StanChart Equity Research: India Consumer Sector: 4QFY11 preview - The dichotomy continues

- Strong net sales growth at 18% YoY despite high inflation, driven not only by price hikes but also steady volume growth

- High inputs costs to result in 80bps QoQ EBITDA margin decline, but still remain healthy at 21.3%. Aggregate sector recurring PAT growth to be strong at 16% YoY

- Valuations will remain high. Maintain Titan, ITC and Asian Paints as our top picks

The dichotomy continues - Strong sales growth despite high inflation. Despite high inflation in general & higher food inflation in particular (and add to that a high base quarter - 18.8% growth in 4QFY10), net sales growth for the sector is estimated to be robust at 18% in 4QFY11. Though this growth is aided by some of the recent price increases, our industry interactions indicate that volume growth has been steady with hardly any indication of down trading. HUL's volume growth is expected to be in double-digits despite high base; also domestic sales growth of Asian Paints and Nestle is expected to remain strong at >20%. Pipeline correction by trade could result in ~5% decline in ITC's cigarette volumes. Consumer sentiment continues to be buoyant – we expect Titan to report ~30% sales growth. Recent decline in food inflation should help demand sustenance in the near term.

Margins under pressure, but still at healthy levels. Rise in cost of commodity inputs will result in marginal decline in profitability, but moderate price hikes and benefits of operating leverage will limit QoQ operating margin decline – we expect sector EBITDA margins to decline by 80bps to 21.3%. HUL's operating profit will decline marginally, while strong pricing power will enable ITC to post strong operating profit growth at 17.4%. Recurring PAT growth for the sector is expected to remain strong at 16% YoY, with Nestle and GSK posting >25% PAT growth. In the past one month, there has been some softening in commodity prices - continued softening, if any, augurs well for profitability of the sector in the near term.

Valuations will continue to be on the higher side. Sustained growth in the sector, healthy profitability and high quality of earnings will keep valuations high. At one-year forward P/E of 24.7x, the sector trades at a reasonable premium of 9% to its five-year median. The marginal premium is justifiable given the sharp improvement in sector RoE over the past five years - FMCG RoE has increased from 33% to 41% over FY05-10. Titan continues to be our top-pick with an expected upside of ~30%. Other top picks include ITC (best-placed in inflationary scenario) and Asian Paints (key beneficiary of structural growth in paints sector)

Source : Equity Bulls

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