JPMorgan: Sell Hindustan Unilever -Valuations reflect excessive optimism

We reiterate our UW on Hindustan Unilever. The stock has surged over
the past month on the back of newsflow on selective price hikes undertaken
in the laundry and soaps segment. We believe that these price increases
have been necessitated by input cost pressures and would not change our
margin assumptions for FY11 in any significant manner. We believe there is
limited room for meaningful upgrades in the medium term as: 1) Our FY10-
13E forecasts already factor in strong operating performance, 2)
Competitive intensity continues to remain stiff for most categories limiting
incremental market share gains, and 3) Input costs have started to tick up.
While volume growth is likely to remain strong at c11% on a favorable base
in Q2FY11, higher brand spends, rising input costs and royalty payouts will
result in subdued 2% y/y earnings growth in our view.
• Valuations – Historical comparisons are not meaningful in our view.
Structural and competitive risks have risen materially in the HPC space with
many new entrants, rising fragmentation of consumer spends, limited
pricing power and narrowing distribution advantage for market leaders like
HUL. This is reflected in lower growth rates through the cycle. Unless one
can argue for a very strong margin expansion, we find it hard to envisage a
scenario in which this business can deliver above-average earnings growth
compared to the market. The stock trades at 30x FY11E and 26x FY12E P/E
constraining any potential re-rating. The company is in the midst of a share
buyback (up to Rs280) which may provide near term downside support to
the stock.
• Operating leverage in this business? This is best examined by looking at
the past 15/10/5-year operating track record of this business. We find that
during these periods revenue CAGR was 13%/5%/12% and EBIT CAGR
was 15%/7%/11%, implying limited operating leverage in this business.
• Expensive regionally and globally. When compared to global or regional
domestic HPC names, HUL is amongst the expensive ones on a PEG basis.
The parent, Unilever Plc (OW, covered by Celine Pannuti), is trading at half
the P/E for similar growth expectations. Unilever Plc is trading at 15x CY10
P/E for EPS CAGR of 14% over CY09-11E and offers better risk-reward
opportunity than its Indian subsidiary in our opinion.