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Diary #1: Standard deviation of margins is just 10%. Concern about higher input prices seems overdone

With this report, Aniruddha Joshi, Manoj Menon and Karan Bhuwania assume coverage of White Goods & Durables. Our new monthly series on White Goods & Durables will have high frequency data – short-term demand trends, raw material prices, product price changes, key launches, management commentaries etc.

While consensus appears concerned over rising input prices and its impact on margins, our analysis of last decade’s performance suggests: (1) companies have (largely) maintained margins in a narrow range of 10-12% despite volatile input prices. The coefficient of variation (Standard deviation / average margins) is also just ~10%, (2) White goods & durables are (mostly) problem-solution categories and hence, consumers may defer purchases. Consumption loss appears low.

Hence, the price hikes have negligible impact on the volumes in medium-term, in our view, (3) commodity-linked categories like cables, wires and lighting benefit from industry consolidation and formalization when inflation is high and recoup lost margins over medium-term. Our sector view remains constructive; top picks are Havells, Bajaj Electricals.

* Steep inflation in raw material prices: Prices of key raw materials such as copper, steel, aluminum is up 20-40% YoY. Prices of HDPE are also up 43% YoY. Steep inflation in input prices may have impact on profitability for 1-2 quarters.

* Problem-solution nature of products ensures limited impact on demand: Most White goods & durables resolve specific needs of the consumers and are not vanity products in nature. Hence, we believe the consumers may postpone/ down-trade in case of steep inflation but they still need to consume the durables.

* Inflation augurs well for commodity linked categories: We believe most commodity linked categories are able to pass on the inflation with a lag. In this process (1) they gain market shares from smaller/unorganized players as well as (2) are able to retain/ improve margins over medium to long term. We expect white goods and durable companies to win market shares in near term and recoup loss of margins (in any) over medium term.

* Higher impact on unorganized sector: Smaller as well as unorganized players are more impacted by steep inflation in input prices. Larger players are likely to gain market shares from smaller players.

* Stable margins over past decade in-spite of volatile input prices: While the input prices have remained volatile over past decade, the Consumer durable companies have maintained their margins in a narrow range of 10-12%. The coefficient of variation (Standard deviation/Mean margin) over past decade is also just ~10%.

* Selective price hikes: Considering the demand is largely back on track and the input prices are inching upwards, white goods and durable companies have raised prices by 5-18% across products. There is some tweaking of trade and consumer promotions too. We believe the increase in costs will be passed on to end consumers via pricing actions in multiple traches over next 3-4 quarters.

* Sector view & top picks: Considering strong return ratios and healthy growth potential and low penetration levels, we remain structurally positive on White goods and durables sector. We also expect the migration from unorganized to organized sector to steadily generate value. Havells and Bajaj Electricals are our top picks.

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