Portfolio Stabilizer - Hindustan Unilever

Hindustan Unilever (HUL), the largest FMCG company in India, in the past ten years has not gone anywhere in terms of its share price and given a CAGR return of 2.43 per cent in that period. There was a time when the company used to give more than 30 per cent return in a year and was viewed as a wealth creator. But for the past one decade the return has not been that exciting. Here we have tried to understand the business of the company to get a fair idea about its valuations.

HUL operates through five segments—soaps & detergents, personal products, beverages & foods & ice creams, exports, and other operations. While soaps & detergents contribute 45 per cent of net sales, the high margin personal products (PP) segment contributes the most to operating profit at 45 per cent. Together, PP and soaps & detergents, which constitute the home and personal care (HPC) division, contribute 71 per cent of net sales and 82 per cent of operating profit. At present, HUL commands around 39 per cent market share in the soaps and detergents category followed by 16 per cent of P&G and 18 per cent of Ghari brand detergent powder.

HUL commands a market share of 60 per cent in the packaged foods category led by its Knorr brand. In the branded tea segment HUL has a market share of around 16-17 per cent preceded by Tata Global Beverages with a market share of around 20 per cent. In the toothpaste segment Colgate Palmolive is a leader in Indian toothpastes having a market share of around 50 per cent, followed by HUL with around 28 per cent. Its Close-Up brand has a market share of around 17 per cent and Pepsodent of around 11 per cent.

We believe that HUL is a primary force when it comes to the consumption growth story of India. The company has displayed its ability to effect price hikes and avoid the impact of inflation in vegetable oils, which, pre second only to Tata Global Beverages with a market share of around 20 per cent. In the toothpaste segment Colgate Palmolive is the leader in Indian tooth-pastes having a market share of around 50 per cent followed by HUL with around 28 per cent. Its Close-Up has a market share of around 17 per cent and Pepsodent of around 11 per cent.

We believe HUL is a play on consumption growth in India. The company has displayed its ability to effect price hikes and avoid impact of inflation in vegetable oils, which, Combined with the improved outlook for fabric wash and strong growth in processed foods and beverages, boosts our positive outlook on the stock. The recent moves by the company to dispose of its non-core assets, including a few of its properties, give it a short-term upside. “We experience good sales volume when it comes to HUL products and we can say that the products outflow from our store is more than any of its rivals,” said the floor-in-charge of a large retail chain, requesting anonymity. From this we can understand that the acceptability of the products of HUL is much more than any of its rivals.[PAGE BREAK]

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In the recent past, HUL has initiated a price increase in its soap portfolio – a 6.7 per cent price hike on 120 gm Lifebuoy from Rs 15 to Rs 16, a 5.2 per cent price hike on 75 gm bar of Liril from Rs 19 to Rs 20, an increase in price from Rs 33 to Rs 34 on 75 gm Dove, an increase in price from Rs 26 to Rs 27 on 80 gm Pears, and weight reduction on Lux from 110 gm to 100 gm implying an effective price increase of 10 per cent. The price hikes are initiated to mitigate the more than 20 per cent increase in palm oil prices in recent months. When asked about the impact of this move, the floor-in-charge said, “The recent price increase has not played any deterrent role in the volumes of HUL.”

During Q2FY2011, the BSE FMCG Index outperformed the Sensex marginally by 1.8 per cent driven by a sharp rally in heavyweights ITC and HUL. The company’s share price staged a comeback after several quarters of underperformance, thus attaining a near all-time high buoyed by the first signs of the easing of competitive pressures (price hikes in detergents and soaps) and expectations of better earnings’ growth.

This year’s monsoon, which has been 4 per cent above normal till September 2010 and has registered good spatial distribution with 31 out of the 36 sub-divisions getting excess/normal rainfall compared to 13 same time last year, spells good times for the FMCG companies ahead. Companies in the FMCG space will benefit from the increase in demand since good harvests will cool down food inflation, thereby increasing the consumers’ buying power, especially among the low/middle-income group.

HUL’s production units are following the principles of Kaizen, the Japanese management philosophy of constant improvement based on a common sense approach and the use of cost-effective techniques. The key achievements of this method include turning the single assembly line of its Silvassa detergent factory into a twin track last year, doubling the output, improving the overall machine production levels from 75 per cent in 2009 to 92 per cent in 2010, reduction in defects per 1,000 pieces by 50 per cent as also a drop in wrapper wastage by 70 per cent, and a reduction in the stocks of finished goods and raw materials in the chain by an impressive 30-40 per cent.

The FMCG story in India, in our opinion, has become more attractive after the global meltdown. The competitiveness of the industry has been there in the past and will be there going forward. But who wins the race is going to matter the most. In our view, HUL with its unique supply chain management and its efforts to penetrate deeper into the rural areas in India is likely to be a key driver going ahead. The company plans to raise the distribution to 3 million outlets by 2012-13 from its present 1 million outlets which will make HUL the biggest rural player in the world.[PAGE BREAK]

On the financial front the company has reported a topline growth of 7 per cent for Q1FY11 on a YoY basis at Rs 4,794 crore as against Rs 4,475 crore. The bottomline witnessed de-growth of 1.8 per cent for Q1FY11 on a YoY basis at Rs 533 crore as against Rs 543 crore. The main reason for the decline is the substantial increase in the A&P cost which increased by 33 per cent and the increase in depreciation cost and raw material prices by 26 per cent and 24 per cent respectively on a YoY basis for Q1FY11. On the valuation front the stock trades at a P/E of 30.29x on its TTM EPS and an EV/EBITDA of 22.15x which is a shade lower when compared to its other listed peers. The dividend yield of the company is at 2.10 per cent. Thus, adding HUL to your portfolio at the present levels with a long-term perspective is likely to provide it with stability.