HUL 2Q FY11 - Profitability isn't as impressive as the top line :: JPMorgan

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Hindustan Unilever Limited
Underweight
HLL.BO, HUVR IN
2Q FY11 - Profitability isn't as impressive as the top line




• 2Q FY11 earnings – Revenues in-line, EBITDA disappoints: HUL reported
net sales, EBITDA, and recurring PAT growth of 10.7%, -0.8% and 6.8%
respectively for 2Q FY11. While sales came in marginally ahead of our
estimates, EBITDA was 3% below. Higher other income (+63% y/y) and a
lower tax rate (on account of higher production from new manufacturing facility
in tax-exempt zone commissioned in Mar’10) led to 4% better-than-expected
net earnings growth.
• Underlying domestic business volume growth was strong at 14% (vs our
estimate of 11%), implying a price/mix decline of 3%. The overall EBITDA
margin declined 160bp y/y due to higher other expenses (increased royalty
payout, higher freight costs and costs related to packaging moulds) and
increased brand spends y/y.
• EBIT margin decline of 330bp y/y for PP was a key negative: This was due
to higher competitive spends in skin/hair care and to some extent to higher cost
of packaging moulds to support innovation in this segment. Sales growth (+6%
y/y) and margins (-190bp y/y) for soaps & detergent were impacted by price
cuts. Beverages performance was disappointing with sales growth of 9%
(impacted by downtrading in tea segment) and margin decline of 170bp y/y.
Foods and other (Pureit) sales were strong.
• Gross margin decline was restricted to 20bp y/y, despite price cuts
undertaken in the laundry segment. Mgmt noted that improved mix, various cost
saving programs and buying efficiencies led to this. However commodity costs
have moved up significantly and we expect near-term GM to be under pressure.
• Overall A&P/Sales was up 30bp y/y during 2Q FY11, though moderating
sequentially from 15.7% in 1Q FY11. While advertising spends were firm
(+90bp y/y), promotional spends were lower during the quarter.
• Maintain UW: While volume growth has held up well (off a favorable base),
we expect it to moderate as the base effect catches up after Dec’10. We expect
A&P/sales to remain firm at 14-14.5% in the near term and input cost pressures
to step up incrementally. As we build in lower tax rates (now at 21% vs our
assumption of 23% earlier) and higher other income, our EPS estimates for
FY11/12 are revised up by 1-3%. Current valuations at 30x FY11E and 26x
FY12E earnings look expensive, and we stay UW.


Price target and valuation analysis
We raise earnings for FY11/12E marginally by 1-3% as we build in

lower tax rates (21% vs our assumption of 23% earlier) and higher
other income. We roll forward our price target by six months and set a
new Sep’11 PT of Rs275 (up from our Mar’11 PT of Rs235). Our new
PT is based on 22x one-year forward P/E (earlier 20x) which is at a
15% discount to the consumer sector average. Our target multiple is at a
15% discount to its average three-year trading multiple, which we
believe is justified considering the stiff competitive environment
leading to poor earnings growth visibility in the near term.


Key risks to our PT are a benign input cost environment, sharp recovery
in volumes, and lower competitive intensity than expected.