Investor's Eye
[November 19, 2013 | | |
| Summary of Contents
SHAREKHAN SPECIAL Q2FY2014 FMCG earnings review
Volume growth tapering off; better to remain selective in picking stocks Key points -
Growth tapering off: In Q2FY2014 most of the fast moving consumer goods (FMCG) companies saw a lower growth (compared with some of the earlier quarters) due to lower sales volume and almost nil or a marginal gain in realisation (in the absence of any meaningful price hike). The sales volume (especially in the discretionary categories) remained under pressure against the backdrop of persistently high food inflation and slowdown woes which had a significant impact on consumer sentiment and buying decisions. The volume growth of the highly penetrated soap and detergent category along with the price-sensitive categories, such as branded hair oil and skin creams, remained sluggish during the quarter. On other hand, some of the low penetrated categories, such as household insecticides (HI), health food drinks and hair colours registered a strong growth during the quarter. -
Benign input cost supports GPM: As the price of the key inputs (barring a few) remained lower on a year-on-year (Y-o-Y) basis and most of the companies had an inventory of low-priced raw materials, the gross profit margin (GPM) of the FMCG companies remained firm in Q2FY2014. However, a steep depreciation in the rupee would eat into the gains from the low raw material cost going ahead. -
But higher ad spends dented OPM: The savings at the GPM level were largely utilised to push sales through aggressive advertising and promotional spending in Q2FY2014. Most of the FMCG companies offered price discounts/freebies/promotional ad-ons in most of the key segments they operate in. Hence, most of the FMCG companies under our coverage (except for Marico and Jyothy Laboratories Ltd [JLL]) saw a flat operating profit margin (OPM) or a decline in the OPM (of 100-200 basis points) in Q2FY2014. In the current environment of a slowdown in volume growth, we expect these FMCG companies to continue to spend increasingly on advertisements in the near term. -
Sharekhan's FMCG universe-a mixed performance: Within the universe of the FMCG stocks actively covered by us, the performance was mixed with both Hindustan Unilever Ltd (HUL) and ITC managing to post an adjusted profit after tax (PAT) of over 10% despite growth pangs in the core business. HUL's ability to manage its margins (in spite of a moderating volume growth was ahead of expectations; though the valuation is stretched) whereas ITC managed to show a considerable improvement in the profitability of its cigarette and non-cigarette businesses (which negated the impact of a decline in the sales volume in the cigarette segment). In the mid-cap space, Bajaj Corp disappointed with moderation in the sales volume but some of the other companies, JLL, Godrej Consumers Products Ltd (GCPL) and GlaxoSmithKline Consumer Healthcare (GSK Consumer) posted a strong performance in a difficult business environment. -
Outlook-a good monsoon and higher MSP to support strong rural demand; demand in urban areas to remain under pressure: Most of the companies expect the growth rate to slightly pick up as a strong and extended monsoon has given hope of better agricultural production (both kharif and rabi). This will not only trim the inflationary pressures, but also boost the rural demand for FMCG products. On the other hand, the urban demand is expected to be muted until there is a substantial correction in food inflation. We expect the companies to continue to support their existing portfolio of brands and new launches with adequate brand building and promotional activities in the coming quarters. Going ahead, any improvement in the sales volume growth of the FMCG companies and any sequential drop in the GPM are the key monitorables in the coming quarters. -
View-remain selective: Given the moderation in volume sales, a tough macro-economic environment and premium valuations, it is advisable to remain selective in the FMCG space. We prefer ITC among the large-cap FMCG companies but are more bullish on some of the mid-cap names, such as Marico, Bajaj Corp, JLL and Tata Global Beverages Ltd (TGBL) in view of their decent valuations and long-term growth visibility. Q2FY2014 Auto earnings review
Earnings in slow lane Key points Auto sector (ex Maruti, Tata Motors) reports low single-digit earnings growth
In Q2FY2014, the aggregate revenues of the automobile (auto) companies under our active coverage grew by 3.6% year on year (YoY) while the earnings grew by 19.3% YoY mainly on the back of a strong performance by Maruti Suzuki (Maruti; which reported robust earnings due to the low base of Q2FY2013). Excluding Maruti, the coverage universe saw a revenue decline of 5.2% YoY while its profit after tax (PAT) remained flat.
Similarly, the auto tracking universe (consisting of coverage and non-coverage companies) reported a revenue growth of 18% YoY and PAT growth of 42% YoY. However, excluding Maruti and Tata Motors, the tracking universe saw a flat revenue growth and a lower single-digit growth of 3.3% in the earnings during the quarter. OPM improved marginally on back of subdued commodity prices and cost-control efforts
Despite the subdued revenues, most of the companies reported a marginal improvement in their operating profit margin (OPM). Most of the companies in our tracking universe reported an improvement in the contribution margin on the back of a lower material cost due to subdued commodity prices. The margin improvement was further aided by the cost-control initiatives adopted by the companies. Maruti and Tata Motors outperform; Ashok Leyland disappoints
Maruti's Q2FY2014 earnings almost trebled on a low base of the corresponding quarter of the last year (in Q2FY2013 its earnings had been affected by a strike at its Manesar plant). Tata Motors exhibited a robust earnings growth on the back of a strong operating performance of the Jaguar and Land Rover (JLR) business. Ashok Leyland Ltd (ALL) disappointed the most by reporting a loss in the quarter on account of a steep decline in the commercial vehicle (CV) volumes and higher discounting in the medium and heavy commercial vehicle (MHCV) space. Apollo Tyres added to our Buy list on robust Q2FY2014 performance and lower probability of the Cooper Tire deal
We recently included Apollo Tyres in our Buy list in view of its strong operating performance in Q2FY2014 and the continued high margin in its business on the back of subdued raw material prices (refer to our update on Apollo Tyres dated November 12, 2013). Also, the possibility of the Cooper Tire deal going through (which would have led to significant leveraging and increase in the earnings volatility) seems low due to the wage hike demanded by Cooper Tire's US workers and the opposition by its Chinese joint venture partner. Demand environment remains challenging; two-wheelers and tractors likely to outperform
We expect the demand for automobiles to remain under pressure after the end of the festive season. A persistently weak macro-economic environment, increase in the prices of fuel (diesel) and firm interest rates are expected to maintain pressure on the demand.
