Growth revival, easing of curbs may help Hindustan Unilever stock shine

Higher demand for discretionary products and price hike to support margins

The stock of Hindustan Unilever (HUL), the country’s largest listed consumer company, has been underperforming its peers and the benchmark indices in September. Valuation worries after the price run-up in August, margin pressure, and weaker earnings growth than peers in recent quarters led to this muted stock performance.

This weak run may soon come to an end as improving demand and easing concerns on the margin front are making brokerages optimistic about the company. The key near-term trigger is demand revival and the impact on volume growth after the Covid-hit June quarter. 

Easing of restrictions, extended store operations, and rising mobility led to an improvement in demand over the past three months. While demand from urban centres is picking up, rural consumption remains resilient. This is due to a robust rabi crop, higher minimum support prices, and pick-up in kharif sowing, with monsoons picking up over the past fortnight. Though general trade (smaller stores) continues to show steady demand trends, modern trade (supermarkets) is inching towards normalcy, though it has not recovered to the August 2019 levels.  

What may incrementally add to overall sales volumes is the digital capabilities of the company, which is expected to improve its share of digital sales to revenues. This metric is currently at 10 per cent, the highest among peers.

While demand has picked up, the Street will keep an eye on margin trends, especially the pick-up in higher-margin discretionary products, which have been the hardest hit during the pandemic. Products, such as the skincare, colour cosmetics, deodorants and out-of-home segments (ice cream) that account for 20 per cent of sales, were impacted due to the restricted hours of operations in urban areas.

Mihir P Shah and Abhishek Mathur of Nomura Research expect HUL to benefit from the uncoiling of demand in the out-of-home/discretionary categories on the back of increasing mobility and rising demand for discretionary products. At 28 per cent, personal care has the highest segment margin across its key categories with the average segment margin at 21.8 per cent.

The other factor is commodity prices. While inflation in palm oil and crude oil continues, tea prices have softened sequentially, though they remain higher than FY20 levels. What should help offset this is a price increase of 3.5-14 per cent taken in the skin cleansing and laundry segments.

Analysts led by Amnish Aggarwal of Prabhudas Lilladher says: “We believe the worst is over on margin pressure, led by higher prices and peaked-out input costs.” The company’s gross and operating profit margin was down 110-140 basis points YoY in the June quarter. Analysts expect the operating profit margin to be in the 24-25 per cent range in the near term.

While there are multiple tailwinds for the stock, at 59x its FY23 earnings estimates, the stock is second-most expensive in the FMCG universe after Nestlé, and trades at a premium to its five-year average of 51.2 times. Investors can look at it for their long-term portfolios on dips.