Confluence Of Events, Being Selective

February 23, 2011

Confluence of events circling consumer (1) input cost

Price Performance Asian Paints

(%) Absolute Rel. to Nifty 1M 3M 6M 12M -5.0 -2.8 -1.4 34.0 -2.0 8.6 -2.6 17.4

pressure (2) rising intensity of competition and (3) restricted pricing actions
Earnings upgrade has become selective w.e.f Q2FY11 owing

to multiple headwinds - earnings upgrades implemented in Titan and Jubilant FoodWorks (JFL)
Events worth highlighting (1) Marico adhered to unit margin

GCPL
(%) Absolute Rel. to Nifty 1M 3M 6M 12M -8.4 -14.5 0.8 44.8 -5.5 -4.5 -0.4 26.9

formula in difficult times and (2) JFL reported same-store growth of 39% yoy in 9MFY11 is combination of strong volume growth and pricing power Marico, Titan and Jubilant FoodWorks are preferred picks

Prefer companies with better predictability in earnings which

HUL
(%) Absolute Rel. to Nifty 1M 3M 6M 12M 1.3 3.6

Confluence of events circling the consumer sector

As forecasted in our earlier report Hair-Pin Bend, Drive Cautiously, consumer sector is currently circled by confluence of events. Prominent amongst them impacting earnings performance are as under:

-10.0 -10.0 2.6 18.3 -7.1 0.5

Jubilant FoodWorks
(%) Absolute Rel. to Nifty 1M 3M 6M 12M -11.4 -15.0 10.6 116.5 -8.6 -5.1 9.2 89.7

Severe input cost pressure- all inputs pot boiling (agri & non agri) Competitive activity intensified, driving higher A&P spends (25% increase in expenditure on like-to-like basis) Selective pricing actions, not fully covering the input cost rise owing to intense competition in market place Few instances of distortions in volume growth

Marico
(%) Absolute Rel. to Nifty 1M 4.7 3M 1.1 6M 12M 2.7 10.9 1.4 -9.4 4.0 26.6

Earnings upgrade cycle has halted- broad-based upgrades gives way for selective upgrades
Consumer sector had 6-quarter streak of earnings upgrades, which has largely halted in Q2FY11. The earnings upgrade cycle had been broad-based with consumer sector at large undergoing 10% (Including HUL) and 24% (Excluding HUL) upgrade to FY10E earnings. The highest upgrade was seen in Asian Paints at 57%, whereas HUL remain rare exception to undergo earnings revision of -10%. Earnings upgrade for the sector has halted w.e.f Q2FY11, rather paved way for selective upgrades owing to multiple headwinds. In Q2FY11 and Q3FY11, earnings upgrades were selectively implemented in Titan and Jubilant FoodWorks.

Titan
(%) Absolute Rel. to Nifty 1M 3M 6M 12M -5.9 -17.9 9.0 86.7 -2.9 -8.3 7.6 63.5

Highlighting few important events, acting strong reference pointsSeparating Wheat from the ChaffFew exceptional events of past quarters are (1) Marico implemented large price increase (24% in Parachute and 12% in Saffola), adhering to unit margin formula in difficult times (2) Jubilant FoodWorks reported Same-Store-Sales growth of 39% yoy in 9MFY11, significantly higher then median growth of 20% and (3) HUL turned corners, by reporting double-digit volume growth for (4) consecutive quarters. Citing these exceptional events, its not atleast all dooms for the sector.

Pritesh Chheda, CFA pritesh.chheda@emkayglobal.com +91 22 6612 1273

Emkay Global Financial Services Ltd

Sector Update

FMCG Sector

FMCG

Sector Update

Companies fully discounting FY12E earnings, but there are upsides on FY13E earnings
Consumer sector at large is fully discounting FY12E earnings, offering little room for ups ides on discounting near-term earnings. Asian Paints and HUL are trading at 8% premium to 5-year average. Godrej Consumer is trading at 9% discount to 5-year average PER at 19.4X. In case of Marico and Titan, current PER is equal to 5-year average.
PER FY11E 28.3 26.2 28.1 43.2 26.6 33.3 PER FY12E 24.4 19.4 25.9 32.4 21.0 27.1 Average 5-yr PER 22.5 21.2 24.2 NA 20.6 27.0 Premium to 1 yr PER 8% -9% 7% NA 0% 0%

Asian Paints Godrej Consumer Hindustan Unilever Jubilant FoodWorks Marico Titan

Selectively roll to FY13E earnings- reward predictability of earnings

Though, consumer sector at large is fully discounting the near term earnings with no room for upsides, roll-over to FY13E earnings at large yields upsides. Citing confluence of events and multiple headwinds, we have been selective in roll-over of valuations to FY13E earnings. We prefer companies with higher predictability in earnings which is combination of strong volume growth and pricing power. Also, due importance is given to recent events which will be instrumental in investors preference for companies . Consequently, we have rolled valuations to FY13E earnings for Marico and Jubilant FoodWorks and shall do it progressively for Titan in ensuing quarters.

