Not all gloom; selective opportunities exist

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SummaryInvestors cite sluggish volume growth, rising input costs, and a peak in margins amidst high valuations

Our AlphaWise survey shows buoyant consumer sentiment in rural India, which inspires confidence in steady volume growth and 2015 gross margin flexibility – our base case. Overall survey results are mixed, but selective opportunities exist. Dabur is our top HPC (home & personal care) pick; upgrade HUL to EW (equal weight), GCPL to OW (Godrej Consumer Products to overweight).

The market is bearish on consumer staples… Investors cite sluggish volume growth, rising input costs, and a peak in margins amidst high valuations.

even as there are some tailwinds that cannot be ignored…

These include continuing strong rural growth, moderation in consumer inflation, higher agri crop income, rational competitive intensity, and a murky macro climate, which could support current valuations.

…hence, we conducted a pan-India AlphaWise survey in 2013 among 4,492 grocery shoppers to gather primary evidence:

Our key takeaways:

(i) Rural growth will continue to outpace urban.

(ii) Strong trend of mix improvement, especially in rural markets.

(iii) Stronger volume growth for HUL(Hindustan Unilever) from here, led by improved performance in mass market brands.

(iv) P&G is performing well across categories. Price tiering strategy has worked well.

(v) Regional/emerging brands are likely to show improved performance over the next 12 months.

(vi) Expect a step up in competitive intensity, but P&G and HUL are doing well, so it’s unlikely to be irrational.

(vii) Middle-income Indian consumers are more value-conscious than just price-conscious—there is real opportunity for a rapid rise in HPC profit pools.

Maintain In-line industry view–stock selection will remain important:

The key is to remain focused on earnings growth and the visibility thereof. We expect investors to pay a premium for companies that report operating margin expansion.

Summary and conclusions

Our strategy for 2013 emphasised stock selection…

In our report of January 25, 2013, Becoming More Selective on Consumer Staples, we argued that “continued fundamental sweet spot supports average earnings growth of >18% for H1CY13 – but stock selection is crucial after 2012’s strong, broad-based run-up.

…amid a sharp correction in H2CY2013…: This was led by moderation in volume growth across consumer categories.

…and industry fundamentals for 2014 appear bleak…

The India consumer industry outperformed the Sensex by 4% in 2013 but has underperformed by 10% over the past six months. Consensus view on industry performance for the next 12 months is perceptibly more bearish than it has been for the past two years, led by:

Potential further moderation in volume growth;

Recent rise in input costs;

Concerns about lower industry pricing power amidst

weak

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