Sanjiv Mehta is an old Unilever hand but even he couldn’t have expected his first year at the MNC’s India outfit—the R30,000 crore Hindustan Unilever—to have been so tough. The CEO and managing director, who moved back to India after two decades of working overseas, is struggling with what is possibly the most sluggish demand environment in a long, long time.
The 3% increase in volumes in the December quarter may have been way better than the 1% that other makers of consumer staples are understood to have posted. The quarter may also have been a blackout period for the soaps and detergents portfolio—a time when inventories are cleared before a price cut—and the winter may have been delayed but it was nonetheless discomforting. Indeed, at a time when the FMCG major should have been enjoying the spoils from falling commodity prices and bumping up spends on advertising, HUL is working on price cuts so as not to lose market share.
In the three months to December 2014, HUL’s gross margins hit a ten-quarter high of 50.5% and the operating margin wasn’t bad either at 17.6%. But that could change. Mehta indicated as much when he spoke to the media and analysts last week. “While the gross margin could expand in the coming quarters we would manage pricing dynamically and hence expect only a ‘modest improvement in the Ebitda margin,” Mehta is understood to have said. Prices for the soaps and detergents portfolio have been trimmed by a weighted average 5% with Mehta saying the management had acted decisively to adjust pricing and pipelines in the commodity-linked category to make the brands competitive.
To be sure, HUL’s strategies in the past have been astute, save perhaps for one time around 2009 when the company lost market share because its products weren’t priced attractively enough and consumers were downtrading. This time around, the company has responded swiftly to the market situation. “HUL’s competitive strategy in the commodity-sensitive segments is to not create situations that result in price wars (as it happened in the last cycle) and hence HUL has been very proactive in taking price cuts in the detergent segments in the range of 5-10%. It will dynamically manage the situation with volume growth and market share as key priorities. We believe this is a very sensible strategy but the margin expansion is likely to be modest, “an analyst observed.
Unlike in the 1990s and early 2000s when HUL was obsessive about protecting its margins, as a result of which it lost market share in some key categories, the company, it would now appear, is more focused on market share and will, therefore, maintain spends on advertising and promotions (A&P). Indeed, while hinting at further price cuts, the management simultaneously allayed concerns that expenses on A&P may be pruned; in Q3 FY15, ad spends as a share of total operating income fell 30 basis points to a shade under 13%.
But, that may have been just a blip because HUL does intend to grow market share. Bringing some fresh perspective to the way in which the FMCG space was being viewed, Mehta, in a recent interview had questioned the proposition put forward by many in the HUL team, that for a player with such a large share, there wasn’t enough room to grow. Mehta believes that none of the categories in which HUL operates is saturated, not even the soaps and detergents segment, which is a highly penetrated segment. His belief stems from his experience in other markets.
While Mehta may get it right in the long run, the sluggish economy could keep volume growth subdued for a while; one big reason for which is the flagging rural demand. The dramatic rise in rural wages seen between 2011 and 2013, when they increased by 21% , 17.6% and 16.3% respectively, is unlikely to be maintained and global brokerage Nomura estimates that the growth in the average daily wage rate for rural labourers moderated to below 10% y-o-y in June. The smaller increases in the minimum support price for crops has also hurt farm incomes and since HUL makes a huge chunk of its revenues from the hinterland that’s cause for concern. Recognising this, HUL recently came up with a new cluster in central India covering Bihar, Uttar Pradesh, Madhya Pradesh, Rajasthan and Chattisgarh which would allow it to cater to around 50 crore people. Given the lower per capita consumption and product penetration in these regions, HUL can hope for better volumes here.
In urban markets, consumers appear to be preferring lower price points though the modern trade channel has been doing well with premium products such as Dove and Surf not having been impacted. A demand recovery may be some time away but in the meantime the price cuts should do the trick.