HINDUSTAN UNILEVER Harnessing Digital Edge to Gain Heft

COMPANY UPDATE

HINDUSTAN UNILEVER Harnessing digital edge to gain heft

India Equity Research| Consumer Goods

Hindustan Unilever’s (HUL) AGM interaction further bolsters our EDELWEISS 4D RATINGS confidence COMPANYNAME in company’s digital capabilities. Initiatives like 'TrendsWatch' Absolute Rating BUY and 'People Data Centre' help quickly gather & decipher demand trends, rejig innovation plans (launched >50 new products & packs) and adjust to Rating Relative to Sector Outperform Risk Rating Relative to Sector Low channel shifts. During the lockdown, when new communication was Sector Relative to Market Underweight difficult, HUL leveraged influencer network and broadcast partnerships to produce consumer-relevant content. Digital transformation has accelerated with a fully automated fulfilment centre – a robotics & MARKET DATA (R: HLL.BO, B: HUVR IN) guided vehicle, connected store programme is live in 0.1mn stores and an CMP : INR 2,180 app for physical distancing & contact tracing. In the short term, HUL will Target Price : INR 2,550 52-week range (INR) : 2,614 / 1,659 rephase capital expenditure, maintain unwavering focus on receivables and make more costs variable. Any stock price correction on the back of Share in issue (mn) : 2,347.8 weak Q1FY21 result can be used as buying opportunity. Maintain ‘BUY’. M cap (INR bn/USD mn) : 5,058 / 30,671 Avg. Daily Vol.BSE/NSE(‘000) : 1,654.3

Well connected to cash in on new consumer trends SHARE HOLDING PATTERN (%) COVID-19 has given birth to new consumer trends like home cocooning, value-based Current Q3FY20 Q2FY20 volume shopping, reinvention of hygiene, contactless culture, an innate fear of getting Promoters * 61.9 67.2 67.2 infected or losing livelihoods. Mom and pop shops have staged a strong come back MF's, FI's & BK’s 6.3 6.7 6.7 during the lockdown and HUL’s 'connected stores' programme has helped bring FII's 12.0 12.3 12.4 digital connectivity to thousands of stores. We believe GSK merger is a match made Others 19.7 13.8 13.7 in heaven and HUL has recently launched Horlicks with extra zinc (almost doubled) as * Promoters pledged shares : NIL zinc may possess potent anti-viral effects against Coronavirus. This category has huge (% of share in issue) potential as only one in four households buy it and that too only once a year. PRICE PERFORMANCE (%) EW Consumer Acceleration in digital transformation Stock Nifty Goods Index HUL is leveraging data and harnessing latest technologies & emerging business models to redefine how it engages with consumers and customers. Key transformative 1 month (14.8) (1.5) (4.9) initiatives are: (i) an app which has temperature measurement control, an alarm if 3 months (12.3) (21.4) (7.3) physical distancing is not maintained, etc; (ii) connected store programme; and 12 months 11.6 (23.3) (10.7)

(iii) scaling up the fully automated fulfilment centre.

Outlook and valuation: On a firm footing; maintain ‘BUY’ We expect HUL to benefit from changes in consumer behaviour, share gains and rural demand recovery. Although the lockdown will affect Q1FY21 volumes, we expect volumes and earnings to bounce back once the situation normalises. We maintain Abneesh Roy +91 22 6620 3141 ‘BUY/SO’ with TP of INR2,550. The stock is trading at 55.5x FY22E EPS. [email protected]

Financials Alok Shah

Year to March FY19 FY20 FY21E FY22E +91 22 6620 3040 Revenues (INR mn) 3,85,790 3,91,360 4,42,134 4,73,594 [email protected]

EBITDA (INR mn) 88,800 98,610 1,16,140 1,27,747 Tushar Sundrani Adjusted Profit (INR mn) 62,880 69,640 82,686 92,236 +91 22 6623 3004 Adjusted Diluted EPS (INR) 29.1 32.2 35.2 39.3 [email protected]

