Q1 miss, demand uncertainty may cap upside for Hindustan Unilever stock

Margin gains going ahead is a key positive

The market’s response to Hindustan Unilever’s (HUL) first quarter of financial year 2023-24 (Q1FY24) results has been negative. While there are some signs of rural demand revival, the results came in below Street expectations.  Some analysts are downgrading target prices, and investors are looking at a longer timeframe for visibility in earnings and revenue growth.

HUL’s volumes grew 3 per cent year-on-year (YoY) - higher inflation still seems to be adversely impacting consumer spending but the bright spot was better in the rural segment. Seasonal issues could also have played a part in pulling down volumes.

HUL is hiking advertising & promotional (A&P) spending, which rose by around 11-12 per cent YoY. The current A&P spend was around 9.8 per cent of revenues, but pre-Covid expenditure was above 11.5 per cent.  There was also a 120 basis points YoY increase in ‘other expenses’, and the impact of new royalty incentives payable to the parent to contend with.

Lower commodity costs may eventually feed through in the next two or three quarters, given strong prior inflation and inventory build-up. Strong competition is affecting pricing power, especially in categories like teas and detergent bars. Weather conditions could be a key variable when it comes to rural demand.
 

Net sales grew 6.1 per cent YoY to Rs. 15,150 crore.  Operating profit grew 8.4 per cent YoY to Rs. 3,520 crore and profit before tax grew 9.8 per cent YoY to Rs. 3,400 crore while profit after tax (PAT) was up 9.2 per cent YoY to Rs. 2,500 crore. Other income and a lower depreciation helped boost PAT. Gross margin had dropped 550 basis points between FY21 and FY23 and it has pulled back around 260 basis points YoY, which is why the consumer goods giant can look to start hiking A&P spends again as it pursues a premiumisation strategy.

Segment-wise, home care contributed 35 per cent of total sales and revenues were up 10 per cent YoY, while personal care contributed to 38 per cent of total sales, and revenues rose 4.4 per cent YoY, while food & refreshment (F&R) sales contributed 25 per cent of total sales and rose 4.7 per cent YoY. Home care and F&R have seen double digit annual growth in the last four-year period. The home care margin improved 60 basis points YoY to 18.3 per cent and personal care margin remained flat at 26.3 per cent. F&R margin rose 200 basis points YoY to 17.9 per cent. Overall, operating profit margin was at 23 per cent.
 

Management is hoping for growth through the next three quarters to be volume-driven as it does not wish to take price hikes in a competitive environment. Margins could be sustained or improved if commodity costs continue to ease down or stay flat. The company has initiated price-cuts in skin care and laundry segments. Inflation data is mixed, though it looks moderate. Inputs for home care and personal care are benign but commodities like coffee, milk, barley, etc. continue to see high inflation.

Most analysts have downgraded earnings growth expectations for FY24 but there’s little change in recommendations. The stock is trading at the lower end of its historical valuation levels.