (1) favourable base as 3QFY17 was im­pacted by de­mon­e­ti­za­tion, and (2) GSTre­lated clas­si­fi­ca­tion changes af­fect­ing all cost line items. We ex­pect all com­pa­nies (ex-ITC) to see high sin­gle-digit to low-teen vol­ume growth across cat­e­gories. We be­lieve con­sumer com­pa­nies with high whole­sale and ru­ral ex­po­sure (Dabur, Emami and Col­gate) and dis­cre­tionary port­fo­lio (GSK Con­sumer, Ju­bi­lant Food­works) are likely to see the strong­est bounce back, as they were most im­pacted by de­mon­eti­sa­tion.

For the next three quar­ters (till 2QFY19), we sug­gest in­vestors to look at EBITDA/net in­come growth (yoy) and avoid look­ing at topline growth as it may not re­flect the cor­rect pic­ture due to ac­count­ing changes. In Q3FY18, we ex­pect the EBITDA/PAT of FMCG uni­verse (ex ITC) to grow 23% yoy each and EBITDA/PAT for the en­tire con­sumer cov­er­age uni­verse to grow by 17%/16% yoy.

KEY THEMES: Con­sumer de­mand in­tact: Our chan­nel checks sug­gest that con­sumer de­mand has not been im­pacted at all be­cause of GST im­ple­men­ta­tion. Ru­ral de­mand re­mained healthy in 3Q; in fact, for some com­pa­nies, it out­paced ur­ban de­mand. We ex­pect a pickup in ru­ral de­mand to ac­cel­er­ate in com­ing quar­ters, as the cen­tral gov­ern­ment is likely to fo­cus on job creation and ru­ral in­fra­struc­ture be­fore gen­eral elec­tions (sched­uled to be held in 1QFY20).

WHOLE­SALE AND CSD RE­MAINS A CHAL­LENGE: Our re­cent on-ground vis­its sug­gest that the whole­sale chan­nel (par­tic­u­larly ur­ban whole­sale) has not re­turned to nor­malcy, as a good amount of whole­salers are not will­ing to go the com­pos­ite scheme (which is sim­ple and con­ve­nient) since their turnover ex­ceeds sales thresh­old limit (Rs 15 m) and are also not will­ing to go for mul­ti­ple reg­is­tra­tions due to pos­si­ble tax scru­tiny.

GST HAS MADE THE SUP­PLY-CHAIN LEANER: The trade chan­nel was af­fected in mid-Novem­ber due to 1) re­duc­tion in GST rates in some of FMCG cat­e­gories and 2) schemes/of­fers given by com­pa­nies to clear older stocks. How­ever, it has sta­bi­lized since then and is now op­er­at­ing smoothly. Our dis­cus­sions with com­pa­nies sug­gest that GST has en­abled them to make the work­ing-cap­i­tal cy­cle (par­tic­u­larly by re­duc­ing in­ven­tory days) leaner.

IN­TER­NA­TIONAL BUSI­NESS ON A RE­COV­ERY PATH: We be­lieve In­ter­na­tional busi­ness (par­tic­u­larly MENA re­gion) for mid-cap com­pa­nies will re­cover due to a favourable base and surge in crude oil prices.

RAW MA­TE­RIAL HEAD­WINDS TO ABATE: Al­though there has been in­fla­tion in crude (LLP up 29% yoy, PP up 9% y-y), co­pra (up 76% y-y), Men­tha oil (up 66% y-y), we be­lieve most of the com­pa­nies have levers to off­set in­put in­fla­tion such as im­proved vol­ume growth on ru­ral re­cov­ery, cost ra­tio­nal­i­sa­tion pro­grammes, and price in­creases.

Q3FY18 RE­SULTS OUT­LOOK: Most FMCG com­pa­nies in the Uni­verse should see strong EBITDA and net in­come growth. How­ever, Mari­cos EBITDA and PAT growth is likely to be muted due to a spike in co­pra prices. ITCs EBITDA and net in­come could re­main sub­dued for the sec­ond con­sec­u­tive quar­ter due to sub­dued cig­a­rette vol­ume growth; We ex­pect EBITDA mar­gin ex­pan­sion to con­tinue for most of com­pa­nies due to be­nign raw ma­te­ri­als and economies of scale;

TOP PICKS: Ju­bi­lant, Ti­tan, Col­gate, GSK Con­sumer and Nes­tle on strong growth vis­i­bil­ity and earn­ings up­grade pos­si­bil­ity. We be­lieve con­sumer com­pa­nies might not re­act much de­spite ro­bust num­bers due to: (1) rich val­u­a­tions and (2) in­vestors find­ing it dif­fi­cult to de­ci­pher un­der­ly­ing de­mand trends.

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