HUL's strong margin show may not sustain

Even as analysts believe volumes have bottomed, margins could correct as ad spends go up

Hindustan Unilever (HUL) has posted a strong margin show in the June quarter. Net sales (up 13.2 per cent year-on-year to Rs 7,571 crore), Ebitda margin (17.4 per cent, up 119 basis points) and net profit (up 3.7 per cent to Rs 1,057 crore) were much ahead of consensus Bloomberg estimates of Rs 7,424 crore, 16.2 per cent and Rs 967 crore, respectively.

However, a large part of the margin performance came from reduced ad spending. As a proportion of net sales, this was down 83 basis points at 12.5 per cent. A one-time write back of Rs 32 crore towards the unutilised pension corpus of earlier years reduced employee cost to 4.4 per cent of sales, and aided margins.

  While net profit is not comparable because of extraordinary gains in the year-ago period (by Rs 67 crore), analysts believe the lower ad spending this quarter appears unsustainable. Amnish Agarwal, senior vice-president (equities) at Prabhudas Lilladher, says: "Reduction in ad spends is not sustainable. Thus, the Ebitda margin could correct from here on." While lower ad spending helps margins in the near term, these can hurt volumes in the mid-longer term, say analysts.

Volume growth in the June 2013 quarter was low at four per cent due to inventory stocking up in March 2013 quarter (pre-empting transporters' strike). Adjusted for these, analysts peg core volume growth at five per cent. Says Agarwal: "Core volume growth stands at five per cent and has come in despite delay in monsoon. We believe volume growth has bottomed out."

The benefit of low base will aid volume growth, says Abneesh Roy of Edelweiss Securities.

Among other important events is the pick-up in personal products margin. It expanded by 277 basis points to 27.6 per cent, driven by good traction in the Fair & Lovely brand. All key segments also delivered double-digit sales growth in the quarter. If some of these can be sustained, it will help support the high stock valuations.

The stock, which has risen 11 per cent in the past month to Rs 686, trades at 37 times FY15 estimated earnings versus its historical average one-year PE ratio of 26.6 times. After the profit beat, some analysts could also revise their FY15 earnings estimates upwards by three to five per cent. But high valuations mean limited gains from hereon.

Management continues to remain cautious on near-term growth as discretionary demand remains under pressure. The impact of a delayed monsoon is also yet to be felt.