>Indian consumer: Exorcising the ghost of the downturn (NOBLE)

The recent Q3FY10 results signalled an end to the urban consumer downturn with retailers reporting resurging confidence among consumers in the major metros even as food inflation becomes a worry for lower income households. These broad trends, coupled with the inherent operating leverage of retailers and the possibility of a price war in FMCG, lead us to prefer retailers over FMCG companies as a play on the “India consumption story.”

EMERGING TRENDS VISIBLE IN THE Q3FY10 RESULTS
The recently concluded Q3 results hinted at some significant developments as far as the Indian consumer is concerned. The main messages we take away from the results as well as the surrounding commentary are:

■ The Metro consumer is coming back: companies across the retail sector made bullish noises about the metro consumer, highlighting the recovery against the despondent performance in Q3 of FY09 and hinting at much more to come.

■ Semi-urban/rural demand has held up: the semi-urban and rural consumer has surprised on the upside with FMCG companies as well as small town retailers seeing momentum continuing despite the toughening comparables.

■ Inflation a worry: multiple companies have cited inflation as a worry for FY11. With food inflation running in the high teens, household budgets are being put under pressure, creating uncertainty around spending in other areas. This is a bigger worry for lower income consumers than for mainstream metro consumers.

LOOKING AHEAD: WINNERS AND LOSERS
The broad based nature of these trends has specific implications for the FMCG and Retail sectors:

■ FMCG – for whom the bell tolls: the continuing newsflow around FMCG has increased the conviction level of our Negative stance on the sector even further. We see significant risks for the sector arising from three main trends: food inflation running in the high teens which may dent consumer demand and pricing flexibility for FMCG companies; rising input costs (both raw materials and advertising) are pressuring the inordinately buoyant margins seen in H1FY10; and the price war in detergents may spread to other segments, dragging down margins across the sector. The punchy valuations that the midcap FMCG companies in particular trade at (24x FY11 PE for Colgate and Dabur), seems to be ignoring these risks.

■ Retail – the roller coaster turns: organised retail will benefit from the resurgence in urban demand on the back of three factors: concentration in metros alongside higher exposure to mid-high income segments; higher exposure to discretionary products; and high operating leverage. All these factors make retailers a levered play on the urban consumer recovery with momentum likely to gather in revenues as well as margins. Whilst valuations in the sector are high, we expect that upgrades to consensus numbers are likely to keep multiples elevated and drive share prices higher still. As such, stocks like Titan and Pantaloon are likely to perform well despite the punchy valuations. Overall, the two sectors seem to have a materially different outlook for CY10 with retailers likely to outperform in terms of earnings growth as well as share price performance. On relative terms, Pantaloon and Titan trade at 11x and 17x FY11 EV/EBITDA whilst Dabur and Colgate trade at 19x. Given that the retailers’ earnings are likely to see upgrades while the FMCG companies’ might see downgrades, the valuation premium for Dabur and Colgate seems inverted. Among the retailers, Koutons is at a disadvantage as it is less exposed to the metro consumer and more exposed to lower income segments.

To read the full report: INDIAN CONSUMER