Monday, July 20, 2009


Stay on the front foot

After the rally − what next?
The recent rally in the consumer discretionary and retail stocks in India was breath-taking. In some cases, stocks are up as much as 200% in three months. Stocks are (naturally) taking a breather at this time. The sharp rally makes a defensive stance look more compelling, in our view. We however continue to believe that this as a good time to accumulate ‘beta’ from a longer-term perspective. Staples may outperform by holding ground in a falling market, but most (notably HUVR) seem too expensive to be able to deliver material absolute performance. Macquarie’s regional consumer analyst, Mohan Singh, in his 7 May 2009 flyer, “Going cyclical”, noted that “the excess premiums that consumer staples companies enjoyed in 2H08 due to the credit squeeze and declining consumer confidence levels appear to be dissipating”. This Asia-wide theme was clearly applicable in India.

2010 will see the resurgence of the urban consumer
The last twelve months have been the year of the rural consumer. While samestore- sales (SSS) growth and demand for high-end discretionary goods came under pressure, rural consumption growth was resilient. A good monsoon in 2008 and pump priming by the government helped demand for low ticket items, helping staples companies deliver 15−20% top line growth. Our conversations with consumer companies suggest that the buoyancy of rural demand is likely to
continue driven by continued support from the government unless the monsoon fails. In any case, we believe that the largest delta on company sales growth is likely to be delivered by a resurgence of growth in urban consumer demand.

GDP growth in India has surprised positively, coming in at a healthy 5.8% for 1Q09. Macquarie India economist (Rajeev Malik) has since upgraded his GDP growth forecast for FY10E and FY11E to 7% and 7.5%, respectively. This is likely to spur demand growth for discretionary goods and SSS growth, which is also likely to get a boost in 2H FY10 due to a low base effect. In fact, the first signs of a demand revival have started showing up in reported SSS numbers.

Focus on stocks with upgrade potential
To play the theme of GDP growth recovery, we would recommend that investors focus on stocks which are leveraged to economic growth.
  • Demand perspective: A recovery in GDP growth would lead to upgrades in sales forecasts for Pantaloon (driven by SSS), UNSP and Marico (demand for discretionary products) and ITC (hotels and high-end cigarettes).
  • Cost perspective: After reaching their worst point in 4Q08, debt and capital markets have revived. The de-leveraging story is playing out in the case of UNSP and Pantaloon (see individual notes for further details).

For investors who prefer a defensive stance after the recent rally, we highlight stocks with some element of growth and upgrade potential. We would pick ITC (notably after the union budget) and Marico in the mid cap staples space.

UNSP stands out amongst beverage/consumer companies with a discretionary element. Pantaloon is our top retail sector pick. In both cases, we expect earnings upgrades and triggers on the back of a stake sale and capital raising.

To see full report: INDIA CONSUMER