Subdued Performance on the Cards
We expect implementation of GST to have an adverse impact on performance of consumer companies in 1QFY18. Lack of clarity over input tax credit on old stocks resulted in trade de-stocking its inventory in June before the GST rollout, which impacted the primary sales of most consumer companies. We expect the situation to be transient in nature and would reverse in the coming quarter. Our consumer coverage universe comprising of 16 companies is estimated to report 5.1% and 7.1% growth in revenue and earnings, respectively, mainly led by ITC and Titan.
Most of the commodity prices have been benign during the quarter on QoQ basis. Average crude oil prices were lower by 9% on QoQ basis, while PFAD prices too were lower by 12% in the same period. Other Agri-commodities like Wheat, refined palm oil and sugar prices too were benign. TIO2 prices however were higher by 14% on QoQ and 27% on YoY basis. We expect the consumer companies to rationalise A&P spends in 1Q to maintain the margin profile and wait for markets to stabilise before taking pricing action. However we estimate that overall A&P spends would be on a higher trajectory in FY18.
GST – Long-term Benefits Outweigh the Near-term Concerns
Long-awaited Goods & Services Tax (GST) was finally rolled out w.e.f. July 01, 2017. Notwithstanding the near term negatives, its implementation would be a definite long-term positive for the organised consumer industry in India. We expect faster conversion from unorganised to organised sector as it would become extremely difficult for the unorganised players to avoid taxes on account of end-toend audit trail of all transactions. Further, it would also result in lower tax incidence for most consumer companies as they would be able to take input tax credits for several services availed. Elimination of Central Sales Tax would result in efficient supply chain management as it removes the requirement to establish depots in each and every state.
ITC – Biggest Beneficiary of GST The proposed GST
rates announced by the Government in May 2017 have been largely positive to neutral for consumer companies under our coverage universe. The biggest positive in terms of rates came in for ITC, which saw its overall tax incidence going down by 6-7% as per our calculations. We expect ITC to pass on the benefit of lower tax to the consumers especially in the fast growing DSFT cigarettes that would lead its volume growth in coming quarters. Apart from lower tax, the Government has also brought uniformity in tax rates across states removing all ambiguity. The stock has returned 20% since announcement of the rates and we expect the momentum to sustain and volume growth trajectory to improve substantially in coming quarters.
Proposed Rates Largely Positive to Neutral
Among other players, Colgate-Palmolive has benefited from lower GST rates, as the proposed 18% GST is lower than the indirect tax incidence of 25% in pre-GST regime. The Company has already initiated the process of undertaking price cuts across its product range to pass on the benefit to the consumers. Again, lower product prices should aid the feeble volume growth trajectory of the Company. Apart from Colgate-Palmolive, Pidilite has also benefited as GST rate on Adhesives has been fixed at a lower rate of 18%. Jubilant FoodWorks would also be benefitted, as GST rate of 18% is lower compared to erstwhile applicable tax rate of 20%. Apart from lower absolute tax rate, the Company would also be able to take input tax credit for services availed such as lease rent paid. On the other hand, Asian Paints would need to undertake a marginal price hike, as GST rate proposed on paints at 28% is higher than the erstwhile tax incidence of 26%. Similarly, GSK Consumer would also require to take 3-4% price increase as proposed rates of 28% are higher than previous tax rate of 25%.
Valuations Rich; Time to be more Stock-specific
Our consumer coverage universe currently trades at rich valuations of 35.6x FY18E and 30.8FY19E earnings. Excluding ITC, the valuations are even richer at 44.1x FY18E and 38.1x FY19E earnings. The BSE FMCG Index has given 24% return in past one year compared to 14% return given by the benchmark BSE Sensex. We recommend the investors to be stock-specific in assessing suitable investment opportunities in the sector in coming quarters. We continue to rate ITC as our Top Pick in the sector, while among the Mid-caps, we prefer Pidilite Industries, Emami and Bajaj Corp.
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