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* Our widespread consumer coverage universe, with combined revenue of INR4,000b and market cap of INR32,000b, registered aggregate revenue growth of 8%/9% in 2QFY25/FY24. The coverage includes six segments, most of which posted revenue growth in 2QFY25/FY24 (i.e., staples +7%/+6%, paints -2%/+4%, liquor +4%/+5%, innerwear +11%/-3%, QSR +7%/+12%, and jewelry +22%/+28% YoY). Staple companies missed the expectation of further pickup in volume growth in 2QFY25; however, their performance was steady and better than that of many discretionary categories. With rural performance improving, there was expectation for a sequential improvement for staple companies in 2QFY25. However, extended monsoon, disruption in supply chain, adjustment in GT inventory, and slow urban demand limit the desired pickup. We continue to believe that revenue growth acceleration for staple companies was driven by steady volume, aided by price hikes. Gross margin was affected by commodity price inflation, which we believe will be gradually offset by pricing actions.

* Discretionary categories have been a drag on overall volume growth and margins. The paint segment witnessed a slowdown in growth due to industry-wide challenges, and pressure on margins from high input costs and negative operating leverage. The alcoholic beverages segment revenue was impacted by seasonality and adverse weather conditions (heavy rains), which dampened consumer demand. Similarly, the quick service restaurant (QSR) category continued to face growth challenges, particularly in the dine-in format, with sluggish margins adding to headwinds. On the other hand, the jewelry segment outperformed, with strong revenue growth driven by a recovery in demand after the customs duty reduction. However, profitability was a mixed bag due to a change in the product mix and gold inflation (margin impact).

* Though management commentary for 2HFY25 remains optimistic, backed by pricing, it appears more achievable for staple and jewelry companies at present. Among our coverage companies, Page Industries, UBBL and Varun Beverages were the outliers in 2QFY25, with revenue/EBITDA growth of 11%/21%, 12%/23% and 24%/30%, respectively.

Performance summary of all categories and key areas to monitor:

* Staples:

Following a modest upswing in 1QFY25, volumes were marginally impacted in 2QFY25 by several factors, including subdued macroeconomic conditions, inventory corrections by select companies to improve systemic health, adverse weather conditions such as floods and heavy rains (disrupted categories like beverages), and persistently high inflation. While rural markets continued to recover, urban demand remained challenging for FMCG players during the quarter. Additionally, the rapid growth of e-commerce and quick commerce channels exerted pressure on the general trade (GT) channel’s growth for the industry. Gross margins for most companies remained under stress due to rising inflation, though a few companies managed post EBITDA margin expansion by controlling their A&P spends. Despite these efforts, EBITDA growth was slow across companies. Looking ahead, companies are expected to implement price hikes in 2HFY25 to offset the rising raw material costs. We anticipate a gradual improvement in volumes in the coming quarters, supported by a healthy monsoon season, consistent rural pickup and better portfolio play for emerging channels. In terms of revenue, Colgate (+10%) and Marico (+8%) were outliers, but EBITDA performance was better for Pidilite (+13%) and Emami (7%).

* Paints:

The paint sector reported flat value growth in 2QFY25, reflecting subdued demand dynamics amid multiple headwinds. Demand was impacted by weak consumer sentiment, extended monsoons, and floods that disrupted offtake during Aug-Sep’24. Additionally, price cuts in prior quarters, an unfavorable product mix, and competitive intensity further weighed on revenue performance. Urban markets have seen a bit of slowdown pressure, contrasting with relatively better recovery trends in rural and tier-3/tier-4 regions. Margins came under pressure due to raw material inflation, the adverse product mix, and increased discounting. Modest price hikes of 1-2% implemented during 2QFY25 are expected to yield benefits in 2HFY25. A near-term demand outlook remains challenging as urban markets continue to underperform, and the festive season was subdued due to extended monsoons and an early Diwali, coupled with rising competitive pressures. Asian Paints performance was the weakest among its peers, with revenue/EBITDA down 5%/28% YoY.

