Market growth for consumer staples and cigarettes is seen coming off in a lagged manner, both in urban and rural markets, as spending stalls and pricing remains stable.
Considering that this impending slowdown will pose several challenges to the earnings growth of domestic consumer staple players, we initiate coverage on the sector with a “cautious” view.
Urban markets have proved to be extremely challenging for the defensive consumer staple sector since December 2008. Modern trade has come to a stall and even general trade is sluggish.
In case of cigarettes, nothing much has changed in terms of growth trajectory. We expect industry value growth for FY10-11 to be subdued, in the region of 13% vis-à-vis 19% for FY08-09 and 17% for FY05-09.
Heightened price sensitivity and dropping consumption levels are likely to make pre-immunization and product mix improvement a highly challenging exercise.
Also, price competition in a sluggish growth environment cannot be ruled out; this, to some extent, could offset the margin gains expected from commodity deflation.
Although there has been a change of guard at key ministries influencing policy decisions for the tobacco sector, we cannot completely rule out any further policy changes, considering the government’s zeal in pursuing these issues in the past.
Policy announcements from finance and health ministries would thus be critical to the performance of the sector.
We recommend a HOLD on Hindustan Unilever Limited (HUL) and a SELL on ITC Limited with a six-month price target of Rs250 and Rs180 respectively. We are 4% above and 5% below consensus in our HUL and ITC estimates respectively.