Hindustan Unilever - What goes up... - Ambit

Hindustan Unilever's (HUL) volume growth has gradually moderated from a steady run rate of 12-13% until FY11 to 6-8% over FY12-13. With a product portfolio that is skewed towards fully penetrated categories and with intense competition from MNC peers like Colgate, L'Oreal and Nestle, we expect an average volume growth of only 7% over FY13-15. Also, EBITDA margins are likely to decline by 50bps over FY13-15 due to rising competitive intensity, leading to increased advertising spends and an increase in royalty rates (as announced by the parent). With the stock currently trading at a 35% premium to its historical three-year and five-year P/E multiples, we initiate coverage with a SELL stance.

Due to the size and width of its product portfolio, HUL is able to ride the wave of evolving consumption in most product categories either by creating such a wave or by becoming the second entrant and yet a key beneficiary. However, we expect structural headwinds from the following:

Volume growth moderation: HUL's overall volume growth could remain subdued at ~7% CAGR over FY13-15. HUL derives ~60% of its revenue from soaps & detergents (S&D) and tea—three fully penetrated categories with likely volume growth of only 2-5% per annum. Also, HUL is likely to lose market share in oral care (due to Colgate's strong competitive advantages), skin care (high penetration in the mass market and intense competition from L'Oreal in the premium market) and beverages (weak brand recall of '100% coffee', competition between HUL's Bru Gold and Nescafe Classic).

EBITDA margin compression: Whilst we expect gross margin expansion of 40bps per annum over FY13-15 (related to portfolio premiumisation), we expect EBITDA margins to decline by 50bps over FY13-15, due to: (a) 50bps increase in advertising spend to sales ratio in response to strong competition from GCPL (S&D), L'Oreal (cosmetics, hair care and skin care), P&G (detergents, shampoos, skin care, oral care) and Nestle (beverages); and (b) a 140bps gradual increase in royalty rates over FY13-18 and a 4 percentage point increase in tax rates over the next two years.

Valuation: HUL's one-year forward P/E multiple of 37.2x is at a ~35% premium to its three-year and five-year historical average of 27.0-28.0x. However, given the ongoing and forthcoming drag on EBITDA margins and volume growth, the extent of this premium rating is not justified. Unilever's open offer indicates the parent company's confidence in HUL's long-term leadership positioning in India's fast growth consumption story. However, we do not expect revenue and EPS CAGR to incrementally benefit from the parent's increased ownership. Our DCF-based valuation generates a TP of Rs. 503/share (15% downside), an implied FY14 P/E multiple of 31.6x.

Source : Equity Bulls

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