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Marico's profit warning: Our view - Views on News from Equitymaster

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Marico's profit warning: Our view
Sep 21, 2011

In our June' 2011 quarterly update, we had pointed out that the Marico stock is fairly priced given the short term hiccups it continues to face. The view has been re-enforced by the recent company release wherein Marico has categorically said that it will not take further price hikes despite continued raw material cost pressures. Even advertisement and sales promotion expenditure are likely to remain high which coupled with high price of inputs will depress margins in the coming quarters.

In our quarterly analysis, we had highlighted how Marico's profitability was getting pinched by unprecedented jump in commodity inflation, mainly coconut. Although, the company had hiked prices in a phased manner in 2HFY11, off take jumped up by 21% in Q1FY12 reflecting strong brand equity enjoyed by it. Coconut prices increased sequentially by 5% in Q1FY12, but like a true price warrior the company held on to its price level even as its competitors hiked prices. This enabled the company to garner increased sales offtake but at the expense of margins.

Stubbornly high inflation close to double-digits has led to protracted round of monetary tightening with Reserve Bank of India (RBI) hiking key policy rates 12 times since March 2010. This has failed to tame inflation but has slowly started to hurt discretionary demand. Sales of passenger cars fell steeply in the past two months on account of fuel price hikes and higher interest rates. Even Index of Industrial Production, the economy's sensitive barometer has displayed worrisome signals of slowdown in July. Thus while the manufacturing and mining sectors are reeling under subdued growth, capital investments have fallen.

As the government is faced with a challenging task of arresting inflation without stifling growth, the uncertainty continues. The FMCG industry which till now had remained insulated from the slowdown is now staring at the possibility of muted consumer demand. Demand from rural India decelerated in FY12 for the first time in three years. Therefore in the current scenario, FMCG players are faced with the dilemma of protecting margins or market share. This is reminiscent of the classic David & Goliath story wherein a small player Nirma through its mass market appeal was able to take on FMCG giant HUL in the 1980's. This prompted HUL to switch strategy from margin led growth to volume led growth.

Marico has spelt out its strategy for growing its volume franchise by holding on product prices even in the face of high commodity inflation. Apart from this, the other stumbling blocks in its profit growth are currency fluctuations and inflation impacting international earnings & brand amortization clipping Kaya profits. Factoring these downsides in our forecast, we expect margin to contract sharply in FY12. However, we believe Marico is likely to reap the benefits of its strengthening brand equity and market share in future. The new product offerings in the value-added hair oil category and extension of the Saffola brand to breakfast cereals and staple food will drive future growth. Even the Kaya operations are likely to benefit from increasing share of product offerings and roll-out of affordable services.

All in all, the very long term prospects of the company continue to remain as solid as its business model. Also the near term concerns cited by the management are not unforeseen. In fact they are well factored in into our earnings estimates. However we believe that correction of around 35 to 40% in the stock price would be necessary to offer some margin of safety to investors for the next 2 to 3 years.

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