Upgraded ratings on Marico and HUL, retain ratings elsewhere

We upgraded ratings on Marico and HUL by One Notch- factoring the aggressive price hikes of former and stock underperformance of latter. This is despite the 1.5% upgrade in Maricos FY12E earnings and 6.9% downgrade in HUL FY12E earnings . We upgraded rating on Marico from HOLD to ACCUMULATE and HUL from REDUCE to HOLD. We retain ACCUMULATE rating on Titan, Jubilant FoodWorks and Godrej Consumer. We retain HOLD rating on Asian Paints with high base effects in volume growth and Ebidta margins, stumbling blocks to near-term earnings growth.

For HUL, Q4FY11 would be D-eciding, Asian Paints stumbles against high base -effects
For HUL, true impact of initiatives undertaken to augment volume growth would be visible in Q4FY11E, once benefits from low base tapers -off. Hence, Q4FY11E will be D-eciding Zone delivery of double-digit growth would be positive trigger- driving volume upgrades and rating changes. Asian Paints has been on roll in FY10, reporting robust volume growth and strong Ebidta margins triggering 57% upgrade in FY10 earnings. But, earnings upgrades have halted for last 2 quarters - and Asian Paints has stumbled high base effects in Volumes and Ebidta margins.

Emkay Research

23 February 2011

FMCG

Sector Update

EMKAY top picks in consumer sector- Marico, Titan and Jubilant FoodWorks

Marico has showcased strength of brands in difficult time. It has adhered to absolute unit margin strategy by implementing large price increase. We have ACCUMULATE rating with price target of Rs142/Share. Titan trades at attractive valuations of 27X FY12E earnings, leaving room for upside on absolute basis. Also, there is room for earnings upgrades, led by upgrade in volume growth of Jewellery segment. We have ACCUMULATE rating with price target of Rs3876/Share. Remain positive on growth prospects of QSR segment in India and Dominos business model in particular. JFL should witness robust earnings growth for next 5 years, backed by strong category growth at +20% (higher then personal care products). We have ACCUMULATE rating with price target of Rs600/Share.

Key highlights on companies under coverage

Asian Paints
CMP (Rs) 2,571 Price Target (Rs) 2,510 Rating HOLD PER 24.4X FY12E FY10-12E Earnings CAGR 13%

Though, Q3FY11 APAT at Rs2.2 bn meets expectation Ebidta margins decline at 320 bps yoy w higher then expectation. It clearly signals Ebidta margin pressure on as account of rising input costs (Titanium Dioxide & Crude Oil Derivatives) and inadequate pricing actions. Since, EMKAY estimates factors contraction in gross margins, earnings remains unchanged at Rs91.5/Share and Rs106.1/Share respectively. Annual volume growth expectation at 2X GDP or 15-17% for FY11E and FY12E despite erratic movement on quarterly basis. Expect robust volume growth in domestic business (better then long-term correlation of 1.8X GDP) and muted growth in international business (especially Caribbean & East Asia region). YTD price increase is 11.4%, whereas the corresponding input cost increase on weighted average basis is 15%. Input cost pressure is most likely to persist -high probability of impacting gross margins in ensuing quarters. Since, last 8 quarters Asian Paints has recorded positive surprise reported high volume growth and Ebidta margins - strongest in its history. Thus, Asian Paints is already facing high base virtually not seen any earnings upgrades since last 2 quarters for the same reason. Asian Paints trades at rich valuations of 24X FY12E earnings. The upside is capped unless rolled to FY13E earnings. Considering, risk to earnings estimates from high input cost and unfavorable base, we maintain HOLD rating with target price of Rs2510/Share (Rating Unchanged).

Godrej Consumer
CMP (Rs) 359 Price Target (Rs) 420 Rating ACCUMULATE PER 19.4X FY12E FY10-12E Earnings CAGR 31%

Contrary to popular notions, Godrej Consumer delivers satisfactory performance in Q3FY11 APAT growth at 39.6% yoy to Rs1.2 bn. We revised FY11E earnings by 1.8% to Rs15.2/Share. Godrej Household delivers robust performance in Q3FY11 - 24% yoy growth in revenues to Rs2.5 bn. It offsets weak performance in Soaps business and muted performance in UK and Africa business. Business environment of Q3FY11 would most likely prevail in H2FY11. Hence, expect continuation of growth momentum in Godrej Household accompanied by healthy Ebidta margins. Whereas, Soaps business would experience margin pressure led by high input costs and limited price hikes.

