Hindustan Unilever; In a slow-moving phase: Nomura

Updated: May 5 2014, 12:19pm hrs
Volume growth remains muted: Q4FY14 results showed another quarter of slowing volume growth momentum, with the 3% underlying volume growth being the lowest in the past 22 quarters. The managements outlook indicates no significant turnaround in the near term; we expect H1FY15F (forecast) to mirror the performance seen in the current quarter. Pricing growth has seen an uptick and this should continue over the next quarter, although the quantum is likely to be small. With no pick-up in growth and valuations continuing to remain high, we maintain our Reduce rating on the stock. We raise our target price to Rs510 on account of the roll-forward of earnings, which still provides a 12% downside potential from current levels.

Q4 results below estimates: Q4FY14 results came in below our forecasts. While sales were 1% below our estimate, profit after tax was 6.6% below our and 5.5% below the Streets estimate.

Volume growth of 3% was quite disappointing and what is more concerning is the trajectory slowdown. Remember, growth was 4% in Q3FY14. This is the key negative, in our view.

Key numbers

* Net sales income from operations increased by 8.9% to R69.36bn vs. our estimate of R70.04bn and consensus at R69.97bn.

* Gross margin expanded 10bps to 46.2% against our expectation of 90bps y-o-y.

* Ebitda came in at R9.19bn, vs. our estimate of R10.16bn.

* Ebitda margin came in at 13.3%, down 40bps y-o-y. We were expecting Ebitda margins at 14.5% (up 80bps y-o-y).

* The key surprise was: other than weak gross margins, staff costs rose 60 bps y-o-y to 5.5% vs. our estimate of 5%.

* PAT came in at R8.06 bn vs. our estimate of R8.63 bn.

No pick up in volume growth: Volume has been growing at a slow pace over the past six quarters and there are no signs of a revival yet. In Q4FY14, volume growth was at 3%. Last time, volume growth was below this level was in September 2009. We do not see any immediate signs of a pickup in growth and believe H1FY15F is likely to mirror the performance over the past couple of quarters. We expect low single digit volume growth and some price increases across the portfolio.

Building in below-average growth over FY15-16F: We cut our net income estimate by 3% for FY16F and now build in an average net income growth of 8.6% over FY15-16F. Part of the cut in earnings estimates is on account of our higher tax rate estimate over the next couple of years. On revenue growth, we build in a 12% growth in FY15F (which assumes a pickup in growth in H2) and 14% in FY16-17F. We believe the company will be able to deliver some margin improvement over the next couple of years, when growth starts to pick up. The discretionary part of the portfolio has been a big laggard and we see a pickup in that part of the portfolio as being positive for margins as well.

However, the growth in both top line and bottom line is lower than what we are building in for the sector. We continue to believe that HUL will deliver slower growth than both large cap and mid cap peers in the near termthis is one key reason why our preference within the sector lies away from HUL.

Valuation: Despite YTD (year-to-date) underperformance (HUL +2% vs. Sensex +7%), Hindustan Unilever trades at 28.7x FY16F P/E (EPS: Rs20.3), which is an 18% premium over the sector average. Over the next couple of years, we except HUL to deliver an 8.5% average net income growth vs. the sector average of 17-18%. Given the lower growth trajectory and already high valuations, we believe there is significant room for underperformance in FY15F. We prefer ITC (Buy, TP: R392) at current levels, for which growth is higher and valuations are more reasonable.