FMCG - Results Preview - Demonetisation Steals the Show...Literally! - Reliance Securities

Demonetisation has had a major impact on performance of the consumer companies in 3QFY17E. We expect single-digit fall in revenues in the quarter on the back of instability in the system marked by cash crunch following demonetisation drive. However, we expect the impact on net profit to be limited as the companies have recalibrated their A&P and other expenses in wake of sharp decline in sales.

While all consumer companies would be adversely impacted, the companies like Godrej Consumer Products (GCPL), ITC, Nestle & Bajaj Corp will have a moderate impact on their quarterly numbers due to several factors. In case of GCPL the reason being international business accounting for half of its revenues, which has not been affected due to demonetisation. ITC has reported decent volume growth in cigarettes and has also hiked the prices of some of its flagship brands, which should limit the downside. Nestle too would report positive growth, as the base quarter was adversely impacted due to ban on Maggi. Similarly, Bajaj Corp's net profit numbers would be positively impacted as impact of Nomarks amortisation has been fully accounted for by 2QFY17.

Demonetisation has impacted the sector on two fronts.

- Severe Currency Crunch: The sudden announcement led to severe currency crunch with >86% of total issued currency ceasing to be valid legal tender. This resulted in consumers using available resources only for meeting bare necessities. However, the situation started improving gradually in the following month. While smaller cities and rural areas are still witnessing shortage of currency, the situation has reportedly improved even in those areas.

- Impact on Cash-driven Wholesale Channel: The wholesale channel bore the brunt of the demonetisation drive. All the FMCG companies have focussed on improving their respective distribution network for the last five years, especially in rural areas. The distribution structure in rural areas is predominantly depended on wholesale channel for last mile connectivity unlike their urban counterpart, where distribution structure is more formalised. This increases the cost of direct distribution for the FMCG companies. Over 2/3rd of India's population resides in rural areas and is geographically scattered. Moreover, the purchasing power is lower in rural areas as a result of which the pace of premiumization is slower than in urban areas. These two factors aided the companies favouring the wholesale system.

Roughly 30-40% of sales of the consumer companies accrue through this channel, which predominantly driven by cash and has been significantly impacted following demonetisation. It is to be noted that most FMCG companies, who earlier did not provide any credit, have now extended credit to distributors who have passed on the same to their respective wholesalers. We expect the situation to return back to normalcy by 1QFY18E.

Input Cost Index: Input cost index remained high on both yoy and qoq comparison across commodities, especially led by crude oil and derivatives. The average price of Palm Fatty Acid Distillate (PFAD) rose by 60% yoy, while crude oil prices inched up 16% yoy in the quarter. Liquid milk prices too were higher by 17%, while the prices of Light Liquid Paraffin (LLP) were 9% higher. Though the average price of copra fell by 8% yoy, it rose 14% sequentially.

Outlook & Valuation

While demonetisation is certain to adversely impact 2HFY17 numbers, we believe that good monsoon and implementation of 7th Pay Commission's recommendations would revive consumer demand in FY18E. Our coverage universe trades at 34x FY17E & 29x FY18E earnings, while excluding ITC, the sector trades at 39x FY17E & 33x FY18E earnings. We continue to remain positive on ITC in Large-cap space and Pidilite, Titan & Jubilant Foodworks among others in Mid-cap space.

Source : Equity Bulls

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