HUL: Time to push up volumes

With period of benign input costs behind, improvement in volumes is a must for re-rating of the stock

The days of large windfall gains from benign input costs seem largely behind consumer companies, at least that's what Hindustan Unilever Ltd’s (HUL)'s June quarter (Q1) results suggest. Rising prices of palm fatty acids, a key input for soaps, limited Ebitda (earnings before interest, taxes, depreciation, taxes, and amortisation) margin gains for HUL. Part of the 88-basis-point expansion in Ebitda margin to 20.5 per cent was driven by a cut in advertising spends, which as a proportion of sales fell 56 basis points over the year-ago quarter to 11 per cent.   

Given the high base of FY16, gains in Ebitda margins are likely to moderate and the focus will now need to shift to volume growth, essential for stock re-rating, believe analysts.

In addition to continued ad spends, improved rural demand on strong monsoon and public sector wage rise could boost volumes. Gains from the last two are likely to come with a lag of two-three more quarters.

In the meantime, HUL has discontinued offers in select segments and this could test its pricing power. Sachin Bobade, consumer analyst at Dolat Capital, says HUL has removed offers in the middle of Q1 in detergents, soaps, tea, and beverages, and believes the company could discontinue offers on a wider range of products. "We do not want to overheat the markets and have taken select pricing actions. There will not be trade promotion but some consumer promotion will continue," HUL said.

It will be interesting to see the impact of these moves on HUL’s overall volumes and Ebitda margin in the September quarter. In Q1, HUL's volumes grew four per cent and met the lower-end of the four-six per cent growth expectations of analysts.

Overall, continued price deflation, especially in soaps, led to a lower growth of 3.6 per cent in its revenues to Rs 7,988 crore in Q1. Although the numbers are not strictly comparable given the adoption on new accounting norms from April, net profit (excluding exceptional items) grew 6.1 per cent to Rs 1,128 crore and missed Street expectations of Rs 1,147 crore; reported net profit stood at Rs 1,174 crore. Revenues were short of Bloomberg consensus estimate of Rs 8,517 crore.  

The stock is expensive at 41 times FY17 estimated earnings. “Uptick in volume growth, especially in personal products, is essential, else stock may continue to be under pressure,” say analysts at Emkay Global.