Equity Research INDIA December 7, 2020 BSE Sensex: 45080 Hindustan Unilever ADD ICICI Securities Limited Maintain is the author and Prioritising (volume) growth over (gross) margins is distributor of this report a significant trajectory shift Rs2,184 A potential change in stance at HUL in favour of volume growth, in our opinion, Company update could be a key driver for HUL stock’s outperformance in CY2021. We note that this Consumer Staples & strategy has already started playing out in tea (price hike lower than competition and commodity inflation), soaps (price hikes lower than competition despite steep Discretionary input inflation (palm prices up over 30% in 6M) and detergents. In India, a “growth market”, investors tend to (rightly) ignore short-term profit sacrifice, provided the Target price Rs2,400 trajectory of volume outperformance is clear (as it’s DCF-accretive). Nestlé stock’s 43% outperformance between Oct’18 – Sep’19 driven by volume growth-led Shareholding pattern valuation rerating, despite weak earnings, is a case in point. Mar Jun Sep ‘20 ‘20 ‘20 We are amending our FMCG portfolio strategy recommendation of Godrej, Marico, Promoters 61.9 61.9 61.9 Institutional Dabur, Tata Consumer over HUL (post HUL’s 26% underperformance (versus investors 18.4 23.2 25.4 MFs and others 2.6 4.4 4.0 Nifty) over last 6 months). ADD retained. Banks, FI’s, HUL’s comment in Q2FY21 call: Insurance co 3.7 3.8 3.8 FIIs 12.1 15.0 17.6 Others 19.7 14.9 12.7 “I think the right thing for us to do is to focus on competitive volume-led growth. And if it Source: BSE means that some of the margin expansion is not at the desired levels or the levels we would like to be, itis absolutely okay with us. We will invest to drive growth.” Price chart 2600 Focus on volume growth, even at the cost of margin pointing to a trajectory 2300 change: We believe that HUL is likely at the cusp of a period of volume growth 2000 acceleration – even if that means sacrificing gross margins to an extent. We note 1700 HUL’s comments in Q2FY21 earnings call stating the change in thought process. 1400(Rs) 1100 This strategy is already playing out in tea and soaps, where HUL has taken a much 800 500 lower price hike versus competition and versus commodity inflation, in a bid to gain market share. Even in detergents, HUL has been quick in passing input cost Jun-18 Jun-19 Jun-20 Dec-17 Dec-18 Dec-19 Dec-20 benefits, again ahead of competition. Nestle had outperformed peers over Oct’18 to Sep’19 period driven by P/E multiple expansion: Recently, over a 12-month period (Oct’18 - Sep’19), Nestlé’s stock significantly outperformed peers (see figure 2). However, during this period, Nestlé’s earnings growth significantly lagged peers – a strategic move by Nestle to delay price increases offsetting diary inflation, thereby driving volume growth at the expense of profitability. We believe that in India, a “growth market”, investors tend to ignore short-term profit sacrifice, provided the trajectory of volume outperformance is clear. Market Cap Rs5131bn/US$69.6bn Year to March FY19 FY20 FY21E FY22E Reuters/Bloomberg HLL.BO/HUVR IN Net Revenue (Rs mn) 382,240 387,850 441,441 490,856 Research Analysts: Shares Outstanding (mn) 2,349.6 Net Profit (Rs mn) 62,630 69,350 84,338 97,996 Manoj Menon 52-week Range (Rs) 2488/1838 Dil. EPS (Rs) 29.0 32.1 36.0 41.8 [email protected] Free Float (%) 38.1 % Chg YoY 18.2 10.7 12.0 16.2 +91 22 6637 7209 Vismaya Agarwal, CFA FII (%) 17.6 P/E (x) 75.3 68.0 60.7 52.3 [email protected] Daily Volume (US$'000) 76,513 CEPS (Rs) 31.4 36.4 40.3 46.6 +91 22 2277 7632 Absolute Return 3m (%) 2.8 EV/EBITDA (x) 53.9 48.5 44.9 38.8 Karan Bhuwania Absolute Return 12m (%) [email protected] 7.1 Dividend Yield (%) 1.0 1.1 1.3 1.6 +91 22 6637 7351 Sensex Return 3m (%) 17.7 RoCE (%) 64.4 64.6 27.1 18.8 Sensex Return 12m (%) 11.7 RoE (%) 85.0 88.4 32.8 22.0 Please refer to important disclosures at the end of this report Hindustan Unilever, December 7, 2020 ICICI Securities Revenue growth could accelerate while peers are likely to decelerate in FY22: We note that HUL’s revenue growth in FY22 could accelerate, given a weak base of FY21, while peers are likely to witness moderating growth in FY22. Having said that, we do believe consensus should consider 2-year CAGR while comparing the performance in FY22 (adjusting for base effect of FY21). Valuation and risks: Our earnings estimates are largely unchanged; modelling revenue / EBITDA / PAT CAGR of 12 / 16 / 19 (%) over FY2020-22E. Maintain ADD rating with DCF-based unchanged target price of Rs2,400. Key downside risks are delayed recovery in demand and irrational