Hindustan Unilever Ltd (HUL) surprised the Street with a record volume growth of 14% in the quarter ended September. The company had taken some price cuts, due to which revenue growth was lower at around 11%, which, again, was higher than Street estimates. This compares with volume growth of 11% and revenue growth of around 7% in the previous quarter ended June.

But while revenue growth was a positive surprise, profit margins came in lower than estimates. Operating margin fell by around 200 basis points (bps) and operating profit fell by 3%, a disappointment considering that revenue grew in double digits. This is after including other operating income, but excludes gains/losses on account of foreign exchange mark-to-market valuation of open forward contracts, and foreign currency receivables and payables.

Also See Growth Concerns (Graphic)

At first sight, the margin performance looks slightly better than that in the June quarter, considering that margins had fallen by 275 bps back then. But in the June quarter, advertising and sales promotions cost had increased by over 300 bps. Gross margins, before deducting advertising and sales promotions expenses, had risen by around 30 bps last quarter. In the September quarter, gross margins have declined by around 170 bps. Advertising and promotions cost have risen by only 24 bps as a proportion of sales. Other expenditure rose sharply last quarter, partly due to increased packaging costs. These costs increased because of investments in new moulds used by the company in the packaging process.

In the first six months of the fiscal, revenue has risen at a healthy pace of 9.2%, but operating profit has declined by 7%. As far as analysts’ estimates for the company go, revenue targets are likely to be raised because of the positive surprise on the volume growth front. But earnings estimates will, in all likelihood, remain unchanged because of the sharper-than-expected drop in margins. According to an analyst with a domestic brokerage, while the company’s volume growth is very impressive, it is coming at a very high cost.

Coming to the segment results, the mainstay soaps and detergents, and personal products divisions, which together account for 75% of the company’s revenue and 85% of theoperating profit, reported a decent 9.4% increase in revenue last quarter. But their cumulative profit declined by 3.7%. Other divisions such as beverages, processed foods and ice creams cumulatively grew revenue and profit by 13% and 14%, respectively. Exports did well too; but all of these other businesses account for a small proportion of the total business, and their influence on overall performance is limited.

Based on the growth momentum in the first two quarters, the company is expected to grow revenue at a brisk pace even in the remaining two quarters. But any earnings upgrades seem unlikely considering that margins may remain under pressure. With the company’s shares already trading at 29 times estimated earnings for the current fiscal, there seems to be little scope for upside.

Graphic by Yogesh Kumar/Mint

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