September 7, 2020 Sector Report Varun Singh | [email protected] | +91-22-2217 1727 Upasana Madan | [email protected] | +91-22-2217 1860 FMCG | Sector Report Content of the report A) Hygiene, health and packaged-food to drive outperformance ………………………………………………………… 3 B) Strength comes from uncertainty; mapping companies response to COVID on NPDs, pricing and discounting …………………………………………………………………………………………………………………….. 15 C) Fundamental recovery in rural still not in-sight; better distribution efficiency to drive outperformance ………………………………………………………………………………………………………………………. 27 D) International business recovery to be faster compared to India ………………………………………………………… 38 E) P/E re-rating justified on intrinsic basis ……………………………………………………………………………………………… 43 F) Company section: a. Hindustan Unilever ……………………………………………………………………………………………………..…………… 51 b. ITC……………………………………………………………………………………………………………………………………….…… 69 c. Nestle ………………………………………………………………………………………………………………………………………. 83 d. Britannia……………………………………………………………………………………………….…………………………………. 103 e. Dabur ………………………………………………………………………………………………………………………………………. 123 f. Godrej Consumer……………………………………………………………………………………………………………………… 141 g. Marico ………………………………………………………………………………………………….…………………………………. 159 2 Sector Report FMCG Anti-fragility to rescue under-performance Investment rationale COVID19 has made mankind realize its fragility-quotient in this universe. On similar NEST, BRIT and ITC to benefit from favorable industry tailwinds note, we get to know the fragility-quotient of companies in FMCG space as well. We expect that the shift from out-of-home to in-home consumption will help The famous quote; “One should never cross a river 4 feet deep on an average” NEST, BRIT and ITC to record strong growth in packaged food led by favorable should always be remembered to protect risk of wealth-destruction. In this report industry tailwinds. In our view, this trend will persist for next 7-9 months. Large we attempt to dissect anti-fragile companies which, in our view, will continue to players will gain market share led by distribution efficiency and switch from un- outperform in wealth creation over a long period of time. We initiate coverage on branded products to branded products by customers due to safety concerns. ITC Ltd (ITC) with BUY rating, TP Rs259, Godrej Consumer (GCPL) with BUY rating, Outperformance hinges on distribution efficiency and not rural-urban mix TP Rs817, Britannia (BRIT) with BUY rating, TP Rs4,267, Marico (MRCO) with Despite low number of COVID cases in rural India we note that fundamentals and ACCUMULATE rating, TP Rs397, Hindustan Unilever (HUL) with ACCUMULATE re-enforcement of lockdown is not supporting rural recovery. Hence, we expect rating, TP Rs2,424,Nestle (NEST) with HOLD rating, TP Rs16,940, and Dabur superior distribution infrastructure to be the key to drive outperformance. HUL (DABUR) with HOLD rating, TP Rs491. ranks at the top on distribution efficiency followed by NEST, ITC and BRIT. Hygiene, health and packaged-food to drive outperformance Business recovery in international market to be faster compared to India FMCG sector has resumed revenue growth with-in 3-4 months in the last 3 Asian Daily new COVID cases in top 7 countries (which represent c. 72% of revenue of crises. However, since this crisis has forced people to work-from-home and avoid Indian FMCG companies in foreign geographies), has either declined or social gathering, we expect companies with high exposure to health, hygiene and witnessed flattening of the curve. Though, in India it continues to rise. We expect food portfolio (a.k.a. anti-fragile companies) to deliver better revenue growth business recovery of MRCO to be faster in international markets followed by during FY21-22E. NEST, BRIT, HUL and GCPL have anti-fragile portfolio of DABUR and GCPL. products and score over others on this parameter. Positively, these companies also outperformed in wealth creation during pre-covid times (FY15-19). P/E re-ratings are fundamentally justified; don’t anticipate cut in multiples P/E multiple of all FMCG companies is fairly justified. As we note that there are In hygiene; GCPL competes with focus on price-disruption while HUL on variety three vectors for P/E re-rating; (i) higher dividend pay-out ratio (ii) higher We like GCPL’s approach of democratizing hygiene portfolio through innovative fundamental growth rate (retention rate * ROE), and (iii) lower cost of capital. launches and disruptive pricing (Protekt is first-ever powder to liquid hand-wash FMCG companies with high ROE and growth rate (supported by anti-fragility at Rs15/200ml; 1/4rth the price of existing handwash). However, HUL competes factor) to continue enjoy higher valuation multiple (refer exhibit 85 to 91 for with a wide portfolio; multiple brands straddling at several price points. In FMCG working on each of the 7 stocks). industry, we expect HUL and GCPL to gain market share in hygiene portfolio led by better distribution