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Hindustan Unilever (HUVR)
Consumer products
Diwali festival gift arrives a week late! HUL’s 2QFY12 results beat line-by-line our
highest-on-the-Street earnings estimates. Its strategy of strong focus on competitive
growth is paying off—volumes +10% (on a base of +14%) and sharp improvement in
soaps and detergent margins due to likely return of rational competition in detergents.
Reiterate our thesis of (1) continuing good growth in personal products and (2) likely
bottoming out of detergents margins as key drivers for FY2011-13E. We upgrade our
EPS estimates by 5% and 7% for FY2012E and FY2013E, respectively. HUL remains our
preferred pick; reiterate ADD with a revised target price of Rs420 (Rs370 previously).
Results beat line-by-line our highest-on-the-Street earnings estimates
HUL reported net sales of Rs55 bn (+18%, KIE Rs53.4 bn), EBITDA of Rs7.4 bn (+31%, KIE Rs6.3
bn) and PAT of Rs6.5 bn (+22%, KIE Rs6.0 bn) in 2QFY12.
Sales growth was driven by volume growth of +10%. Good volume growth was likely aided by
continuing momentum in personal products (PP) as well as benefits of product relaunches and
new launches of FY2011. Realization/mix growth during the quarter was ~8%.
Input cost inflation not neutralized by commensurate price hikes led to gross margin
contraction of 340 bps (lower than 490 bps in 1QFY12). Most of the gross margin contraction
is likely in the soaps and detergents category, in our view. Palm prices have increased by 17%
yoy and LAB increased by 28% yoy in 2QFY12. However, flat ‘Other expenditure’ and adspends
(200 bps) aided EBITDA margin expansion of 140 bps to 13.4%. The company had
implemented selective price increases in 1QFY12 in detergents, which, in our view could help
mitigate gross margin pressure in rest of FY2012E. Flat other income in 2Q is due to phasing of
innovation centre billings and likely investment of surplus cash in fixed maturity plans (wherein
interest income is accounted on receipt and not accounted on accrual basis).
Segment-wise, soaps and detergents sales growth of 22% indicates good volume growth in
detergents. Personal care sales growth of 18% is volume-led (~12%, in our view). Soaps and
detergents PBIT margin at 12.4% (70 bps higher yoy) likely indicates that detergents margins
have bottomed out. Personal products PBIT margin expanded by ~140 bps yoy to 24.4% (base
quarter had one-off mould costs of ~Rs400-500 mn, in our view). PP PBIT growth was 25%.
What next? The needle movers
Rural slowdown and sustainability of volume growth
In a tough environment for volume growth (articulated below), we believe that HUL’s
volume growth is aided significantly by continued expansion in direct coverage reach (the
company has increased direct distribution coverage to 1.5 mn from 1.0 mn over the last
couple of years). While, this tailwind has likely benefited HUL over the last few quarters, we
note that it could possibly help it significantly when industry growth has likely moderated.
We continue to believe that in the backdrop of sustaining high food inflation incremental
rural spends, including NREGA, have likely plateaud for the time being—an incremental
negative for rural spends and for the sector. The past three years have seen a confluence of
factors which have likely aided incremental spends on consumer products (1) higher outlay
on NREGA, (2) wealth effect due to higher land prices, (3) benefits of farm loan waiver, (4)
benefits from the Sixth Pay Commission. As we look into medium term, we highlight that
most of these positive factors are in the base and lower incremental spends have the
potential to hurt demand for consumer products. Dabur in their concall today alluded to
food inflation impacting consumer demand and that rural demand growth being marginally
lower than last few quarters.
Market share—likely getting better
The company commented that its growth is better than market growth. While, HUL has
stopped disclosing market shares since CY2010, our industry sources also suggest that it is
gaining shares in key personal products categories of skincare and shampoo. HUL’s category
outperformance likely explains its high-than-expected volume growth performance, to some
extent.
Volatility in input costs and margin outlook
The company has likely benefited from lower consumption costs in palm oil sequentially, in
our view (palm oil, a key input cost for its soaps business accounts for ~20% of input costs,
in our view). However, the costs are still higher yoy which explains the gross margin
contraction yoy and improvement qoq. It is yet to have any meaningful benefit accruing
from other inputs like LAB, soda ash etc., which are still higher yoy. Considering the price
increases implemented by it in CY2011, gross margins are likely to decline at a lower rate in
2HFY12E, in our view. Rupee depreciation poses a big risk to HUL’s gross margins in
2HFY12E.
We revisit couple of our positive arguments from our HUL upgrade note of May
2011 and August 2011
Moderation in adspends is not a worry
Contrary to Street, moderation in adspends does not worry us as the company is
maintaining competitive spends (measured as share of voice/share of market), in our view.
