Demand recovery hopes, valuations to support Hindustan Unilever stock

FMCG major Hindustan Unilever’s (HUL’s) move to sell its water purification business, Pureit, to AO Smith India for Rs 601 crore was well received by the market. The HUL stock ended the day with gains of 2.7 per cent.

Analysts say the water purification business is very competitive and product differentiation is difficult and it has low margins.

The turnover in FY24 was around Rs 293 crore, which is just about 1 per cent of HUL’s revenues and the sale values it at around 2 times the turnover.

The divestment allows HUL to focus on core categories and the sale should be completed in around three months.

The FMCG sector is hoping for demand recovery with hopes of a better monsoon helping rural demand and expectations of a pro-consumption Budget. While rural recovery is expected to an extent in Q1FY25 driven by election spending, the hopes are for sharper rebound in H2FY25.

In H1FY25, mid-single digit earnings growth is expected for large-cap FMCG with a little margin expansion but single-digit volume growth could also be on the cards.

HUL is expected to log around 2-3 per cent volume growth. Raw material inflation has moderated somewhat due to base effect and certain key commodities like milk and packaging material have seen Y-o-Y price drops but companies are mostly passing on price benefits. Hence gross margin gains will be small.

Advertising and promotional spends are also likely to rise and this will further limit margin expansion.

Most FMCG large-caps have seen re-rating post-Q4 results, due to positive management commentary and Budget expectations. Companies have focussed on distribution and brand communication. Volume growth rates have bottomed out and gradual volume recovery is expected in FY25, with a faster recovery in H2, given a normal/ above-normal monsoon. HUL’s wide product range and its presence across price segments should help achieve steady growth. 

HUL is trading at a one-year forward price to earnings ratio or PE of 47 times which is well below the five-year average forward PE of 60 times.

Hence valuation looks to be reasonable. The trailing enterprise value to operating profit for FY24 is around 33.5 times while FY25 valuation on the same metric is expected to be around 31-32 times. Return on equity was around 20 per cent for FY24 and is expected to rise to 21.7 per cent in FY25. Analyst recommendations are there across the gamut of reduce, hold, add and buy with some targets indicating upsides of 15-20 per cent.

The Q-o-Q growth expectations for Q1FY25 over Q4FY24 are better than the Y-o-Y growth expectations. HUL is expected to report 3 per cent Q-o-Q revenue growth (1 per cent Y-o-Y) with 5 per cent Q-o-Q (2 per cent Y-o-Y) operating profit growth and margin expansion of about 100 basis points Q-o-Q to 24 per cent. Net profit growth is expected to be in the range of 6-7 per cent Q-o-Q (2 per cent Y-o-Y). This indicates that growth did bottom out in Q4FY24 and is now expected to be picking up with around 2-3 per cent gains Y-o-Y.