Hindustan Unilever (HUL): Investment Prospects

In the previous articles, we looked at the important business segments of Hindustan Unilever (HUL). In this article, we review the key challenges confronting the company and the measures it is taking in response. We then examine the investment prospects of HUL.

The key challenges facing HUL

Growth potential = Intense competition: One of the key drivers of the Indian FMCG industry, in which HUL operates, is its strong growth potential. It appears even more attractive in the context of slowing consumption in the developed nations. Little wonder then, many new competitors have been drawn into HUL’s turf across categories. It has resulted in intense competition, which is evident in aggressive pricing and greater media & trade spends.

Soaring inflation: There has been a runaway inflation in commodities. Be it crude and its derivatives or agricultural commodities. For example, in the last few months, palm oil (used in the manufacture of soaps), crossed its peak prices observed in 2008. This commodity inflation has resulted in higher input costs, which has impacted margins.

HUL’s response to the challenges

Product innovation: HUL classifies its brands into two categories. Core category such as detergents & soaps; and emerging category such as hair conditioners, facial cleansing, premium skin care, soups, deodorants, post-wash fabric conditioners and water purifiers. The company is experiencing much faster growth in the emerging category. It is moving towards a premium sales mix in hair care, deodorants, skin-lightening and anti-aging. Little wonder then, they have a better margin profile. In fact, a larger portion of the company’s earnings before interest and taxes (EBIT) now comes from personal care than detergent and soaps. Hence, HUL is focusing on innovating new products and developing the market for these emerging categories.

Re-launches: HUL puts a great deal of emphasis on consumer understanding. It observes where and how consumers shop for and use its brands. This helps add new features to existing brands. For example, in FY10, the company had about 70 activities, i.e. launches or re-launches, across brands. 

Variants:  An important fact of the Indian FMCG industry is the heterogeneous nature of India. There is great variety in consumer preferences and the nature of competition etc. Hence, HUL employs micro marketing. For example, it has 35 different tea blends.

Media spend: HUL’s advertising & promotion (A&P) spend, as a percentage of sales, varies according to categories. Personal products tend to have higher gross margins and higher levels of investment. Categories like soaps and detergents, foods and beverages have lower gross margins and lower levels of spend. However, the company’s A&P levels have gone up of late due brand building in emerging categories, higher competitive intensity, and the changes towards premiumization in the portfolio mix.

Changing prices: In most brands, HUL explores the opportunity of increasing the price and holding the grammage. The grammage reduction is usually on miniaturized packs like the Rs 1, 2, 5 and 10 units, where holding on to that price point is critical from a consumer standpoint.

Distribution efforts: Distribution has always been a competitive advantage for HUL. The company is further strengthening its rural and urban network. This will substantially improve the availability of its products. While general trade (kirana shops) continues to be the primary channel for distribution, modern trade is an emerging channel for the future. Winning in this channel is one of the company’s key priorities. As of now, HUL’s overall markets are now equally spread in urban and rural India. The company plans to triple its rural coverage and improve urban coverage by 15%.

Tapping its parent: HUL’s parent, Unilever, helps its subsidiary in several ways. It benefits from the high priority that Unilever places on emerging markets, which now account for half its global business. HUL also leverages the scale of Unilever in global procurement to manage commodity costs. Further, it receives significant technology and brand development inputs from Unilever, which play a key role in product innovations.

HUL’s investment prospects: Our view

A traditional blue chip stock for decades, of late, HUL has fallen off the radar of Indian investors. Mainly due to the increased competition in the company’s strongholds. Investors’ attention is now squarely focused on smaller FMCG players, which offer much better growth profiles.

Despite that, in our view, value investors must not underestimate HUL’s sustained brand power. They must also give sufficient importance to the extraordinary returns on capital it enjoys. A tepid growth can be compensated for, provided we get the right valuations. Those valuations, unfortunately, remain at some distance.

At the price of Rs 285 per share, HUL is trading at 26X times its normal earning power of about Rs 11 per share. Hence, we would advice value investors to wait for the right price.

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