Growth in HUL’s Q2 margins a good sign in tough times
Hindustan Unilever Ltd’s (HUL) September quarter (Q2) results suggest the worst is behind it (and the packaged consumer good sector) after major events such as demonetisation and the goods and services tax (GST) roiled growth.
While the company’s volume growth recovered a bit, the shift change in profitability can propel earnings growth by much more in the coming quarters if sales growth continues to improve.
First, the quarter itself saw domestic volume growth of 4% which is good but also comes off a low base, as the year-ago quarter had seen a decline of 1%. Still, considering that the June quarter saw zero growth, this is good. HUL said the early part of the quarter was affected post-GST but is now recovering, and the wholesale and CSD (canteen stores department) channels are stabilizing gradually.
That’s a sign that things should improve further in the December quarter on the volume growth front, and this quarter also has a low base effect of 4% volume decline, thanks to demonetisation.
A gradual improvement is what is being signalled on the GST front. The trade situation in urban markets is normal, but reaching customers in the rural markets is still a challenge as the wholesale channel is not back on its feet. Still, this problem appears one that can be solved, although it may take time.
Consumer demand is stable, said HUL. That is a good sign considering economic growth is slowing. On the risks, input costs are beginning to increase, says the company but if demand is increasing, then they can be passed on by hiking prices.
What of value sales growth? While GST has skewed the reported growth comparison, the company said underlying sales grew by 10%. That is good because it implies price and product mix changes contributed significantly to sales growth. This is despite prices being reduced by an average of 3-4% to pass on the benefits of lower tax on products such as soaps and detergent bars.
While HUL said its savings programmes helped lower costs, it is likely that net benefits of GST also contributed to better margins. That’s why, even after a sharp increase in advertising and sales promotion (A&P) spending by 20% over a year ago, its Ebitda (earnings before interest, tax, depreciation and amortization) margin rose by 180 basis points on a comparable basis. In absolute terms, Ebitda rose by 19.7% over a year ago, while profit before tax and exceptional items rose by 13.3%.
HUL’s September quarter numbers indicate it is on strong ground as far as margins are concerned and its sales growth should get better. The uptrend in A&P spending can be taken as a sign of confidence that growth is improving, especially if spending stays up in the December quarter as well. A gradual return to normalcy in the wholesale trade and CSD sales should also see volume growth improve. The company signalled a gradual improvement in rural demand.
All these point to an improving outlook for HUL and for its peers as well, although some of them may have problems specific to their categories.
HUL’s shares are already expensive, trading at 54 times its consensus earnings estimate for fiscal year 2018. While the benefits to the company from GST may already be factored in, the jump in its profitability could support a further improvement in valuations.
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