Bumper quarter driven by low base
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.