Demand woes, volume-margin trade-off likely to weigh on HUL

Hindustan Unilever’s Q3FY24 performance was lacklustre, with both sales and operating profit barely moving from the year-ago period due to price cuts and higher advertising costs.

Besides weak demand, the FMCG (fast-moving consumer goods) major is facing increased competitive pressures, particularly from regional players, which, coupled with a slow recovery in rural markets, could put revenues under pressure going forward.

Margins are expected to remain range-bound as benefits from falling raw material costs are expected to be neutralised by rising promotional budgets.

Given the underwhelming showing and muted near-term outlook, most brokerages have cut their earnings estimates by up to 5 per cent and taken a cautious view on the stock.

While the stock ended Saturday’s session with a decline of over 3 per cent, it could face more pressure given the uncertain outlook and downgrades by brokerages.

The demand trajectory will be a key monitorable going ahead.

The company highlighted that the operating environment remained challenging given a delayed winter, weak festival season, and uneven growth across markets.

It expects a gradual demand recovery with rural income growth and winter crop yields to influence the pace of growth.

Both of Hindustan Unilever’s largest categories — beauty and personal care (BPC) and home care — saw single-digit volume growth in the December quarter largely led by price cuts.

Further, given the delayed winters, the winter portfolio, which accounts for a third of BPC, was impacted.

Skin cleansing (part of BPC) portfolio revenues were impacted given price cuts on the back of falling commodity prices.

The company is splitting the BPC into the beauty and wellbeing segment and the personal care segment.

While the first will include skin care, cosmetics, hair care, and health/wellbeing, the second will comprise skin cleansing, oral care, and deodorants.

Benign inflation is leading to heightened regional competition and customer downtrading in segments, such as tea, soaps, and detergent.

The health food drink (HFD) segment has been impacted by rising milk prices.

The HFD is part of the food and refreshment category, which witnessed low single-digit volume growth and 1 per cent sales growth led by price increases.

According to analysts led by Abneesh Roy of Nuvama Research, competitive intensity shall remain high with commodity prices staying benign.

Further price cuts to garner volumes and counter heightened competition will have implications on profitability.

The company was able to boost gross margins in the quarter by 401 basis points to 50.6 per cent, and implement price increases given the leeway of softer commodity prices.

However, the 32.8 per cent rise in advertising costs meant that the operating profit margin gains were limited to 8 basis points year-on-year (Y-o-Y) at 23.3 per cent.

It was down 87 basis points on a sequential basis.

While the management expects gross margin gains on the back of cost-saving programmes, better mix led by premium products, revenue management, and productivity focus, brokerages are cautious on the outlook given multiple challenges.

Shirish Pardeshi of Centrum Research believes that investors need to be watchful given the dent from regional competition, volume priority given that the company is stepping up advertising and promotional spends, and margins being in a tight band.

The company has cut its EPS estimates and downgraded its rating to reduce.

Abhijeet Kundu and Dhiraj Mistry of Antique Stock Broking believe that HUL’s volume and value growth is likely to remain muted; they expect a gradual recovery in rural markets and an increase in the competitive intensity from local/regional players.

In the long term, however, they expect the consumer giant to be one of the biggest beneficiaries of the rural market recovery due to its wide product portfolio across price ladder and strong premiumisation trend.

The brokerage has a hold rating.

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