Institutional research firm reduces fair value of HUL share, after disappointing results, but company’s management still hugely confident. ‘The business is consistently winning in the marketplace by remaining sharply focused on the needs of our (HUL) large consumer base and successfully leveraging Unilever’s strong global innovation pipeline and best practices,’ says Chairman.

Hindustan Unilever (HUL) is caught between a desire to protect its return on equity and the compulsion to expand sales volumes while being unable to raise prices. If the December quarter results are anything to go by, its decision to shift from its volume strategy has yielded disappointing results, with the company managing just 5% volume growth. Espirito Santo Securities (ESS) has, therefore, reduced its fair value for the HUL share to Rs400 from Rs490 and maintained its ‘SELL’ rating for the share.

Analysts of ESS warn of increased pressure on HUL’s management to achieve sales volume growth, which should lead to higher advertising and promotion spending, which will, in turn, hurt EBITDA growth year-on-year.

Interestingly, despite profitability pressures, HUL’s management is projecting an  increase  of  200 basis points in  the  effective  tax  rate  in  the  next  few  years, reflecting expectation of higher profits. According to Harish Manwani, chairman, HUL, “The business is consistently winning in the marketplace by remaining sharply focused on the needs of our large consumer base and successfully leveraging Unilever’s strong global innovation pipeline and best practices.”

Please click here access Moneylife’s analysis on other Espirito Santo Securities reports.

However, during the December 2012 quarter, the domestic consumer business grew at 15% with underlying volume growth of 5%. Both home and personal care and foods & beverages registered double-digit growth. The operating context remained challenging during the quarter with input costs holding firm and high competitive intensity. Profit after tax but before exceptional items grew 15% to Rs873 crore during the quarter. Net profit at Rs871 crore grew 16%.

The quarterly weak performance of HUL is attributed to an unsustainable  pricing  gap  between  regional  and  branded  products  (in  both  soaps  and detergents)  and  high  elasticity  of  demand  (as  reflected  by  the performance of  Fair  &  Lovely  and  Dove  shampoo  sachets).

Commenting on the market strategy of HUL, ESS points out that “HUL  seems  to  be  moving  away  from  its  successfully  implemented volume  leverage  strategy.  Moreover, we are not surprised by the consumer response to price increases in discretionary categories like personal products. The weakening consumer  sentiment  due  to  high  inflation  and  employment challenges  are  putting  pressure  on  consumers’  wallets;  discretionary categories  are  now  facing  stress  and  we  continue  to  believe  that  the  lack  of inclusive growth in the economy will hurt low-ticket spending.”

The brokerage report also cautions that the  fast-moving consumer goods sector  currently  trades  at  a  price-to-earnings ratio  of  28 times  on  its FY13-14 earnings estimates,  which  is  not  sustainable.  HUL  highlighted  the  decline  in sales  in  the  modern  retail  channel  and  discretionary  spending.  Discretionary categories like packaged foods rank prominently in the slowdown vulnerability index of the analysts of the brokerage firm.

Another negative for HUL is, of course, the increased royalties to be paid to Unilever. According to an HUL press release, “Given the need for increased levels of service and the consequent additional costs, Unilever asked for a review of the royalty arrangements in order to ensure a fair recovery of costs.”