Emkay Research

23 February 2011

FMCG

Sector Update

New growth drivers like Godrej Household, Megasari, Argencos and Issue are bracing for robust performance. Whereas, erstwhile growth drivers like Keyline, Inecto and Rapidol to report muted performance. 18% correction after Q3FY11 results - despite robust performance in Godrej Household and International Business offsets concerns on Ebidta margins in Soaps business. Godrej Consumer offers good buying opportunity for target price of Rs420/Share (Rating Unchanged).

Hindustan Unilever
CMP (Rs) 280 Price Target (Rs) 275 Rating HOLD PER 25.9X FY12E FY10-12E Earnings CAGR 4%

HUL Q3FY11 performance was below expectation largely led by higher then expected decline in Ebidta margins (decline of 310 bps yoy to 14.1%). The volume growth was strongest at 13% yoy. Earnings were reduced by 6.9% for FY11E (Rs9.7/Share) and FY12E (Rs10.5/Share). Price-led growth eludes, reported blended price decline of 1.1%. Severe cost pressure witnessed in Soaps N Detergents business with YTD Ebit margin decline of 470 bps. Price increase is imperative to regain margins any development would be positive surprise. Q4FY11 will be the D-eciding Zone- would see base effects in volume growth from Q4FY11E-- hence recurrence of double-digit growth on high base would be positive trigger- driving volume upgrades. Various initiatives undertaken to augment volume growth (1) re-launch of 80% product portfolio (2) introduction of 40 new products in last 4 quarters and (3) speed-up in execution. The benefits of these changes would be visible in Q4FY11E, once benefits from low base tapers -off. Though, HUL saw earnings downgrade in Q3FY11, we believe that CMP is discounting the earnings downgrade and low Ebidta margins. We have upgraded HUL from REDUCE to HOLD with target price of Rs275/Share. Q4FY11 will set tone for any further rating changes. (Upgraded Rating from HOLD to ACCUMULATE)

Jubilant FoodWorks
CMP (Rs) 503 Price Target (Rs) 600 Rating ACCUMULATE PER 32.4X FY12E FY10-12E Earnings CAGR 73%

Jubilant FoodWorks (JFL) reported satisfactory performance in Q3FY11 APAT at Rs189 mn meets expectation. Earnings estimates were retained at Rs11.5/Share and Rs15.3/Share for FY11E and FY12E. Same-Store-Sales growth was robust at 39% for 9MFY11 versus erstwhile expectation of 20%. With forthcoming Cricket season in India spanning 90 days, expect robust Same-Store-Sales growth. In long term, Same-Store-Sales growth should be 20% (higher then personal care products), equal to median growth. JFL has total store network of 364 Nos with presence in 87 cities, until Q3FY11. There is room to multiply the store network atleast 2X in next 5 years. Accordingly, we have factored addition of 70 Nos every year for next 5 years, equivalent to current run-rate. Eyeing new growth drivers in QSR segment- deploy excess cash generated from Dominos franchisee and augment overall growth. JFL is hopeful to launch new brand in next 6-8 months. The same remains un-factored in our earnings estimates. JFL trading at premium valuations - PER of 33X FY12E earnings. Valuations to sustain until (1) JFL ventures into ROE dilutive business proposition and (2) new avenues for investment in QSR or foods service segment in listed domain. Remain positive on growth prospects of QSR segment in India and Dominos business model in particular. JFL should witness robust earnings growth for next 5 years, backed by strong category growth at +20% (higher then personal care products). We have ACCUMULATE rating with price target of Rs600/Share (Rating Unchanged). 4

Emkay Research

23 February 2011

FMCG Marico
CMP (Rs) 125 Price Target (Rs) 142 Rating ACCUMULATE PER 21.0X FY12E

Sector Update

FY10-12E Earnings CAGR 26%

Maricos Q3FY11 performance meets expectations APAT at Rs695 mn, up 11.8%. In Q3FY11, revised FY11E earnings by -3.3% (Rs4.7/Share) and FY12E earnings by 1.5% (Rs6.0/Share). Inflationary pressure in input costs has been passed through price increases - Marico is exception amongst consumer companies to implement 24% price increase in Parachute and 12% increase in Saffola. Marico has adhered to the absolute unit margin formula, yet again showcased the efficacy and strength of Parachute and Saffola brand only drawback is its inability to create large and profitable product extensions Thus, Marico is best placed for earnings upgrade in ensuing quarters on any softening of input cost prices Just drawing attention to 2HFY09 and 1HFY10, which have identical chronology of events to 2HFY11. Marico has showcased strength of brands in difficult time. It has adhered to absolute unit margin strategy by implementing large price increase. We have ACCUMULATE rating with price target of Rs142/Share.

