For the third consecutive quarter, all consumer companies under the coverage of Motilal Oswal which have a rural reach of over 30 percent have stated that rural growth has outpaced urban growth.
Rural demand had been the fulcrum of the strong volumes witnessed by the sector in the years leading up to FY14 but had slowed down in FY15 and FY16 because of drought, and in FY17 because the impact of demonetization had negated the potential positive benefits of a normal monsoon.
While urban volume growth has remained fairly resilient at mid-single-digit levels, rural growth, which was growing at the 1.5-2x urban growth in the years leading up to FY14, declined to flat and even negative levels in the years that followed.
Factors which are fuelling rural growth are normal monsoon in FY18, low base effect, increase in MSP in FY18, an increase in rural allocation in recent budgets.There are four factors in particular which brighten the prospects of a further recovery in rural demand to earlier high levels:
- Initial reports by both Skymet and IMD indicate that the monsoon is likely to be normal in FY19.
- Unlike the preceding two years, there will (hopefully) be no disturbances like demonetization/GST implementation, impacting purchasing power or product availability.
- Likely spate of new launches in FY19, as demand trajectory is improving.
- Distribution expansion by most companies over the past 3-4 years will start bearing fruit.
Motilal Oswal has a buy rating on all four stocks that have a high rural exposure which include names like Hindustan Unilever, Colgate-Palmolive, Dabur India and Emami. Hindustan Unilever, Emami and Britannia Industries remain top rural picks from a medium-term perspective.
Five key trends are particularly relevant for Hindustan Unilever, resulting in an elevation in its earnings growth trajectory compared to the past:
- its rapidly improving adaptability to market requirements,
- its recognition of Naturals as a key subsegment across categories,
- continuing strong trend towards premiumisation;
- extensive plans to employ technology, and
- renewed emphasis on margin growth through ZBB and other cost-saving efforts. Allied with best-of-breed RoE, Hindustan Unilever remains sole buy in the large-cap FMCG universe.
Motilal Oswal believes Emami remains a credible long-term play due to:
- healthy growth likely in existing product categories where it has a dominant market share,
- best-of-breed R&D spend and A&P spend, resulting from innovative products as well as ability to back up innovation with strong marketing, and
- much-needed efforts on improving direct distribution reach.
At 29.4 times its estimated earnings per share for FY20, Emami is inexpensive relative to peers, particularly given the healthy long-term earnings growth opportunity and mid-30s return ratios.
While Britannia is currently an urban company because rural is only around 20 percent of sales, a combination of:
- its remarkable efforts in distribution ramp up- both in direct and total reach over the past four years, and
- its success in its new strategy of Low Unit Packs of its premium products as well as 'Tiger' Creams have resulted in tremendous growth in the hinterland states in recent years with FY18 being particularly strong.
The management is targeting 33 percent of sales from rural. Rapidly expanding distribution, continuing investments in R&D and significant expansion of its own manufacturing indicate the immense confidence that management has on the growth prospects.
Colgate Palmolive India:
Motilal Oswal is optimistic on Colgate Palmolive’s earnings prospects, given:
- its impressive execution after a delay in the herbal portfolio launch – the two products launched have seen a good response, and more products will be rolled out under the Vedshakti umbrella, and
- its high rural market share of 60 percent, which makes it a promising play on rural recovery. Patanjali had severely impacted business initially, but the threat is perceptibly reducing.
Even on FY18 EPS, Colgate Palmolive trades at 10 percent discount to our ex-cigarette and alcohol consumer peer valuations. With return ratios superior to peers barring Hindustan Unilever, such discounts are unwarranted.
The much-vaunted earnings revival in the sector appears poised to come through, and rural-dependent plays are likely to be at the vanguard in FY19.
Dabur has addressed the market share loss issue in its two key categories of Juices and Honey, while Oral Care continues to do very well. With an expected EPS CAGR of 16 percent going forward (v/s less than 12 percent CAGR over FY14-17), Motilal Oswal values the stock at 42x March 2020E EPS (10 percent premium to three-year average) and derive a target price of Rs 435.
Relative to other three rural plays, DABUR has a much more diversified product portfolio and is not dominant in many of them. Weaker competitive advantage, therefore, results in some risks to earnings projections. RoE is also weaker than the peers mentioned above.Disclaimer: The article is extracted from Motilal Oswal’s report on the consumer sector. The views and investment tips expressed by investment expert on Moneycontrol.com are Motilal Oswal’s own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.