Hindustan Unilever Rating: hold; New subsidiary likely to be used for capex

HUL board has approved setting up of a 100% owned subsidiary with an authorised share capital of Rs 20 bn.

Move to avail tax benefit could be followed by other consumer firms, reviving investment; ‘Hold’ retained given high valuations

As expected, HUL has formed a 100% subsidiary to set up new manufacturing unit (s) and to potentially avail lower income tax rate of 15%, in our opinion. As proposed by the government in FY20, new investments in manufacturing which commence operations by Mar’23 would attract only 15% income tax

(+ surcharge) rather than the current tax rate of 25.2%. We believe that this is an opportune strategy (neutral if denied tax benefits) and is likely to be replicated by other consumer companies as the tax exemptions in North East and Himalayan states end in a few years.

Our capital goods analyst, Renjith Sivaram believes that if this trend is followed by other cash-rich companies, it could support revival of private sector capex. Our relative positive view of HUL is intact; Hold reflects the requirement of lower multiples to turn more constructive.

New subsidiary to avail lower income tax rate: HUL board has approved setting up of a 100% owned subsidiary with an authorised share capital of Rs 20 bn. The official statement says it is “to leverage the growth opportunities in a fast-changing business environment and will help HUL in becoming more agile and consumer-focused.” We believe that HUL is likely to use this subsidiary to invest in manufacturing facilities to avail tax benefits. The company is also likely to use it to manufacture high-growth categories and for import substitution.

High asset turn businesses likely to follow similar strategy: We note that the Staples companies are generally cash rich (barring GCPL and JLL in our coverage) and have high asset turns. This means these companies have the ability to set up and utilise any additional capacity. We further believe that as the tax exemptions in North East and Himalayan states end in a few years, the companies are likely to look for the opportunity to lock the tax rates at 15% + surcharge.

Private capex could revive: Our capital goods analyst, Renjith Sivaram, believes this could support the revival of private sector capex and result in improvement in demand for capital goods companies like L&T, Siemens, ABB, Cummins and Thermax.

Valuation and risks: Our HUL estimates are unchanged; modelling revenue/Ebitda/PAT CAGR of 13/14/15% over FY20-22e. We maintain Hold with DCF based TP unchanged at Rs 2,100. At our TP, the stock will trade at 47x P/E multiple Mar-22e. Key downside risks are deceleration in consumption demand and pressure on margins from irrational competition.

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