Titan Industries
CMP (Rs) 3,369 Price Target (Rs) 3,876 Rating ACCUMULATE PER 27.1X FY12E FY10-12E Earnings CAGR 43%

Q3FY11 performance of Titan surpasses expectations with APAT at Rs1.37 bn led by robust volume growth in Watches and Jewellery segment. Factored volume upgrades in Jewellery and Watches, revised earnings by +10% and 2% for FY11E (Rs96.5/Share) and FY12E (Rs118.7/Share). For 9MFY11 - Jewellery continues to shine and glitter, Watches continue to tick and Eyewear reports pick-up in sales nos. Consequently, we revised FY11E volume growth assumptions in Jewellery from 15% to 30% and Watches from 10% to 16%. Expect Jewellery and Watches business to report median volume growth in ensuing quarters in worst case scenario. We have factored volume growth of 11% and 23% for Watches & Jewellery in FY12E, tad lower then 16% and 30% in FY11E leaving scope for earnings upgrades. Gold price remains key risk to earnings estimates - especially in case of sharp movement in gold prices in short time span. Sensitivity analysis points at 8-10% cut in earnings for 10% decline in Gold prices. However, FY12E earnings already factors 5% decline in gold realizations. Titan trades at attractive valuations of 27X FY12E earnings, leaving room for upside on absolute basis. Also, there is room for earnings upgrades, led by upgrade in volume growth. We maintain ACCUMULATE rating with price target of Rs3876/Share (Rating Unchanged).

Emkay Research

23 February 2011

FMCG

Sector Update

Annexure 1
EPS (Rs/Share) FY09 Asian Paints Godrej Consumer Products Hindustan Unilever Jubilant FoodWorks Marico Titan 41.2 6.8 11.5 1.4 3.3 47.3 FY10 79.7 9.7 9.7 5.3 4.0 57.8 FY11E 91.5 14.0 9.7 11.5 4.7 96.5 FY12E 106.1 18.9 FY09 53.1 37.0 ROCE (%) FY10 76.0 41.8 117.2 37.1 33.6 45.9 FY11E 61.2 29.2 96.8 61.5 32.9 62.7 FY12E 53.8 24.9 92.4 65.3 36.4 55.0

10.5 174.9 15.3 6.0 118.7 21.5 35.8 42.3

PER FY09 Asian Paints Godrej Consumer Products Hindustan Unilever Jubilant FoodWorks Marico Titan 63.0 53.7 23.7 365.2 38.6 67.8 FY10 32.5 37.7 28.2 93.9 31.7 55.6 FY11E 28.3 26.2 28.1 43.2 26.6 33.3 FY12E 24.4 19.4 25.9 FY09 20.7 16.6 28.8

PBV FY10 14.5 11.8 23.0 27.0 11.8 19.7 FY11E 10.6 6.4 19.5 17.5 8.6 13.3 FY12E 8.2 5.2 17.7 12.2 6.5 9.4

32.4 126.9 21.0 27.1 16.9 25.9

Emkay Research

23 February 2011

FMCG

Sector Update

Annexure 2
Fund holding in consumer sector has increased by 200 bps in last 3 quarters
42.0 Absolute Fund Holding (%) 41.3 41.1

40.5 39.3 39.0 39.1 39.1 39.2 38.8 38.5 38.5 38.6 38.7 38.5

37.5 Mar'08 Sep'08 Mar'09 Sep'09 Mar'10 Sep'10

Fund versus Benchmark weightage in consumer sector

14 Sector Weightage (%) 12 10 8 6 4 2 0 Mar'08 Sep'08 Mar'09 Sep'09 Mar'10 Sep'10 Fund Weightage Market Weightage

Factoring simple average, Funds are largely OVERWEIGHT consumer sector for last 3 quarters
Over / Under Weight - In bps 200

175

Overweight Zone

150 Underweight Zone 125 Mar'08 Sep'08 Mar'09 Sep'09 Mar'10 Average Sep'10

Fund Weight Relative to Market

Emkay Research

23 February 2011

FMCG

Sector Update

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Emkay Research

23 February 2011

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