FMCG: Post-monsoon input prices & impact analysis - downgrading Colgate and Dabur

Motilal Oswal Securities - In our report titled Monsoon Impact and Category Analysis (dated 8 June 2010), we had highlighted that a normal monsoon would result in a twin benefit for FMCG companies - benign agri-input prices and improved pricing power. While commodity prices indicate mixed trends, companies have raised prices in a few categories.

- Input prices a mixed bag - sugar, ENA benign; PFAD, titanium dioxide up: We observe a mixed trend in raw material prices for our FMCG universe. While crude-linked inputs are ruling firm YoY, agri input prices are softening. Prices of sugar have declined 34% from the recent peak while ENA prices have declined 8% YoY. Milk and edible oil prices are likely to soften post the festive season. Copra prices are likely to remain firm until the new harvest in December. Prices of major crude-linked inputs are up 5-50% YoY, with PFA (up ~47% YoY) and titanium dioxide (up ~15% YoY) witnessing a major surge, though prices of LAB (down ~3% YoY) and HDPE (down 4% YoY) are benign.

- Normal monsoon, subsiding inflation reinstate pricing power of FMCG majors: Overall, the monsoon has been normal, with 4% surplus as on 15 September 2010. This should boost farm output and income levels. Higher output will reduce supply-side inflationary pressure while higher incomes will boost purchasing power. HUL (5-8% in select SKUs in soaps and detergent) Asian Paints (~7%), Marico (3-5% in Parachute and Saffola), Dabur (3-5% in select brands) and Nestle (5-8% in major brands) have increased prices.

- FMCG universe margins unlikely to deteriorate significantly from FY10 levels: Much of the input cost pressure for our FMCG universe is likely to be offset by (1) selective price increases / better mix, (2) control on ad-spend (for select companies), and (3) operating leverage (led by robust volume growth). United Spirits and Britannia would witness meaningful margin expansion while HUL and Nestle would witness margin pressure. For the other companies under coverage, margins are likely to be range-bound (up/down 10-20bp).

- Prefer ITC and Nestle; downgrade Colgate and Dabur to Neutral: Most companies in our FMCG universe are trading at 10-25% premium to their historical multiples. ITC and Nestle are our top picks. We downgrade Dabur and Colgate to Neutral.

Source : Equity Bulls

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