Lower category spends in soaps and detergents (which are anyway highly penetrated
categories) may not impact its market growth. Moreover, HUL is likely to focus on
consolidation of FY2011 new launches in FY2012E, in our view (implying relatively lower
adspends). HUL spent ~Rs4-5 bn on new launches in FY2011, in our view (out of total
adspends of Rs28 bn) (Exhibit 6). It is pertinent to note that the industry-level adspends in
soaps and detergents have been calibrated as commodity inflation hits these categories the
most, whereas adspends in the other consumer categories have increased in 1HFY12.
Can irrational competition impact more categories? Unlikely, in our view
Considering that the competitive activity levels in many categories are dictated by the MNCs’
attempt to build a stronger business in India (P&G, L’Oreal, Beiersdorf etc.) and entry of
players with deep pockets (ITC), one of the key worries for HUL is whether competitive
activity can turn irrational in many of its categories.
The scenario of irrational competitive activity spreading beyond detergents and shampoo is
unlikely in our view—the category dynamics would dictate the same (Exhibit 9). For example,
categories like skincare could likely see elevated marketing spends for a long period,
however, HUL could potentially benefit as (1) market development expenses now gets
shared by many players, (2) relatively underpenetrated categories could grow faster, and (3)
HUL could potentially improve gross margins (GM) as the skincare category and its subsegments
has higher GM than the blended GM for the company. However, we believe that
oralcare category is exposed to irrational competition, if any, in the event of P&G’s entry (it
accounts for ~6% of HUL’s sales and profits, in our view).
Retain ADD; HUL remains a preferred pick
We reiterate that our confidence on FY2012-13E earnings estimates continues to be high as
we believe, (1) continuing good growth in PP, (2) likely bottoming out of detergents margins
and (3) adspends moderation. We have upgraded our earnings estimates by 5% and 7% for
FY2012E and FY2013E, respectively. We retain ADD rating with a revised target price of
Rs420 (Rs370 previously); we continue to value HUL at a 10% premium to last 3-year
average P/E (valued at 29X FY2013E for EPS estimate of Rs11.8 (+19.6% yoy growth) and
FY2013E EPS of Rs14.2 (+19.7% growth yoy). Key risk is acceleration in input cost inflation
and further price hikes could potentially hurt sector demand growth and HUL’s volume
growth.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Hindustan Unilever (HUVR)
Consumer products
Diwali festival gift arrives a week late! HUL’s 2QFY12 results beat line-by-line our
highest-on-the-Street earnings estimates. Its strategy of strong focus on competitive
growth is paying off—volumes +10% (on a base of +14%) and sharp improvement in
soaps and detergent margins due to likely return of rational competition in detergents.
Reiterate our thesis of (1) continuing good growth in personal products and (2) likely
bottoming out of detergents margins as key drivers for FY2011-13E. We upgrade our
EPS estimates by 5% and 7% for FY2012E and FY2013E, respectively. HUL remains our
preferred pick; reiterate ADD with a revised target price of Rs420 (Rs370 previously).
Results beat line-by-line our highest-on-the-Street earnings estimates
HUL reported net sales of Rs55 bn (+18%, KIE Rs53.4 bn), EBITDA of Rs7.4 bn (+31%, KIE Rs6.3
bn) and PAT of Rs6.5 bn (+22%, KIE Rs6.0 bn) in 2QFY12.
Sales growth was driven by volume growth of +10%. Good volume growth was likely aided by
continuing momentum in personal products (PP) as well as benefits of product relaunches and
new launches of FY2011. Realization/mix growth during the quarter was ~8%.
Input cost inflation not neutralized by commensurate price hikes led to gross margin
contraction of 340 bps (lower than 490 bps in 1QFY12). Most of the gross margin contraction
is likely in the soaps and detergents category, in our view. Palm prices have increased by 17%
yoy and LAB increased by 28% yoy in 2QFY12. However, flat ‘Other expenditure’ and adspends
(200 bps) aided EBITDA margin expansion of 140 bps to 13.4%. The company had
implemented selective price increases in 1QFY12 in detergents, which, in our view could help
mitigate gross margin pressure in rest of FY2012E. Flat other income in 2Q is due to phasing of
innovation centre billings and likely investment of surplus cash in fixed maturity plans (wherein
interest income is accounted on receipt and not accounted on accrual basis).
Segment-wise, soaps and detergents sales growth of 22% indicates good volume growth in
detergents. Personal care sales growth of 18% is volume-led (~12%, in our view). Soaps and
detergents PBIT margin at 12.4% (70 bps higher yoy) likely indicates that detergents margins
have bottomed out. Personal products PBIT margin expanded by ~140 bps yoy to 24.4% (base
quarter had one-off mould costs of ~Rs400-500 mn, in our view). PP PBIT growth was 25%.
