EPS boost of 4.5% likely in FY20e; expected to rise further in subsequent years; TP revised to Rs 2,030; one of top picks in sector
The acquisition of Glaxosmithkline Consumer Healthcare (SKB) by Hindustan Unilever (HUVR) for Rs 317 bn will make HUVR the largest listed foods company in India. Armed with the no. 1 HFD portfolio and considering FY20 to be a full consolidated year, HUVR’s: (i) share of Foods & Refreshment (F&R) would jump from 18.4% to 27.8%; (ii) Ebit margin for the F&R segment would improve from 15.6% to 17.8%; (iii) EPS would increase 4.5% in FY20 without factoring in synergies and cost-savings. With the HFD category slated to grow at 9% through CY22e and HUVR’s ability to drive penetration using its distribution muscle, we are confident it would clock double-digit revenue growth in SKB’s portfolio in the medium term. Maintain Buy; retain HUVR as one of the top sector picks.
What excites us about the deal
This deal will add about 12/13.5% to HUVR’s revenue/PAT. This means HUVR’s revenue contribution to Unilever Plc will likely touch double digit—global parentage support will thus increase. EPS accretion (4.5% in FY20) will improve further once HUVR initiates operational improvements, go-to-market and distribution network optimisation, and harnesses scale efficiencies across line items including ad spends—HUVR has guided for 8–10% margin expansion in the acquired portfolio.
HUVR’s strategy to unleash category potential
Contrary to perception, the HFD category has recorded 6% growth over CY14–17 with 9% expected growth till CY22e. By category penetration, it is 45% urban and 14% rural, which signifies huge potential. Post-acquisition, HUVR will, inter alia, drive penetration (distribution network >7.5mn v/s SKB’s 1.8mn), upgrade and premiumise through new SKUs, unlock northern and western Indian markets, etc. This is potentially negative for Nestle’s Milo and Zydus’s Complan. HUVR may also become aggressive in oral care (through Sensodyne), which is potentially negative for Colgate.
Outlook and valuations: On terra firma; maintain ‘BUY’
HUL’s aggression for the category is reflected in the way it swept the deal when pitched against Nestle. Considering EPS upgrades, benign RM costs, HUVR’s ability to reap benefits post-acquisition (e.g. Indulekha), we raise the FY20e target PE multiple to 55x (earlier 50x), which yields our revised TP of Rs 2,030. Maintain ‘BUY/SO’. At CMP, the stock is trading at 51.7x FY20e EPS (non consolidated).
Other key parameters
The acquisition is in line with HUVR’s strategy of building a strong F&R portfolio. HUVR had tried this category through Amaze a few years back and, now with this acquisition, it will test this category again. Against Unilever Plc’s 41% revenue contribution from the F&R segment, it was 18.4% for HUVR. Thus, this will give a fillip to HUVR’s F&R portfolio share, lifting it to 27.8%. Simple EPS accretion would work out to be 4.5%. However, we believe that with generation of goodwill of approximately Rs 270,000 mn, a likelihood of tax break for five years is likely on this—potential tax savings of Rs 20 bn over four years assuming amortisation of 25% p.a. Overall, expect double-digit growth in the medium term with full synergy benefits estimated to be 800–1000bps to Ebitda margin (net)—this will yield approximately 80-90bps Ebit margin expansion at company level.