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Hindustan Unilever Ltd’s (HUL’s) investors are nervous. The relentless escalation in costs for fast moving consumer goods (FMCG) companies has come at a time when the demand environment is sombre. Some companies are likely to be more hurt than others, and HUL’s relatively high exposure to raw materials such as palm oil, and crude oil and its derivatives makes it more vulnerable given the surge in prices following the Russia-Ukraine conflict.
These concerns are reflected in the stock’s performance. HUL’s shares have declined by 16% so far in CY22 vis-à-vis a 4% drop in the Nifty FMCG index. The stock is now trading at 40 times estimated FY24 earnings, according to Bloomberg data. Valuations have corrected meaningfully but the scope for significant near-term upsides appears capped.
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Expectations from the March quarter (Q4FY22) results are subdued. “The mix is deteriorating both year-on-year (y-o-y) and sequentially in a quarter where relatively higher mobility should have brought back demand for high-margin beauty products. Instead, customers are tightening their purse strings on premium purchases,” analysts from Motilal Oswal Financial Services pointed out in its latest report, featuring HUL’s Q4-end update.
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Already, HUL’s underlying volume growth fell sequentially in the previous three quarters. Given the rural demand slowdown, price hikes taken and a higher base (volume growth of 16% in Q4FY21), expectations from volume performance are not particularly rosy. “With a deterioration in the mix and commodity inflation weighing down on margin, ad spends will not act as a buffer in protecting margin,” the Motilal Oswal report pointed out.
Brent crude prices have risen again post their softening last week and are now hovering around $115/barrel. Palm oil prices as on 21 March have gained 23% so far in CY22.
HUL can capitalize on its superior pricing power and the advantage of a strong brand, but raw material headwinds pose margin challenges. Product price hikes are expected to offer respite in Q4, but margin pressures are likely to show up from the beginning of FY23, analysts said “Compared with our earlier assumption of gross margin recovery in FY23, we now build a y-o-y gross margin contraction (for HUL). We maintain our revenue growth estimates, as benefit from price hikes is likely to be offset by lower volume growth,” said analysts at Jefferies India Pvt. Ltd in a report on 18 March.
Even so, a cutback on ad spends may offer some cushion to FY23 earnings before interest, taxes, depreciation and amortization (Ebitda) margins. However, with FMCG companies having gone through supply-chain disruptions because of the pandemic initially, and now due to the fallout of the Russia-Ukraine crisis, it remains to be seen how well HUL tackles inflation now.
It is worth noting that HUL’s earnings have fallen short of its peers in recent quarters. Motilal Oswal’s analysts attribute this to “a higher proportion of the discretionary/out-of-home portfolio at 15-20% of sales and steep commodity cost inflation in its three largest categories—soaps, detergents, and dish wash”.
These factors along with the slowdown in demand recovery of premium products continue to cast a shadow on earnings. Accordingly, Motilal Oswal has cut FY23E/FY24E earnings per share by 10.3%/8.4%.
Meanwhile, a Mint report citing sources said HUL is in talks to buy a majority stake in the maker of MDH spices. “The potential MDH acquisition would be positive for HUL as it can benefit from the growth in the Indian spices market” said Varun Singh, analyst at IDBI Capital Markets & Securities Ltd.
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