Growth revival and impact on volume growth may help HUL stock to shine

Higher demand for discretionary products and price hike to support margins

The stock of the country’s largest listed consumer company, Hindustan Unilever (HUL), has been underperforming its peers and benchmark indices in September. Valuation worries post the price run-up in August, margin pressures and weaker earnings growth compared to peers in recent quarters has led to the muted stock performance.

This, however, could reverse going ahead as improving demand and easing concerns on the margin front are making brokerages optimistic about the company. The key near term trigger is demand revival and the impact on volume growth after the Covid-hit June quarter.  

Easing of restrictions, extended store operations and rising mobility have led to an improvement in demand over the last three months. While demand from urban centres is picking up, rural consumption remains resilient. This is due to a robust rabi crop, higher minimum support prices and pick up in kharif sowing as monsoons picked up over the last fortnight. While general trade (smaller stores) continue to show steady demand trends, modern trade (supermarkets) is inching towards normalcy, despite the fact that it has not recovered to August 2019 levels.  

What could incrementally add to overall sales volumes is the company’s digital capabilities which are expected to improve its share of digital sales to revenues. This metric is currently at 10 per cent, the highest among peers.

While demand has picked up, the Street will keep an eye out for margin trends, especially the pick up in higher margin discretionary products which have been the hardest hit during the Coronavirus (Covid-19) pandemic. Products such as skin care, colour cosmetics, deodorants and out-of-home segments (ice cream) that account for 20 per cent of sales were impacted due to the restricted hours of operations in urban areas.

Mihir P Shah and Abhishek Mathur of Nomura Research expect HUL to benefit from the uncoiling of demand in out-of-home/discretionary categories on the back of increasing mobility and rising demand for discretionary products. At 28 per cent, personal care has the highest segment margins across its key categories with average segment margins at 21.8 per cent.

The other factor is commodity prices. While inflation in palm oil and crude oil continues, tea prices have softened sequentially though they remain higher than FY20 levels. What should help offset this is a price increase of 3.5-14 per cent taken in the skin cleansing and laundry segments.

Say analysts led by Amnish Aggarwal of Prabhudas Lilladher, “We believe the worst is over in margin pressures led by higher prices and peaked out input costs.” The company’s gross and operating profit margins were down 110-140 basis points y-o-y. Analysts expect operating profit margins to be in the 24-25 per cent range in the near term.

While there are multiple positives for the stock, at 60 times its FY23 earnings estimates, the stock is the second most expensive in the FMCG universe after Nestle and trades at a premium to its five year average of 51.2 times. Investors can look at it for their long term portfolios on dips.

Returns (%)	1 month	3 months	P/E (x)
Hindustan Unilever	4.3	10.3	59.8
ITC	15.9	17.3	17.1
Nestle India	0.4	12.7	79.7
Dabur India	10.0	13.3	52.9
Godrej Consumer	2.8	19.7	47.1
Britannia Industries	6.1	9.6	46.8
Nifty FMCG index	7.5	13.4	35.9

P/E (x) is price to earnings ratio based on FY23 estimates | Source: Bloomberg | Compiled by BS Research Bureau