Hindustan Unilever: Buy

This time last year, the stock of Hindustan Unilever Ltd (HUL) was trading at ₹464, sliding sharply after it posted a sharp drop in volume growth in the December 2012 quarter.

The open offer by HUL’s parent to up its stake in the company, announced in April, propped the stock’s price, which eventually pushed past the ₹700-mark.

The stock has since corrected back to ₹554. At this price, valuations are a reasonable 33.8 times the trailing 12-month earnings (three-year average 35 times) and 32 times the next fiscal’s estimated earnings. Smaller peers such as Nestle India and GSK Consumer trade at higher valuations.

Yes, consumers are still a listless lot. Inputs such as palm oil derivatives are up. But for investors with a long-term perspective, HUL is a good stock to buy. Here’s why.

HUL’s biggest advantage is the sheer size and diversity of its product basket. It has a stronghold on the soaps and detergents segment — its bread-and-butter business.

The segment contributes about half its revenues. Another third of revenues comes from personal products such as skin care, hair care and oral care.

This segment, being an under-penetrated category, is the key growth driver. Beverages (teas and coffees) and packaged foods make up the rest. Within each product line, too, HUL straddles many price points giving it a wide consumer reach.

This shields the company from losing out in case consumers cut back purchases or down trade to cheaper products. One good segment can compensate for a weak one.

For example, it cut prices in the crowded soaps and detergents segment to push volumes. Premium coffees and green and flavoured teas helped beverages grow.

Good growth in these categories made up for the slow expansion in the skin care and packaged foods sectors in the June and September 2013 quarters.

So, while HUL’s overall sales growth did moderate to 10 per cent by December 2013 from the 15-16 per cent earlier, peers such as Marico and Bajaj Corp with smaller product baskets were hit harder. HUL’s reach is also wide, with a good mix of modern trade and traditional retail. Efforts to push into rural areas, where growth is slightly ahead of urban regions, also bode well.

Dominance affords pricing power in some categories, allowing the company pass on of pricier inputs. For instance, in the December 2013 quarter, HUL rolled back its promotions on soaps and detergents. Even so, neither the segment’s growth nor its margins dropped. HUL can cut down on media activity, as it has in the past, to compensate for higher input or manufacturing costs without hurting revenues too much.

Volume expansion for HUL has, unsurprisingly, come off the highs in late 2011 and 2012. From December 2012 onwards, the company has maintained volume growth at 5 per cent. But this is commendable in the light of the concentrated slowdown in consumer spending. With overall growth at 9-10 per cent, HUL has a healthy mix of volume and price-driven growth.

The personal products segment floundered between September 2012 and 2013 due to a penny-pinching consumer and key brand Fair & Lovely faltering. The brand was re-launched in the September 2013 quarter, and has since been successful.

Other brands in the segment such as Axe, Pond’s, Dove, Lakme and Tresemme are still firmly in their high-growth mode. Personal products’ revenue growth has resumed its double-digit levels. With the segment contributing to more than half the profits, its revival is paramount to growth. What will also hold HUL in good stead in the long term is its product mix tipping towards the premium range across product categories.

Operating margin has moved up from 13 per cent three years ago to 15 per cent now. For the nine months ended December 2013, the operating margin was 16.6 per cent.

Cost of key input — palm oil derivatives — was up 6 per cent in the December quarter alone, though tea prices are starting to correct. Reduced import duties on inputs used in soaps and detergents, can also help lower costs.

Among FMCG players, HUL is best-placed to weather the slowdown and deliver well once demand recovers.

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