Hindustan Unilever (HUL) Gearing up for next leg of growth :Espirito Santo,

Hindustan Unilever (HUL)
Gearing up for next leg of growth
HUL has underperformed the BSE-FMCG index by ~12% YTD. The
trend should reverse as HUL starts to deliver in FY13 on the very high
base of FY12. HUL is the best positioned consumer company to
exploit the Indian demographic advantage and premiumization trend.
While companies like Nestle are still ramping up production
capabilities to meet consumer demand, HUL is ahead of the curve
with no such constraints. We reiterate our BUY on HUL.

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28% Y-o-Y PBT (pre-ex) growth impressive
Despite the high inflation environment, 28% Y-o-Y PBT (before exceptional items)
growth was achieved in FY12 following operating leverage and robust volume
growth. HUL is reaping benefits of a successful ‘volume leverage’ strategy as pricing
power returned back to the soaps and detergents business. Advertising and sales
promotion (A&P) expenses were down 250bps Y-o-Y and yet there were no signs of
demand destruction, testimony of the strong brand equity of the HUL portfolio.
Medium to long-term growth drivers in place
HUL is transforming itself from a commoditized (soaps and detergents) business into
a non-commoditized one, like personal products (PP) and packaged foods.
Extrapolating the growth potential of various categories of HUL, we expect ~60% of
FY20E profits to come from PP, while the contribution of soaps and detergents to
overall profitability will reduce to ~25% from ~37% in FY12. Blended EBITDA margins
should improve to 16.9%, up 150 bps from FY12 levels. The new products pipeline
looks strong, with opportunity to introduce more products from the parents’ stable.
No signs of disruptive competition in the market
The low penetration of branded consumer goods and demographics would continue
to interest global giants like L’Oreal. Similarly, we have seen emergence of regional
competitors in the commodity categories of soaps and detergents as commodity
prices decline. We expect competitive intensity to remain high in the Indian
consumer market place; however, we are seeing no signs of 2010 style disruptive
competition yet.
Pricing running ahead of cost inflation; factoring higher A&P
The worst in palm oil inflation is behind us, though any benefit has been delayed by
INR depreciation. We note that HUL took price cuts in 2009 and wouldn’t be
surprised to see such a move in FY13 if the commodity environment remains benign.
While Investors tend to focus on operating margin expansion, we think HUL would
direct some of the tailwind benefits towards investment in higher A&P in FY13. Hence
we are building up ~130bps of operating margin expansion from FY12-14 despite
estimating a 240bps gross margin expansion for FY12-14E.
Risks to Fair Value
HUL has a diversified portfolio, which in turn implies that it is subject to competitive
risk at various levels. We see risk from disruptive competitive intensity (in soaps from
ITC/GCPL or in Personal Products from multinational companies). A sharp increase in
input costs, combined with INR depreciation, can hurt margins.
Valuation
HUL is currently trading at P/E of 29.9x and 25.6x on our FY13 and FY14 EPS estimates,
well above the long term average. However there is room for earning and multiples
expansion if HUL can deliver 20%+ PBT growth consistently in FY13, and beyond.
Despite a stellar FY12, we are building in ~18% FY12-FY14E PBT (before exceptional
items) CAGR in our estimates, and are ~7% ahead in our estimates from consensus. We
are, however, tweaking our FY13/FY14 EPS estimates slightly to bake in de-merger of
FMCG exports business and higher tax rates as more production units come out of tax
exemption units. We roll-over our DCF and increase fair value to INR 500, from INR
434 earlier and with no change to the valuation methodology (see report 11 Dec 2011).
HUL is our silver bullet idea for Q3CY12 and we reiterate Buy.