Marico sees sharp volume contraction in Q1: GST or Patanjali effect?

Marico posted a weak set of numbers amid destocking that led to sharp volume decline. While the company is keen on holding its turf in the various categories and refraining from any price action, competitive intensity remains formidable. While the outlook remains challenging, valuation looks elevated and we remain cautious about the stock.

Weak consolidated results

Marico posted sales de-growth of 4% in Q1 2018, impacted by sharp volume decline of 7% owing to  channel destocking in its India business. EBITDA margins for the quarter contracted by 215 bps, impacted by trade offers, jump in raw material costs (52.5% of sales vs 48% in FY 2017), partially offset by lower advertising cost (9.5% of sales vs 11.1% of sales in FY 2017).

India operations impacted by sharp destocking

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Marico’s India FMCG business (77% of FY 2017 sales), witnessed a volume contraction of 9% YoY leading to sales de-growth of 4%. Volume decline was visible in all the major categories. Operating margin contraction of about 360 bps was mainly contributed by sharp increase in copra prices (69% YoY, 7% QoQ) and liquid paraffin (21% YoY), partially offset by lower prices of rice bran oil (-5%) and packaging materials (HDPE prices, -4%). Copra prices are likely to remain elevated in the near future due to weak crop. Hence, margin pressure is expected to continue. However, in the medium term, the company is confident of maintaining 20%+ operating margin.

Chart: Q1 2018 value/volume mix

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International operations: Pricing action helps Bangladesh operations

Sales from International operations (23% of sales, -1% YoY) were impacted by currency headwinds and subdued volume growth (1%). Key highlight was the Bangladesh operations (44% of international sales) which posted a good result aided by pricing improvement in the coconut portfolio by 10%. In this market, the company expects inflation led value growth to be the key driver of the coconut portfolio. Volume growth appears limited as the category has matured here with 86% market share. In Bangladesh, management’s focus is on expanding non-coconut portfolio from current 19% to 30-40% in three years.

Elsewhere, particularly in the MENA region, Marico faced difficult macroeconomic environment with persistent down trading.

Significant GST impact

As per management, GST transition impact was the key reason behind the steep channel correction which was particularly visible in the wholesale channel and rural areas. CSD (Canteen state department) channel (7% of sales) witnessed a 15% decline in sales on account of a virtual pause in business in the month of June. Having said that, the company expects a normalization in channel inventory in this quarter and is projecting volume growth revival to the tune of 8-10%.

Market share gain in coconut oil (25% of sales) but Patanjali remains biggest disruptor

Company reported a slight market share gain in coconut hair oil to 58% (+37 bps) after the contraction visible for the past four quarters. Looking back at the company’s commentary in Q4 2017, we feel that not resorting to price hikes even in the face of steep increase in raw material prices could have helped in holding on to the market share.

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If we look at one the major competitor, Patanjali, it has improved market share by 40 bps (1% vs. 0.6%) in the coconut hair oil segment, as per market research sources. Interestingly, market research firms don’t take into account the sales from Patanjali’s own stores. Therefore the reported market share numbers could actually differ a lot from the reality.

Anecdotal evidences, focused group consumer survey, and the Patanjali’s last year sales number from hair care segment (Kesh Kanti) suggest that market share of Patanjali in hair oil segment should be much higher. Last year, Patanjali clocked sales of Rs 825 crore in the hair care segment which is at least 4% of the hair care market (market size: Rs 19,670 crore, source Bajaj corp). This provides some basis for estimating Patanjali’s market share in coconut hair oil, especially in the context of the relatively better customer perception of Patanjali coconut hair oil in the hair care category.

Since Marico is expected to continue with its strategy of defending market share in hair oil and so not increase prices in near future, this segment would be interesting to watch out for.

Difficult quarter and elevated valuation

Marico was amongst the most impacted by GST transition so far. Volume contraction was visible in all categories. Marginal market share gain in the Parachute coconut category needs to be watched carefully, in near term. Company’s improved market share in Amala hair oil seems to be amongst the few positives to look at.

In the near term, elevated raw material cost and competition would prevent any margin expansion. Some moderation in margin cannot be ruled out. Given the elevated multiple (52x 12m trailing earnings), we remain cautious on the stock.

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