Hindustan Unilever - Earnings Quality Deteriorates; Margins to Improve in H2; Result Update Q2FY15 :: Edelweiss

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Hindustan Unilever’s (HUL) Q2FY15 headline numbers came in line with our estimates. Despite the in-line performance, the stock tanked ~5% due to dip in gross margins by 160bps YoY and muted performance by personal products (PP; reported 9.9% YoY growth). As highlighted in our Q2FY15 consumer sector preview and further validated by the subdued 7.3% YoY ad growth for Zee, HUL’s A&P spends dipped by 175bps YoY. As a result, EBITDA margin gained 55bps YoY. Margins are set to improve in H2FY15 following correction in palm oil prices, LAB and crude oil, though sustainability remains key. Key risks are increase in competition (likely entry of ITC in Coffee), comeback of regional players due to fall in raw material prices.

Volume growth in line; margins perk up on A&P cut

HUL saw in-line 5% YoY growth in volumes. Packaged foods maintained double-digit (fourth quarter in a row). Premium offerings like Dove, TREsemme, Vim liquid, Surf, colour cosmetics and Pureit did well and will gain from urban recovery. A&P spends at 12.1% of sales was second lowest in the past 10 quarters. Base quarter Q2FY14 had seen a 169bps YoY improvement in the gross margins due to decline in RM prices. We expect gross margin to improve in H2FY15 as palm oil prices, LAB, crude oil have cooled off.

Key takeaways from conference call

Historically, there has been a lag of 2-3 quarters for FMCG growth to pick up. HUL’s rural growth is faster than urban growth. Instead of 4 branches in India, HUL will now have additional branch in Central India (has a population of 500mn with per capita consumption only 50-60% of rest of country). Modern trade growth has stabilized. ~70% contribution to A&P spends is from advertising and ~30% is from promotions. Improvement is required in Oral, Deo category and Clear shampoo.

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https://www.edelweiss.in/research/Hindustan-Unilever--Earnings-Quality-Deteriorates;-Margins-to-Improve-in-H2;-Result-Update-Q2FY15/27364.html