We met the management of Hindustan Unilever to understand the major trends in demand and the outlook on performance in key segments. The key takeaways from the meeting are as follows:
HUL has not seen any visible signs of slowdown in its product portfolio; the management believes that consumer products are typically the last sector to get impacted due to a demand slowdown. HUL posted 8.3% volume growth in Q1FY12 after five quarters of double-digit volume growth; the management believes that the current pace of volume growth is likely to continue over the medium term and revenue growth will have a higher mix of pricing as compared to FY11. We expect volume growth for HUL to sustain in mid- to high-single digits given that 46% of sales contribution comes for soaps & detergents which have volume growth of 3-7%. Double-digit volume growth in FY11 was driven by a 8% volume growth in soaps and a 19% volume growth in detergents which we believe are unsustainable. We are modelling in 8% volume growth for FY12.
The management has maintained that competitive intensity has not reduced in key segments of detergents and personal products; however, players’ aggressive promotional activities and price cuts have abated due to steep RM (raw material) inflation impacting margins. The recent news of the company increasing distribution margins by 150 bp (basis points) is incorrect; the 21% price cut in Surf Excel Blue 4kg pack is just part of a promotional exercise and is not a permanent change. In oral care, the company is not planning to enter the premium sensitive toothpaste segment which has seen significant investments being made by GSK Consumer and Colgate in the last few months; it may consider the space at a later stage. Personal products, particularly premium skin and hair care, continue to be key focus segments; the management is looking at sustainable double-digit growth in personal products, though margins are not expected to erode significantly (unlike soaps & detergents); 100-150 bp margin erosion in the process of growth is possible in the medium term.
We note that HUL is already fighting price-based competition in shampoos and heightened competitive activity in toothpaste. Personal product margins have declined from 36.7% in CY(calendar year)?03 to 25.6% in FY11; we model in 110 bp decline in personal care margins over FY11-13.
With higher RM pressures across consumer companies, adspends were lower across companies for the past couple of quarters. HUL?s adspends declined 16% year-on-year in Q1FY12 and adspend to sales ratio declined 410 bp to 11.3%. The management believes that such low levels of adspends are unsustainable and are likely to inch up during the year. We model in 140 bp decline in adspends in the current year at 13%. Though RM prices have seen some softening, the past price increases had not been sufficient to pass on the inflation; thus, significant margin expansion is unlikely. The management believes that single digit Ebit (earnings before interest and taxes margins) in soaps and detergents are unsustainable and are likely to move up in the future; however, the time-frame is somewhat unclear given continued competitive pressure. We note that PFAD (palm fatty acid distillate) prices are up 24% in the last two months post-correcting from their high, up 27% y-o-y; LAB (linear alkyl benzene) prices continue to rule near lifetime highs.
In Q4FY11, HUL launched various food products under the Kissan brand. Kissan Creamy Spread has been launched in 20 cities; management believes that it is a sound product though not a replacement to butter, and that the category will evolve over a period of time. Soya juice has been launched in three cities and a national launch will take time. Nutrismart (malted food drink) is available in only two southern states, and remains a test launch given high competition from brands like Horlicks, Complan and Bournvita. Knorr Soupy noodles continues to meet internal expectations and is available nationally. In water, HUL has changed the distribution structure from direct-to-home to retail, which will result in significant cost savings but will also impact growth till the transition is complete. The company believes it has a strong portfolio (products from R900-13,000) which is likely to do well in the retail based model.
Valuation and view: We believe competitive pressures across segments and the high base of soaps and detergents (FY11 volume growth of 8% and 19%) will keep volume growth at 7-8% for FY12, lower than 13% achieved in FY11. Margins are unlikely to rebound strongly due to continued RM pressures and likely increase in adspends from current levels. A focus on new product launches and profitable growth is a key positive change in HUL?s strategy over the last few months. However, with single-digit volume growth and muted margin expansion, we expect the company to deliver only 13% PAT CAGR (profit after tax, (compound annual growth rate) over FY11-13. Recent exuberance in stock price has driven up stock valuations to 31.2x FY12e (estimate) and 27.6x FY13e EPS (earnings per share). We believe such high valuations are not justified given continued competitive intensity and earnings volatility. Maintain Neutral.
?Motilal Oswal Securities