HUL, ITC save the day for FMCGs

The general inflationary scenario doesn’t seem to have stopped Indian consumers from spending on their increasing daily needs and growing aspirations. This is evident from the continued strong volume growth witnessed by the top fast moving consumer goods (FMCG) companies such as Hindustan Unilever (HUL), ITC, Dabur, Godrej Consumer Products (GCPL), Tata Global Beverages (TGBL) and Colgate in the quarter ended September. Revenue growth for most was robust, about 13-30 per cent.

The operating profit margin for FMCG companies has remained flat, not a bad achievement, considering the sharp rise in input costs. The good news ends there. The sector’s over-dependence on HUL and ITC for their fortunes is evident with every passing quarter. For example, the OPM of companies other than HUL and ITC declined 50-350 basis points, as price rises and cuts in advertising spending (except for Colgate) were insufficient to compensate unabated rise in input costs. Still, the margin pressure was not a big negative surprise, as the Street was anticipating this. This, and continued investments in brand building, new product launches and innovations, led most companies (excluding HUL and ITC), especially those with global operations or acquisitions, to miss net profit growth estimates.

HUL and ITC (about 70 per cent of total sales of the universe) enthused analysts the most, as they delivered good performance on an overall basis. However, at current levels, their stocks look fairly priced at 29 times and 23 times the 2012-13 estimated earnings, respectively.

More, competition continues to loom large on HUL. “Ad spends are unlikely to decline, as competition continues to remain high,” said Nitin Paranjpe, CEO and managing director of HUL, at the company’s results press conference. Also, uncertainty over duty increases on cigarettes will weigh on ITC. Says Gautam Duggad, analyst, Prabhudas Lilladher, “We expect the stock (ITC) to remain range-bound, as speculation on a cigarette excise increase in the FY13 Budget dominates sentiments.”

With competition remaining high in the sector across product categories, synergies of acquired companies (in the case of Dabur, GCPL) yet to be played out and valuation looking fair, the upsides in the near-term look capped.

RISING COSTS
Aggregate net sales of the six companies jumped 19 per cent year-on-year to Rs 16,464 crore during the quarter. Except ITC, all companies witnessed escalation in raw material costs, which most tried to mitigate by curbing advertising expenditure, resulting in a decline in operating profit margin. The pressure on net profit margin was slightly higher than expected for most firms, thanks to brand building and promotional investments, followed by higher tax rates.
 

MARGIN PRESSURES
In Rs crore	HUL	ITC	Dabur*	GCPL*	TGBL*	Colgate
Net sales	5,610.5	6,085.0	1,271.0	1,192.0	1,630.0	675.5
Y-o-Y change (%)	17.7	18.2	29.3	23.5	12.7	18.7
Operating profit	826.5	2,219.0	245.7	198.0	136.0	130.5
Y-o-Y change (%)	27.7	18.3	15.4	9.1	5.4	0.9
OPM (%)	14.7	36.5	19.3	16.6	8.3	19.3
Y-o-Y change (bps)	115.0	3.5	-234.0	-220.0	-58.0	-339.3
Raw material cost**	3,106.0	2,399.0	757.0	622.0	806.0	294.5
Raw material to sales (%)**	55.4	39.4	59.6	52.2	49.4	43.6
Y-o-Y change (bps)	101.2	-477.0	499.0	73.0	1,251.0	600.7
Advertising expense	651.4	1,282.0	128.0	111.0	269.0	114.3
Advertising to sales (%)	11.6	21.1	10.1	9.3	16.5	16.9
Y-o-Y change (bps)	-196.0	-143.0	-229.0	-84.0	-23.0	304.0
Adjusted net profit	645.0	1,514.0	174.0	128.0	87.5	100.0
Y-o-Y change (%)	22.6	21.4	8.5	-1.7	4.2	-0.3
P/E (x)	29.0	23.0	20.8	19.5	13.0	27.4
All financial figures are for quarter ended September 2011; Basis points (100 bps is one percentage point); * Consolidated financials **Adjusted for change in stock and includes purchase of traded goods; Advertising expenses for ITC is included in other expenses Source: Companies

COMPETITION, VALUATION
Volume growth prospects broadly continue to be robust, thanks to rising incomes, growing aspirations and rural focus. However, competition remains a concern, especially given high inflationary pressures and a slowing economy. Analysts suggest this could induce companies to keep their advertising spending at elevated levels.

General inflation and the rupee’s depreciation versus the dollar also pose challenges for growth and margins, putting pressure on already high input prices. With concern over profit margins overshadowing the robust underlying volume and revenue growth, stocks of most FMCG companies look fairly priced.

Analysts do not see any significant positive trigger in the medium term for the sector, unless inflation and raw material cost pressures subside. Among individual stocks, the medium-term outlook appears bleaker for Dabur, GCPL, TGBL and Colgate than for HUL and ITC.

OUTLOOK
Among individual companies, analysts do not foresee further tailwinds in HUL’s businesses from either volume or margin catalysts. While many have raised their earnings estimates for the company, the recent sharp rise in its stock means near-term upsides are capped. For ITC, the absolute return (for its stock) in the short term is constrained because of taxation overhang, say analysts. Manoj Menon of Kotak Institutional Equities, in his report on ITC, says: “The impact of pictoral warnings slated to be released in India in December needs to be monitored. Potential to implement further price increases in cigarettes in the second half of FY12 exists.”

For the relatively smaller FMCG firms, analysts remain cautious or neutral. “Competition/deteriorating pricing dynamics in key segments rules out a further re-rating at this juncture,” says Jamshed Dadabhoy, analyst, Citigroup Global Markets, in his report on Dabur. For GCPL, analysts say though the valuations are relatively lower, the gap will remain or widen vis-a-vis peers. Amnish Aggarwal, analyst, Motilal Oswal Securities, notes: &ldqu