Hindustan Unilever- Profitability remains elusive; Underperform : BoA ML

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Hindustan Unilever
Profitability remains elusive;
Maintain Underperform
􀂄 Operating profits decline despite improved volume growth
Sep Q profit of Rs5.3bn was up 5% yoy and beat our estimate by 4% led by a
sharp jump in Other Income. Sales growth at 12% yoy supported by volume
growth of 14% was marginally ahead of expectations. However margin decline of
160bp was more than we estimated leading to operating income declining by 2%
and disappointment with quality of earnings. We tweak our earnings by 3% to
factor in the surprise and raise our PO to Rs240 (Rs225) accordingly. We
maintain Underperform as we expect flat earnings in FY11E. The road to recovery
of market share and volume growth remains expensive and unprofitable for HUL.
Sales growth will require pricing support to sustain
We are not very enthused by 14% yoy volume growth as it is riding on a highly
favorable base of only 1% growth in Sep Q last year. We expect volume growth
to moderate down to single digits from next quarter onwards as a favorable
base effect wears off. However, there could be further price hikes by HUL to
cover for rising input costs which could support the ~9-10% yoy sales growth.
Margins decline on gross margin hit and packaging costs
Negative margin surprise was led by 1) gross margin decline of 20bp despite
recent price hikes as HUL appears to have run out of its low cost raw material
inventory and 2) higher other expenditure on change in packaging moulds for new
innovations. A&P spends remained high at 13.8% of sales though lower than est
as HUL seems to have toned down A&P spends to make up for gross margin hit.
Valuation expensive on weaker than sector growth
HUL at 27xFY12E is trading at 20% premium to sector. This appears unjustified
given our expectations of ex-HUL sector growth of ~20% in FY11E vs 8% for
HUL. Hence, we expect HUL to de-rate with weak earnings results and negative
news flow around rising competition to act as downward triggers.