Hindustan Unilever's valuation premium over peers hits record high

Trading at 77x, its trailing 12-month net profit against industry average of about 43x

Investors on Dalal Street, who are increasingly turning risk averse, have pushed Hindustan Unilever’s (HUL’s) valuation premium to a record high. The FMCG company’s price-to-earnings (P/E) multiple is now nearly twice that of its industry peers — the highest in 17 years.

At its current market capitalisation of Rs 5.18 trillion, HUL is now valued at nearly 77x its trailing 12-month net profit, against the industry’s average P/E of 43x. At around 3,300 basis points (bps), its valuation premium over the industry is nearly 6x its historical average of around 570 bps. One basis point is one-hundredth of a per cent.

The Business Standard analysis is based on the financial year-end and current P/E multiples of the top 20 consumer goods makers by revenues. Besides HUL, others in the sample are ITC, Nestlé, Asian Paints, Godrej Consumer Products, Marico, Dabur India, Colgate-Palmolive, P&G Hygiene, Britannia Industries, Pidilite Industries, Tata Consumer, Berger Paints, Emami, and Gillette India.

Analysts attribute HUL’s premium valuation to its relatively faster earnings growth in the post-demonetisation period, and its superior capital efficiency. “HUL’s operating and net profits have grown in double digits after demonetisation. This has made it among the top choices for investors eyeing a pie of the India consumer story,” says Dhananjay Sinha, head (research), Systematix Group.

For example, in the last three years, HUL’s net sales grew at a compound annual growth rate (CAGR) of 5.7 per cent, in line with the industry’s combined net sales growth (also 5.7 per cent). HUL’s annualised net profit growth at 14.7 per cent was 200 bps above the industry’s combined net profit growth of 12.7 per cent (annualised) during the period.

Further, it beat the industry in terms of operating profits. In the last three years, HUL’s operating profit grew at a CAGR of 13.8 per cent, growing from Rs 6,934 crore during FY17, to Rs 10,231 crore during the 12 months ended December 2019. During the same period, the industry’s combined operating profit grew at a CAGR of 8.8 per cent. Others attribute the rich valuation to its market leadership.

“Before the lockdown, HUL was rewarded for its leadership in the FMCG space. After the virus outbreak, investors see it as a firm that will continue to grow despite the lockdown, because of its leadership position in essential categories such as soaps, and cleaning & hygiene products,” says G Chokkalingam, founder & MD Equinomics Research & Advisory Services. He expects the stock to underperform the broader market once the broader economy returns to normalcy, thereby boosting revenues and earnings growth of pro-cyclical sectors such as banks, NBFCs, as well as metals and mining companies.HUL’s valuation has also been supported by its industry-leading financial ratio.

For example, at 86 per cent, HUL has one of the best return on equity (RoE) in its peer group, and among the country’s top listed firms. In comparison, the industry’s average RoE was just 30 per cent during the 12 months ending December 2019.

At 65 per cent, HUL’s return on assets is also nearly two and half times that of industry average of 25 per cent.

This makes the company capital-efficient. “HUL has one of the best capital efficiencies among large firms, which makes it a great defensive play in uncertain times,” says Sinha.High capital efficiency means the company requires very little incremental capital to fund its growth that translates into high free cash flows and large dividend payouts.

For example, HUL accounted for only 7 per cent of the industry’s assets, but 17.4 per cent of net profits during the 12 months ending December 2019.

Lower assets mean lower liabilities, which translates into lower risks during periods of economic downturn, making it a favourite of risk-averse investors.