Fast-moving consumer goods (FMCG) and pharmaceutical stocks are considered to be defensive plays in the market. Generally, when the markets are falling, investors shift their position to stocks in these sectors.
However, over the last one week when the market was falling on global cues most of the stocks in the FMCG and pharmaceutical space also fell. The only exception was Hindustan Unilever (HUL). The stock has moved up from Rs 760 levels to Rs 865 in a span of four days, a move of 13.8%. For a heavyweight like HUL, it is a very strong move.
For a company with a pan-India network of distributors’ growth in HUL would be seen as a pick-up in consumer spending across the country. However, that does not seem to be the case for bullishness in HUL. Analysts are bullish on the company because of a fall in crude oil prices and have said that volume growth is bottoming out.
Phillip Capital in their note on HUL has said that the industry has continued to remain sluggish but decline in raw material prices is likely to provide a fillip to both volume and earnings growth in the forthcoming quarters. Considering the significant exposure of around 35% of costs to crude derivatives, HUL will be able to realize sizeable benefits.
JP Morgan has cited four main reasons for their upgrade in their report. They say the upgrade is led by expectation of gradual volume growth recovery over FY16; a better margin outlook on account of moderating input costs and relatively rational competitive spends. Proactive approach towards product innovation and distribution enhancement which provides a more sustainable competitive edge over peers a relative non-performance of the stock in the recent rally.
Slowing economy has resulted in subdued growth for the company. Over the past eight quarters, the company has posted a 4-6% volume growth. JP Morgan expects soft trend to continue in the second half of FY15 but expect a revival in volumes starting in FY16 aided by improved consumer sentiment and promotional activities.
But the big story in HUL is the sharp drop in input cost. Credit Suisse has upgraded the stock pointing out that the fall in input cost is unprecedented in many ways. The quantum of fall in crude over the last 12 months average is around 35% versus the previous highest fall of 16% seen in FY10 and 12% in FY02. Also, palm oil prices are down.
Credit Suisse adds that conventional logic is that sharp input cost deflation hurts HUL as price growth drops and competitive intensity rises. However, price-led competition has structurally weakened. P&G's strategy has more profit focus now with the company aiming to grow profits at twice the rate of revenues. Unorganised players, another source of price competition, have become much weaker compared to the past.
JP Morgan says that key raw materials for HUL are PFAD (Palm Fatty Acid Distillate), LAB (Linear Alkyl Benzene), and Crude derivatives which have declined sharply by 10-40% over the past six months. HUL is expected to retain some input cost deflation gains despite price reductions and estimate gross margins will expand meaningfully by around 200 basis points in FY16.
Benefits of falling crude prices has started to trickle down to corporate level.