Diluted P/E (x) 75.1 67.8 61.9 55.5 ROAE (%) 82.8 86.3 33.5 22.1 July 1, 2020 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL , Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

Consumer Goods

Table 1: New segment growth and margins under Ind AS Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Overall volume growth (YoY) 7.0 5.0 5.0 5.0 (7.0) Overall net sales growth (YoY) 9.0 6.7 6.2 3.6 (9.4)

% sales growth (YoY) Home care 12.9 10.1 9.4 9.8 (4.3) Beauty and personal care 7.3 4.1 5.3 (2.8) (13.5) Foods & Refreshments 10.4 9.2 8.4 7.9 (6.7) Others (18.3) (26.2) (32.1) (47.6) (46.3)

EBIT margins (%) Home care 17.7 20.2 17.7 18.2 19.0 Beauty and personal care 27.8 29.6 28.9 28.4 24.9 Foods & Refreshments 18.1 19.4 15.9 17.9 12.6 Others 1.5 1.8 2.2 16.5 5.6 Source: Company, Edelweiss research

Product response to COVID-19 HUL is using in-house capabilities like 'TrendsWatch' and 'People Data Centre' to quickly pick up and decipher trends. This has enabled it to understand the shift in demand, rejig innovation plans and adjust to channel shifts. Golden triangle of procurement, quality and R&D have enabled HUL launch over 50 new product and pack innovations:  Production of sanitizers was ramped up 100x.  Several formats of Lifebuoy alcohol-based sanitizer (gels, liquids, sprays) in various packs and sizes , as well as an alcohol-based multi-surface spray.  Domex sodium hypochlorite-based spray for use in homes and offices.  Lifebuoy laundry sanitiser.  Surf excel laundry powders with enhanced germ kill.  Indian population is highly zinc deficient and this deficiency leads to a weakening of the immune system. Recent in-vitro studies have shown that free zinc itself may possess potent anti-viral effects against Coronavirus replication. Horlicks historically had 4.3mg zinc/100g, which has now been boosted to 8.3mg/100g.  World's first company to show that Lifebuoy soap, handwash and hand sanitisers are 99.9% effective against the actual SARS-CoV-2 (COVID-19 causing) virus, based on extensive studies done in the US .

Innovation in communication During the lockdown, when new communication could not be produced, HUL leveraged large influencer network and broadcast partnerships to produce consumer-relevant content.  Intervention on Lifebuoy led to over 99,000 pieces of user-generated content and a record 55bn views on a social media platform.  Brooke Bond Red Label tea used influencers to take the message of 'Dooriyan Banakar Bhi Apnapan Dikha Sakte Hain'.  Surf excel worked with its brand influencers to deliver the powerful 'Daag Acche Hain' at home with kids learning new skills and hobbies.

2 Edelweiss Securities Limited Hindustan Unilever

 Hamam told consumers to #StaySafeInside.  Kissan Tiffin Timetable helped millions of mothers make interesting dishes for their children at home using Kissan products.

Changing consumer behaviour India as a nation is metamorphosing from a positive, optimistic, vibrant populace to an anxious one which is physically distanced yet emotionally connected. A few trends and behaviour are becoming increasingly discernible e.g. home cocooning, digital transformation of consumers' lives, value based volume shopping, reinvention of hygiene, contactless culture, heightened focus on well-being, an innate fear of getting infected or losing wealth or losing livelihoods.

Comeback of mom and pop shops The survival of groceries in India is important from social perspective as over 100mn lives depend on these stores. HUL has long and deep relationships with millions of these stores. Over the past few years, the company’s 'connected stores' programme has helped bring digital connectivity and modern science of retailing to thousands of these stores. The current crisis will make adoption of technology much easier.

