Investor's Eye: Thematic - Switch from HUL to Colgate; Update - Maruti Suzuki India

 

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

Summary of Contents   THEMATIC REPORT Switch from HUL to Colgate  Prefer Colgate over HUL We prefer Colgate India to Hindustan Unilever Ltd (HUL) primarily because of a distortion in the valuation of and a better growth outlook for Colgate India. In the past one and half years, HUL has appreciated by over 60% (partially driven by the buy-back of shares by its parent) and trades at a steep valuation of 37x (one-year forward earnings), which is at a 34% premium to Colgate India's valuation of 27.3x one-year forward earnings. Second, the volume growth of HUL has moderated to low single digits (4% in Q1FY2014) from a high single digits earlier whereas the volume growth in Colgate India remains at 9-10% despite intense competition. Going ahead also, the economic slowdown and depreciation of the rupee would adversely affect HUL's volume growth and financial performance. On the other hand, we expect Colgate India to sustain its volume growth momentum and perform better than HUL. Thus, we advise shifting at least part of your exposure to HUL to Colgate India for better returns over the next 6-12 months.   Widening valuation gap  In the past one and half years, the price-earnings multiple of HUL has got re-rated by 40% whereas the valuation multiple of Colgate India has declined by 10% (leading to a valuation gap of 50%). Consequently, HUL trades at a 34% premium to Colgate India now as compared with a discount of 10% in March 2012.   Colgate's growth outlook better than HUL's In addition to the distortion in their valuations, there are some key fundamental reasons why we prefer Colgate India to HUL.  HUL's domestic consumer business is bearing the brunt of persistent inflationary pressures (which have affected the sales of its premium products) and intensifying competition in some of the highly penetrated categories, such as soaps and detergents, in recent times. HUL's volume growth decelerated from 9.0% in Q1FY2013 to 4% in Q1FY2014. In view of the sustained inflationary pressures and the macro-economic concerns, we don't expect HUL's volume growth to reach 8-9% in the near term. On the other hand, Colgate India has consistently maintained its volume growth in the range of 9-11% for the past several quarters. We believe a consistent shift from tooth powder to tooth paste and improving rural penetration would help Colgate India to maintain the volume growth in the range of 9-12% in the coming quarters. HUL has higher sensitivity to input cost pressures due to its limited pricing power in the fiercely competitive categories of soaps and detergents. On the other hand, Colgate India being a market leader (with above 50% market share in the toothpaste segment) is much better placed to pass on the input cost pressure to the consumers through selective price hikes.  Proctor and Gamble (P&G) has entered the Rs5,400-crore domestic toothpaste market with the launch of Oral-B Pro Health brand. P&G commands the second largest position in the toothbrush segment in India. We believe players like HUL and Dabur need to pull up their socks in view of the tough competition P&G poses in the toothpaste segment. On the other hand, we expect Colgate India to be less affected by P&G's entry in the toothpaste segment because of its strong brands, excellent market positioning, focus on enhancing reach in the rural market and portfolio of brands straddling the pyramid.     STOCK UPDATE Maruti Suzuki India Recommendation: Hold Price target: Rs1,589 Current market price: Rs1,406 Annual report review Key points Strong diesel car sales boost realisation amid challenging environment in FY2013: Despite the challenges on the macro-economic front (lower economic growth, higher interest rates and inflation, and rising fuel prices) which led to a lower-single digit growth in Maruti Suzuki India Ltd (MSIL)'s volumes, the realisation/vehicle grew in high double digits on account of a strong growth in the diesel vehicle sales. The diesel prices remained government controlled for most of FY2013, while the petrol prices were market driven leading to a huge differential between the fuel prices. Market share improves in FY2013 on account of new launches: MSIL's market share improved from 38.3% in FY2012 to 39.1% in FY2013 on account of new product introductions. MSIL introduced Ertiga to cater to the fast-growing utility vehicle (UV) segment. Also the company introduced the new Alto 800. Apart for the new launches, MSIL introduced refreshed versions of the Wagon R, Ritz and SX4. To increase rural presence and enhance distribution network to fortify leadership position: MSIL is targeting rural areas to maintain the market share amid rising competition. It has steadily increased the rural dedicated network (resident dealer sales executives [RDSE]) and the rural areas now contribute about 28% of the sales. Also the company is further strengthening its distribution network to fortify its leadership position in the passenger vehicle industry. SPIL merger to create synergistic benefits: During the year, MSIL merged the engine manufacturing arm Suzuki Powertrain India Ltd (SPIL) with itself. Apart from better localisation and product planning, the merger is expected to provide synergies in the raw material procurement. Outlook--growth environment challenging; Hold maintained: Given the continued weak macro-economic scenario and rising fuel price trend, the management expects the demand to remain subdued in FY2014. The management has guided for a volume growth of 2-4% for FY2014. Further, a decline in the demand for diesel vehicles is expected to restrict the realisation growth. Also increased competition in the sluggish environment has increased the discounting/vehicle, which would impact the margin. Our estimates for FY2014 and FY2015 remain unchanged. Given the subdued volumes and increased discounting, we maintain our Hold recommendation on the stock. We maintain our price target of Rs1,589/share. 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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