HUL: Growth strategy pays

Company’s recent increase in prices may prevent further slide in margins.

After posting slower growth than its rivals, a shift in strategy by Hindustan Unilever (HUL) is yielding results. Fund managers could have never imagined that HUL could post such a dramatic turnaround. After shifting focus to high-volume growth, the company has clocked double-digit volume growth for five straight quarters, barring the first quarter of FY12, when it dipped to 8.3 per cent. Bank of America Merrill Lynch expects volumes to continue growing at around 10 per cent, due to increased rural reach, focus on modern trade and growth in the personal care segment.

Analysts believe the gross margins saw their worst decline in the first quarter and should improve from current levels, thanks to a rise in prices and stable input prices. In the second quarter, they expect margins to improve by 120 basis points, as the company undertook selective price rises last month and is clocking decent growth in the personal care and processed foods businesses. To stem margin fall, HUL has increased the price of Lux soap by six per cent and of Pears by five per cent. Prices of detergent bars have also been raised. Also, if commodity prices correct, it would directly show on the bottom line. Over the next three-four years, margins could surprise positively and expand 150–250 basis points on an enhanced product mix and slightly better soap and detergent margins, says Religare.

Margin expansion seems highly possible from the second quarter, as the company is also curbing advertising spends besides undertaking price rises. As a percentage of sales, ad spend is likely to stay at 12–13 per cent (compared to 15 per cent in FY11), given the improved operating leverage, lower media inflation and reduced soap/detergent spends, says a brokerage report. Analysts expect the personal care division to be the game changer for HUL. The segment reported 19.4 per cent growth in the first quarter and the Ebit (earnings before net interest and tax) margins expanded 53 basis points to 25.3 per cent. At the Ebit level, the personal care division’s contribution stands at 54 per cent, compared to 45.8 per cent from soaps and detergents.

After a 23 per cent year-to-date outperformance, HUL’s one-year price to earnings ratio stands at 26 times, in line with its five-year historical average despite higher growth and, hence, is conservative, says a brokerage. Clearly, the company’s changed strategy is finally showing in the valuations, even as downside risks emanating from high commodity prices remain.