Offsetting factors likely to limit impact on margins; FY22/23e EPS down 4-5%; TP revised to Rs 2,650 from Rs 2,780; ‘Buy’ maintained
While HUL would be able to largely maintain Ebitda margins, this warrants EPS cuts of 4-5%, despite which growth would be strong at 14%+ over FY21-23e; BUY.
Rising input price inflation is a headwind for HUL with the current input basket close to a decade high level, on our assumptions. This raises concern on HUL margins, but we see some offsetting factors like product mix normalisation (post pandemic), product price hike and operating leverage benefits. While HUL would be able to largely maintain Ebitda margins, this warrants EPS cuts of 4-5%, despite which growth would be strong at 14%+ over FY21-23e; BUY.
Input price inflation: HUL’s widespread portfolio makes it hard to track the input price inflation but our RM Index points to the highest level in a decade. Inflation is particularly high in case of palm oil, tea and crude oil derivatives. This implies the next few quarters would be tough for HUL on the input cost front.
Staggered price hikes: We note that the impact of input price inflation requires sharp product price hikes in soaps & packaged tea but HUL has been staggering the hikes. This is to ensure consumer acceptability without a significant negative impact on volumes. We also think HUL would like to be sure on competition reaction. In the past six months, prices of soaps are up nearly 6-14%, with hikes in past two weeks as well; packaged tea has seen 17-23% increase since Sep-20.
Adverse mix will help: Since the Covid-19 induced lockdown, HUL has underperformed some of its listed FMCG peers due to a higher salience of discretionary (& out-of-home) products. While this had an obvious impact on revenues, the impact has been even higher on the margins as segments like skincare, colour cosmetics, deos have margins better than the company average and significantly higher than skin cleansing (soaps) which witnessed strong growth.
Case study on Q1FY21: In order to highlight the extent of adverse mix impact on margins, we reanalysed the quarter of Q1FY21. The RM Index in the quarter points to a fairly stable input price trend. However, HUL actually reported an LFL gross margin decline of 350bps, which we believe was due to adverse category mix estimated at 300bps, based on our back of the envelope calculations.
Margin concern but not as bad? While the impact of sharp rise in input prices is inevitable, we believe the impact may be lower than the general perception. This is due to product price hike, mix improvement, self-help measures on costs and operating leverage benefits. We currently build in c.6% product price hike in FY22 and history suggests that HUL could easily pass this on. While there would be a slight decline in YoY GMs, we forecast near-stable Ebitda margins.
Our view: We cut our FY22/23e EPS forecast by 4-5% to factor in input price surge yet expect HUL to report a strong 14% EPS CAGR over FY21-23e. We retain BUY with Rs 2,650 TP and HUL continues to be in our top sector picks.