* Liquor:

The alcoholic beverages segment faced several challenges in 2QFY25, with seasonal factors and heavy rainfall dampening overall demand. Volume growth remained subdued, particularly in the mass segment, which continued to experience pressure. United Spirits' (UNSP) P&A segment saw a deceleration in growth, owing to the front-loading of sales in 1QFY25, a high base effect due to festive-related loading in the prior year, and softer consumer demand during the quarter. In contrast, peer companies, Radico Khaitan, UBBL and Sula Vineyards, reported better volume growth. ENA prices continued to face inflationary pressures, while glass prices remained stable, providing partial relief from cost volatility. However, barley costs exhibited an inflationary trend and are expected to remain volatile, keeping margin pressures elevated in the near term. Looking ahead, higher volume growth supported by a focus on premiumization and better realizations should drive revenue growth and improve operating margins. Additionally, stability in excise duties and the rollout of excise policy reforms in Karnataka and Andhra Pradesh are likely to support demand for premium brands, offering a positive outlook for the segment. UBBL outperformed that category with 5%/27% growth in revenue/EBITDA, while UNSP was a laggard with revenue/EBITDA performance of -1%/+8%.

* QSR:

The segment continues to face significant demand challenges, marked by weak unit economics and heightened market competition. The subdued underlying growth during 2QFY25 weighed heavily on financial performance, with restaurant margins and EBITDA margins contracting across all major brands. Profit before tax also declined universally, reflecting the broader pressure on profitability. We remain cautious about the recovery prospects for the QSR sector in the near term. Despite favorable ADS and SSSG bases, meaningful underlying improvement in 2HFY25 appears unlikely. Restaurant operating margins remain under strain, and we expect this pressure to persist in the coming quarters, given the challenges in the current demand environment and competitive dynamics. Jubilant outperformed its peers in 1HFY25.

* Jewelry:

Jewelry companies have delivered robust sales growth, driven by demand recovery after the customs duty reduction. Titan (jewelry standalone), Kalyan, and Senco delivered revenue growth of 26%, 37%, and 31%, and SSSG of 15%, 23%, and 20% respectively. Studded jewelry sales declined across companies, except for Kalyan, due to softer diamond demand, which impacted margins. For Kalyan, a higher revenue contribution from franchise stores led to a contraction in reported margins. The reduction in customs duty resulted in an inventory loss of INR2.9b for Titan, INR690m for Kalyan, and ~INR300m for Senco, which hurt the reported profitability of companies. Festive demand in Oct’24 was robust and we remain positive on the jewelry sector, anticipating an accelerated shift in consumer preference from unorganized/local channels to organized, driven by trust and transparency.

* Innerwear:

Consumer sentiment remained muted during the quarter, though rural consumption recovery continued to support demand trends. The onset of the festive season toward the end of the quarter provided encouraging signs, while e-commerce channels maintained strong growth momentum. Urban markets underperformed compared to tier-3 and tier-4 towns, where demand recovery was more pronounced. Margin expansion was driven by stable raw material costs, particularly cotton, along with improved cost efficiencies. Page Industries focused on optimizing inventory levels across its distribution network, reducing channel inventory in 1HFY25, with further improvements planned for 2HFY25. Secondary sales were higher than primary sales by ~4% as the company strategically calibrated inventory to align with market demand. Looking ahead, the festive season and normalizing trade inventory should further drive improvement in primary sales in 2HFY25. Input prices have eased, which should help PAGE sustain margin expansion. PAGE remained an outlier among its innerwear peers, with 11%/21% YoY growth in revenue/EBITDA.

Valuation and View: Maintain preference for staples and jewelry companies

* In our last consumer sector thematic report published in Apr’24, we emphasized our overweight stance on staple companies owing to favorable risk-reward dynamics and anticipated volume recovery in FY25 and FY26. Over the past two quarters, we have observed steady improvement in volume growth, along with optimistic management commentary regarding further acceleration in growth in the upcoming quarters. After a strong run-up in stocks during Apr-Sep’24, we saw a sharp correction in stock prices as these companies failed to show further volume pickup in 2Q, along with adverse stock market activities. We continue to believe that the growth cycle will see an upward trend and valuations will also fall in place accordingly. We reiterate our overweight stance on the staple segment and continue to prefer HUL, GCPL, and Dabur as our top picks.

* We remain selective for our discretionary universe. Jewelry companies are expected to sustain strong growth momentum, led by SSSG and store addition. Kalyan Jewelers and Titan are our top picks in the jewelry segment. For Page Industries, we have recently upgraded our rating after the earnings pickup and normalizing trade inventory.

* We are monitoring QSRs, liquor, and paint companies for indications of improved growth. The recent fall in stock prices certainly captures a large part of negative sentiment for these companies too. We will choose these stocks selectively once we see the business cycle turning.

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