Reimagine HUL's agenda | digital transformation Leveraging data, harnessing latest technologies and emerging business models to redefine how it engages with consumers and customers.  An app for factory operations which has temperature measurement access control, an alarm if physical distancing is not maintained and facilitates contact tracing.  Connected store programme has evolved further and now includes app-based ordering and digital payments for stores and is live in more than 0.1mn stores enabling a frictionless experience.  Post a successful pilot, HUL is now scaling up the fully automated fulfilment centre – a robotics and guided vehicles powered warehouse.  Combined with machine learning powered demand management and IoT-enabled digital factories, this is creating increased agility across the fulfilment value chain.  Power of automated warehouse kicked in and enabled to deliver to stores even in situations where the distributor was not operational.

Cash and costs  Stringently evaluated all costs to make them as much variable (i.e. linked to sales) as possible and eliminate those which will not add value under current circumstances.  Supporting partners (suppliers and vendors) to maximise growth while keeping a laser like focus on receivables.  Shorter and dynamic planning cycles help manage inventory better and reduce business waste.  In the short term, HUL will also rephase capital expenditure considering growth opportunities and execution timelines.  Taking various steps to maintain safety and liquidity of investments. In this environment, both 'Return of Capital' and 'Return on Capital' are equally important.

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GSK merger: A match made in heaven  HUL acquired capabilities in clinical research, product development, stronger portfolio at the pharmacy channel and direct connect with doctors and experts.

 Horlicks and Boost, market leaders in health drinks category but only 1 in 4 households buy this category even once a year.

 This merger provides us significant synergistic benefits, impacting both revenue and costs. These include increased scale in advertising and media, complementary capabilities in the chemist channel, increased scale in material procurement and a wider logistics footprint, among others.

HUL as a ‘responsible capitalist’  Reduced CO emissions in manufacturing by 85% per tonne of production since 2008.

 Increased share of renewable energy in manufacturing to 71% in 2019.

 Now has 112,826 environment-friendly freezers across ice cream fleet in India.

 Water usage in manufacturing has reduced by 58% since 2008.

 Total waste generated in manufacturing has been reduced by 63% compared to 2008.

 76% of tomatoes used in Kissan ketchup and 78% of its tea for brands have been sourced sustainably.

 In 2019, arranged environment-friendly disposal of over 39,000 tonnes of plastic.

 To enhance the livelihoods of rural women, Shakti programme has 120,000 Shakti entrepreneurs in India who together generate sales of a few thousand crores.

 A 30gm soap like Lifebuoy typically sells at INR5 in India and can last at least 50-60 handwashes which implies INR0.10 per wash. There is simply nothing more effective and cheaper and till a vaccine/cure is found, the humble soap is humankind’s best hope.

4 Edelweiss Securities Limited Hindustan Unilever

Company Description HUL, the largest FMCG player in India, was formed by merging three subsidiaries of Unilever in 1956. Currently, Unilever Plc holds 61.9% stake in the company. HUL’s portfolio of products covers a wide spectrum including soaps, detergents, skin creams, shampoos, toothpastes, tea, coffee, packaged foods and branded atta.

Powerful brands and an envious distribution network (direct coverage of >3.4mn outlets) are its primary strengths. The company operates through segments—home care, personal care, foods & refreshments, and other operations.

Investment Theme HUL is a play on consumption growth in India. The company has proved its ability to effect price hikes and ability to grow ahead of market, which, combined with improved outlook for S&D and personal care, and strong growth in processed foods and beverages, boosts our positive outlook on the company. HUL has strongly entered the natural’s category and termed it a mega trend. HUL's acquisition of GSK Consumer's HFD portfolio will also aid in overall revenue momentum. We appreciate its revenue growth from a medium to long term perspective. Though commodity prices have started to inch up, we are not worried since HUL has sufficient pricing power to offset any pressure likely to arise at the gross margin level.

Key Risks INR depreciation impacts price of imported raw materials.

Ad spends likely to spike due to increased competition from regional players. Maintaining market share will also be a challenge for HUL.

The price war in HUL’s popular segments with new entrants entering the fray could hit the company hard.

