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Published on 8/04/2020 2:01:54 PM | Source: Motilal Oswal Financial Securities Ltd 

FMCG Sector - Commodity costs largely benign; packaging costs to drop - Motilal Oswal

Posted in Broking Firm Views - Sector Report| #FMCG #Sector Report #Motilal Oswal Financial Services Ltd

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Commodity costs largely benign; packaging costs to drop

Savior in subdued demand environment

In this edition of our consumer sector update, we analyze price movement in key commodities and identify companies under our coverage that could benefit from or be negatively impacted by it. It is relevant to analyze price trends from the perspective of 4QFY20 earnings and beyond as topline growth in the sector is expected to be subdued due to various factors, while the commodity cost impact being quite sharp in some cases.

 

Commodity costs remain largely benign for consumer companies

* Consumer companies are expected to witness subdued sales growth due to an uncertain demand environment, disruption in the supply chain on account of COVID-19-related lockdown, channel liquidity issues, and rural slowdown, among other factors. However, we believe lower input costs would offer some relief to companies, providing room for spending on promotions/price-offs and other offers to drive up category volumes once the lockdown impact ends. But, rising competitive intensity would also mean low material cost’s benefits would be nowhere near as high as they would in a more favorable operating environment. Moreover, most companies in the sector have curtailed ad spend / new launches due to persistently weak demand. Therefore, promotion intensity is expected to be high and affect realization and sales growth in the quarter.

* Crude prices plummet: After trending up on a QoQ basis in 3QFY20, crude prices began their downtrend 4QFY20 onwards – down 18.5% sequentially (up 1.1% in 3QFY20), down 19.3% YoY, and down 39.1% MoM at USD33.5 per barrel levels (monthly average for March). A similar level was witnessed in Feb’16, when crude prices came in at USD33 per barrel (previously observed in Mar’04).

* Agri commodity basket sees moderate inflation/deflation in 3QFY20: The sugar index fell 2.4% QoQ / 2.6% YoY. On the other hand, wheat cost rose 7.5% YoY / fell 3.1% QoQ, against fears of a further sequential increase. Barley cost continued at high levels (up 10.8% YoY / 0.2% QoQ). Similarly, palm oil costs were up 33.4% YoY / 7.5% QoQ. Mentha prices declined 21.8% YoY and 3.4% QoQ. Copra costs came in flat YoY, but were up 6.5% QoQ (YTD Feb’20).

* Non-agri commodity basket, barring gold and PFAD, sees deflation: VAM costs declined 18.2% YoY / 0.8% QoQ. Tio2 costs were down 9.5% YoY / 3.5% sequentially. Up to Feb’20, HDPE costs declined ~15.2% YoY YTD, and LLP costs were down 2.1% YoY YTD. Gold prices (MCX Gold) expanded 26.1% YoY and 7.3% sequentially. PFAD prices were up 49.5% YoY / 26.8% QoQ.

* On an MoM basis, the entire commodity cost basket declined 4.4% on average, v/s rising 1.2% QoQ and 2.7% YoY.

 

Impact on top picks: Hindustan Unilever (HUVR), Marico (MRCO)

* HUVR: HUVR is witnessing inflation in palm oil, but has undertaken adequate price increases. Packaging costs are declining significantly, which would support gross margins. Moreover, the company’s cost-saving measures, along with premiumization across the portfolio, should aid margin improvement going forward.

* MRCO: Copra costs still remain flat YoY, while other costs continue to decline, filliping overall margin growth.

 

Other material beneficiaries: APNT, PIDI, CLGT, and HMN

* APNT and PIDI: APNT and PIDI are significant beneficiaries of declining VAM, Tio2, and crude costs in the quarter. The sales growth outlook, however, weakened in the last month of the quarter and remains weak during the lockdown period.

* CLGT: The company is a significant beneficiary of the moderate crude pricerelated packaging cost.

* HMN: Following several quarters of inflation impact on mentha, HMN is expected to be a key beneficiary of ongoing decline in mentha and packaging costs. A weak growth outlook, however, would likely restrict the potential upside from such benefits.

* UBBL and GSKCH: Continued high barley costs are likely to impact the gross margins of UBBL and GSKCH.

* BRIT: Wheat and sugar costs, which have been declining sequentially, witnessed lower-than-expected inflation YoY. From an operating margin standpoint, the company’s strategy of holding a very high level of lower cost inventory has proved successful. Its all-time high margins in recent quarters and the sequential deflation in wheat and sugar cost potentially indicates it has tided over the threat of material cost inflation.