Hindustan Unilever
Rating: Sell
HUL reported underlying top-line growth of 12% y-o-y (year on year) in Q1FY15 led by volume growth of 5% y-o-y and pricing growth of 7% y-o-y, both marginally ahead of our expectations. Ebitda (earnings before interest, taxes, depreciation, and amortisation) margins were ~119bps higher than our estimates due to lower A&P (advertising and promotions) spends and operating leverage benefits. We have upgraded our EPS (earnings per share) forecasts by 5% from FY15 onwards, with a 46bps y-o-y increase in our Ebitda margin estimates from FY15 onwards and no changes to our revenue forecasts.
This is because we expect most drivers of the positive surprise in Q1FY15 to be unsustainable, as: (i) high price elasticity of demand will limit price hikes; and (ii) A&P spends are likely to increase in the future due to high competitive intensity across most categories. Due to portfolio constraints around competitive intensity, high category penetration, and rising royalty and tax rates, we expect EPS CAGR of only 13% over FY15-17. We reiterate our Sell rating with a target price of R576 (16% downside, implied FY16 price-to-earnings ratio of 27.8x).
Results overview: Volume growth improves; margins surprise
HUL?s Q1FY15 results were ahead of our estimates, with revenues 3% higher and PAT (profit after tax) 7% higher than our estimates. Underlying revenue growth of 12% y-o-y was led by volume growth of 5% y-o-y and by a 7% contribution from price increase and mix change. Gross margins contracted by 55bps y-o-y to 48.3%. The A&P spends to sales ratio reduced by 82bps y-o-y, due to lower media intensity. Employee costs were lower due to one-time pension credit of R32 crore. Despite a 50bps y-o-y increase in royalty rate, there was an 18bps y-o-y contraction in other expenses/ sales ratio due to supply chain cost controls. Adjusting for the one-time employee expense benefit, the Ebitda margin expanded by 70bps y-o-y to 16.6%. As a result, PAT growth was 8% y-o-y, compared with our expectation of 1% y-o-y growth.
Pricing-led gains in soaps and detergents; FAL drives personal care growth
HUL took price hikes in the soaps category whilst sustaining volumes, as promotional intensity reduced in this category. Premium brands such as Dove, Pears in the soaps category and Surf and Rin in the detergents category led the growth for the segment. Recovery in FAL sales, we believe, was led by the introduction of R5 SKUs in the previous quarter. The strength in FAL also helped boost the overall personal care margins. Smaller SKUs drove the growth of other categories like hair care and oral care. Pepsodent sales are yet to revive and the company would need to invest further into this brand.
Volumes drove double-digit growth for tea, whilst Bru Gold, we believe, continues to take market share away from Nescafe. Due to the prolonged summer, ice-creams led by the introduction of Magnum in metros did extremely well. HUL continues to try new activations for Kissan, a brand which is yet to mature despite significant investments.
Where do we go from here? Price hikes contributed to almost 7% y-o-y growth in the first quarter. However, as market growth still remains weak, price elasticity of demand is high. This is also exhibited in consumer preference for smaller SKUs, as indicated by the management. As a result, we do not think that price hikes are sustainable without having a corresponding offsetting impact on volume growth rates. Competitive intensity remained high, as all the players have stepped up their A&P spends (mainly led by promotions) in Q1FY15 after a cut in Q4FY14. We believe HUL will have to continue to invest in brands to sustain/increase its volume growth rate.
Consequently, moderation in A&P spends during Q1FY15 is likely to be temporary in nature. We expect leverage benefits of ~50bps to Ebitda margins to be sustainable in the future, with margin benefits from a recovery in FAL sales likely to be sustained for the firm. For FY15, we expect Ebitda margin expansion of 46bps y-o-y over FY14 led by savings in other expenditure and flat A&P spends y-o-y.
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