Lower raw material costs, premium products to improve HUL's profitability

Faster growth of premium products is likely to add to HUL's profitability score

Hindustan Unilever (HUL) delivered a strong 33 per cent return in 2018, outpacing a 11 per cent rise in the BSE Fast Moving Consumer Goods (FMCG) index and about 6 per cent in the Sensex. 

While the company is riding high on steady volume growth, the Street will keenly watch out for the upside from the current levels, given its pricey valuation of 53.5 times its FY20 estimated earnings.

Among the triggers for the stock are prices of key inputs such as palm oil, which has dropped in the December 2018 quarter (Q3) on a sequential basis. Further, the recent sharp correction in crude oil prices and the rupee-dollar rate is expected to have a favourable impact on packaging costs.

Besides, faster growth of premium products is likely to add to its profitability score. Two products, Ayush and Indulekha, for instance, have received good market acceptance. 

The management has also indicated strong growth for premium products in its key segments — personal care and home care — during the September 2018 quarter (Q2) and its increasing focus on premiumisation. These two segments together account for 80-86 per cent in terms of revenue and operating profit. 

During April-September 2018, operating margin of these two segments expanded 160-320 basis points year-on-year.

Also, the acquisition of GSK Consumer has only brightened HUL’s premium portfolio with products such as Horlicks, which has strong brand equity. 

The growth of the newly acquired products is expected to improve further with HUL’s already-established strong distribution network. Analysts expect HUL to launch more premium products.

“HUL’s focus on premiumisation should help it in terms of margins and the top line. This, along with correction in input prices, improves HUL’s earnings potential. Valuation (price-to-earnings ratio), though expensive, is likely to remain high in the medium term, says Nitin Gupta, analyst at SBICAP Securities. 

HUL’s earnings before interest, tax, depreciation and amortisation (Ebitda) margin is estimated to improve to 24-25 per cent in FY21, from 21 per cent by FY18, driving its overall earnings.