Hindustan Unilever. CMP:INR324 TP:INR302 Neutral

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1 BSE SENSEX S&P CNX 18,197 5, July QFY12 Results Update Sector: FMCG Hindustan Unilever CMP:INR324 TP:INR302 Neutral Bloomberg HUVR IN Equity Shares (m) 2, Week Range (INR) 347/250 1,6,12 Rel. Perf. (%) 0/22/25 M.Cap. (INR b) M.Cap. (USD b) 15.7 Key takeaways from the conference call FMCG sector maintained double-digit sales growth in 1QFY12 but volume traction was lower than 4QFY11 levels. The Hindustan Unilever (HUVR) management emphasized profitable volume growth, which we believe is a change from its earlier strategy of growing volumes and market share. It plans to achieve this by increasing cost savings and channelizing them into brand investments and market development. HUVR's 1QFY12 volume grew just 8.3% from 14% in 4QFY11. Personal care volumes grew by more than 15% and soaps and detergent volume growth suffered. Personal care growth was volume led and soap and detergent growth was a mix of volume and value. Detergent volumes increased 19% and soap volumes increased 8% in FY11, a 15- year high, 2-2.5x the industry volume growth. HUVR increased prices of soaps and detergents (7-8% the weighted average) over the past few months. The management indicated price increases had not sufficiently covered input cost inflation in PFAD and LAB. HUVR's ad spends declined 16% (420bp) mainly due to lower ad spends on commodity linked categories like soaps and detergents, which was in line with competitive spends in the category. However ad spends of personal care and processed foods increased. It's undertook new launches in the personal products and foods categories. Major launches include Fair and Lovely face wash, Ponds cream, Clear Nutrium shampoo, Bru Exotica coffee and Lipton ice tea. Cutting FY12 volume growth estimates; Neutral: We are reducing FY12 volume growth estimates from 11% to 8.5% due to a sharp decline in volume growth and increased pricing component in the mix. We increased FY12 EBITDA margin estimates from 13.6% to 13.9%. However our EPS estimates at INR11.2 for FY12 and INR12.6 for FY13 are unchanged. We believe a decline in volume growth and volatility in input costs are key risks to multiples. The stock trades at 29x FY12E EPS of INR11.2 and 25.6x FY13E EPS of INR12.6. Maintain Neutral. Amnish Aggarwal (AmnishAggarwal@MotilalOswal.com); Tel: Harit Kapoor (Harit.Kapoor@MotilalOswal.com); Tel:

2 Conference call takeaways: Soap, detergent volume growth falls, price increases inadequate We attended an HUVR conference call to understand the likely trend in volume growth, competitive intensity and input costs. Key takeaways are: The FMCG sector is maintaining double digit sales growth but volume traction is lower than 4QFY11 levels. Urban India is growing faster than rural India as per AC Nielsen, however as per HUVR's internal study the rural segment is growing ahead of the urban market. The HUVR management has emphasized profitable volume growth, which we believe is a change from its earlier strategy of growing volumes and market share. It plans to achieve this by increasing cost savings (15% overhead reduction and 60% increase in supply chain savings in two years) and channelizing them into increased brand investments and market development. HUVR's 1QFY12 volume growth softened to 8.3% from 14% in 4QFY11. Personal care volumes grew by more than 15% and soap and detergent volume growth suffered. Personal care growth is volume led and soap and detergent growth is a mix of volume and value. Detergent volumes increased 19% and soap volumes 8% in FY11, a 15-year high, which is 2-2.5x the industry volume growth. HUVR increased soap and detergent prices (7-8% weighted average) over the past few months. The management indicated that the price increases were not sufficient to cover the input cost inflation in PFAD and LAB. HUVR's ad spends declined 16% (420bp) mainly due to lower ad spends on commodity-linked categories like soaps and detergents, which was in line with competitive spends in the category. However personal care and processed foods ad-spends increased. HUVR undertook new launches in the personal products and foods segments. Major launches include FAL face wash, Ponds cream, Clear Nutrium shampoo, Bru exotica coffee and Lipton ice tea. 1QFY12 volumes up, gross margin falls; 16% cut in ad spend enables 11% PAT growth HUVR's 1QFY12 net revenue grew 14.4% to INR55.8b (against our estimate of INR55.3b), led by 8.3% volume growth (against our estimate of 12%). Gross margin contracted 490bp to 44.9% (against our estimate of 47%) due to a sharp increase in input costs and inadequate price increases. Ad-spend declined 16% YoY (420bp) to 11.3% to INR6.3b. Staff cost increased 14.2% YoY, after 2.7% YoY growth in FY11. EBITDA increased by 10.8% to INR7.5b (against our estimate of INR7.4b) as margin contraction was restricted to 50bp at 13.5% (against our estimate of 13.3%), mainly due to a sharp cut in ad-spends. Other income increased 20% YoY to INR506m (against our estimate of INR450m). The tax rate increased to 22.7% from 22.2% YoY. Adjusted PAT increased 11% to INR5.8b (against our estimate of INR5.6b). 29 July

