With an increasingly normal-looking monsoon and consumption catalysts in the second half, the focus will be on an imminent volume growth recovery that will be a key catalyst for stock performance.
HUL Q1 FY17 was marginally below expectations as rural growth has come under pressure, but this was broadly expected. With an increasingly normal-looking monsoon and consumption catalysts in the second half, the focus will be on an imminent volume growth recovery that will be a key catalyst for stock performance. HUL is one of our long-term structural winners, and the current valuation builds in among the least implied growth in earnings (barring ITC) in the consumer sector. We think weakness on the back of these results is a good opportunity to add HUL. We have a Buy rating and increase our target price to Rs975 (from Rs950) as we roll forward our valuation. Q1 earnings in line with estimate: Q1 revenue/Ebitda/Clean PAT grew by c4%/ 8%/6%. The phase-out of excise benefits negatively impacted the top line (-40bp) and PBIT margin (-15bp), which will diminish in FY17. Volume growth of 4% y-o-y reflects deterioration in rural demand and pending urban recovery. Homecare was strong, registering volume-led sales growth of c7% y-o-y, while premiumisation helped in 180bp margin expansion, leading to c23% earnings growth.
In Personal care, revenue growth was c2% y-o-y, adversely impacted by deflation in the soaps business, while PBIT growth was flat. The Refreshments business grew c5% y-o-y as steady growth in Tea, Ice Cream & Frozen desserts was pulled down by deflationary pressure in the coffee segment. The Foods business grew c5% y-o-y as Kissan and Knorr maintained strong growth but a one-off event impacted the Jams.
Investment case rises above short-term weakness: HUL is paving the way for structural growth in the next decade. We regard HUL as a long-term structural growth story given its wide array of brands, leading scale across categories, ability to out-invest rivals, superior cost economics of innovation and astute competitive strategy. In our view, management is paving the way for consistent structural growth through long-term initiatives, such as Winning in Many Indias (WiMi), proactively seeking to monetise growth from all channels, taking the lead in the market development of nascent categories and even bridging gaps in its product portfolio (e.g. herbal).
Increase DCF-based TP to Rs975 from Rs950, maintain buy rating: Current valuation builds in undemanding long-term earnings growth of c10%, which HUL can achieve easily, in our view, and even surpass given its structural strength and right to win across several categories, as well as its astute competitive strategy and long-term growth focus. HUL is among our favourite long-term consumption ideas.
The demand environment has remained quite challenging in the quarter as rural growth has been extremely weak. At the market level, it has come down below the urban growth rate, which has led the overall market growth to be nearly half that of the previous quarter. In this environment, HUL has still grown ahead of the market. The bulk of the slowdown has been general trade-driven as the modern trade channel for HUL registered robust growth. Even within general trade, smaller pack grew slower than midpremium packs which grew slower than the premium SKUs. All of this points to worsening demand in the rural market, much of which is centred around regions with rain deficits in each of the past two years.
However, HUL believes that an increasingly normal-looking monsoon, government initiative to boost rural incomes and consumption catalysts such as the 7th pay commission could lead to an imminent recovery in demand. This quarter was the first in which HUL was reporting in new Ind-AS, which also led to some reorganisation of its segmental reporting. Personal wash (soaps) is now a part of “Personal care”. Detergents, household care and water are now called “Homecare”. Ice-cream has been put together with Coffee and Tea under “Refreshments”.
The phasing out of the excise duty had an adverse impact on revenue growth of 40bp and of 15bp on margins. The commodity basket is now bottomed out, and HUL expects input price inflation to now set in. Its priorities in this environment will remain volume growth and delivering modest expansion of margins consistently.
It aims to generate pricing-led growth mainly through a better mix of revenue, and pricing strategy will be led by the competitive environment. Nonetheless, HUL is aiming for aggressive cost control as it enters FY17. HUL is planning to invest close to R10 bn in a new factory in Assam, which on acquiring all approval should be commissioned before 31 March, 2017.
This should also enable HUL to be eligible for excise duty and income tax-related benefits. HUL contends that products with natural ingredients or a natural platform are gaining traction globally and that is also central to its product strategy and new innovations.
The company has now integrated the Indulekha brand in its portfolio and is quite encouraged by its consumer response. Indulekha is a hair care brand (comprising Ayurvedic hair oil) for which the acquisition was completed in Q1 FY17.Within Home care, the detergents category is fast premiumising, and HUL’s strength in the premium segment is helping it gain market share. Even Wheel, a mass end offering in the detergent segment, has started to grow.
Revised estimates: We have revised our estimates marginally post Q1 results as we have cut FY17-19 earnings estimates by c2%, reflecting short-term demand weakness. We have a positive long-term view on HUL and consider it to be one of the long-term structural winners in the fast-moving consumer goods sector. We have rolled our valuation forward from April 2016 to July 2016, which led to a higher fair value estimate of Rs975 (from Rs950).