Hindustan Unilever - Back to business - Near-term volume growth challenges persist :: JPMorgan

Post the closure of open offer by parent Unilever (stake rises to 67.3% from
52.5%), we believe investor focus will now shift towards underlying business
trends. While we are still optimistic about the long-term growth outlook for the
company, near-term risks to growth rates persist on account of vol growth
weakness and moderating price/mix growth. While recent sharp rupee
depreciation and uptick in palm oil prices threaten to limit GM expansion in 2H,
we believe company could consider pricing actions to counter that. We remain
Neutral with a new Mar’14 PT of Rs550. Valuations will likely be supported by
lower float and expectations of further buybacks/creeping acquisition.

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 Volume growth weakness likely to persist near term; pace of
premiumisation moderates. Growth rates across most FMCG categories are
being challenged by weak macro particularly in urban areas and more so for
discretionary products. Personal care (skin & hair care) and foods segments
have been affected the most. Pace of premiumisation is also slowing in
segments like soaps, laundry and tea. We expect HUL to register mid single
digit vol growth in 1H. In Q1 there will likely be reversal of ~80bps of upstocking impact seen in Q4FY13 and marginal impact of sales disruption owing
to LBT issue. However HUL continues to do well on market share front,
holding or gaining share across most of product segments.
 Weakening price/mix growth. HUL’s pricing growth has come off from ~10%
in CY12 to ~7% in Mar’13 qtr. We believe it will moderate further in 1H led by
laundry (roll over pricing will anniversarize) and full impact of promotions in
soaps. However given recent uptick in palm oil prices, company has chosen to
discontinue some of the promotions for its soaps portfolio.
 Margin trends. While we expect GM expansion to continue over 1H, recent
sharp rupee depreciation and uptick in palm/crude oil poses downside risk to
GM in 2H and may necessitate some price hikes. Product mix deterioration,
lower revenue growth and higher royalty payout may limit margin expansion,
though supply chain/other cost savings could help negate some of the impact.
Competitive intensity remains high (step up seen in laundry/oral and sustained
in hair/skin) which would keep A&P/Sales at 12-13% on our estimates.
 Valuations to be supported by lower float and expectations of further
buybacks/creeping acquisition. Post the open offer, free float for HUL has
come down significantly to 33% which along with street expectations of further
stake increase by parent to take their holding to 75% may provide some
downside support to the stock price. However at current valuations of 35x
FY14E P/E, we see no upside and maintain Neutral rating on the stock.