HUL's sky-high valuations to come under the 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 firm's sales have grown by 6.7 per cent, with an underlying volume growth of four per cent. This is against the market's estimates of a five-to-six per cent 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 such as land sale and tax credits, the company has put out an adjusted profit after tax (APAT) figure, which has grown by 3.6 per cent 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 per cent and operating margin is up 80 basis points to 15.9 per cent 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 per cent in Q1. In the soaps and detergents segment, margins have improved by 70 basis points to 12.9 per cent as input prices (palm fatty acid distillate) have come down. The pain seems to be coming from the personal care segment, which has grown by two per cent 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 per cent.

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 firm's royalty will increase by 50 basis points to 1.9 per cent of sales. Over the next few years, it would touch 3.5 per cent of sales. Tax rate, too, will rise from 22 per cent to 26 per cent.