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Tepid volumes & elevated input costs impact earnings print

3QFY25 earnings performance for staples is expected to be lacklustre with festive season/weak base failing to bring any acceleration on the volume growth. Rural is seeing a gradual recovery, which along with moderation in urban consumption, grammage cuts (in foods) and delayed winters (for Skin care, healthcare segment) have impacted the volume growth. Some of this was partly known from cautious commentary of staples players post 2QFY25 results. Value growth is estimated to be higher than volumes growth as pricing has turned positive (due to price hikes & anniversarisation of price cuts), after decline for past 4 quarters. For 2HFY25, while sales growth (+ 7% yoy) for staples players is expected to be better, operating profit is likely to be weaker (low-single-digit yoy) vs 1HFY25 and vs our earlier estimates primarily on account of higher than anticipated gross margin compression. Hence for staples peers we have cut our earnings by 2-7% over FY25-27E, with higher cuts for foods players. Going ahead, how urban consumption and RM basket (some moderation seen in palm oil, stable crude prices) shapes up will be key. We expect staples coverage (exITC) earnings to grow at 13% CAGR over FY25-27E. Valuations at c.50x NTM PE are closer to 10 year average. While some of the issues are transient in nature, it is difficult to gauge the time period it will last for. Given volatile environment, we stay selective – prefer Varun Beverages, Marico, ITC within our coverage universe.

*Festive season fails to lift volume growth for staples: Contrary to expectations of festive led improvement in underlying volumes for Staples, the quarter has been challenging with demand trends remaining weak – our channel checks and pre-quarter commentaries from staples players suggests that volume growths have moderated on sequential basis (baring Marico), despite favourable base. Rural is seeing recovery (although gradual), urban consumption is seeing moderation (Exhibit 9-13). This apart, grammage cuts (especially in Foods to offset some impact of high RM costs) and delayed winters (even base quarter had mild winters) too had impact on certain segments (Healthcare for Dabur, Skincare for HUL). On the Discretionary space, as per our checks and pre-quarter updates, the underlying trends have remained buoyant in certain pockets like Jewellery (Titan/Kalyan), Value Fashion (healthy SSSG registered by V-Mart,V2 Retail), Alcobev and Cigarettes.

*Price hikes to aid higher revenue growth (vs Q2), inflation in agri-commodities and scaledeleverage to impact profitability: With pricing turning positive (especially in Foods & Personal Care – Exhibit 4), revenue growth for staples (ex-ITC) is expected to be higher at 6% yoy in 3QFY25 (vs c.3.6% in 2QFY25). Normalised sales growth on 2yr/5yr CAGR has not seen any acceleration. We expect Marico/TCPL to outperform with mid-teen sales growth, Bikaji/Colgate/GCPL (domestic) are likely to see moderation in sales growth vs 1H trends while rest of the staples pack is expected to see low to mid-single digit sales growth in Q3. Within discretionary, we expect VBL sales growth of c.42% yoy (organic sales growth c.5-6%), ITC-Cig sales growth of 7% yoy (volume growth of 3%) & flattish sales for Asian Paints. On the operating profit front, we expect EBITDA margin compression for all the staples players (on account of RM inflation led GM compression & weak operating leverage). EBITDA growth for staples (ex-ITC) is expected to be flattish on yoy basis for Q3, with margin compression of c.130bps yoy.

*2H unlikely to be better than 1H: For staples players, while sales growth (c.7%) is likely to be higher (led by higher pricing growth) vs 1HFY25, it is lower vs our earlier expectations (of high single digit) with volume growth acceleration remaining elusive. Moreover, the impact of RM inflation is also estimated to be higher (indicative from pre-quarter commentaries of staples players) than envisaged. As a result, EBITDA growth is likely to be in low single digits for 2HFY25, lower vs 1HFY25 as well as vs our earlier expectations (of mid-high single digit). (Exhibit 8)

*Key near term monitorables: a) For staples players, sales growth is expected to be key earnings driver, estimated to contribute to >75% of FY26E incremental EBITDA. For our staples coverage universe, we are building acceleration in sales growth from mid-single digit in FY25E to high single digit in FY26E (a combination of improvement in volumes and higher pricing growth). b) RM basket has been inflationary (JM Proprietary FMCG RM Index up 6% yoy in Q3) primarily driven by agri-commodities (Copra,wheat,Palm Oil,Tea,coffee), partially offset by benign crude prices (down c.10% yoy in Q3). Price hikes typically come with a lag and are not commensurate to input cost inflation in certain segments (especially Foods & Soaps where RM inflation is steep). We are building a modest margin expansion for FY26E for staples peers. Hence how pervasive is the urban slowdown and how RM basket behaves will be the key monitorable over next 2-4 quarters.

*Earnings trimmed factoring weaker Q3: We tweak our estimates (Exhibit 19) as we build 3Q expectations (lower volume growth and impact of RM inflation on margins). For FY25E, material downgrades are in Bikaji (c.13%, impact of inflation in palm oil), Honasa (c.29%, muted growth/margins in 2H & recovery likely from FY26 onwards) and TCPL (c.11%, impact of inflation in tea prices). For most of the other staples players we have cut our earnings by 2-4% over FY25-27E, factoring higher input costs. As a result, there is commensurate change in TP for the coverage universe too (Exhibit 20).

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