Aggregate sector valuations continue to be expensive; reason to ‘tread selectively’

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Published: February 27, 2017 2:44:51 AM

Tight cost control, deferment/cuts in A&SP spends and savings in staff costs protected sharp decline in profitability. The quarter did see its fair share of outperformances due to subdued expectations.

MT/chemist channel, Q3FY17 balance sheet, geographic/ channel mix, Tight cost control, demonetisation, Titan, FMCG Players, Ebitda, Demand/margin outlook Tight cost control, deferment/cuts in A&SP spends and savings in staff costs protected sharp decline in profitability. The quarter did see its fair share of outperformances due to subdued expectations.

On balance, Q3FY17 turned out to be a better-than-expected quarter as barring a few, most companies mitigated topline pressures through agile response, extending credit to channel partners and pushing growth via MT/chemist channel; strong festive season also helped and some companies also fared better due to better geographic/ channel mix. Tight cost control, deferment/cuts in A&SP spends and savings in staff costs protected sharp decline in profitability. The quarter did see its fair share of outperformances due to subdued expectations. We continue to find aggregate sector valuations expensive and retain our ‘tread selectively’ stance. Preferred picks – ITC, BRIT, CLGT and BJCOR.

Q3FY17—topline better than expected; tight cost control and lower A&P protect profitability: Aggregate revenue growth in staples (ex-Nestle) declined 0.6% y-o-y as volumes decelerated across categories (partly dragged by pipeline correction); we note that barring Nestle only 4 out of 11 staple companies under our coverage posted positive revenue growth. Discretionary companies fared relatively better with aggregate revenue growth (ex-ITC) of 3.9% led by Page and Titan (both posted double-digit revenue growth).

Aggregate Ebitda and PAT growth (ex-ITC/Nestle) declined 3% and 4% respectively; we note 9 out of 22 companies under our coverage (ex-Nestle) posted decline in Ebitda. However, given subdued expectations, we did see a fair share of outperformances this quarter (11 out of 23 companies beat our Ebitda estimates); key outperformances were BRIT, JYL, TGBL, ITC, Pidilite, Page, Titan, UNSP and Coffee Day while UBBL, SH Kelkar and PCJ were the only misses. However, on revenue front we saw more misses (7 out of 22 companies) with additional misses being CLGT, GSK-CH, Marico and JUBI.

Quick thoughts on key parameters
Volumes (impacted by demonetisation and pipeline correction): Broader FMCG (staples) growth weakened across categories; we note barring BRIT and Marico (Saffola) all reported company/category/brand volumes declined y-o-y (GSK-CH, CLGT and Marico/VAHO posted double-digit volume decline). On the discretionary side, performance was relatively better as APNT, Page and Titan (jewellery) posted positive volume growth. ITC also performed better than expected while JUBI (3.3% negative SSG) and liquor companies (UBBL and UNSP posted 8% and 5% volume decline respectively) performed in line with expectations.

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Margins (dip in GMs and weak leverage drag margins): Aggregate Ebitda margin dipped 60 bps y-o-y due to weak leverage and 90 bps contraction in GMs; we note only 7 out of 23 companies under our coverage posted Ebitda margin expansion. While GMs witnessed severe pressure this quarter (11 out of 23 companies posted 100 bps+ GM contraction), 40 bps cut in A&SP and tight cost controls (aggregate staff costs and other expenses up 2-3% y-o-y) limited margin contraction; however, we would be wary of extrapolating such sharp savings and treat them as exceptional (we note staff costs and other expenses grew 9-13% and 7-8% over past few quarters respectively).

Demand/margin outlook (pre-demonetisation): Management commentary was mixed on demand recovery but tilted towards a more gradual recovery as wholesale rebalancing and rural pickup is likely to take some time; GST-led destocking in Q1FY18 is also another risk highlighted by most companies. On margin front, fading RM tailwinds will continue to put pressure on GMs partly negated by price hikes, cost control and cut in A&SP .

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