Markets
HUL on slippery ground, for now
Summary
For HUL, price cuts would mean revenue growth would be driven by volume. But investors would do well to keep expectations muted as rural demand recovery is gathering pace gradually amid a weak monsoon season so far this year.
For Hindustan Unilever Ltd (HUL), the September quarter (Q2FY24) is likely to be the fourth one where it sees gross margin improve sequentially. This would be driven by the softening trend in input costs even as the fast-moving consumer goods (FMCG) company has cut product prices in certain categories. In Q1, HUL’s gross margin stood at 49.9%.
But apart from that, business conditions are not too encouraging. Commenting on the industry growth, Mihir Shah of Nomura Financial Advisory and Securities (India) said in a report: “Consumer demand in Q2 has remained unchanged quarter-on-quarter versus our earlier expectation of gradual improvement. Urban demand is stable and continues to lead growth, while rural is positive but is still impacted (-3.5%) on two-year CAGR."
For HUL, going ahead revenue growth would be driven by volume. But investors would do well to keep expectations muted as rural demand recovery is gathering pace gradually amid a weak monsoon season so far this year. Moreover, with cooling inflation, competitive intensity is high for the sector, with unorganized players making a comeback.
Further, a potential jump in advertising & promotion (A&P) expenses is expected to weigh on the Ebitda margin. HUL intends to maintain its share of voice ahead of the market. A&P spending as a percentage of revenue has been on an upward trend with this measure touching nearly 10% in Q1.
To be sure, post Q2, HUL’s investors will keenly watch how demand pans out in the festival season. Indeed, price cuts would support volume growth, but results would be seen after a lag. “As per HUL, it takes 3 to 4 quarters between price cuts and demand upticks, thereby recovery will be more back-ended," said analysts at HDFC Securities in a report on 14 September. Retailers too continue to keep lower inventory (price cut phase), impacting primary growth in the near term (a similar trend in Q1), said the HDFC report.
As such, HUL’s pricing growth can be expected to further taper off in the coming quarters. Against this backdrop, it will not be surprising if HUL’s revenue growth in FY24 falls short of initial estimates. “We expect HUL’s revenue in FY24 to grow by 6.5%. But there is a possibility of downside risk to this estimate if the festive demand in Q3 and overall rural demand conditions remain sombre," Alok Shah, an analyst at Ambit Capital, said.
Moreover, the rising crude oil price is an additional headache for FMCG companies in this environment. If oil prices remain elevated, HUL too would be hurt and the impact would reflect with a lag. In general, while HUL’s key commodities such as palm oil, tea have fallen from peaks seen in recent years, the trend is still volatile.
“If the strength in Brent crude oil price (over $90 per barrel) sustains, then the packaging costs would rise, which in turn would weigh on HUL’s margin," said Shah of Ambit. This means the pace of gross margin improvement could be slower as it would be too soon to take a price hike to pass on the rise in this cost, he added.
Meanwhile, HUL’s shares are down by 2% in 2023 so far, sharply underperforming the 18% gain in the Nifty FMCG index led by ITC Ltd. HUL’s shares trade at 46 times its FY25 estimated earnings, shows Bloomberg data, which is not exactly cheap. For now, significant near-term upsides for the HUL stock appear few and far between. The company is well placed should demand recovery pick up pace. On the flip side, lower volume growth could act as a dampener.
