Multiple margin levers ahead for Hindustan Unilever

Volume growth and profitability exceed Street expectations in Q4

Improvement in operating profit margin was the surprise element in Hindustan Unilever's (HUL's) March quarter (Q4) results. Most analysts had muted expectations, given the rise in prices of key inputs such as palm fatty acids and elevated advertising spending, leading to benign margin estimates. In contrast, HUL's margin inched up 98 basis points (bps) over a year to 20.4 per cent. Like its peers, HUL toned down its ad spends in Q4 but this is unlikely to sustain, believe analysts. Continued high competitive intensity will mean the company will have to invest in advertising and promotional activities to protect and grow its market share and volumes. However, the company does have a host of margin levers at its disposal.

With parent Unilever's renewed focus on improving of margins, HUL is expected to follow. The management noted input cost inflation had moderated from earlier levels, which should help margins. Though the company is likely to pass on any benefits arising from lower rates under the goods and services tax (GST), its focus on driving overall cost efficiencies and premiumisation across segments will rub off favourably on the margins.

For Q4, volumes grew four per cent, slightly ahead of the analyst expectations of flattish to three per cent growth. Healthy growth in its three large categories of home care, personal care and refreshment segments fuelled this. Coupled with select price hikes, it led to a 6.4 per cent increase in net revenue to Rs 8,213 crore, slightly ahead of the Bloomberg consensus estimate of Rs 8,114 crore. Margin expansion and lower tax rate enabled growth of 7.6 per cent in net profit (before exceptional items), ahead of the estimated Rs 1,090 crore.

Its smaller segment of packaged foods continued to see low single-digit growth in revenue, and its margins also contracted by 370 bps. Part of this was due to a high base; it remains to be seen if the company is losing to competition in this segment. Oral care, too, remained weak. On demand, the rural market continued to be weaker than the urban one. As HUL derives nearly half its revenue from rural India, recovery in this market is key. While there are enablers such as a normal monsoon, implementation of GST will create near-term pressure, particularly in the wholesale channel.

The stock has been making new highs in the past two trading sessions. The scrip currently trades at a punchy valuation of 44 times the FY18 estimated earnings and seems to adequately capture all the positives.