What next? The needle movers
Rural slowdown and sustainability of volume growth
In a tough environment for volume growth (articulated below), we believe that HUL’s
volume growth is aided significantly by continued expansion in direct coverage reach (the
company has increased direct distribution coverage to 1.5 mn from 1.0 mn over the last
couple of years). While, this tailwind has likely benefited HUL over the last few quarters, we
note that it could possibly help it significantly when industry growth has likely moderated.
We continue to believe that in the backdrop of sustaining high food inflation incremental
rural spends, including NREGA, have likely plateaud for the time being—an incremental
negative for rural spends and for the sector. The past three years have seen a confluence of
factors which have likely aided incremental spends on consumer products (1) higher outlay
on NREGA, (2) wealth effect due to higher land prices, (3) benefits of farm loan waiver, (4)
benefits from the Sixth Pay Commission. As we look into medium term, we highlight that
most of these positive factors are in the base and lower incremental spends have the
potential to hurt demand for consumer products. Dabur in their concall today alluded to
food inflation impacting consumer demand and that rural demand growth being marginally
lower than last few quarters.
Market share—likely getting better
The company commented that its growth is better than market growth. While, HUL has
stopped disclosing market shares since CY2010, our industry sources also suggest that it is
gaining shares in key personal products categories of skincare and shampoo. HUL’s category
outperformance likely explains its high-than-expected volume growth performance, to some
extent.
Volatility in input costs and margin outlook
The company has likely benefited from lower consumption costs in palm oil sequentially, in
our view (palm oil, a key input cost for its soaps business accounts for ~20% of input costs,
in our view). However, the costs are still higher yoy which explains the gross margin
contraction yoy and improvement qoq. It is yet to have any meaningful benefit accruing
from other inputs like LAB, soda ash etc., which are still higher yoy. Considering the price
increases implemented by it in CY2011, gross margins are likely to decline at a lower rate in
2HFY12E, in our view. Rupee depreciation poses a big risk to HUL’s gross margins in
2HFY12E.
We revisit couple of our positive arguments from our HUL upgrade note of May
2011 and August 2011
Moderation in adspends is not a worry
Contrary to Street, moderation in adspends does not worry us as the company is
maintaining competitive spends (measured as share of voice/share of market), in our view.
Lower category spends in soaps and detergents (which are anyway highly penetrated
categories) may not impact its market growth. Moreover, HUL is likely to focus on
consolidation of FY2011 new launches in FY2012E, in our view (implying relatively lower
adspends). HUL spent ~Rs4-5 bn on new launches in FY2011, in our view (out of total
adspends of Rs28 bn) (Exhibit 6). It is pertinent to note that the industry-level adspends in
soaps and detergents have been calibrated as commodity inflation hits these categories the
most, whereas adspends in the other consumer categories have increased in 1HFY12.
Can irrational competition impact more categories? Unlikely, in our view
Considering that the competitive activity levels in many categories are dictated by the MNCs’
attempt to build a stronger business in India (P&G, L’Oreal, Beiersdorf etc.) and entry of
players with deep pockets (ITC), one of the key worries for HUL is whether competitive
activity can turn irrational in many of its categories.
The scenario of irrational competitive activity spreading beyond detergents and shampoo is
unlikely in our view—the category dynamics would dictate the same (Exhibit 9). For example,
categories like skincare could likely see elevated marketing spends for a long period,
however, HUL could potentially benefit as (1) market development expenses now gets
shared by many players, (2) relatively underpenetrated categories could grow faster, and (3)
HUL could potentially improve gross margins (GM) as the skincare category and its subsegments
has higher GM than the blended GM for the company. However, we believe that
oralcare category is exposed to irrational competition, if any, in the event of P&G’s entry (it
accounts for ~6% of HUL’s sales and profits, in our view).
Retain ADD; HUL remains a preferred pick
We reiterate that our confidence on FY2012-13E earnings estimates continues to be high as
we believe, (1) continuing good growth in PP, (2) likely bottoming out of detergents margins
and (3) adspends moderation. We have upgraded our earnings estimates by 5% and 7% for
FY2012E and FY2013E, respectively. We retain ADD rating with a revised target price of
Rs420 (Rs370 previously); we continue to value HUL at a 10% premium to last 3-year
average P/E (valued at 29X FY2013E for EPS estimate of Rs11.8 (+19.6% yoy growth) and
FY2013E EPS of Rs14.2 (+19.7% growth yoy). Key risk is acceleration in input cost inflation
and further price hikes could potentially hurt sector demand growth and HUL’s volume
growth.
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