Hindustan Unilever Q3FY11 Result Update; Upgrade to HOLD; Target: Rs 275: Emkay

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Hindustan Unilever

Entering D-eciding Zone, Upgrade to HOLD

HOLD

CMP: Rs 271                                        Target Price: Rs 275

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n     Hindustan Unilever (HUL) Q3FY11 performance below expectation – price changes eludes and cost pressure witnessed – 2.8% yoy decline in APAT to Rs5.7 bn

n     Ebidta margins fall 310 bps yoy, both higher and earlier then expectation – led by Soaps N Detergents and Processed Foods segments

n     Volume growth at 13% yoy, highest in last 4 quarters – but now enters tough N testing zone – Q4FY11 would be D-eciding zone as benefits from base-effect and portfolio re-launch subside

n     Revised earnings by -6.9% for FY11E and FY12E to Rs9.7/Share and Rs10.5/Share respectively- with sharp correction and reasonable valuations upgrade from ‘REDUCE’ to ‘HOLD’

Q3FY11 performance below expectation- price changes eludes, but

severe cost pressure witnessed

Q3FY11 performance below expectation, HUL reports 2.8% yoy decline in APAT to

Rs5.7 bn versus EMKAY and Consensus expectation of Rs6.4 bn. HUL reported sharp

cuts in Ebidta margins at 310 bps yoy to 14.1%, impacting quarterly performance.

Company reported 140 bps reduction in gross margins and large increase in business

expenditure. Also, price changes remains far fetched especially in Soaps N Detergents

segment, which is witnessing severe cost pressures. However, revenue growth was

robust during the quarter, up 12.1% yoy to Rs51.3 bn beating EMKAY expectation of

Rs49.5 bn.

Volume growth at 13% yoy, highest in last 4 quarters – but now enters

tough N testing zone

The 12.1% yoy value growth in Q3FY11 is translated into 13% blended volume growth

and blended price decline of 1.1%. HUL has posted strong volume growth for 4th

consecutive quarter, benefiting from low base effect, 80% portfolio undergoing re-launch

and 40 new product introduction. Thus, Q4FY11 would be testing zone for HUL as

benefits from base effects vanish and portfolio re-launches subside.

Ebidta margins fall 310 bps yoy, higher then expectation – led by Soaps N

Detergents and Processed Foods segments

HUL reported sharp decline in Ebidta margin at 310 bps yoy- it was both earlier and

higher then estimates. The Ebidta margin drop was led by (1) 140 bps yoy reduction in

gross margins, largely linked to cost pressures in Soaps N Detergents (2) increase in

A&P spends from 13.8% to 14.5%, also A&P spends was up 90 bps on qoq basis and

(3) other expenditure also increased 70 bps yoy to 14.5% of revenues. Infact, at

segment level Soaps N Detergents saw 39.2% decline in Ebit to Rs1.7 bn and

processed foods saw higher loss at Rs160 mn. Soaps N Detergents segment saw

severe cost pressure and processed foods saw impact from new product launches.

Now HUL needs to prove its mantel, Q4FY11 to be the D-eciding zone

HUL has implemented numerous strategies to enhance overall growth momentum, retain

market share and capture much larger share of consumer wallet. Consequently, HUL has

successfully enhanced volume growth to 11% for 4 consecutive quarters, but the same also

benefits from (1) re-launch of 80% of product portfolio and (2) introduction of 40 new

products. We believe that, Q4FY11E would be D-eciding period, as benefits of favorable

base effect and portfolio re-launches will subside. HUL needs to prove its mantel, for

continuation of volume growth in ensuing quarters, later transpiring into strong earnings

growth.

Revised earnings by -6.9% for FY11E and FY12E to Rs9.7/Share and

Rs10.5/Share respectively

Owing to better-then expected revenue growth, we have fine-tuned our growth assumptions

on Soaps N Detergents, Processed Foods and Others business and upgraded revenue by

4.9% for FY11E and FY12E. But, sharp decline in Ebidta margins, both earlier and higher

then expectations; we lowered Ebidta margins by 80 bps for FY11E and FY12E.

Consequently, we have revised earnings by -6.9% for FY11E and FY12E to Rs9.7/Share

and Rs10.5/Share respectively.

Recent correction and lack of premium valuations, Upgrade HUL to ‘HOLD’

Sharp correction of 10% in quarter and 19% from recent high, seems discounting the

earnings downgrades and lower Ebidta margins. Yet again, HUL is trading at reasonable

valuations unlike peer companies trading at premium to historic averages. But, Q4FY11E

will be remain the D-eciding quarters for HUL- whether it is able to overcome the high

hurdle and translate volume growth into earnings growth. Until the, we upgrade HUL from

REDUCE to HOLD with target price of Rs275/Share. For further rating changes, Q4FY11

should largely set the tone and direction.