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Discretionaries set for a rebound; rural remains resilient

2QFY22 is likely to report strong cumulative growth numbers – ~15% on the topline, ~10% on EBITDA, and ~10% on PAT – for the 18 consumer companies under our coverage. This is on a cumulative base of 5.4% and 7.3% in sales and EBITDA, respectively, in 2QFY21. A large portion of this growth is likely to come from pent-up demand for discretionaries on the back of a) improved mobility, b) restrictions being progressively lifted, c) stores remaining open for a longer time, and d) modern trade (MT) reopening in a phased manner all of which have been faster than last year. Since the rural markets have remained resilient on the back of a strong kharif crop, good rabi sowing, and the monsoons ahead of their long-period averages, Staples demand is also likely to be healthy. In the case of the distribution channels, ecommerce continues to strengthen its salience for most consumer companies, while general trade (GT) remains resilient. In the MT channel, the situation is now progressively improving. As we enter the festive season – with the nationwide vaccination drive continuing in full swing and daily case numbers remaining subdued – discretionary companies are set to witness continued demand momentum over the remainder of the year. This is provided a) India does not see a third COVID wave, b) the vaccination pace remains healthy, and c) the pandemic’s impact on incomes/wealth is contained.

Out-of-home categories to outperform this quarter

Among the large companies, we expect HUVR to report 10% YoY sales growth (6% volume growth) and 8.5%/7.2% EBITDA/PAT bei growth. APNT is likely to report 42% topline growth and 14–15% EBITDA/PAT growth, led by pent-up demand. ITC is expected to post 15.5% overall sales growth, with 12% volume growth in Cigarettes (on 4% sales decline and 12% volume decline in 2QFY21). Profitability pressures are likely to ease due to recovery in the high-margin Cigarettes business as well as improved performance in the Hotels business. Staples are likely to report ~9% sales growth over 2QFY21– with good all-round numbers from MRCO, PGHH, and JYL. TCPL is also likely to report healthy 9–11% growth on all parameters in 2QFY22. Among the discretionaries, UBBL and VBL are likely to report strong YoY revenue growth in Sep’21 (56%/19%). Similar impressive trends are expected in operating profit and PAT on the back of improved mobility and a very weak base in the case of UBBL. PAG is also likely to report 10–15% YoY growth across parameters in 2QFY22.

Material costs remain elevated; sequential improvement in margins likely

While overall inflation in the commodity basket was flat sequentially in 2QFY22, YoY inflation remained high. Healthy demand has enabled companies to pass on a significant portion of the cost inflation. Nonetheless, YoY gross margins are likely to remain under pressure, with significant improvement likely only in 3QFY22. The prices of non-agri commodities remain elevated. Crude prices have continued to surge 69.5% YoY / 5.5% sequentially. HDPE/LLP costs – which affect packaging / hair oil companies – have also increased 22.7%/32.7% YoY, but remain stable on a sequential basis. VAM prices softened on a sequential basis, but are up 118.8% YoY and likely to affect PIDI’s gross margins. Palm oil prices remain near the peak of May’21 (average prices up 59% YoY / 5.2% QoQ) and are likely to impact HUVR, GCPL, and TCPL (to some extent). Among the other agri commodities, barley and wheat prices rose sequentially, with prices for most others softening or remainingflat. Barley costs rose 46.3% YoY and 7.3% QoQ in 2QFY22, reaching a one-year peak of INR2,180/quintal in Sep’21. Copra prices fell 8.3% QoQ on account of a good harvest. Tea prices have seen sharp correction, with average prices down 28.4% YoY and 3.8% QoQ. While companies would continue to experience varying degrees of material cost inflation, price increases taken during this quarter would help relieve some of the margin pressure. In addition to gross margin pressure, higher ad spends YoY and sequentially owing to healthy demand (even as ad spends are yet not back at 2QFY20 levels) have resulted in estimated cumulative EBITDA growth of ~10% (v/s ~15% cumulative sales growth), with EBITDA margins declining/flat for almost all companies in our Coverage Universe.

Top picks in Consumer Staples space

HUVR, GCPL, BRIT, and VBL: HUVR continues to lay the foundation for future growth and displays dexterity in decision-making, in addition to cost savings being plowed back into the business. Recovery in discretionary demand (high margin) and flat/declining commodity costs augur well for earnings going forward. The appointment of the new CEO at GCPL offers scope for transformative change, especially if the company is able to robustly grow the domestic business and introduce better capital allocation. BRIT’s structural story remains strong, aided by a) direct reach expansion to ~2.4m outlets and b) further investments in IT infrastructure. We like VBL owing to a) the revival in out-of-home consumption on the back of an increase in vaccine distribution, b) rising penetration in newly acquired regions (southern and western India), and c) the growing penetration of refrigerators in rural/semi-rural areas per household as well as power availability for longer hours.

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