[T.S.R:16157] Morgan Stanley-Inflation Eats Into The Margins Of FMCG Companies

Maintain Cautious industry view: We believe Indian home and personal care products EBITDA margins have peaked for now. Rising input costs amidst intense competition and slowing revenue growth are likely to continue to constrain earnings.  We maintain our OW rating on United Spirits – the top pick in our coverage universe. We reiterate our UW rating on HUL and Marico and downgrade ITC to EW from OW as valuations look less compelling.  We upgrade Colgate to EW (UW earlier) given the recent sharp increase in operating margins in a relatively benign competitive environment for oral care in India. We upgrade Nestlé to OW from EW on recent stock underperformance and a potential tailwind from input costs. What's new: Our proprietary input cost index has risen 8% YoY with prices of palm oil up 14% and copra up 4% over the past month. Higher input costs further squeeze FMCG companies in an already intensely competitive environment.  We estimate that an inability to pass on input costs could erode operating margins of the HPC companies under our coverage by 90bps in F11. Where we differ: Valuations of Indian consumer companies are the highest in four years (25x F11E earnings vs. last four-year average of 22x).  Part of the outperformance can be explained by an investor penchant for consumer stocks in emerging economies in the current volatile macro environment – the MSCI AxJ consumer index has outperformed the MSCI AxJ index by 15% over the past year.  However, with an improving global economy and thus increased appetite for risk, Indian consumer stocks may underperform. We believe investors are factoring in sporadic and short-lived competition in the domestic HPC segment, while we expect competition to persist, since it is driven by companies with long-term commitments and strong balance sheets. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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