Mumbai: If analysts were expecting an 8% growth in consumer bellwether Hindustan Unilever Ltd’s volumes in the September quarter, then 7% qualifies as under-performance, but not intolerably so. So why did its stock drop 2.1% after the results were announced? Expensive valuations could be a reason. But a bigger worry for investors is a pattern of slowing volume growth, from 10% in the March quarter and 9% in the June quarter.
The headline numbers are not bad by normal standards. Sales in its domestic consumer business rose 16% year-on-year to Rs.5,876 crore, which means price—and maybe product mix to some extent—played an important role in driving sales growth. If price hikes were merely to pass on cost hikes, as in the past, then it’s understandable.
But HUL’s results show otherwise. Net sales from operations (includes domestic consumer and other revenues) rose 11.6%, but its cost of goods sold rose by a lower rate of 8.7%. It retained the benefit of past price increases even as pressure from rising raw material prices eased.
Its gross margin, therefore, rose by 143 basis points (bps) from a year ago and by 77 bps sequentially. One basis point is one-hundredth of a percentage point. Employee cost inflation and other expenses grew at a lower rate than sales did. That gave it enough room to spend 18% more from the year-ago period on advertising and promotions, and still take its operating profit margin up by 74 bps from last year and by 33 bps sequentially.
HUL’s business segments give an idea of which parts of the businesses are facing stress. Soaps and detergents have overshadowed the others. Sales rose 22.3% while segment profit rose by a substantial 41.2%. Price increases and a moderation in raw material prices have helped, as margins rose sequentially too.
The personal products division continued to disappoint, as sales rose by 12.1% while profit rose by only 6.6%. In beverages, sales rose by 17.5% while profits were virtually flat from a year ago, but margins were sustained on a sequential basis. Packaged foods disappointed on both the sales and profit growth fronts.
The soaps and detergents business dominated to such an extent that it contributed to 84% of the increase in consumer sales, and 90% of the rise in profit. Credit goes to HUL for using its dominant position to expand both sales and profit in this segment.
But it also raises a question mark on how long this segment can compensate for the other divisions. If raw material prices are moderating, and product prices are not, it is only a matter of time before smaller players jump in to fill the gap. At a time when headline inflation is high, consumers will be quick to latch on to bargains.
HUL has said that growth was partly hit by lower demand from the canteen stores department. But this business contributes only 6-7% to sales, according to the company, and should, therefore, not have a very big impact. The trend of slowing sales growth does not defy logic either, as India’s gross domestic product (GDP) growth has slipped.
HUL has proved it is no pushover in the market, but whether it has overestimated its pricing power is a question that should worry investors. If volume growth keeps slipping, however, at some stage it is bound to affect profit growth.
Operating profit grew 18% during the quarter, which is more representative of its performance, even as adjusted profit rose 25%. That level of growth in profit may not be enough to justify valuations, as it trades at 38 times 2012-13 estimated earnings per share, and 33 times its 2013-14 estimated EPS, according to consensus estimates compiled by Thomson Reuters. In the past, a combination of slowing volume growth and price-driven sales growth has eventually affected performance. Investors are right to react to the earnings with a dose of caution.