Q2 FMCG preview: GST roll-out to depress performance

For the July-Deptember quarter of this year, we expect our consumer coverage universe, comprising 18 companies, to report growth of 4.3 per cent, 5.3 per cent, and 7 per cent in revenue, EBITDA and net profit, respectively, on a year-on-year basis. Despite a subdued YoY performance, we expect a marked improvement in sequential performance. Teething troubles post-GST roll-out in July has had an impact on all the companies in general. 

While the corporates and large distributors have aligned with the new taxation regime, problems continue to persist at smaller wholesale and retail level. We expect companies like HUL, Asian Paints, and Britannia to deliver strong top-line growth, while ITC may witness a tough quarter due to falling cigarette volumes post a sharp price increase necessitated by revised GST rates.

The situation on the raw material front remained largely mixed during the quarter. Average crude oil prices were 6 pr cent YoY higher in 2Q, although the prices have moved up sharply in September. On the positive side, the average prices of liquid milk, wheat, sugar, and refined palm oil remained flat on YoY basis.

Following two droughts in past three years, the country witnessed relatively normal monsoon in 2017. While the average Southwest rainfall of 841.3mm was five per cent lower than the long period average of 887.5mm, 30 out of 36 sub-divisions reported normal/excess rainfall in the season. Rural demand has lagged urban demand in the past three years due to poor monsoon, lower productivity levels, marginal improvement in Minimum Support Prices (MSPs) and lack of traction in MGNREGA. We expect gradual improvement in rural demand on the back of normal monsoon in past two years that would aid agricultural growth and increase disposable income in the hands of the farmers.

GST roll-out from July resulted in trade pipeline correction in the month of June, as confusion prevailed with respect to input tax credit under the new system. This severely impacted the performance of most companies in 1Q. While the corporates and large distributors have registered themselves under the new GST system, a large number of wholesalers and retailers are still in the process of aligning with the new system. The problem is more acute in northern states and rural areas. Hence, we expect 2QFY18 performance too to be impacted owing to the transient impact of GST implementation.

Notwithstanding near-term negatives, we expect GST implementation to be positive in the long term for consumer sector as it will result in faster conversion from unorganised to organised with increased tax compliance due to end-to-end audit trail of transactions. In an era of tax compliance by all players, the unorganised players will find it difficult to compete with their organised counterparts, in our view.

Our coverage universe comprising of 18 companies currently trades at 38.4x FY18E and 33.1x FY19E earnings. Excluding ITC, the price-earnings multiple are richer at 44.9x FY18E and 37.9x FY19E earnings. We expect the sectoral revenues and earnings to witness 12.9% and 15.5% CAGR, respectively through FY17-19E as a result of which we expect the sector to sustain premium multiples. A normal monsoon, GST, increased direct distribution network and stable input cost would drive revenue and earnings growth of the sector in coming years. Our top picks in the sector are: Britannia Industries, Kajaria Ceramics and ITC.

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Rakesh Tarway is head of research at Reliance Securities. The views expressed are his own.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.