HUL's sky-high valuations to come under scanner after Q1

Few catalysts for earnings growth in coming quarters, even as royalty and tax payouts set to rise

Analysts who have been repeatedly putting a “sell” call on the Hindustan Unilever stock now stand vindicated, as the company’s first quarter numbers are nothing to write home about. In the June quarter, the company’s sales have grown by 6.7%, with an underlying volume growth of four%. This is against the market’s estimates of a five-six% volume growth. 

The slowdown in consumer spending is pinching both sales and profit growth. In a bid to prevent any skew in the quarterly numbers caused by exceptional items like land sale and tax credits, the company has put out an adjusted profit after tax (APAT) figure, which has grown by 3.6% to Rs 885 crore compared to last year. According to analysts, current valuations suggest the stock is commanding a scarcity premium. Sanjay Manyal of ICICI Securities believes valuations will track growth over time. 
 

Even though gross margin has expanded by 160 basis points to 48.9% and operating margin is up 80 basis points to 15.9% compared to last year, nobody is cheering. Emkay Global says margin expansion has been largely driven by fall in prices of coffee, tea and palm fatty acid distillate (used in soaps). 

The slowdown is visible across segments, with the exception of beverages, hair and oral care. The soap and detergent segment has grown by eight% in Q1. In the soaps and detergents segment, margins have improved by 70 basis points to 12.9% as input prices (palm fatty acid distillate) have come down.  

ALSO READ: HUL adjusted PAT up 3.6% to Rs 885 crore

The pain seems to be coming from the personal care segment, which has grown by two% year-on-year. Analysts say that with government spending on social schemes tapering off, rural demand is coming under pressure and the slowdown is more secular on the discretionary side. The personal care segment’s margins have declined by 90 basis points year-on-year to 24.9%. 

Going forward, there are several downsides that worry analysts. Analysts believe there is no real catalyst for growth and earnings will be curtailed by several factors. For one, the company’s tax rate and royalty are expected to rise in the coming years. In FY14, the company’s royalty will increase by 50 basis points to 1.9% of sales. Over the next few years it would touch 3.5% of sales. Tax rate too will rise from 22% to 26%.