The next few months should provide clues on whether the consumption engine is staging a revival or not
It’s that time of the year again when most of India will be hopping from one festival to another, groaning under the weight of sweets and shopping. While the financial community will do likewise it will also watch for anecdotal and empirical data to diagnose the health of the consumption engine. Festivals are an annual feature but this year is different. There are cracks developing in the consumption story and fears are growing that they could deepen.
That’s scary talk for India’s economy and consumer stocks. The next few months also coincide with the September quarter results being announced, which means managements will also throw more light on market conditions.
One season or even one bad year does not change the long term outlook for consumption in an emerging market like India. But relatively high valuations for many consumer stocks make investors anxious during trying times such as these. In fact, valuations have come down from their highs of a year ago.
So, here are some trends you can watch out for in the forthcoming festival and earnings season.
Volume growth: Investors are worried on this front. Since inflation is low, it is volume growth that has to drive sales growth. Higher volume growth should lead to better scale economies and better margins. Volume growth of big ticket items such as automobiles and even daily consumption items such as soaps had declined in the June quarter. Auto sales data for September should give an idea of whether the worst is behind the sector, but even if it does we need to see if it continues to improve in October and subsequent months.
For FMCG companies, don’t put too much importance on the overall volume growth number but look at main categories to see if the improvement or decline is across the board or localised to a few categories. In the case of Hindustan Unilever, for example, the June quarter saw soap sales pull down growth while several other products did quite well. The September quarter may see it pull up overall growth as HUL has cut prices and may spend more on advertising and promotions. Don’t get carried away by that, either.
Rural demand: This is another thread that one must pick up, on what different industries are saying about rural demand. A better than expected monsoon should result in better output. Prices of some farm produce have also risen. That makes for a good combination to boost farm income. A revival in rural demand is much needed. Urban markets are good for selling more premium products but rural markets have an important role in overall sales growth.
What to look for in earnings: Now, the above factors will reflect in earnings as well but earnings data will give specific clues about the state of business.
a. See if pricing is staying low or is inching up compared to the June quarter. Some recovery in pricing is a positive sign.
b. In the past, material costs have remained low and helped margins improve. Now, companies may decide to push sales growth. Therefore, they may cut prices or spend more on advertising and promotions. That should be visible in the financials. Don’t fret too much if that happens, as long as there is a commensurate revival in sales growth. At this point, that is more important than a percentage point or two of Ebitda margin that is sacrificed.
c. If sales growth picks up smartly and net profit growth is robust, that’s a combination you should be happy with in this market, even if operating margins slip a bit.
d. Look out for management commentary on rural and urban market trends. If they signal that advertising and promotional spends will continue to be at higher levels, that has consequences for margins.
e. On the corporate tax rate cut, companies may state whether they intend to switch. That could give some clarity on the effect on their due to potential tax savings and how they plan to use the additional profits.
Seasonality: In FY20, the festival periods are earlier compared to last year and investors should adjust for a low base effect where applicable. This could mean, for instance, that companies may have pushed out more stock to their dealers in the September quarter itself, and may therefore reflect in higher September quarter numbers. This will normalise in the subsequent quarter. This is especially true for big ticket items such as consumer durables but also packaged food products, apparel and the retail industry.
Data releases and noise: The big billion sales data by e-commerce portals is already being talked about as the highest ever while some point out that the growth is slower than before. This is good to know but has little value since e-commerce is a small part of India’s retail market. Ignore it if you can. The Nielsen data for the FMCG sector will become available soon, and that should give some idea of whether growth has slipped further or has steadied itself.
Similarly, today will see prominent automobile companies release their sales data for the month. After adjusting for seasonality, do see if a recovery is around the corner. In this recent article, we had said that retail data appears to suggest that could be the case.
Managements of consumer durable companies, FMCG and automobiles will be interviewed during earnings and on other occasions in coming months. See if what they are saying is matched by the data emerging from the market and from corporate earnings.
A few companies have begun to release early reports on the quarter that went by, even before earnings are released. Keep a watch out for these for early signs.While the festival season will continue till the year-end, the next few months should give investors a fair sense of what to expect in the near term, based on what companies say and other data/anecdotal evidence. That would then determine how consumption stocks perform in the rest of FY20. While the near term may seem uncertain as of now, the longer term picture for stocks that are a play on India’s consumption basket still remains bright.The Great Diwali Discount!
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