However, the sectors that have a relatively higher exposure to the rural areas (two-wheeler and tractors) may see a demand uptick on the back of a rise in the rural income due to an increased crop output and higher minimum support prices (MSPs). The commodity prices are expected to remain subdued which would help automakers to sustain their margins. Mahindra and Mahindra (M&M) remains our preferred pick in the auto sector as it is a direct beneficiary of increased rural income. Q2FY2014 Banking earnings review
Operating performance weakens, asset quality concerns persist Key points -
Earnings decline 13% YoY, weaker than expected: During Q2FY2014, the aggregate earnings of the Sharekhan banking universe declined by 13% year on year (YoY), led by the public sector banks (PSBs), which saw their earnings decline by 35% YoY. The private banks managed the challenges better and reported a healthy growth of 22% in their earnings while the PSBs were affected by treasury losses (due to a rise in yields) and an increase in non-performing asset (NPA) provisions. -
Operating performance falters in case of PSBs: Due to compression in the net interest margin (NIM), a slower fee income growth and a rise in the operating expenses (opex; led by wage hike related provisions) the operating profit of the PSBs (pre-provision profit [PPP]) declined by 3.6% YoY (in line with our estimate). However, in case of the private banks the PPP increased by 25% led by a stable NIM (due to base rate hikes) and a lower opex. -
No respite from asset quality stress, private banks fare better: Asset quality pressure continued for the banking sector though it was better managed by the private banks during the second quarter of FY2014. In case of the PSBs, the slippages remained elevated (though lower than the Q1FY2014 levels) while the recoveries improved in some banks (Bank of India [BoI], Allahabad Bank, State Bank of India [SBI]). Not much respite is expected on the restructuring front in the near term due to increasing additions to the corporate debt restructuring (CDR) pipeline. Given the trend of the economy and the stress in several sectors (infrastructure, engineering, metals etc), the pain on the asset quality front may continue for the next few quarters. -
Outlook-private banks to outshine PSBs: The second quarter of FY2014 was quite challenging against the backdrop of the exceptional measures taken by the Reserve Bank of India (RBI) to curb volatility in the currency market that led to tight liquidity and a spike in the bond yields. Consequently, it was not surprising that the operating performance of most PSBs was quite weak whereas the private sector banks fared better in sustaining profitability (NIM that is) and managing asset quality. In general, we expect the earnings of most PSBs to remain weak on account of pressure on the margin (NIM), rising credit cost and the need for higher provisions (related to assets and investment book). We, therefore, continue to prefer private banks like ICICI Bank (whose return ratios are improving), Axis Bank (where the risk-reward ratio is attractive), Federal Bank (whose valuation is attractive and whose margin will improve due to the inflow of funds into the non-resident Indian [NRI] deposit portfolio) with the exception of Bank of Baroda (BoB; a better capital position and relatively lower NPAs) among the PSBs. At the moment, we continue to avoid PSBs from the mid-cap space despite their low valuation due to high volatility in their performance and their weak capital position.
MUTUAL GAINS | Debt Mutual Fund Picks Bond / Debt market round up - Bonds yields eased during the month on the back of narrower-than-expected Current Account Deficit data. Moreover, trade deficit data touched a 30-month low of $6.76 billion in September, led by rising exports and declining imports. Strong recovery in the rupee, seen throughout the month, also supported bond yields. Bond prices gained further following liquidity measures taken by the RBI and after weak economic data from the U.S. increased expectations that the Federal Reserve is unlikely to scale back its bond-purchase program anytime soon. However, higher-than-expected headline and retail inflation numbers put some pressure on bond yields.
- The 10-year benchmark bond yield fell 15 basis points (bps) to close at 8.62% against previous month's close of 8.77%, after moving in the range of 8.42% to 8.73%.
Bond / Debt Outlook - Bond yields are expected to remain supported on normalization of exceptional measures and on the provision of additional liquidity support. However, the reduction in the GDP estimate and increase in inflation forecast suggest that the Central Bank would have to adopt a balancing act and there could be calibrated approach moving forward. It is expected that main triggers for the market will be any news on Fed bond buyback program, movement in domestic currency and updates on economic indicators. The RBI will conduct the auction of Government Securities and Treasury Bills for an aggregate amount of Rs75,000 crore and Rs48,000 crore respectively.
| | | | Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article. | | | |
Regards,
The Sharekhan Research Team | |
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