Home / Markets / Mark To Market /  Hope on the horizon for HUL, high valuations aside

It has been a somewhat rough journey for Hindustan Unilever Ltd’s (HUL’s) investors. The shares have fallen by 12% since results of its September quarter were announced on 19 October. While HUL’s quarterly volume performance was disappointing, another factor that hurt sentiments for the stock is the management’s comments on some softening in rural demand. HUL said while its own Q2 rural growth was decent, recent trends suggested demand moderation, which needs to be monitored in the coming months.

Analysts reckon any rural slowdown is a red flag from a growth perspective for HUL. Be that as it may, it is not as if the performance for the six months to 30 September has been stellar. The company has had to cope with rising raw material (RM) prices and somewhat muted performance in its discretionary segments.

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Nevertheless, some factors could offer respite from a near-term perspective. As analysts from Kotak Institutional Equities said in a report on 6 December, “Hindustan Unilever’s stock has underperformed index and consumer sector peers owing to (1) raw material pressure, (2) growth drag from discretionary and OOH categories, and (3) rural weakness called out by management recently. We expect improvement in outlook on the former two fronts (#1 and #2) in 2HFY22." OOH refers to the out-of-home category. In general, improving mobility augurs well for the demand outlook of discretionary categories.

The brokerage expects a sequential improvement in gross margin in the March quarter (if not in the three months ending 31 December) as raw material prices stabilize and price increases reflect on the P&L (profit & loss account). Note that steep commodity cost inflation in HUL’s large categories, such as soaps, detergents, and tea, have played spoilsport in recent quarters. HUL’s gross margin contracted by 139 basis points (bps) and 142bps year-on-year in the June and September quarters, respectively. One basis point is one-hundredth of a percentage point.

Kotak’s analysts point out, Hindustan Unilever’s category leadership in more than 80% of its portfolio and over-indexation at the premium end positions it well to pass on RM inflation and protect profitability. As a result, the brokerage expects Ebitda margin to improve to 26.5-27% in FY24E from the current 24-25% levels. Ebitda is earnings before interest, taxes, depreciation, and amortization.

As such, sustained momentum in HUL’s discretionary categories and the nutrition business, along with a sharp cool-off in commodity inflation, would go a long way in boosting sentiments for the stock. Needless to say, investors would do well to follow input costs’ trajectory in future. Meanwhile, in a report on 3 December, Edelweiss Securities Ltd analysts said, “The merger of GSK’s portfolio with HUL has begun to yield revenue delta; we believe the larger story will be innovation and new products in HFD and allied categories."

Having said that, HUL’s valuations remain pricey, with the stock trading at 51 times the estimated earnings for FY23, based on Bloomberg data. Sachin Bobade, an analyst at Dolat Capital Market Pvt. Ltd said, “Valuations of the HUL stock have always been high and appear to be factoring positives from the expected improvement in margins and GSK integration."

That said, investors would have to keep a close eye on revenue growth given the overall high base for H2FY22, which also means growth may not be superlative. “Against this backdrop, it won’t be surprising if the HUL stock sees a time correction," Bobade said. As things stand, so far this calendar year, HUL’s shares have declined about 3% vis-à-vis the 8% rise in the Nifty FMCG index and 22% gain in the Nifty 50 index.

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