Single-digit profit growth doesn't justify HUL valuation

Adjusted for exceptional gains, net profit grows by 6.6% while volume growth plummets to 3%

Single-digit profit growth and double-digit valuations don't go hand-in-hand. India's largest fast-moving consumer goods company (FMCG) Hindustan Unilever's (HUL) stock is expected to come under pressure after it reported weak numbers for the March quarter.

HUL’s profit after tax from ordinary activities has grown a modest 6.6 per cent to Rs 832 crore in the fourth quarter, while net sales rose 8.9 per cent, year-on-year (y-o-y). Standalone sales swelled 9.7 per cent. Clearly, business momentum has been weakening over the past six quarters and HUL’s volumes have steadily declined. In Q3, volume growth has hit a low of three per cent, as rural demand also started weakening.

HUL’s numbers for FY14 are equally unimpressive, with analysts calling them ‘unhealthy’. Sales grew 8.6 per cent, with an underlying volume growth of four per cent, while its domestic business grew nine per cent, compared to the previous year. Adjusted profit after tax grew 7.3 per cent y-o-y. With no triggers for an uptick in demand, valuations look expensive and profitability is expected to remain stressed, as raw material costs have flared up since January. Emkay Global says: “Earnings performance of HUL is in low quartile of the FMCG sector, whereas valuations for HUL are in top quartile. We retain negative bias amidst expensive valuations and single-digit earnings growth.”

The company’s margin performance, too, has been less than impressive both for the quarter and full year. Compared to last year, operating margins rose 20 basis points (bps) to 15.2 per cent. However, most of the expansion was primarily due to a boost gross margins got from lower advertising and promotion spends. Advertising and promotion spends have declined 90 bps, compared to last year, to 11.8 per cent. Operating margins for FY14 expanded by 50 bps to 16 per cent, mainly due to expansion at the gross margin level. Analysts believe the firm is under-investing in brands to drive profitability, which would impact growth in subsequent quarters.

As far as segments are concerned, HUL's soaps and detergents grew 9.6 per cent, driven by double-digit growth in the laundry segment. Personal products expanded 8.3 per cent, much of this was price-led as volume growth has plummeted to one per cent. Profitability of the personal products has declined during the quarter, while that of other segments has improved. Ritwik Rai of Kotak Securities believes weakness in the personal products’ profit growth is an area of concern as the segment accounts for 45 per cent of the firm’s profits.