1. Volume growth soft, margins expand

Volume growth soft, margins expand

The overall market context remains subdued and recovery is contingent on a good monsoon and impact of fiscal stimulus

By: | Published: May 16, 2016 5:18 AM

Hindustan Uni-lever’s Q4FY16 earnings print was broadly on expected lines–marginally lower-than-expected underlying volume growth (UVG) and ahead-of-estimated margins/PAT not-withstanding. There was little in the results to alter forward prognosis on the sector or the company either—market context remains subdued and recovery remains contingent on positive impact of likely good monsoons and fiscal stimulus. We like HUVR’s execution and superior quality of earnings. The stock is fairly valued, however.

Volume growth (UVG) disappoints a tad; margins expand across segments  HUVR’s Q4FY16 earnings print was mixed–net operating revenues up 4% y-o-y to Rs 79.5 bn  (KIE: R80 bn), adjusted Ebitda

(adjusted for one-off credits in base quarter) up 18% y-o-y to

R14.7 bn (KIE: R13.8 bn) and recurring adjusted net profit up 17% y-o-y to Rs 10.1 bn (KIE: R9.9 bn). Underlying volume growth (UVG) of 4% disappointed a tad (versus our estimate of 6% growth); management attributed the same to further deterioration in demand environment (led by stress in rural) and residual impact of realignment of channel spends (impacted PP segment most). Ebitda margins expanded a strong 210 bps y-o-y to 18.5% (120 bps ahead of our estimate) aided by sustained RM tailwinds (GMs up 290 bps y-o-y) and muted A&SP (up 6% y-o-y, significantly lower versus 16-24% y-o-y jump over past four quarters). Segmental margins were ahead of expectations across segments.

Modest end to a year with ‘high expectations’; we like the company’s strategic approach

HUVR ended FY2016 with a modest revenue, Ebitda and PAT growth of 4%, 12% and 8% respectively; lower versus high expectations at the start of the year but commendable given a challenging demand environment and in line with company’s consistently stated objective of ‘ahead-of-market volume growth and sustained, modest margin expansion’. The company chose to use significant portion of RM tailwinds (GMs up 300 bps y-o-y) to drive premiumisation (especially in core S&D segment) and invest in market development in nascent categories. We like the intent, approach, as well as recent execution.

Fairly valued; retain REDUCE — raise TP to Rs 865 on account of rollover to March 2018

Our estimates remain broadly unchanged as marginal cuts in our revenue estimates get negated by Indulekha acquisition (we bake in Rs 1.5 bn revenues in FY2017e). While management commentary was cautious on near-term growth due to further stress in rural demand, we expect price-led growth to recover due to pick-up in commodity inflation (especially in S&D segment); this coupled with lower A&SP (we bake in 60 bps cut y-o-y) and sustained cost efficiency programmes should help HUVR tide any margin pressures. We believe HUVR is a quality franchise to own with much better internals (FCF generation/RoE) versus many of its peers and we like it on relative terms; however, our absolute valuation methodology prevents us from upgrading the stock at current levels. Retain REDUCE with revised TP of R865 (from R825).

Segmental highlights

S&D (47% of revenues, 38% of Ebit); fourth consecutive quarter of low single-digit revenue growth: S&D segment revenues grew ~2% y-o-y, in line with our estimates dragged by sustained price-deflation. We believe mix improvement has been a key UVG driver in both soaps and detergents portfolio. Ebit margins expanded 120 bps y-o-y driving 12% y-o-y jump in Ebit driven by sustained RM tailwinds, mix improvement, and selective price hikes in laundry portfolio.

Management highlighted—(i) growth in soaps was led by strong volume growth in Dove and Lifebuoy; commodity inflation has picked up significantly led by sharp spike in PFAD prices towards quarter-end, (ii) laundry growth was driven by Surf and Wheel’s growth continues to recover and (iii) Vim growth was driven by liquids format.

PP (29% of revenues, 47% of Ebit); impacted by one-offs, underlying growth in line with expectations: PP segment posted 6% y-o-y adjusted revenue growth (adjusted for one-off credits in base quarter). Growth was partially impacted by phasing of excise benefits (100 bps impact) and residual impact of realignment of channel spends. Segmental Ebit margins expanded a strong 410 bps y-o-y to 29.5% driving a robust 23% Ebit growth.

Management highlighted—(i) skin care posted healthy growth with FAL, Pond’s, Lakme, and Vaseline performing well, (ii) shampoos delivered volume-led double-digit growth, (iii) oral care posted another subdued quarter even as Close Up sustained its good underlying performance; we note HUVR has relaunched Pepsodent core this quarter with new formulation and remains confident of growth recovery (iv) Lakme posted another quarter of double-digit broad-based growth.

Beverages (13% of revenues, 14% of Ebit); another weak quarter”: Beverages posted modest revenue growth of 6% y-o-y and a 9% y-o-y growth in Ebit (led by 60 bps y-o-y expansion in margins). Both tea (broad-based growth led by Red Label Natural care and green tea/natural care portfolio) and coffee performed well.

Foods (7% of revenues, 2% of Ebit); another quarter of double-digit revenue growth: Foods segment sustained double-digit growth momentum for tenth consecutive quarter delivering 12% revenue growth, in line with our estimates. Ebit margins expanded 40 bps y-o-y driving robust 20% y-o-y growth in Ebit.

Management indicated—(i) sustained volume-led growth in all core food brands—Kissan, Knorr, and Kwality Walls/Magnum, (ii) HUVR unveiled a host of innovations in foods across core brands and (iii) HUVR has completed divestment of Modern Foods.

Others; growth in the water business was led by RO devices: In terms of channel mix, MT and Pureit perfect stores performed well while e-commerce channel continues to grow rapidly. Management highlighted that it has undertaken a portfolio refresh to play in a wider market and rolled out Pureit Ultima with Oxytube during the quarter. We note others segment posted 3% revenue growth and losses were flattish y-o-y at R78 m.

Key takeaways from earnings call; segments discussed above

Rural demand weakens further: Management highlighted that overall market growth has deteriorated further in recent months impacted by rural demand slowdown on account of severe drought conditions in several key markets (Maharashtra, Andhra Pradesh and parts of Karnataka impacted the most).

w Volume pick-up core focus: Management reiterated that its core focus is to drive volume-led growth (will not take pricing up at cost of volumes) and it remains committed to modest margin expansion. However, it expects price-led growth to pick up in a few quarters aided by – (i) phasing out of excise impact from Q1FY17, (ii) price-cuts anniversarising and (iii) premiumisation push.

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