Consumer goods firm Hindustan Unilever Ltd (HUL) reported a disappointing 2% growth in volumes for the quarter ended December, a big drop from the 7% growth recorded in the September quarter. Still, net sales grew by as much as 17% and profit before interest and tax rose by 15%, thanks to large price increases last year to counter rising raw material prices.
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The soaps and detergents segment, where volumes actually fell, registered a 25% growth in revenues and a 24% growth in profit as a result of increased prices. High retail prices coupled with the slowdown caused consumers to go slow on purchases, but that didn’t stop the company from generating strong profit growth. For the whole year, profit before interest and tax rose by 18% on the back of a 19% increase in net sales.
The year 2009 is set to witness phenomenal growth at least as far as profitability goes, thanks to the sharp decline in commodity prices. According to an industry observer, who has tracked the sector for at least 10 ten years, for many of the company’s products, prices of inputs have fallen to levels last seen in 2003. Meanwhile, selling prices of these products continue to be close to 2008 levels. While HUL has taken some price cuts lately, they were only marginal. It hasn’t even fully passed on the benefit of recent excise cuts by the government.
As a result, the company is in a sweet spot, where price increases effected in the last five years are set to flow into the bottom line. While commodity prices started falling in August 2008, the full benefit of the drop will be visible only from the January-March quarter, as the company would have used up its high-cost inventory in the December quarter and honoured its forward purchases of certain raw materials.
But the company is likely to choose not to pocket the entire gains from lower raw material prices. It has had a philosophy of profitable growth, and now that profitability will come by easily, it can be expected to step up investments in advertising and marketing. As a result, the company can even be expected to move from its past value-led growth performance to one that’s volume-led.
But even with this rosy outlook, the company’s valuation of 25 times trailing earnings looks expensive, especially since the market trades at 12 times trailing earnings. But that’s the value the market is now willing to pay for a firm where growth is visible and corporate governance is not an issue. There are very few businesses left where profit can be forecast with some certainty.
With HUL, cash flow generation is high and steady and the outlook for profit growth has hardly been better. After having underperformed the markets between 2003 and early 2008, it’s HUL’s time to bask in the sun.
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