competition. Figure 1: HUL’s comment in Q2FY21 call I think the right thing for us to do is to focus on competitive volume-led growth. And if it means that some of the margin expansion is not at the desired levels or the levels we would like to be, itis absolutely okay with us. We will invest to drive growth. Figure 2: Nestle stock outperformed peers over Oct’18-Sep’19 period… 50 40 30 20 10 (%) - (10) (20) (30) (40) (50) ITC JYL VBL HUL BaCo TCPL Dabur GCPL Nestle Zydus Marico Emami Colgate Britannia Source: Bloomberg, Company data, I-Sec research 2 Hindustan Unilever, December 7, 2020 ICICI Securities Figure 3: …despite underperforming in earnings growth… (average quarterly PAT growth over Oct’18-Sep’19) 35 30 30 25 20 20 18 16 (%) 15 15 11 10 10 10 6 6 6 5 1 - ITC JYL HUL TCPL BaCO GCPL Dabur Nestle Marico Emami Colgate Britannia Source: Company data, I-Sec research Figure 4: …driven by volume growth outperformance (average quarterly volume growth over the same period) 12 10 10 8 8 7 6 6 (%) 6 5 5 5 4 4 3 2 1 - ITC HUL BaCo Nestle Dabur GCPL Emami Jyothy Marico Colgate Britannia Source: Company data, I-Sec research 3 Hindustan Unilever, December 7, 2020 ICICI Securities Figure 5: HUL’s comment on margin expansion after 2015 Quarter Comments …we'll continue to manage the business dynamically for 2015 volume-led growth and margin Q3FY15 improvement …And we will continue to focus on driving volume-led growth with improvement in operating Q3FY16 margins. Our strategy for the period remains unchanged- consistent, competitive, profitable and responsible growth. Q4FY16 …we will continue to focus on driving volume-led growth with improvement in operating margins. Q1FY17 …we continue to focus on driving volume-led growth with improvements in operating margins. Q2FY17 …We will continue to focus on volume growth and an improvement in operating margin …Our strategy remains unchanged. We will continue to focus on our volume growth, as well as Q3FY17 improvement in operating margin. …focus on volume driven growth and improvement in operating margin, while continuing to Q4FY17 deliver consistent, competitive, profitable and responsible growth. A question that keeps getting asked all the time and again stating on how confident are we on the savings agenda and the margin agenda. Just thought we will just pull our thinking together on this. The margin delivery program is a widespread company-wide program and that's been Q1FY18 running, giving us excellent benefit for the last few years. And here we are thinking and delivering end-to-end savings of 6-odd percent of turnover is the ambition that we work with. And here we work as no functional silos. These are end-to-end business thinking. The whole zero based budgeting comes into this particular piece as well. Q2FY18 …we will focus on volume-driven growth and improvement in operating margin in tandem Source: Company data, I-Sec research Figure 6: HUL’s EBITDA margin expansion over CY2001-FY2020 30 25 20 15 (%) 10 5 - FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CY01 CY02 CY03 CY04 CY05 CY06 CY07 15MFY09 Source: Company data, I-Sec research 4 Hindustan Unilever, December 7, 2020 ICICI Securities Figure 7: Revenues and growth rates Figure 8: EBITDA margin 6,00,000 EBITDA margin Mean +1SD -1SD 28 5,00,000 26 24 4,00,000 22 3,00,000 20 (%) (Rs mn) (Rs 2,00,000 18 16 1,00,000 14 - 12 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CY01 CY02 CY03 CY04 CY05 CY06 CY07 15MF… FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CY01 CY02 CY03 CY04 CY05 CY06 CY07 FY21E FY22E FY21E FY22E Source: Company data, I-Sec research Source: Company data, I-Sec research Figure 9: Net profit and growth rates Figure 10: Return ratios and cost of capital 1,20,000 RoE RoCE Cost of Capital 160 1,00,000 140 80,000 120 100 60,000 80 (%) (Rs mn) (Rs 40,000 60 40 20,000 20 - - FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY01 CY02 CY03 CY04 CY05 CY06 CY07 FY21E FY22E FY21E FY22E Source: Company data, I-Sec research Source: Company data, I-Sec research Figure 11: Gross margins and Ad-spend as % of Figure 12: Volume growth sales Gross margin Ad-spend as % of Net Sales 20 60 15 50 10 40 5 30 (%) (%) 0 20 10 (5) - (10) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Jun-08 Jun-11 Jun-14 Jun-17 Jun-20 CY01 CY02 CY03 CY04 CY05 CY06 CY07 Mar-06 Mar-09 Mar-12 Mar-15 Mar-18 Dec-06 Sep-07 Dec-09 Sep-10 Dec-12 Sep-13 Dec-15 Sep-16 Dec-18 Sep-19 FY21E FY22E Source: Company data, I-Sec research Source: Company data, I-Sec research 5 Hindustan Unilever, December 7, 2020 ICICI Securities Figure 13: Mean P/E and standard deviations 75 HUL P/E -1 Std Dev.