With Hindustan Unilever Ltd’s (HUL) recent price cuts and Procter and Gamble Home Products Ltd (P&G) joining the price war, we believe the competitive intensity in HUL’s core category of detergents has clearly reached alarming levels. We believe that HUL is once again likely to witness the 2004 era of steep margin erosion and earnings fall, in turn justifying the fall in its share price and drop in valuation.
Also See Losing Ground (Graphics)
HUL is currently trading at 19 times its revised FY12 earnings per share of Rs11.70, a 40% premium to the Sensex against the five-year average of 60-70% premium. After revision in estimates, we have downgraded the stock to neutral, with a revised target price of Rs224 based on a price-earnings of 19 times its FY12 estimates (25% discount to its five-year average) owing to weak earnings growth vis-a-vis the fast-moving consumer goods sector, uncertain earnings environment and significantly higher competitive intensity.
In retaliation to HUL’s around 30% price cut in Rin and the comparative advertisements (Rin vs. Tide) broadcast by HUL, P&G has finally struck back taking a 20% indirect price cut (via 25% grammage hike) in Tide Naturals. In line with the 2004 detergent wars, we expect HUL to once again bleed heavily in the current price wars.
On 26 February, HUL took the war to a completely new level by launching a controversial Rin commercial, highlighting the new affordability of Rin, and directly taking on both Tide and Tide Naturals. The advertisement showed direct comparison between the brands claiming that Rin is better than Tide, with a tagline “Tide se kahin behatar safedi de Rin”.
In 2004, the price war had severely affected HUL’s financials and resulted in complete collapse of its soaps and detergent segment margins by almost 750 basis points (bps), which led to an overall 500 bps decline in earnings before interest, tax, depreciation and amortization margins, which HUL is yet to reclaim.
Slowdown in economy and HUL’s pricing strategy (took price hikes in 2008 to combat severe input cost inflation) is took its toll on HUL’s laundry segment as consumers started down-trading to low-priced regional companies. This affected HUL’s mass laundry brands (Wheel and Rin) driving an overall 410 bps erosion in its market share. HUL reacted by taking both price corrections (price cuts and grammage increase) and improvement in product formulations in its mass laundry brands (both powders and bars) to restore volume growth and regain lost market share.
Hence, we have pruned our estimates for the company by 3-4% in revenue and 15-16% in profits to factor in negative value growth in its core soaps and detergents segment after the steep price cuts and possibility of further price cuts in other brands/categories.
We anticipate the following to unfold in the ensuing months with the price war spreading to other brands, companies and categories as well: HUL will increase grammage for Wheel to widen the gap with Tide Naturals; P&G will cut prices/hike grammage for Ariel to reduce gap with Tide; HUL will react cutting prices of Surf Excel to match Ariel pricing. Other categories susceptible to price war include shampoo and skin care where P&G has a presence.
We believe that the following factors will decide the course of the HUL stock price in the near future: news flow on pricing action in detergents by either HUL or competitors; spill over of pricing war in other categories; market share trends and volume growth figures for detergents in the next quarterly results after the price cuts.
Graphics by Yogesh Kumar/Mint