Bajaj Consumer Care Q1: Uptick in competition intensity & downtrading as demand softens

EBITDA margin contracts due to higher advertising spend & other expenses

Product diversification remains a key aspect to watch in medium term

Bajaj Consumer Care’s quarterly result was adversely impacted by consumer demand slowdown, partially translated through consumer choice for low priced variants, also known as downtrading and increased competitive intensity.

While softer raw material cost comes as a respite and gives confidence to the management to maintain gross margins, product diversification strategy remains a factor that deserves a close watch for investors.

Key negatives

Q1 FY20 sales growth of 8.5 percent YoY (year on year) was aided by both volume and pricing growth. Volume growth of 4.7 percent was in line with expectations and came on a base of 8.7 percent last year. Domestic market witnessed a moderation in growth. Part of it was due to absolutely zero sales to Canteen Stores Department (CSD channel) on account of procedural delay related to registration of the company with CSD with its new name (Bajaj Consumer Care from earlier Bajaj Corporation).

However, even after excluding the CSD channel, domestic sales has slowed to 7.05 percent from 11.61 percent in Q4 FY19. The management observes that while there was some recovery in April, demand weakness intensified thereafter.

Sequentially, gross margins improved (+252 bps QoQ) due to contraction in raw material prices (Light Liquid Paraffin/LLP, refined vegetable oil). However, due to surge in advertising and other expenses, EBITDA margin contracted.

Table: Financials

Source: Company

Key positive

Among trade channels, growth in modern trade remains strong at 20.6 percent YoY and now constitutes 7.6 percent of sales. Additionally, international business witnesses continuous improvement in offtake since Q4 FY19 and now comprises ~3 percent of sales.

Other observations

Over the past three years, the company has lowered wholesale channel contribution from 60 percent to 33 percent. While part of the impact is due to GST implementation, the company has had a higher share of direct reach, which at present is 5.11 lakh outlets compared to 2.8 lakh outlets at the end of FY18.

Second, there is an uptick in product diversification for the company. It has recently launched products for sunscreen category (Nomarks Ayurvedic Antimarks Sunscreen) and cooling oil space (Bajaj Cool Almond Drops). This is broadly an extension of existing brands. However, an overhaul of the firm’s existing hair oil business is also on the cards, for which it has mandated consulting firm – Bain & Company. Initial results are expected towards the end of second quarter FY20.

Competitive intensity and limited portfolio range key constraints

While recovery of international sales has sustained in the quarter under review, domestic demand moderation is a key sector-wide risk that the company is grappling with. At the margins, there are signs of downtrading wherein end consumers are switching to low lost hair oil such as coconut- and amla-based hair oil. Furthermore, though modern trade channel continues to post strong numbers, intensified competition with nearest peer Dabur needs a close watch.

In the near term, gross margins are likely to remain stable as the inventory for key raw material (LLP) is covered till October 2019. However, EBITDA margins are likely to remain under pressure due to competitive intensity leading to elevated advertising and sales promotion spend.

As far as the stock is concerned after having corrected by 35 percent from its 52-week high, it is trading range bound. Furthermore, after downward adjustment to our near-term assumptions for EBITDA margins, the stock is trading at 17x FY21e earnings. This makes it among the cheapest FMCG stocks available.

In addition, gradual tweak in product portfolio and a favorable distribution strategy make a constructive case for the stock. Having said that, on account of competitive intensity and limited diversification, we expect it to trade at discount to the median trading multiple of the FMCG sector.

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