Positive triggers factored into Hindustan Unilever's stock price

Falling raw material prices expected to help margins recover in Q3

At 18 per cent return over the past three months, India’s largest listed fast moving consumer goods (FMCG) company, Hindustan Unilever (HUL) is the second highest gainer after ITC in the large cap FMCG space.

Market share gains across segments in its major categories, easing raw material prices, premiumisation gains and expectation of a recovery in the rural markets have been some of the triggers for the Indian subsidiary of British multinational giant Unilever.

The company has gained market share across its three main categories and sub-segments in FY22 and this was among the highest in a decade. In the June quarter the company was an outperformer with volume growth of 6 per cent y-o-y even after taking the highest price hikes among FMCG companies, demonstrating the strength of its brands and distribution, says Kunal Vora of BNP Paribas.

One trigger for the company is the potential to upgrade customers to higher price categories. Sales for about half its tea category and 70 per cent in the laundry business are at the mass or the popular segment level which leaves room to upshift customers from mass to branded and further to premium products. Analysts led by Manoj Menon of ICICI Securities believe that the strategy to upgrade consumers is to drive premiumisation on one side for better margins and simultaneously provide the right price-value equation on the mass product to drive upgradation.

Demand trend is another factor given the uneven growth in urban/rural demand and premium/mass segments. While urban demand is holding up and continues to witness premiumisation, there are some worries on account of rural demand. Lower sowing and rainfall in some key states is hurting rural demand and could impact volumes of companies. Vishal Punmiya of Nirmal Bang Research believes that  any signs of a sustainable recovery in rural FMCG growth could be the next big trigger. Risk factors for the sector which could impact current estimates according to him include delay in rural demand recovery, sticky input prices and higher competitive intensity (from current and new players).

In addition to demand, the margin trajectory will be another key factor to watch out for. The company’s gross margins slipped 309 basis points y-o-y and 220 basis points sequentially to 47.4 per cent due to raw material inflation. The impact at the operating level was lower given the savings on the staff costs which were down 100 basis points y-o-y and other expenses which fell 170 basis points y-o-y. Gains would have been higher but for higher advertising and promotions spends which were up 70 basis points y-o-y. Operating profit margins thus were 110 basis points lower at 22.8 per cent, marginally lower than street expectations.

Analysts highlight that higher input costs coupled with rupee depreciation would remain a significant challenge in the near term. While input costs have softened, full benefit of the same is expected to be realised only in the December quarter. Benefits from the lower input costs could be used to enhance marketing spends and pass on some of the benefits to consumers. For the September quarter, B&K Securities expects gross and operating profit margins to remain close to Q1 levels.

 While there are multiple positives, some brokerages highlight that the street is running ahead of itself on the sales growth/margins front if the historic trends are anything to go by. Over the past two decades the company has delivered not more than 146 basis points operating profit margin expansion in a given year adjusted for accounting changes and has taken at least a couple of years to recover margins.

The Street expects FY21-23 margin decline of 120 basis points to be recovered in FY24 itself, say analysts led by Percy Panthaki of IIFL Securities. “Given HUL’s track record of passing on the benefit to consumers and increasing ad spend, the upside to this may be limited,” believes the brokerage. In this situation sales growth expectations for FY24 (currently at 9.5 per cent) too is unlikely.

While most brokerages have a buy rating, investors should await consistent margin and revenue growth trends before considering the stock which is currently trading at 53 times its FY24 earnings estimates.