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Slow pace of earnings recovery in staples

For the 19 consumer companies under our coverage, we expect cumulative 3QFY23 growth of +9.3% in topline, +9.6% in EBITDA, and +8.1% in PAT. The three-year sales/EBITDA/PAT CAGR is 12.9%/9.6%/7.0%, with EBITDA growth and PAT growth lagging sales growth because of persistent material cost pressure. In terms of volume growth and revenue growth, our FMCG universe is likely to see another subdued quarter in 3QFY22, especially as rural demand remains weak. While some categories such as biscuits and cigarettes are showing signs of demand resilience, other categories such as paints/adhesives/innerwear are showing signs of lower growth on a very high base of the past couple of years. Going forward, weak rural sales growth from 4QFY22 may result in optically better growth from 4QFY23 onward, but on-the-ground rural demand is still adversely affected by inflationary pressures.

Rural continues to be a drag

With no clear signs of recovery in the rural demand, we expect sales in Staples to be driven by price increases and some premiumisation. Cumulative earnings growth appears better because of behemoths like ITC and APNT. Among large companies, we expect APNT to report 9% YoY sales growth with 5% domestic decorative volume growth, and ~17%/18% EBITDA/PAT growth. For HUVR, we expect YoY sales/EBITDA /adj PAT growth of 14%/4%/4%. ITC is likely to post YoY sales growth of 5.2% on a high base, and it should sustain its healthy earnings growth trend, with EBITDA/adj. PAT expected to grow by 17.8%/12.8% (PAT growth trailing EBITDA growth mainly due to unusually high other income in the base quarter). We expect healthy cigarette demand (three-year average volume growth in mid-single digit), high ARR in hotels and higher realizations in the paper & paperboards business. VBL, BRIT and INDIGOPN are likely to report strong numbers on all fronts, especially with EBITDA growth of 30% YoY or higher. On the other hand, we expect weak YoY EBITDA growth/decline for both AlcoBev players, PAG, PIDI, GCPL and HMN.

Input cost decline not as expected

As we mentioned in our commodities note at the end of Nov’22, prices of most commodities have not declined at the expected rate, with the exception of palm oil (which benefits soaps and food players). There is a clear disparity between crude derivatives, where VAM has shown a ~ 50% reduction from the peak, and other derivatives, such as Tio2 and HDPE, which saw minor reductions from the high base. Even in the case of VAM and palm oil, PIDI and GCPL are likely to benefit only from 4QFY23 onward. In the case of agricultural commodities, there has been additional inflation or low deflation. While a sequential gross margin improvement is likely on a cumulative basis for our coverage universe, it will be partially offset by high-cost inventory in 3QFY23, keeping GMs under continued pressure YoY. Following a few quarters of subdued levels, ad-spending is rising in some pockets, checking sequential EBITDA improvement. 13 of 19 stocks under coverage are likely to report flat or lower EBITDA margins YoY, except for ITC (EBITDA margin expansion of 380bps), BRIT, APNT, INDIGOPN and VBL (margin expansion likely to be in the range of 110-140bp YoY).

Top picks

ITC, GCPL and VBL:

A revival in cigarette demand, an improvement in the hotels business, lower input cost pressures vs peers and attractive valuations make ITC our top pick from a one-year perspective. The appointment of the new CEO at GCPL offers scope for a transformative change, especially if the company is able to grow its domestic business strongly and continue on its optimal capital allocation strategies. We like VBL owing to:

1) increased penetration in newly acquired territories of South and West India,

2) higher acceptance of newly launched products, and

3) growing refrigeration in rural and semi-rural areas.

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