From Jefferies to Edelweiss, here's how brokerages interpret HUL-GSK deal

A day after Hindustan Unilever (HUL) said it was merging GlaxoSmithKline (GSK) Consumer Healthcare with itself in a transaction worth Rs 317 billion that triggered a rally in both counters on Monday, HUL and GSK Consumer gave up some of the gains on Tuesday. While HUL slipped nearly a per cent lower at Rs 1,811 levels on the NSE, GSK Consumer Healthcare, too, is trading marginally lower at Rs 7,524 levels.

Most brokerages have given a thumbs-up to the deal and maintain either a ‘hold’ or a ‘sector outperformer’ rating on HUL post the development. 

Thus far in the calendar year 2018 (CY18), HUL has been among the top performing fast moving consumer goods (FMCG) stock in the Nifty FMCG index with a rise of over 33 per cent. GSK Consumer has moved up 33 per cent and has outperformed the Nifty FMCG and the Nifty50 indices that have gained 13 per cent and 3 per cent, respectively during this period.

Here is a quick look at how various brokerages interpret the contours of the HUL – GSK Consumer deal and its impact on the other players in the FMCG space.

JEFFERIES

Pros: 1) Entry into high margin health and wellness foods space with potential to premiumise and democratise; 2) EPS accretive from day one given relative valuations; 3) Significant cost synergy potential over the medium-term; 4) Enhanced access to chemist channel; 5) Tax savings if any due to goodwill.

Cons: 1) Health food drinks (HFD) is a specialised category where HUL (or parent) doesn't bring expertise and its own track record in food categories has been modest; 2) GSK's sales growth  between FY13-18 has been around 8 per cent CAGR (volume CAGR at around 3 per cent) versus HUL at 8 per cent sales CAGR (5 per cent volume CAGR), so not growth accretive at the outset; 3) HFD has not been a high growth category and current EBITDA margins (FY19E at around 24 per cent) are at all-time high, helped by benign raw material costs; 4) Overhang of sizeable share sale by GSK Plc and integration issues if any.

HUL's valuation at price-earnings (PE) of 45x FY21 (proforma post deal even with 800bps synergy in year one) leaves no room for error and thus we maintain our HOLD.

EDELWEISS SECURITIES

Contrary to perception, the HFD category has recorded around 6 per cent growth over CY14–17 with 9 per cent expected growth till CY22E. By category penetration, it is 45 per cent urban and 14 per cent rural, which signifies huge potential. 

Post-acquisition, HUL will, inter-alia, drive penetration, upgrade and premiumise through new stock keeping units (SKUs), unlock northern and western Indian markets, etc. This is potentially negative for Nestle’s Milo and Zydus’s Complan. HUL may also become aggressive in oral care (through Sensodyne), which is potentially negative for Colgate.

HUL’s aggression for the category is reflected in the way it swept the deal when pitched against Nestle. Considering EPS upgrades, benign raw material costs, HUL’s ability to reap benefits post-acquisition, we raise the FY20E target PE multiple to 55x (earlier 50x), which yields our revised target price of Rs 2,030. Maintain ‘BUY/sector outperformer’.

MOTILAL OSWAL SECURITIES

While we continue to have our reservations on category growth in malt-based beverages (MFD), we appreciate what HUL can bring to the table on premiumisation, low unit packs, increased distribution and marketing strength.

Planned cost savings even on a highly profitable business is massive at 800 - 1,000 bps from wide-ranging factors like materials and packaging, advertising and infrastructure costs. On a target multiple of 54x (around 20 per cent premium to three-year average, due to significantly improving business fundamentals) and rolling forward to December 2020 EPS, we arrive at a target price of Rs 2,140. Maintain Buy.

EMKAY GLOBAL

Hindustan Unilever’s big bet on health drinks with GSK acquisition appears positive and we estimate EPS accretion of around 6 per cent from the deal. We are currently factoring only part of the benefits indicated by the management and believe Improvement in growth from higher distribution and innovation capabilities can drive more upsides. Maintain Accumulate stance with revised target of Rs 1,900 (from Rs 1,750), based on 45x Dec-20 earnings.

ELARA CAPITAL

The transaction is EPS (earnings per share) accretive as merged entity’s EPS would be 3 per cent higher (FY18) than current levels even without any synergies. Since book value of GSKCH excluding cash is “negative”, HUL will record a large goodwill on its books (Rs 321 billion) and assuming the goodwill is amortized over a period of 20 years, the tax benefit for HUL will be to the tune of Rs 33 billion (NPV assuming 15 per cent discount rate), which has not been accounted for as yet, as the treatment about goodwill and how much will be recorded has not been declared by HUL. The run in the stock captures the event completely in our opinion. We maintain 'Accumulate' rating on HUL with unchanged target price of Rs 1,732.

ANTIQUE STOCK BROKING

We believe that the benefits and expected EPS accretion in the short-term is already factored in the stock price (stock price has appreciated by 11 per cent in the last 30 days). Based on our proforma financials of the merged entity, we arrive at FY21E EPS of Rs 39.7. By valuing the merged entity at PER of 45x FY21E, we arrive at a target price of Rs 1,786. We maintain HOLD recommendation on HUL.