Analysts remain bearish on HUL

Even as the stock has corrected significantly from its highs, analysts say near-term growth pangs could keep it under pressure

The Hindustan Unilever (HUL) scrip has underperformed both the S&P BSE Sensex and the S&P BSE FMCG indices over the past three months, and is down about 21 per cent from its all-time intra-day high of Rs 725 reached on July 24, 2013. The company’s relatively weak performance and modest outlook are the key reasons for this fall.

Additionally, an investor churn leading away from defensive sectors such as FMCG has added further pressure on the stock. Surprisingly, despite this correction, most analysts remain pessimistic on the stock. In recent analyst interactions, the company management has said it expects further pressure on overall volume growth, which is likely to keep a check on its top line growth. Higher investments in advertising and promotional activities coupled with rising input costs could reflect in subdued profit growth for the company, say analysts.

“We believe that given the weak macroeconomic situation, HUL’s growth is unlikely to pick up any time soon. Moreover, P&G’s entry into the oral care segment may further elevate the already high competitive intensity. We continue to be cautious on the stock," says Manish Jain, consumer analyst at Nomura.

Of the 15 analysts polled by Bloomberg since November 2013, 11 have a Sell rating, three have a Neutral and only one analyst has a Buy on the HUL stock; their average target price stands at Rs 554. For the latest 10 recommendations, the average price is even lower at Rs 542. These suggest the stock is fully priced at current levels. However, from a valuations perspective, the scrip now trades at a rich 32 times its FY15 estimated earnings versus 28 times its historical average one-year forward PE. Given the benign growth, the premium valuations may not sustain.

“We believe the current valuations are expensive, given the sedate near-to-medium term outlook. We cut our earnings estimates by three per cent and five per cent for FY14 and FY15 to factor in lower revenue growth,” says Nikhil Vora, managing director of IDFC Securities.

Given the forthcoming December quarter earnings, the company did not comment, citing the mandatory silent period.

Margin outlook
Rising prices of key inputs such as palm oil and linear alkyl benzene (up about 15 per cent over last year) may put pressure on the company’s margins till end-FY14. The company is also likely to witness the full impact of rupee depreciation in the December 2013 quarter. Though it will continue to invest in advertising and promotional activities, the company has curbed promotions in the soaps and detergents segment. To protect margins, HUL plans to keep overheads under check, say analysts. However, given the high competition and slowing demand, the company may not be able to take price hikes to pass on the input cost inflation. Overall, its Ebitda margins are expected to decline sequentially in the December 2013 and March 2014 quarters, but remain flat on a year-on-year basis, estimate analysts.

Volumes may moderate
Slowing discretionary demand, high competitive intensity and rising inflation are among key reasons for the halving of HUL’s volume growth from eight-nine per cent to about four-five per cent over the past few quarters. While the soaps and detergents (Rin, Surf, etc) segment volume growth has held up fairly well so far (double-digit volume growth over the past year), the company has recently cut down on promotions in this segment. Thus, analysts expect volume growth to moderate and realisations to drive the top line growth of this segment.

HUL’s personal care products segment (Fair & Lovely, Ponds, Lakme, Dove, etc) has been under pressure over the last few quarters. While the June 2013 quarter had seen volume growth fall below 5 per cent, up-stocking prior to the winter/festive season led to strong growth of this segment in the September 2013 quarter, which may not sustain.

“The delayed winter is likely to impact personal product (PP) revenues, as HUL had built up trade inventory in Fair & Lovely in Q2 FY14. We expect PP margins to contract owing to mix deterioration (lower growth in skin care), higher ad spends in oral care, and the high base effect,” MOSL analysts noted in their Q3 FY14 results preview.

“Industry volume trends are now more challenging, with a slower rate of growth across categories. HUL, being the proxy for the industry, will also face the music. Volumes are estimated to dip further from the currently mid-single-digit levels,” adds Nikhil Vora.

The triggers
A pick-up in discretionary demand is key to HUL’s growth as the company has been focusing on premium products. Traction in premium products (such as body wash, face wash hair conditioners, ice creams, etc) could not only push its volume growth but also improve margins. The company’s personal care segment is expected to be under pressure in the foreseeable future but could be a long-term growth driver, believe analysts. However, the shampoo segment (Sunsilk, Clinic Plus, Clear) remains the bright spot and has grown faster than the category in the recent past. The company’s new launch, Tressemme, in the hair care segment has been met with an encouraging response.

Additionally, rural India continues to see strong income growth. With HUL deriving a large chunk of its revenues from rural India, higher than expected demand could offset the pressure in discretionary demand.