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Financial Statements Key Assumptions Income statement (INR mn) Year to March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Macro Net revenue 385,790 391,360 442,134 473,594 GDP(Y-o-Y %) 6.8 4.8 (4.0) 7.0 Other Operating Income 7,310 6,470 6,794 7,133 Inflation (Avg) 3.4 4.3 3.5 4.0 Total operating income 393,100 397,830 448,928 480,727 Repo rate (exit rate) 6.3 4.4 3.0 4.0 Materials costs 184,740 182,590 199,811 213,729 USD/INR (Avg) 70.0 70.7 75.0 73.0 Gross profit 208,360 215,240 249,116 266,998 Company Employee costs 18,750 18,200 22,178 23,272 Volume gr. (overall) 10.0 2.0 5.5 7.0 Ad. & sales costs 46,070 47,130 51,236 53,202 EBITDA margin (%) 23.0 25.2 26.3 27.0 Other Expenses 54,740 51,300 59,562 62,777 A&P as % of sales 11.9 12.0 11.6 11.2 EBITDA 88,800 98,610 116,140 127,747 Employee cost (% of rev) 4.9 4.7 5.0 4.9 Depreciation 5,650 10,020 12,141 12,914 Financial assumptions EBIT 83,150 88,590 104,000 114,834 Tax rate (%) 28.8 25.7 25.2 25.2 Less: Interest Expense 330 1,180 1,270 1,300 Capex (INR mn) 6,710 15,200 35,480 7,500 Add: Other income 5,500.00 6,320.00 7,813.02 9,776.39 Debtor days 15 14 11 12 Profit Before Tax 88,320 93,730 110,543 123,310 Inventory days 50 53 50 55 Less: Provision for Tax 25,440 24,090 27,857 31,074 Payable days 142 147 135 140 Add: Exceptional items (2,280) (2,000) - - Cash conversion cycle (77) (80) (74) (73) Reported Profit 60,600 67,640 82,686 92,236 Dep. (% gross block) 9.4 14.1 11.8 10.8 Exceptional Items (2,280) (2,000) - - Yield on cash 8.5 9.9 8.1 8.1 Adjusted Profit 62,880 69,640 82,686 92,236 Shares o /s (mn) 2,164 2,165 2,349 2,349 Adjusted Basic EPS 29.1 32.2 35.2 39.3 Diluted shares o/s (mn) 2,165 2,165 2,349 2,349 Adjusted Diluted EPS 29.0 32.2 35.2 39.3 Adjusted Cash EPS 31.7 36.8 40.4 44.8 Dividend per share (DPS) 22.0 26.2 28.2 31.4 Dividend Payout Ratio(%) 75.7 81.4 80.0 80.0

Common size metrics Year to March FY19 FY20 FY21E FY22E Materials costs 47.9 46.7 45.2 45.1 Staff costs 4.9 4.7 5.0 4.9 Ad. & sales costs 11.9 12.0 11.6 11.2 Interest Expense 0.1 0.3 0.3 0.3 EBITDA margins 23.0 25.2 26.3 27.0 Net Profit margins 16.3 17.8 18.7 19.5

Growth ratios (%) Year to March FY19 FY20 FY21E FY22E Revenues 10.9 1.4 13.0 7.1 EBITDA 18.4 11.0 17.8 10.0 Adjusted Profit 19.6 10.8 18.7 11.5 EPS 19.6 10.8 9.4 11.5

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Balance sheet (INR mn) Cash flow metrics As on 31st March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Share capital 2,165 2,165 2,349 2,349 Operating cash flow 58,000 76,230 92,909 107,415 Reserves & Surplus 76,510 80,130 408,100 420,432 Financing cash flow (53,900) (68,190) (72,696) (81,204) Shareholders' funds 78,675 82,295 410,450 422,781 Investing cash flow (4,380) 17,910 (35,480) (7,500) Minority Interest 180 170 170 170 Net cash Flow (280) 25,950 (15,268) 18,711 Short term borrowings 990 - - - Capex (6,710) (15,200) (35,480) (7,500) Total Borrowings 990 - - - Dividend paid (57,190) (61,410) (71,631) (79,904) Long Term Liabilities 20,770 25,900 27,154 27,154