efficiency and leading brand positioning. Varun Singh | [email protected] | +91-22-2217 1727 Upasana Madan | [email protected] | +91-22-2217 1860 September 7, 2020 FMCG | Sector Report Valuation snapshot CMP TP Mkt Cap Revenue (Rs mn) EPS (Rs) P/E (x) EV/EBITDA (x) RoE (%) RoCE (%) Companies (Rs) (Rs) Reco. (Rs mn) FY21E FY22E FY21E FY22E FY21E FY22E FY21E FY22E FY22E FY22E Hindustan Unilever 2,125 2,424 ACCUMULATE 4,988,189 442,095 507,800 38.0 44.1 55.9 48.2 39.2 33.6 84.4 90.4 ITC 187 259 BUY 2,296,868 465,602 529,518 11.3 13.2 16.5 14.1 12.8 10.8 23.8 30.9 Nestle 16,231 16,940 HOLD 1,564,967 153,019 171,048 270.0 308.0 60.1 52.7 40.7 35.9 62.1 49.5 Britannia 3,706 4,267 BUY 892,081 136,829 148,128 80.9 85.3 45.8 43.4 34.4 32.3 31.8 31.4 Dabur 484 491 HOLD 854,897 91,958 105,331 9.3 10.9 52.0 44.3 42.8 36.0 24.4 24.0 Godrej Consumer 655 817 BUY 670,083 104,560 117,341 15.7 18.2 41.8 36.1 28.2 24.5 21.2 21.6 Marico 374 397 ACCUMULATE 482,851 74,465 82,261 8.9 9.9 41.8 37.7 30.1 26.9 36.5 39.6 Source: IDBI Capital Research 4 FMCG | Sector Report Hygiene, health and packaged food to drive outperformance HUL, BRIT and NEST well positioned to drive outperformance led by anti-fragile hygiene-health-food driven portfolio Unlike any past crisis, COVID has forced people to stay-at-home, avoid socializing (even during one’s own wedding) while companies have been forced to operate with minimal staff, for restricted timings and with uncertainty of re- enforcement of lockdown. Flight to safety; as enforced by regulatory authorities on corporates and as chosen by consumers will have cascading impact on change in buying and selling strategies. Incrementally customers are choosing convenience (online, home deliveries) and buys essentials while corporates are deploying investments towards core portfolio and value pricing. We believe consumption of out-of-home products (ice creams, bottled water, RTD beverages, confectionaries etc) and non-essentials (value added hair oils, premium skin care, air care etc.) will take long time to re-cover as people rush to save money to fight adversity/uncertainties (of losing job or catching virus) in their own families, change in lifestyle (work from home) inducing people to consume less of non-essential products like personal grooming/suave look etc. Hence, companies having dominant presence in essentials and health & hygiene with strong execution strength are likely to outperform wannabe’/smaller players. BRIT, NEST and HUL are top three companies with highest exposure to essential category in our coverage universe. We believe, these companies should outperform consumer staple space during FY21-22E. Even during pre-COVID time (during FY15-19) NEST, BRIT and HUL outperformed peers in wealth-creation led by both premiumization and efficiency led operating profit growth. MRCO has highest exposure to non-essential category (33% revenue share) followed by DABUR (26% revenue share) compared to competition. As per management, positively MRCO is now shifting its focus towards core portfolio, value pricing, accelerating NPDs (new product development) in food & hygiene space and ramping up direct distribution. While Dabur has ramped up immunity boosting health portfolio followed by NPDs in hygiene. 5 FMCG | Sector Report Exhibit 1: Revenue break-up company and category wise Exhibit 2: 4QFY20; a test of anti-fragility given 10 days national lock-down 4QFY20 Revenue change 4QFY20 PBT change Subs as % of No. of distinct % revenue break-up Non essentials Essentials Semi essential (% YoY) (% YoY) revenue Britannia Industries Ltd. - 90% 10% Standalone Standalone Subs Standalone Subs countries (FY15-20) Nestle India Ltd. - 75% 25% Britannia 1% 34% 9% -518% 7% 4 Hindustan Unilever Ltd. 22% 74% 4% Dabur -17% 3% -27% -196% 29% 14 Marico Ltd. 33% 65% 2% GCPL -18% -5% -26% -55% 46% 24 HUL -9% -22% -11% -82% 3% 1 Godrej Consumer Products Ltd. 19% 50% 31% ITC -6% 13% -9% 23% 7% 7 Dabur India Ltd. 26% 51% 23% Marico -8% -3% 0% 121% 19% 6 ITC Ltd. 10% 35% 55% Nestle 11% 0% - - Source: Company; IDBI Capital Research Source: Company; IDBI Capital Research Exhibit 3:1QFY21; a test of anti-fragility given 2 months national lockdown 1QFY21 Revenue 1QFY21 PBT FY20 revenue break up Subs as % of No. of distinct Change (% YoY) Change (% YoY) 1QFY21; BRIT outperformed all other % non- % semi- revenue Standalone St. Alone Subs St. Alone Subs countries companies due to 22% volume growth in essentials essentials (FY15-20) packaged food portfolio. Britannia 25 66 78 -7760 0 10 7 4 Dabur -8 -24 9 -42 26 23 29 14 GCPL 5 -8 18 -23 12 32 46 24 HUL 4 -32 -6 -46 22 5 3 1 ITC -23 52 -35 21 10 55 7 7 Marico -15 5 0 81 34 2 19 6 Nestle 2 -1 0 25 - - Source: Company; IDBI Capital Research 6 FMCG | Sector Report Exhibit 4: Wealth creation table before COVID19 crisis Before COVID; NEST, BRIT, GCPL and % CAGR FY15-19 HUL outperformed competition in Companies Market cap Revenue Operating profit wealth creation led by premiumization/ Nestle India Ltd.