Investor's Eye: Update - Hindustan Unilever (Volume growth to remain under pressure in H2FY2014), Retail (Tesco ties up with Trent for hypermarket business)

 

Investor's Eye [December 24, 2013]  Sharekhan www.sharekhan.com

Summary of Contents   STOCK UPDATE Hindustan Unilever Recommendation: Reduce Price target: Rs540 Current market price: Rs566 Volume growth to remain under pressure in H2FY2014 We interacted with the management of Hindustan Unilever Ltd (HUL) recently to learn if the company's business environment has improved in comparison with H1FY2014. As per HUL's management, the discretionary categories remain under pressure against a backdrop of sustained inflationary pressures while an increase in the competitive intensity has taken its toll on some of the high-penetrated categories. We expect the volume growth of HUL's domestic consumer business to remain in the range of 4-5% in the coming quarters (which would be lower than its historical trend of an 8-9% volume growth). The increase in the prices of the key inputs coupled with the 10% depreciation in the rupee against the dollar would affect the gross profit margin (GPM) in H2FY2014. This along with a higher investment in advertisements and promotional activities would put pressure on the profitability in the coming quarters. Hence, in view of the expectation of a muted performance in H2FY2014 and the stock's premium valuation, we maintain our Reduce rating on HUL with a price target of Rs540. Key points Volume growth to remain muted in H2FY2014: HUL's management has hinted that the discretionary/premium categories (such as body wash, face wash hair conditioners, ice creams etc) remain under pressure against a backdrop of weak consumer sentiment. The consumer demand in the urban markets has remained weak while that in rural India has moderated. The premiumisation (one of the key growth drivers of HUL) has slowed down in most of HUL's segments. The premium products are growing at a slower rate than their respective categories. Though the rural demand is expected to improve on the back of higher agricultural output, but the benefit will be offset by the falling demand in the urban markets. Hence, the volume growth of HUL's domestic consumer business is likely to sustain in the 4-5% range in the coming quarters.  Holds to its market share in key categories: The management has indicated that it is able to hold on to the market share in most of the categories. This is largely on account of adequate media and promotional spending in respective categories. Proctor & Gamble India made a strong entry in the oral care segment at the end of Q1FY2014 and gained a small share in the toothpaste market within two months of its entry. However, it didn't have any impact on HUL's market share or positioning and HUL remains number two in the domestic market.  Profitability to come under stress in H2FY2014: In Q2FY2014, despite the rupee depreciating by about 10%, the GPM remained higher due to an efficient hedging mechanism and certain upholding of the low-cost inventory. But as some of the key inputs, like palm oil and linear alkyl benzene (LAB), are currently trading at prices 15% higher on a year-on-year (Y-o-Y) basis and as the full impact of the rupee's depreciation against the dollar (by about 10%) shall be felt in Q3FY2014, we expect the GPM to come under pressure in H2FY2014. Also, in view of the overall sluggish demand in the domestic market and competitive pressures in some of the key categories, the company is reluctant to take any substantial price increase in its product portfolio. HUL has maintained its stance of supporting its brands with adequate media spending. Thus, we might see the operating profit margin (OPM) decelerating on a Y-o-Y basis in H2FY2014. Business fundamentals likely to remain bleak in the near term; long-term growth prospects intact: We expect HUL's revenue growth and profitability to remain subdued in the near term. The company has its strategies in place and expects the growth rates to improve once the inflationary pressure ease. Any softness in the key input prices would help the company to take the volume growth of the domestic consumer business back to its historical level, as the company can again focus on improving its volume growth through extensive promotional activities. Though in the near term the business fundamentals of HUL are under pressure, but we expect HUL-one of the strongest domestic players in the fast moving consumer goods (FMCG) space--to see a revival in performance in a good macro-economic environment. Sensing the good long-term growth prospects of the domestic consumer sector in India, the company is gaining good parental support and has been consistent in adding new products or entering into new categories. Maintain Reduce with a price target of Rs540: We have introduced our FY2016 earning estimate in this note. The HUL stock is currently trading at 31.7x its FY2015E earnings per share (EPS) of Rs17.8, which is close to a 15% premium to its historical five-year average multiple of 28x. Hence, in view of the near-term performance head winds and the stock's premium valuation, we maintain our Reduce rating on the stock with a price target of Rs540. We continue to prefer ITC over HUL in the large-cap FMCG space on the back of ITC's better earnings visibility and decent upside potential from the current levels.   SECTOR UPDATE Retail Tesco ties up with Trent for hypermarket business  Tesco PLC and Trent Hypermarket (Trent) have announced a tie-up wherein the former, a global retail player, has entered into an agreement to own a 50% stake in the Tata group's hypermarket business by investing $110 million. This development is positive for Trent, the retail industry and the economy, as it marks the first instance of foreign direct investment (FDI) in the country's multi-brand retail segment 18 months after the approval. Further, at the stated consideration, Tesco PLC values the hypermarket business at 1.8-2.0x its revenues which is attractive, given Trent's thin reach (about 16 stores) and bleeding financials (it is making losses even at EBITDA level). We believe this deal provides a valuation benchmark for the other global retailers looking to enter the Indian market via the FDI route. Hence, it also spells positive for the other Indian hypermarket retailers like Shoppers Stop (HyperCITY), Future Retail (Big Bazaar and Food Bazaar) and CESC (Spencer's).    Click here to read report: Investor's Eye   Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Regards, The Sharekhan Research Team

 

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