Godrej Consumer & Emami Q3: Rural prospects expected to lead recovery

Emami’s Q3 FY18 sales were up 6 percent YoY (like for like 10 percent) led by 6 percent domestic volume growth (vs 0.2 percent volume growth in Q3 FY17) and decent performance in international operations (+16 percent YoY).

Domestic business was aided by continued strong sales traction in BoroPlus (+10 percent YoY, 16 percent of 2017 sales) on a strong base of 13 percent YoY sales growth in Q3 2017. Navratna range benefitted (+15 percent vs -4 percent in Q3 FY17, 24 percent of 2017 sales) from a soft base.

However, overall sales growth was below expectations on account of continued weakness in Kesh King hair oil and Pancharishtha.

Reported EBITDA (earnings before interest depreciation & tax) margin declined 120 bps YoY, partially on account of higher advertising spend.

Focus area for company

Company has stepped up its advertising spend (17.1 percent of Q3 FY18 sales vs 16.0 percent in Q3 FY17) with a focus on product categories like HE range (male grooming) and new launches in pain management (Zandu gel, spray).

Positive on rural recovery and stabilization in Kesh King

The company's management is positive on the growth pick up in rural areas, particularly in eastern areas of UP. Further, among the product categories, Emami is hopeful on improvement in Kesh King hair oil.  The management mentioned that the key reason for the sales weakness in the product category is because of the legacy of high reliance on wholesale channel (~70 percent), which in particular has been impacted due to demonetization and implementation of GST.

Key risks to monitor: Uptrend in raw material price

Investors should keep a watch on price trends for mentha oil and crude oil. For the company, cost of mentha oil increased by ~15 percent in last quarter. Management expects a 200 bps impact on margin if raw material prices remain at current levels.

Godrej Consumer: Quarterly update

Godrej Consumer’s consolidated Q3 FY18 sales was up 11 percent (like for like) mainly led by growth in domestic business (+17 percent YoY). International business sales was up 5 percent on a constant currency basis.

The company's domestic business was aided by 18 percent volume growth, particularly for soaps (+24 percent YoY) and hair colour (+33 percent YoY) categories. Although the volume growth comes on a weak base, for a two year period, CAGR (compounded annual growth rate) of ~8 percent for volumes is commendable.

EBITDA margins expanded by 80 bps YoY, aided by improved gross margins (better product mix) partially offset by higher ad spend.

Weak traction for household insecticides

Comparable growth for household insecticides was 5 percent YoY, which reflected weaker traction for the category. Jyothy Lab also reported weak numbers particularly for its coil products.

Delayed onset of monsoon impacted insecticides business (North & West India) in the earlier quarter and growth did not bounce back in Q3 FY18. High wholesale channel exposure for the category is cited as an additional reason for the slowdown. However, the company is expecting new product launches would help in reviving and expanding the category.

On the other hand, the soaps category (both Cinthol and Godrej no.1) continued to do well for the fourth consecutive quarter, although on a weaker base. Additionally, the management mentioned that it is too early to call a trend for market share gain from unorganized to organized sector.

International business: Indonesia slowdown narrowing

With decline in sales growth (-2 percent YoY vs -7 percent in Q2 FY18) getting arrested in Indonesia, management is hopeful of recovery in near term. Sales in Africa and Europe witnessed steady growth, however Kenya business was impacted by election-related disruption.

Raw material risk

Management expects that palm oil prices should stabilize at current levels. While crude oil price remains a key factor to monitor, the company has no intention to make change in product prices in near term.

Outlook

While Emami’s result was below expectations, the results of both Emami and Godrej Consumer nonetheless point to a sector-wide recovery in terms of volume growth.

Both companies' management highlighted that better growth recovery in rural areas was underway. Emami, for whom 50 percent of sales come from rural areas, remains our preferred bet and the recent correction provides a decent opportunity to enter (35x FY19e earnings).

Godrej Consumer, with its steady performance and improvement in international operations, is also a good proxy for improved consumer sentiment. Though the stock is priced relatively expensive (42x FY19e earnings), volume growth trajectory offers some comfort.

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