Marico business update: Takeaways for consumer sentiment stay bleak

Marico’s business update does not paint an optimistic picture for the FMCG sector. In its Q2 FY20 update, the company said consumption demand has weakened progressively during the quarter. Further, liquidity issues remain challenging for partners in the distribution channel.

We believe that this sets up a sombre context for the upcoming result season where market participants are expecting some positive effect from the measures taken so far by the government and the progress of monsoon.

According to Marico, there has been a weak quarter for “each of the core and some of the new categories”. We are of the view that this translates into mid-single digit volume growth for the quarter gone by as against the projected high-single digit.

The FMCG major spoke of liquidity challenges that has led to some correction in trade inventories and exerted pressure on channel partners' investments and returns. This distress in the traditional channels was visible across rural and urban areas, which is partially offset by the steady performance in alternative channels - modern trade and e-commerce.

The update further stated that international business maintained strong show, with Bangladesh leading the way, while Vietnam witnessed some moderation in the home and personal care segment.

However, despite headwinds on the consumption side, benign input costs in India and Bangladesh businesses should help improve profitability. Copra prices in particular are down by ~20 percent from the start of the calendar year and about 3 percent from the previous quarter. Note that copra makes up about 45 percent of the raw material cost and should continue to help its gross margins.

Takeaways for the FMCG sector are not encouraging. The narrative for the prospects of business recovery now extends to H2 FY20, which can start with the upcoming festive season. As for Marico, certainly, there are higher risks for volume growth guidance of high single digit in FY20. The management is hopeful that the government-led stimulus so far and a good monsoon should help demand recovery.

As far as margins are concerned, the company should be able to execute EBITDA margin guidance of more than 18 percent in FY20. Copra deflation cycle continues to offer support.

Further, we continue to believe in the thesis that the company would use the raw material cost advantage for long-term investments. This will help bring down dependence on Parachute and Saffola and drive growth in premium segments.

In this context, we acknowledge that categories like male grooming, serums, hair nourishment and foods are expected to have a significantly higher share in the next five years. Marico expects 20 percent+ value growth in premium hair nourishment, male grooming, skin care and foods over the medium term.

The stock is trading at 39x FY21 estimated earnings, broadly in line with leading FMCG players – excluding HUL. We believe that investors who want to participate in the potential benefits of the business strategy mentioned above can utilise any decline in the stock price as an accumulation opportunity.

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