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Margins likely to remain weaker in FY23 with increase in ad-spend and continued input inflation

EBITDA margins of white goods and durable companies are likely to correct 100- 200bps in FY22 vs FY21. The consensus is expecting a margin recovery in FY23. However, we believe the EBITDA margins in FY23 will be flattish / slightly lower than FY22 levels due to (1) increase in ad-spend after a gap of 6-7 quarters, (2) inflation in input prices remains at elevated levels. As durable companies have already exercised pricing power by raising prices by 15-20% in past 12 months, we believe that price hikes in FY23 will be calibrated, (3) investments in new products will also increase in FY23 and (4) trade investments will also inch upwards with normalization of business activities. With higher freight costs, it is difficult for durable companies to improve margins in FY23. While the near-term performance is likely to be impacted, we remain positive on the long-term growth prospects. Top picks: Havells (BUY) and Crompton Greaves (ADD).

* Increase in ad-spend after a gap of 18 months: On analyzing Q3FY22 results of Havells, Polycab and Orient, we note that investments in ad-spend have increased after a gap of almost 6-7 quarters. White goods and durable companies focused on protecting margins via cost-saving measures and lower ad-spend. However, we believe most companies need to invest now in their brands via higher ad-spends.

* Raw material inflation remains high: While input prices slightly corrected MoM in Dec’21, we note that inflationary pressures remain high. As most companies have already raised prices by 15-20%, we expect price hikes to be calibrated in FY23. We model gross margins to remain under pressure in FY23.

* Likely increase in new product launches: Due to covid wave 1, 2 and 3, there were multiple restrictions in trade. Hence, there were limited mega launches / relaunches from white goods and durable companies. With normalization of business activities, we expect new product launches to increase and investments (ad-spend, R&D, trade support, etc.) in new product launches to also move higher.

* Investments in sales & marketing to also inch upward: With re-opening of trade, we expect investments in trade to inch upwards. Durable companies need to invest in (1) expansion of dealer network, (2) higher trade schemes and promotions and (3) investments in reconnecting with dealers. Freight cost will also remain at elevated levels.

* Expect margins to remain under pressure: EBITDA margins of most durable companies are expected to correct 100-200bps in FY22 vs FY21. We model EBITDA margins to remain flat/ slightly correct even in FY23.

* Sector view & top picks: Considering strong return ratios, healthy growth potential and low penetration levels, we remain structurally positive on the white goods and durables sector. We also expect the migration from unorganised to organised sector to steadily generate value. Havells India and Crompton Greaves are our top picks.

Valuation and risks

We value stocks in the white goods and durable market on DCF methodology (WACC and TG ranging from 10-13% and 3-6% respectively). Key upside risk: better than expected gross margins due to correction in input prices. Key downside risks: (1) unexpected irrational competition due to deceleration in general consumption demand, and (2) steep inflation in input prices.

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