HUL: Investors can't wait

CY07 topline growth improves to 13.3%, but operating profit margin remains flat.

Hindustan Unilever (HUL) has underperformed the market over the last two years with the stock losing about 8 per cent while the Sensex gained 67 per cent.

Subdued topline growth - 11 per cent in CY05 and 9 per cent in CY06 - and mediocre operating margins of 13 and 13.6 per cent respectively are the main reasons behind the poor stock performance. By that yardstick, CY07 has been a much better year for the FMCG major with net sales growing 13.3 per cent to Rs 13,717 crore.

While the home and personal care (HPC) segment has grown by reasonably at 12.34 per cent, the foods segment has grown by 20.5 per cent to Rs 2,212 crore.

However, the operating profit margin has remained more or less flat at 13.75 per cent because costs too have increased though the company has actually managed to contain expenses on advertising and promotion, which were flat at 10.4 per cent of sales.

As a result, the operating profit is up 14.4 per cent at Rs 1,886 crore compared with 14 per cent in CY06.

The sales numbers for the December quarter have been better than those in the first three quarters and have boosted the overall numbers for the year.

That's because they come on a low base - the sales growth in the fourth quarter of CY06 was a very poor 6.1 per cent - and on that base sales in the fourth quarter of CY07 have grown 16.8 per cent.

The HPC segment has grown at 18.35 per cent in Q4 CY07, whereas the category had not done well in Q4 CY06. To push sales, HUL has had to spend more on advertising and promotions, which have seen an increase of 120 basis points. Besides, other costs have risen marginally.

That's one reason why operating profit margins in the December 2007 quarter are actually lower and also why the stock closed marginally lower in the market that bounced back by 341 points on Wednesday.

At a time when consumer spending is up, HUL has lost market share in several key categories.

For instance, it has yielded ground in the personal wash segment where it has lost 100 basis points between December 2006 and December 2007.

In shampoos too, the company's share has fallen from 48.5 per cent to 47.8 per cent.

Toothpaste is another category where HUL's share has dropped. The company has done well to protect its market share of 54.5 per cent in skin care products and has gained significantly in the laundry segment, where its share is now 37.5 per cent.

It has also done better in the coffee market and now commands a share of 44 per cent. However, it has lost out marginally to competitors in the tea market.

The loss of market share is an indication of the competition in the marketplace. Since the environment remains benign, HUL should be able to post double digit growth even on a high base.

However, it is unlikely to be able to grow above industry rates given the fierce competition from both national as well as store brands that will be put out by organised retailers.

Moreover, the company will have to spend on advertising and promotions for its existing brands and new products that it plans to roll out and may not be able to always pass on cost increases to consumers.

Earnings growth for the next three years should average 17-18 per cent. At the current price of Rs 193, the stock trades at just under 20 times estimated CY08 earnings and should perform in line with the market.