Benign commodity cost trend continues
In this edition of our Consumer sector update, we have analyzed price movement in key commodities. Additionally, we have also identified Consumer companies under our coverage that could benefit or get negatively impacted by it. It is relevant to analyze price trends from the perspective of 2QFY21 earnings and beyond as top line growth in the sector is expected to remain muted amid the gradual recovery post unlock in May’20. Further, we believe the commodity cost impact would be quite sharp in certain cases.
Commodity costs remain largely benign for consumer companies
* Most consumer companies are expected to witness muted sales and EBITDA growth in 2QFY21 due to (a) the gradual resumption of business activities post unlock, and (b) though reviving, weak consumer sentiment. Rural market is leading the revival on account of higher government spends, low COVID impact, and strong monsoons and agri outlook. However, urban recovery remains slow. In this environment, we believe lower input cost would offer some relief to companies. Most companies in the sector have resumed ad spends and brand investments (though not back to pre-COVID levels) and are expected to continue curtailing discretionary spends as part of their efforts on stringent cost savings. All these factors are likely to offset the impact on earnings due to muted sales growth or even sales decline in some cases.
* Crude prices have bottomed out: Crude prices have rebounded with a 35.8% increase sequentially in 2QFY21, but remains down 31.0% YoY. However, prices were down 7.2% MoM at USD41.1/barrel (monthly average for Sep’20).
* Agri commodity basket largely seeing moderate deflation in 2QFY21: The sugar index was down 0.9% QoQ /1.4% YoY. Copra costs were up 4.6% YoY/ down 1.3% QoQ (YTD Aug’20).On the other hand, wheat costs declined 14.6% YoY/3.5% QoQ. Mentha prices declined 21.1% YoY/11.2% QoQ. Barley costs were down 25.3% YoY/8.1% QoQ. However, palm oil costs remained at high levels, rising +37.5% YoY and 21.7% QoQ.
* Non-agri commodity basket largely saw moderate sequential inflation: VAM costs fell 16.2% YoY but increased 9.0% QoQ. Titanium dioxide (TiO2) costs were down 4.2% YoY, but up 0.4% sequentially. Up to Aug’20, HDPE costs declined 1.3% YoY YTD while LLP costs were up 5.8% YoY YTD. Gold prices (MCX Gold) rose 40.4% YoY and 18.9% QoQ. Palm fatty acid distillate (PFAD) prices were up 58.1% YoY/13.5% QoQ.
* On an average, the entire commodity cost basket was flat on YoY/MoM basis (down 0.2%/0.1%), while rising 4.3% QoQ.
Impact on our top picks: HUVR, DABUR, MRCO
* Hindustan Unilever (HUVR): With PFAD costs increasing sequentially and YoY, HUVR is likely to experience some gross margin pressure. Price increases taken by soap companies in Mar’20 might help offset the inflationary impact to some extent. Additionally, packaging costs (crude-related) have also increased sequentially, which would further weaken gross margin on a QoQ basis. However, the company’s cost-saving measures, along with a portfolio that could straddle the price pyramid, should protect significant operating margin decline.
* DABUR: It is a significant beneficiary of the moderate crude price-related packaging cost as well as benign LLP costs.
* Marico (MRCO): Copra costs increased YoY, but it remains benign sequentially. Moreover, other costs continue to decline, aiding overall margin growth.
Other material beneficiaries: APNT, PIDI, UBBL, HMN
* APNT and PIDI: APNT and PIDI are significant beneficiaries of lower vinyl acetate monomer (VAM), Tio2, and crude costs. Despite muted sales growth, soft commodity prices coupled with cost reduction measures should help EBITDA margin improvement for both companies in 2QFY21.
* CLGT: It is a significant beneficiary of the moderate crude price-related packaging cost.
* HMN: It is expected to be a key beneficiary of the ongoing decline in mentha and packaging costs. A muted growth outlook, however, would likely restrict the potential upside from such benefits.
* UBBL and GSKCH: Decline in barley costs is likely to benefit gross margin of UBBL and GSKCH (now merged with HUVR). UBBL, however, should continue with its weak sales and earnings owing to the expected slow recovery as bars and pubs continue to remain shut in most parts of India.
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