Def. Tax Liability (net) (3,730) (2,840) (1,686) (1,686) Profitability and efficiency ratios Sources of funds 96,885 105,525 436,088 448,420 Year to March FY19 FY20 FY21E FY22E Gross Block 63,420 78,620 116,070 123,070 ROAE (%) 82.8 86.3 33.5 22.1 Net Block 41,920 49,600 53,384 41,540 ROACE (%) 116.0 116.9 45.4 29.9 Capital work in progress 4,060 5,970 4,000 4,500 Inventory Days 50 53 50 55 Intangible Assets 5,230 5,190 301,290 301,290 Debtors Days 15 14 11 12 Total Fixed Assets 51,210 60,760 358,674 347,330 Payable Days 142 147 135 140 Non current investments 20 20 20 20 Cash Conversion Cycle (77) (80) (74) (73) Cash and Equivalents 64,715 63,665 96,437 120,676 Current Ratio 1.5 1.5 1.7 1.9 Inventories 25,740 27,670 32,822 32,206 Gross Debt/EBITDA - - - - Sundry Debtors 18,160 11,490 17,587 15,805 Gross Debt/Equity - - - - Loans & Advances 8,070 16,580 16,891 16,891 Adjusted Debt/Equity - - - - Other Current Assets 14,650 18,510 22,370 22,370 Net Debt/Equity (0.8) (0.8) (0.2) (0.3) Current Assets (ex cash) 66,620 74,250 89,669 87,271 Interest Coverage Ratio 252.0 75.1 81.9 88.3 Trade payable 72,060 75,350 83,813 81,978

Other Current Liab 13,620 17,820 24,899 24,899 Operating ratios Total Current Liab 85,680 93,170 108,712 106,877 Year to March FY19 FY20 FY21E FY22E Net Curr Assets-ex cash (19,060) (18,920) (19,042) (19,606) Total Asset Turnover 4.2 3.9 1.6 1.1 Uses of funds 96,885 105,525 436,088 448,420 Fixed Asset Turnover 8.3 7.7 2.2 1.4 BVPS (INR) 36.3 38.0 174.7 179.9 Equity Turnover 5.1 4.9 1.8 1.1

Free cash flow (INR mn) Valuation parameters Year to March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Reported Profit 60,600 67,640 82,686 92,236 Adj. Diluted EPS (INR) 29.0 32.2 35.2 39.3 Add: Depreciation 5,650 10,020 12,141 12,914 Y-o-Y growth (%) 19.6 10.8 9.4 11.5 Interest (Net of Tax) 235 877 950 972 Adjusted Cash EPS (INR) 31.7 36.8 40.4 44.8 Others (2,785) (6,357) 320 328 Diluted P/E (x) 74.2 67.0 61.2 54.9 Less: Changes in WC 5,310 (8,030) 3,188 (966) P/B (x) 59.3 56.7 12.3 12.0 Operating cash flow 58,390 80,210 92,909 107,415 EV / Sales (x) 12.1 11.9 11.4 10.6 Less: Capex 6,710 15,200 35,480 7,500 EV / EBITDA (x) 51.8 46.6 42.7 38.7 Free Cash Flow 51,680 65,010 57,429 99,915 Dividend Yield (%) 1.0 1.2 1.3 1.5

Peer comparison valuation Diluted P/E (X) EV / EBITDA (X) ROAE (%) Name FY21E FY22E FY21E FY22E FY21E FY22E Hindustan Unilever 61.2 54.9 42.7 38.7 33.5 22.1 Colgate 45.9 42.0 29.3 26.9 51.1 53.0 Dabur 50.4 45.3 42.3 38.2 22.6 22.2 Godrej Consumer 43.2 37.9 30.2 26.8 18.7 19.0 ITC 15.6 14.6 11.3 10.5 24.4 26.9 Nestle Ltd 72.9 62.3 51.4 43.8 101.3 96.6 Median 48.2 43.7 36.2 32.5 29.0 24.5 AVERAGE 48.2 42.8 34.5 30.8 41.9 40.0 Source: Edelweiss research

