Soaps & detergents clock double-digit growth despite reining in marketing spend

5% PAT beat: Recurring PAT (profit after tax) at R6.4bn (+29% y-o-y) was ahead of our estimates by 5% driven by higher other income and a slightly lower tax rate. Domestic FMCG (fast-moving consumer goods) growth was 20% year-on-year), supported by 10% volume growth. Despite q-o-q margin compression in soaps/detergents on account of higher input costs and depreciating currency, tight control on indirects/overheads and A&P (advertising, marketing and promotion) ensured operating leverage was sufficient to deliver a 13% Ebitda margin (just 30 basis points below our estimates).

Consistent strategy continues to play out: Overall revenue growth was supported by double-digit volumes, despite a more challenging base. Directionally, management indicated that it continues to gain market share in both rural and modern trade?essentially, both ends of the spectrum. Innovations continue at a steady clip?over the Q, Rin was extended into the fabric whitener space with a differentiated product (RinPerfect Shine), Lifebuoy clini-care 10 was launched, Dove?s Color Rescue range was introduced, Pond?s Age Miracle was relaunched, etc.

Category-wise performance: HUL appears to have gained share in both soaps & detergents. Within laundry, all brands/formats grew in double digits. Within soaps too, all key brands grew in double digits; management noted that premiumisation of the portfolio continues. We note that over H2FY12 earnings have been buoyed significantly by the weak base in S&D( soaps and detergents)?Ebit growth of 110%/ 94% y-o-y respectively in 3/4Q.

Over H1FY13, the base will be far more challenging. PP (personal products) revenue/Ebit growth was driven by double-digit volume growth in hair/skin; whereas oral care remains a challenge. Both foods and beverages had a muted performance in the Q.

Maintain Sell: Our target price is revised to R373 as we roll forward to 25x(times)Sept 2013e (estimates) EPS (earnings per share). We don?t expect a meaningful margin expansion over FY13, given (i) adspends have already been slashed aggressively, (ii) rising input costs/weaker currency will continue to weigh upon GMs (gross margins). Risks are weighted towards the downside. Key upside risks: Cost pressures abate faster than the uptick in adspends, providing enabling margins to sustain/ further improve.

Investment strategy: We have a Sell rating on HUL shares. Multiple challenges are expected going forward?given heightened competition, strategically ad spends will remain elevated, and investments in new brands/categories will continue to impact margins. With the management?s twin focus on volume growth and defence of its market shares, we think margin expansion may remain muted. Further, after the stock?s outperformance over the past year vs the broad market, there is little rationale to be constructive, in our view as (i) the business will face margin pressures and more challenging comps in the key soaps/detergents segment; and; ii) valuations at 29-30x one year forward P/E (price-earnings ratio) leave little room for error.

Risks: The most significant risk to our target price is the possibility of a prolonged battle for market share with other MNC peers as well as Indian companies. HUL is equally leveraged to the rural and the urban economies and, as such, any dislocation would affect the company’s performance. Although the company’s brands have strong pricing power, in a challenging external environment price increases are limited.

P&G is aggressively seeking to increase its market share in detergents, shampoos and some other categories. Upside risks to our target price include:

(i) benefits on the distribution side (plenty of initiatives under-taken in the past one-two years) could kick in;

(ii) a favorable shift towards PP could result in a more stable profit profile, especially as 25% of HUL’s revenues (low-end soaps/detergents) is largely commoditised; and;

iii) cost pressures abate faster than the uptick in ad spends, providing enabling margins to sustain/ further improve.