Growth, margins play whack-a-mole with consumer discretionary space

Some brokerages bet on consumer staples, preferring this more defensive space

The consumer discretionary segment had a muted October-December quarter (third quarter, or Q3) in 2022-23 (FY23), pegged back by weak consumer sentiment. Most sub-categories across price segments bore the brunt. Given sluggish demand conditions and an operational miss in Q3FY23, brokerages expect the trend to prolong in 2023-24 (FY24).

PhillipCapital projects consumer discretionary companies to slacken in FY24 as discretionary consumption takes a possible hit due to high consumer price index-based inflation, job layoffs/slowdown in hiring, a sharp increase in interest rates on home loans, the comeback of local/regional players, and exhaustion of pandemic-spurred savings impacting high-ticket purchase of paints/jewellery.

Margins, too, could come under pressure since recovery is being driven by promotions, discounts, and higher sales of entry-level products.

While the medium-term narrative on discretionary remains engaging, there could be more earnings cuts in FY24, especially on margins, which could drive some more derating in the space and amplify the recent underperformance, believe analysts of Systematix Shares & Stocks, led by Himanshu Nayyar.

While so far companies have not sent out any feelers on a likely delay in expansion plans or putting them on the back burner, brokerages say that may well be the case if the slowdown in the sector persists.

Systematix Shares and Stocks observes that listless growth across the quick-service restaurant (QSR) and apparel retail could be a temporary hold-up. But should it sustain for a few more months, it could handicap the footprint expansion plans of most industry players.

While a reversal of discretionary outperformance has been a recent phenomenon, some brokerages are now betting on the consumer staples segment to outpace the former and prefer to take a punt at this more defensive space.

Say analysts of Axis Capital, led by Anand Shah, “After nine quarters of outperformance, year-on-year (YoY) revenue growth of discretionary companies under coverage converged with that of staples, while operational performance, flat YoY, decelerated sharply on a sequential basis and trailed consumer peers sharply.”

Over the near term, the brokerage continues to pick staples over discretionary players.

Discretionary demand moderation, especially after the festival season, was seen across QSR, retail, and apparel categories.

Says Kunal Vora, head of India equity research, BNP Paribas, “While affluent India’s consumption trend slowed down during Q3FY23, the mass-market category continued to see pressure on the rural slowdown and consumers downtrading, although this improved on a sequential basis.”

Among key segments, the demand dip in Q3FY23 for QSR space after a strong October was disappointing. Weak operating metrics are expected to continue as demand conditions remain slow-moving even in the first two months of the January-March quarter of FY23.

Same-store sales were muted, with overall sales driven by store additions. Further, weak operating leverage and higher costs due to wheat and cheese inflation led to pressure on gross and operating profit margins. Notwithstanding cost pressures, companies have been cautious about raising prices, given the impact on volumes.

In the apparel retail category, sales were affected by weak macros and a delayed winter. While V-Mart, Shoppers Stop, and Page Industries saw deceleration in sales over three years, Aditya Birla Fashion and Retail and Trent sustained the momentum, say analysts at IIFL Research. Margins across players felt the squeeze due to negative operating leverage, they add.

The jewellery segment fared better. While growth moderated on a higher base, sales over three years remained healthy.

BNP Paribas Research highlights that demand trends in November and December were impacted by volatility in gold prices. Buyers returned in January, even as gold prices remained firm. The sector reported healthy on-year sales growth in Q3FY23 regardless of the high base, with a three-year average annual growth in double digits for most organised players.