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Additional Data Directors Data Mr. Sanjiv Mehta Managing Director and Chairman Mr. Srinivas Phatak Executive Director, Finance & IT and Chief Financial Officer Mr. A. Narayan Independent Director Ms. Kalpana Morparia Independent Director Mr. O. P. Bhatt Independent Director Dr. Sanjiv Misra Independent Director Mr. Leo Puri Independent Director Mr. Dev Bajpai Executive Director, Legal and Corporate Affairs & Company Secretary Mr. Ashish Gupta Independent Director Mr. Willem Uijen Executive Director, Supply Chain

Auditors - BSR & Co. LLP *as per last annual report

Holding – Top10 Perc. Holding Perc. Holding Vanguard Group Inc 1.2 Blackrock 0.7 Sbi Funds Management 1.1 Nomura Holdings 0.5 Jp Morgan Chase 0.6 Icici Prudential Life Insurance 0.4 Standard Life Aberdeen 0.3 Norges Bank 0.3 Axis Amc 0.2 Icici Prudential Amc 0.3 *as per last available data

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*in last one year

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded

No Data Available

*in last one year

8 Edelweiss Securities Limited RATING & INTERPRETATION

Company Absolute Relative Relative Company Absolute Relative Relative reco reco risk reco reco Risk Asian Paints BUY SO M Bajaj Consumer Care HOLD SP H Berger Paints BUY SP L Britannia Industries BUY SO L Colgate HOLD SP M Dabur BUY SO M Emami BUY SP H Future Consumer HOLD SP M GlaxoSmithKline Consumer Healthcare BUY SP M Godrej Consumer BUY SP H Hindustan Unilever BUY SO L ITC HOLD SU M Marico HOLD SP M Nestle Ltd BUY SP L Pidilite Industries BUY SP M United Spirits REDUCE SU H

ABSOLUTE RATING

Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING

Ratings Criteria Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

9 Edelweiss Securities Limited Consumer Goods

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098. Board: (91-22) 4009 4400, Email: [email protected]

Aditya Narain

Head of Research [email protected]

Coverage group(s) of stocks by primary analyst(s): Consumer Goods Asian Paints, Bajaj Consumer Care, Berger Paints, Britannia Industries, Colgate, Dabur, Future Consumer, Godrej Consumer, Emami, Hindustan Unilever, ITC, Marico, Nestle Ltd, Pidilite Industries, GlaxoSmithKline Consumer Healthcare, United Spirits

Recent Research

Date Company Title Price (INR) Recos

29 -Jun-20 Emami Balmy outlook: Eyes on Q2, 221 Buy pledging reduction; Result Update 26-Jun-20 ITC COVID-19 snubs cigarette; 195 Hold FMCG resilient; Result Update 26-Jun-20 Berger Lockdown mars volume; 511 Buy Paints margin expansion intact; Result Update

Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to

Rating Distribution* 161 67 11 240 Buy appreciate more than 15% over a 12-month period * 1stocks under review Hold appreciate up to 15% over a 12-month period > 50bn Between 10bn and 50 bn < 10bn 743 Reduce depreciate more than 5% over a 12-month period Market Cap (INR) 156 62 11 594

One year price chart 446 2,600

(INR) 297 2,400

149 2,200

- (INR) 2,000

14 14

- -

- - -

1,800

Jul

Jan

Jun

Oct

Apr

Sep Feb

Dec

Aug Nov Mar May

1,600

20 19

19 20

20 20

19 20

- - -

- -

Jul Jul

Jan

Jun

Oct

Apr

Sep Feb

Dec Aug

Nov

Mar May Hindustan Unilever

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Hindustan Unilever

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11 Edelweiss Securities Limited

Consumer Goods

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12 Edelweiss Securities Limited

Hindustan Unilever

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13 Edelweiss Securities Limited