Hindustan Unilever – Block sale clouds disperse

08 May

Hindustan Unilever – Block sale clouds disperse

Hindustan Unilever (HUVR IN, INR 2,010, Buy)

The COVID-19 outbreak battered the FMCG market when it was already slowing down. On top of that a 10–12 day disruption in Q4FY20 led to a 7% YoY dip in volumes for HUL, belying consensus forecast of flattish volume growth (Edelweiss estimate: 4% YoY dip). The key question is what’s next? We believe the answer is threefold: i) Disruptive times like these are particularly hard on unorganised players; hence, we expect HUL to continue to gain market share (gained 50bps across categories in Q4FY20). ii) Crude oil-led gross margin savings would sustain; besides,  lower ad intensity as well as rates going ahead combined with brutal cost savings would once again boost EBITDA margin. iii) Q1FY21 is difficult to predict; however, HUL has already sprung back to 75% of normal operations, and we expect it to touch 90–100% soon. Q1FY21 will somewhat benefit from pent-up demand and an upswing in categories such as health, hygiene and nutrition, whereas discretionary categories such as beauty and personal care and out-of-home consumption would suffer. On balance, considering part of the valuation froth has been wiped off (down ~19% in past month), HUL’s structural soundness and alleviation of overhang related to HUL’s stake sale by GSK PLC we believe this is a good time to add. Maintain ‘BUY/SO’ with a TP of INR2550.

Cost rationalisation and agility key pillars to navigate crisis

HUL is operating with shorter planning cycles, stepping up agility and building resilience in the supply chain. This should serve well as demand patterns are changing, and the company is likely to see an upswing in categories such as health, hygiene and nutrition. HUL is responding well with 60x production of sanitisers and innovations such as Lifebuoy germ kill spray, Domex germ removal wipes, Domex disinfectant spray. On the cost front, we expect distribution costs to rise in Q1FY21; however, lower ad rates, brutal cost optimisation and synergies from the GSK acquisition would more than compensate for that, keeping it on the EBITDA margin expansion trajectory.

Outlook and valuation: On a firm footing; maintain ‘BUY’

We expect HUL to be a key beneficiary of the rural demand recovery. Although the lockdown would affect near-term volumes, we expect volumes and earnings to bounce back once the situation normalises. Maintain ‘BUY/SO’ with a TP of INR2,550. The stock is trading at 51.5x FY22E EPS. We retain HUL among our top sector picks.

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