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FMCG: Sell HUL
Cost pressure may lead to earnings disappointment: Key inputs such as palm oil and coffee are at all time highs.
Further, rising crude prices is also putting upward pressure on packaging costs, logistics and crude related raw
materials. Despite recent price hikes, we believe gross margins are at risk (currently at ~50%) due to rising cost
pressures. Further, increase in competitive intensity and slowdown in volumes are expected to limit pricing power
Increased competition is a dampener for margins: FY11E net margins at 11% is expected to be lowest in 10 years.
Ad spends as a % of sales (16% for FY11E and 15.6% for FY11E) are the highest in 16 years. We believe the strong
volume growth at 14% in the last quarter was directly related to higher ad spends. A majority of this spend is
focused on increasing share of voice to support pricing actions which is unlikely to result in any long term benefit for HUL
Volume growth momentum likely to slowdown in 2011 due to the second consecutive year of high food and nonfood
inflation, which is prompting consumers to seek better value and even shift to unbranded products. Mass
market products such as soaps, shampoo, toothpaste and hair oils are showing signs of lower volume growth
High valuations (~29x 1-yr fwd EPS vs. 5 yr median of 25x) provide little comfort given the bleak earnings outlook
(8% CAGR from FY10 to FY12E) , highly competitive environment and inflationary headwinds
Target price of Rs. 250, based on 22x FY12E EPS , 20% downside from CMP of Rs. 298
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