3 Domestic FMCG sales grow to a new high, powered by higher prices volume grows (%) in single digits Sep-09 Mar-10 Sep-10 Mar-11 Sep-09 Mar-10 Sep-10 Mar-11 Gross margins fall 490bp YoY.410bp decline in ad-spends cushions margin decline, ad spends unsustainable Gross Margins (%) EBITDA Margins (%) Aug-09 Oct-09 Feb-10 Apr-10 Aug-10 Oct-10 Feb-11 Apr-11 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 Source: Company/MOSL Soap, detergent margins up QoQ; personal care EBIT up YoY Soaps and detergents: Sales grew 12.8% and margins increased 170bp QoQ to 9.2% (down 170bp YoY) and EBIT declined 5%. Volumes grew across detergent brands and Rin volumes increased by double digits. Lifebuoy delivered double digit growth and hand and body wash sales were up 200% over the past two years. Personal products: Sales grew 19.4% as all product segments sustained strong volumes. EBIT grew 22% as margins expanded 50bp YoY to 25.3%. Hair care and oral care delivered double digit growth. HUVR launched FAL multi-vitamin face wash and Clear with Nutrium 10 technology. Beverages: Sales grew 13.1%. EBIT increased 8.4% and margins fell 50bp YoY to 12.4%. Lipton ice tea was launched on the Lite refreshment platform and HUVR entered the premium coffee segment. Foods: Sales grew 17.8% (26% in 4QFY11) and margins fell 350bp YoY to 4.7%. EBIT declined 33% as HUVR promoted new launches like Kissan Creamy Spread, Juice and Soymilk drink, Nutri Smart malted food drink. 29 July

4 Segmental snapshot: Margin pressure in soaps, detergents, foods Segmental FY11 FY10 Chg. (%) 1QFY12 1QFY11 Chg. (%) Net Sales (INR m) Soaps and Detergents 87,916 82, ,550 22, Personal Products 58,441 50, ,307 13, Beverages 23,440 21, ,086 5, Processed Foods 9,026 7, ,721 3, Exports 10,997 10, ,063 2, EBIT (INR m) Soaps and Detergents 8,341 11, ,361 2, Personal Products 14,948 12, ,133 3, Beverages 3,578 3, Processed Foods Exports EBIT Margin (%) Soaps and Detergents Personal Products Beverages Processed Foods Exports Source: Company/MOSL Personal products EBIT grows 22% on 19% sales growth Sales Grow th (%) PBIT Margin (%) Soap, detergent margins bottom out; up 170bp QoQ EBIT Margin (%) Sales Grow th % (2.4) (1.9) Sep-09 Mar-10 Sep-10 Mar-11 Sep-09 Mar-10 Sep-10 Mar-11 Source: Company/MOSL PFAD prices down 20% from peak; LAB prices maintain uptrend PFAD prices declined 20% from their peak and the benefit of the decline will start accruing to HUVR from 2QFY12. However LAB prices are inching up as crude prices rise. LAB prices have climbed 27% YoY over the past six months. Besides, prices of other inputs like tea, coffee, vegetable oil and packaging are high on a YoY basis. HUVR undertook staggered price increases in soaps and detergents but heightened competitive activity will prevent a sharp margin rebound. Our estimates factor in a 40bp decline in gross margins for FY12 and a 30bp expansion in FY July

5 PFAD prices down 26% from their peak LAB prices up 27% YoY Source: Company/MOSL Cutting volume growth estimates, price increases to compensate; Neutral We expect gross margins to increase in the coming quarters led by (1) a 32% decline in PFAD prices from their peak, (2) calibrated increase in detergent prices (8-17%) and toilet soap prices (5-11%) over the past six months and (3) sustained growth above teens in the personal care category. We expect volume growth to decline further led by (1) the impact of high price increases in soaps and detergents in the current environment of high inflation and (2) a high base effect as FY11 volume grew 16% for detergents and 8% for toilet soaps (much above long-term industry growth) (3) the contribution of distribution expansion to growth. We are reducing volume growth estimates from 11% to 8.5% in FY12 due to a sharp decline in volume growth. We have reduced volume growth and increased the pricing component in the mix. Our EBITDA margin estimate is increased from 13.6% to 13.9%. However our EPS estimates of INR11.2 in FY12 and INR12.6 in FY13 are unchanged. Further decline in volume growth and volatility in input costs are a key risk to multiples. The stock trades at 29x FY12E EPS of INR11.2 and 25.6x FY13E EPS of INR12.6. Neutral. 29 July

6 Hindustan Unilever: an investment profile Company description Hindustan Unilever (HUVR) is India's largest company in the FMCG industry, with market leadership in soaps, detergents and personal care categories. It has a wide distribution network with direct reach of over 1m retail outlets. HUVR is a subsidiary of Anglo Dutch FMCG giant Unilever. Key investment arguments Market leader in most categories with strong brands; Wide product range across categories with a presence at all price points; Decline in raw material prices will improve margins. Key Investment risks Loss of market share forced HUVR to pass on significant benefits from reduction in raw material prices. Competitive pressure intensified with more companies entering the personal care, toilet soap and detergent markets, which account for 80% of HUVR's profits. Recent developments HUVR effected price increases in its key detergent and soap brands. In 1QFY12 HUVR's launches focused on skin, hair care and processed foods. Valuation and view We estimate EPS of INR11.2 in FY12 and INR12.6 in FY13. The stock trades 29x FY12E and 25.6xFY13E. Maintain Neutral. Sector view We have a cautious view on the sector due to inflationary pressure in the economy. Companies with a competitive position would be better placed to withstand a slowdown in a segment. Long term prospects bright, given rising incomes and low penetration. Comparative valuations HLL ITC Nestle P/E (x) FY12E FY13E EV/EBITDA (x) FY12E FY13E EV/Sales (x) FY12E FY13E P/BV (x) FY12E FY13E EPS: MOSL forecast v/s Consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) Neutral Stock performance Shareholding Pattern (%) Mar-11 Promoter Domestic Inst Foreign Others Hind. Unilever Sensex - Rebased Jul-10 Oct-10 Jan-11 Apr-11 Jul July

7 Financials and Valuations 29 July

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