Consumer durables firms may have to wait until Q3 to find their sea legs

Hypercompetition, high-cost inventory, and volume-over-margins delay gains

After subdued demand in the second half of the April-June quarter (first quarter, or Q1) of 2022-23 (FY23) and pressure on profitability, brokerages expect prospects of consumer durables companies to improve on the back of good monsoon and softening of raw material costs.

Amid concerns with growth and profitability, some segments within the fast-moving electrical goods (FMEG) sector saw earnings downgrades of up to 16 per cent after Q1FY23 results.

Inflation trajectory, according to Edelweiss Research, remains the most crucial variable for pure consumer segments, supporting both valuation and growth.

Given the heightened risk to growth and profitability, the past year has seen a valuation correction across the consumer durables space, with a 22 per cent drop in sector multiples to 31x.

Cable and wire makers, however, have led the consensus earnings upgrades for 2023-24 over the past year, whilst also leading in terms of stock returns, observes the brokerage.

Stock performance will depend on the pace of recovery and volume/margin trade-off adopted by companies.

Say analysts Ashish Poddar and Pranay Shah of Systematix Research, “Companies expect demand to recover (both urban and rural) from September, ahead of the festival season, on likely good monsoon and channel restocking (on commodity price stabilisation at low levels). Large organised players continued to gain market share, even as small regional players faced operational challenges.”

While there has been improvement in demand month-on-month, Centrum Research believes a strong offtake is likely only in the October-December quarter.

“Weak demand has continued in July, while there are some initial signs of recovery in August. However, with high cost inventory in the system, second quarter (Q2) of FY23 is likely to be a weak one. The benefits of lower input costs, as well as festival season-led pull-back in demand, are expected from the third quarter onwards,” say Chirag Muchhala and Rahul Kumar Mishra of the brokerage.

Although most categories saw weakness in consumer sentiment and a drop in demand due to inflation-led price hikes, the cooling product category (air conditioners or ACs, air coolers, and refrigerators) was the worst hit across consumer segments. 

Within large appliances, ACs were the most impacted, resulting in Johnson Controls-Hitachi and Lloyd (Havells) reporting losses at the operating (segment) profit level and Voltas reporting its lowest margins since Q2 of 2018-19, point out analysts at Kotak Institutional Equities (KIE).

Most brokerages believe that cable and wire, and lighting and fixtures are better placed than others in the consumer electronics sector as cooling products and washing machines grapple with hypercompetition, with companies prioritising market share over margins.

Due to higher raw material costs and weaker volumes, gross and operating profit margins of the FMEG sector remain 400 basis points (bps) and 200 bps, respectively, below pre-Covid levels.

Systematix Research expects margins of consumer durables companies to remain below pre-pandemic levels as they are forced to pass on the entire benefit of input cost reduction. This is on the back of cash-flush new entrants (Lloyd, Voltas Beko), continued aggression of existing market leaders to defend their turf (LG, Samsung, Voltas, and Haier), and rising supplies in the industry with production-linked incentive capacities coming on-stream. The top picks of the brokerage, given the Q1 performance and robust outlook, are KEI Industries, Bajaj Electricals, and Finolex Cables.

IIFL Research in its channel-check of FMEG products finds value growth of flat to minus 5 per cent for July-August period (to date), indicating a drop in volume.

Retailers, however, are optimistic about a double-digit growth in sales for FY23. While revenue growth could recover, given the higher incentives and discounting schemes, the uptick in margins could take longer.

The top picks of IIFL Research within the sector are Bajaj Electricals and Polycab. The brokerage also likes Havells for the diversified business-to-business and business-to-consumer portfolio, but for near-term profitability concerns with Lloyd.

KIE has a cautious stance on the sector in the near term, given expensive valuations, uncertainty on demand drivers, intense competition, and risk of continued pressure on margins, notwithstanding correction in commodity prices.