If there are headwinds, there are no signs of it. The two key takeaways from Hindustan Unilever Ltd’s (HUL’s) June quarter results are that demand growth continues and cost inflation is not bothering it yet.

The management’s conservative stance seems a bit difficult to understand then. Rural demand continues to improve, but the management wants to wait for a few more quarters before calling it a solid trend. Similarly, it has cautioned that input cost inflation could step up. Some of that conservatism may help when growth turns normal from the September quarter onwards.

In the June quarter, the company’s volumes grew by 12% compared to flat growth in the year-ago quarter. This growth will step down from the September quarter onwards, as the market situation began to normalize a year ago. While this was expected, where it will settle at is what investors will be looking out for.

Even as this unfolds, the key metric to look at is profitability. On a sequential basis, HUL’s Ebitda (earnings before interest, tax, depreciation and amortization) margin improved by 1.2 percentage points to 23.7%. That’s a significant jump for a company of its size, with revenue of 9,487 crore.

What contributed to this growth? At the overall level, HUL’s material cost as a percentage of sales declined. While crude oil prices may have risen, those of vegetable oils have fallen. Also, even where prices may have increased, the company may have locked into lower prices. Once its material costs reflect higher prices, costs could increase.

Among segments, HUL’s home care (detergents and household products) has seen a consistent increase in profit margins (see chart). This has been a major reason for the improvement in its profitability. Sales growth of this segment too has been good, rising by 20% over a year ago in the June quarter, compared to 14% for the personal care segment.

The management said profit margins in the home care segment could normalize, as input costs increase once the higher prices of crude oil-based intermediates reflect in costs.

The outlook for HUL continues to look good. All its divisions are reporting good sales growth and saw margins improve sequentially. Its profit after tax but before exceptional items rose by 21% over a year ago, which is good.

While there is the risk of input cost inflation, if consumer demand continues to improve, then the company can hike prices without adversely affecting demand. A sharp increase in costs is a risk to watch out for.

HUL’s valuations are expensive and this quarter’s results don’t give any special reason to justify them.

The company appears to be in a good position to capitalize on the recovery in consumer demand and use its scale to improve margins. That lends a certainty to its earnings growth. In the current scheme of things, HUL investors appear to be willing to pay a very high premium for that.

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