Macquarie Research: Hindustan Unilever- No more cost levers

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Hindustan Unilever- No more cost levers

Event
 Hindustan Unilever reported disappointing 3Q FY11 results, with a 4% decline
in adjusted net profit, which missed our and the street estimates by ~10%. Net
sales grew 12% YoY to Rs51.3bn, aided by 13% volume growth on a lower
base.

 Soaps and detergents (S&D) EBIT margin declined 572bp to 7.7%, lowest
ever in the company’s history. The gross margin declined 220bp on the back
of rising input costs and the lack of a corresponding pricing lever. We reiterate
our Underperform rating.
Impact
 Net profit declined 4% despite 12% YoY sales growth. HUVR’s recurring
net profit declined 4% on account of a 310bp decline in the EBITDA margin.
Margin compression was led by higher raw material costs (↑220bp),
advertising and promotion (↑66bp) and other expenditure (↑66bp). We think
this highlights HUVR’s diminishing cost lever, after holding fort for the last
couple of quarters, when other companies were facing margin pressure. We
do not believe the worst of the raw material inflation is over yet given the
expected crude oil price uptrend.
We have been highlighting raw material inflation risks for HUVR and other
consumer staple players. Refer to our report “India Consumers: Rising
costs to hurt margins” http://macq.wir.jp/l.ut?t=1Cfy1wZkG.
 Across-the-board margin decline in key segments. HUVR reported an
EBIT margin decline in soaps and detergents (S&D) (↓572bp), personal
products (PP) (↓313bp) and processed food (↓657bp). A key point to note,
S&D margin (7.7%) slipped below the lowest level attained during the last
detergent price war with P&G in 2004/05. S&D is the largest segment and
contributes ~45% to the top line. Personal products’ margin, although
declining, is still very high (~25%). As competition intensifies, we expect
margin decline to accelerate.
 Volume growth likely to slow. HUVR has reported a fourth consecutive
quarter of double-digit volume growth (13% in 3Q FY11). This growth has
been achieved off a lower base and by sacrificing profitability. We believe
volume growth will decline to low-single digits from next quarter as the
company faces a higher base and raises prices to pass on the input cost
inflation.

Earnings and target price revision
 We raise our TP to Rs235 from Rs210 as we roll forward our model to FY12E.
Price catalyst
 12-month price target: Rs235.00 based on a DCF methodology.
 Catalyst: Pricing action in personal products segment.
Action and recommendation
 Outlook remains weak due to cost pressures and competition. We
believe the business environment for HUVR is challenging, and the company
is facing twin battles – avoiding market-share losses to competitors and losing
profitability due to rising input costs. Given a weak earnings growth profile
(9% CAGR) for HUVR, we recommend a switch from HUVR toITC (ITC IN,
Rs167.95, Outperform, TP: Rs200.00).