Sector Update: Religare Capital Markets reiterates ‘underweight’ stance on consumer sector

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New Delhi | Published: December 23, 2016 12:54:47 PM

Paring its estimates across the consumer universe, Religare Capital Markets in a research report has said that the Indian consumer sector has been grappling with slowing volume growth over the last two years, even as margins have expanded sharply.

“With valuations still not reflecting earnings risks, we reiterate our underweight stance on the sector,” Religare Capital Markets says. (Reuters)“With valuations still not reflecting earnings risks, we reiterate our underweight stance on the sector,” Religare Capital Markets says. (Reuters)

Paring its estimates across the consumer universe, Religare Capital Markets in a research report has said that the Indian consumer sector has been grappling with slowing volume growth over the last two years, even as margins have expanded sharply. Emerging headwinds from demonetisation and input cost inflation could hurt earnings growth and push back recovery to H2FY18.

“With valuations still not reflecting earnings risks, we reiterate our underweight stance on the sector,” Religare Capital Markets says.

Demand recovery pushed to H2FY18:

Poor demand and low price inflation have weighed on the Indian consumer sector over the last two years. Additional headwinds from demonetisation and likely GST (in FY18) could have a lasting disruptive impact on the indirect distribution value chain. With recovery likely to be pushed back to H2FY18 and big-ticket discretionary spends (jewellery, paints) set to be badly hit, “we expect muted growth for the industry in FY17,” it says.

Limited pricing power, input cost inflation to hurt FY18 margins:

Religare believes FY18 margins for their consumer universe could be at risk given the confluence of factors, namely: (1) the recent spike in costs of inputs (even more in INR terms) such as palm oil (+48% YoY; +11% MoM), crude (+13.1% YoY; +4.5% MoM), wheat (+24% YoY) and copra (+2.4% MoM), and (2) limited pricing growth amid sluggish demand with waning of promotional offers.

“In our view, current valuations do not leave any margin of safety, implying a high likelihood for de-rating of the consumer sector,” it says.

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Key trends to watch out for in CY17:

1. Players would drive incremental growth through a step-up in direct distribution as the wholesale channel may not grow in tandem. This would restrict overall growth in FY18.

2. A&P spends may remain muted due to gross margin pressures.

3. Ability of players to pass on input inflation would be the key this time vis-a-vis the previous RM upcycles, given the more fragile underlying demand. This in turn may lead to weaker price discipline.

4. Premiumisation as a structural trend may take a pause. Also, any signs of downtrading need to be monitored.

5. Players may look for ways to improve distributor ROIs.

Stay cautious:

While the ratings of Religare Capital Markets remain broadly unchanged, they have revised down estimates across their consumer universe to build in the impact of demonetisation and RM cost inflation. “We also roll over to Mar’18 target prices (based on FY19 earnings) and remain underweight on the consumer space as we believe valuations must be reset to a lower earnings profile for the sector going ahead ( vs. ~20% over FY08-FY16),” they say, adding that ITC remains “our only BUY given its favourable risk-reward profile.”

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