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Geopolitical crisis leads to material cost pressures

Consumer Staples have underperformed over the last couple of years largely battered by unprecedented and broad-based material cost increases. The COVID-induced restrictions imposed in urban centers and disruptions to the modern trade (MT) channel also led to lower premium product sales.

In recent months, MT has rebounded to near normalcy in tandem with the gradual lifting of COVID-led restrictions. However, the ongoing geopolitical crisis has led to a further build-up of material cost pressures, which has been quite steep in some cases.

As indicated in our commodity cost update last week, several commodities such as crude, palm oil, and barley have witnessed an extremely steep increase sequentially with end of Feb’22 prices being sharply higher than Dec’21 quarter averages. We also indicated UBBL’s vulnerability to prevailing high barley costs in another note published in the preceding week. Agri commodities, barring palm oil, had been benign earlier but are witnessing a sequential upswing as well.

With several companies having already taken sharp price hikes until 3QFY22 (with some more in Jan-Feb’22 in a few cases), slowing rural and bottom-of-pyramid demand would make them wary of passing on the recent sharp commodity cost increases. We have reduced our estimates for eight of the 23 companies in our coverage that are more vulnerable to recent developments. The remaining companies are less adversely affected and changes to these will be made as part of our 4QFY22 preview, after observing the movement of commodity prices until then.

Changes to our EPS forecasts are largely operating margin driven and have led to an average reduction of ~13%/~8% in FY23/FY24 EPS for these eight companies. Existing stock of lower-cost RM inventory may not dent 4QFY22 estimates materially. The highest FY23E EPS cuts have been taken for GCPL (-22%), UBBL (-17%), APNT (-16%), and PIDI (-16%) while NEST has been the least affected (3%/4% cut in CY22E/CY23E EPS) due to its relatively higher pricing power. If inflation persists at prevailing levels or higher for the next few months, there could be more cuts not only to our FY23E EPS but also to our FY24E EPS (sharper cuts than the ones already assumed). Petrol and diesel price hikes, likely in next few days, would also impact margins of consumer companies adversely (due to transport/logistics costs) along with crude-related packaging costs.

We have also cut our FY24E target multiples for APNT and PIDI from 60x/65x to 50x/55x. Both of these stocks were significant beneficiaries of the re-rating in recent years but intense commodity cost pressures in the recent quarters have made their earnings more susceptible than peers, especially if crude costs sustain at high levels for a few more months.

GCPL, DABUR, and MRCO remain our top picks among Staples. While estimate cuts to GCPL are sharp due to the unexpected steep surge in palm oil costs along with some caution on growth and margins in its Africa business (because of sharp inflation), the turnaround story is evidently intact. We had reiterated in a detailed note in Jan’22 on the building blocks in place (for GCPL) for sustained topline and earnings growth. Valuations here are inexpensive despite earnings cuts. DABUR and MRCO are less adversely affected by the ongoing commodities surge. We had also highlighted the strong investment case for DABUR in a detailed note last month. Within discretionaries, we like TTAN, JUBI and DEVYANI. Demand outlook is buoyant and commodity costs are not worrying yet.

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