Hindustan Unilever HLL.NS HUVR IN

Transcription

1 Hindustan Unilever HLL.NS HUVR IN EQUITY: GENERAL CONSUMER Buy for urban demand revival Upgrade to Buy on account of premiumising portfolio and improving margins Action: Business transformation under way, upgrade to Buy We upgrade Hindustan Unilever (HUVR) to Buy with a TP of INR1,020. We are seeing some signs of demand revival in the urban sector, which augers well for HUVR. In the current cycle, this coincides with HUVR s efforts to focus on the premium segment. A major chunk of the company s current innovation pipeline focuses on the premium segment, along with increased spend on the category. This essentially leads us to believe that growth in HUVR s premium segment is likely to revive in the near- to medium term, which should lead to significant EBITDA margin expansion (~160bps improvement between FY15F- 18F). We also highlight HUVR s scale advantage (please refer to page 3), superior distribution footprint (please refer to page 10) and volume growth trajectory doubling by FY17F. In our opinion, the current share price does not reflect all these positives and thus we upgrade the stock to Buy. Catalysts: Revival of growth in personal products portfolio and soft commodity prices Given the company s focus on the premium portfolio, we think strong growth revival in personal products will lead to better EBITDA margins and stronger volume growth. Further, softness in commodity prices augers well. Valuations: Risk-reward favourable At INR922, the stock trades on a P/E multiple of 38.2x FY17F EPS of INR24.12, which is largely in line with the sector average. Given HUVR s strong earnings growth (CAGR of 18.5% over the next three years) and business transformation, risk-reward seems favourable. Our target multiple of 40x is justified we believe by the negative working capital, strong cash flow generation, RoE of ~120%, dividend payout of 90% leading to 2.1% yield even at high multiples. We upgrade the stock to Buy and it is our top pick in the large-cap consumer space. We recommend investors to Reduce their positions in ITC (ITC, ITC IN, Reduce) and Buy HUVR. Global Markets Research 3 August 2015 Rating Up from Reduce Buy Target price Increased from 785 INR 1020 Closing price 31 July 2015 INR 922 Potential upside +10.7% Anchor themes HUVR is the biggest player in India's consumer space, with the widest product portfolio. We believe a revival in urban consumption will be a key positive catalyst for the company. Nomura vs consensus We are 1% ahead of consensus on our FY17/18F earnings. Research analysts India Consumer Related Manish Jain - NFASL manish.jain@nomura.com Year-end 31 Mar FY15 FY16F FY17F FY18F Currency (INR) Actual Old New Old New Old New Revenue (mn) 319, , , , , ,146 Reported net profit (mn) 43,631 45,718 44,000 52,725 52,192 61,311 Normalised net profit (mn) 36,839 45,718 44,000 52,725 52,192 61,311 FD normalised EPS FD norm. EPS growth (%) FD normalised P/E (x) 54.1 N/A 45.3 N/A 38.2 N/A 32.5 EV/EBITDA (x) 36.4 N/A 31.0 N/A 26.3 N/A 22.3 Price/book (x) 52.2 N/A 46.8 N/A 41.7 N/A 36.9 Dividend yield (%) na N/A na N/A na N/A na ROE (%) Net debt/equity (%) net cash net cash net cash net cash net cash net cash Source: Company data, Nomura estimates Key company data: See page 2 for company data and detailed price/index chart See Appendix A-1 for analyst certification, important disclosures and the status of non-us analysts.

2 Key data on Hindustan Unilever Relative performance chart Source: Thomson Reuters, Nomura research Notes: Performance (%) 1M 3M 12M Absolute (INR) M cap (USDmn) 31,112.0 Absolute (USD) Free float (%) 33.0 Rel to MSCI India mth ADT (USDmn) 20.3 Income statement (INRmn) Year-end 31 Mar FY14 FY15 FY16F FY17F FY18F Revenue 292, , , , ,146 Cost of goods sold -148, , , , ,830 Gross profit 143, , , , ,315 SG&A -83,422-89, , , ,438 Employee share expense -15,758-17,239-19,307-22,203-25,534 Operating profit 44,461 50,913 59,851 70,533 83,343 EBITDA 47,417 54,137 63,418 74,593 87,783 Depreciation -2,955-3,224-3,566-4,059-4,440 Amortisation EBIT 44,461 50,913 59,851 70,533 83,343 Net interest expense Associates & JCEs Other income 5,710 5,667 6,000 6,400 7,000 Earnings before tax 49,764 56,403 65,671 76,753 90,163 Income tax -12,594-19,440-21,672-24,561-28,852 Net profit after tax 37,170 36,963 44,000 52,192 61,311 Minority interests Other items Preferred dividends Normalised NPAT 37,068 36,839 44,000 52,192 61,311 Extraordinary items 2,387 6, Reported NPAT 39,456 43,631 44,000 52,192 61,311 Dividends Transfer to reserves 39,456 43,631 44,000 52,192 61,311 Valuations and ratios Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) Dividend yield (%) na na na na na Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA Normalised EPS Normalised FDEPS Source: Company data, Nomura estimates Cashflow statement (INRmn) Year-end 31 Mar FY14 FY15 FY16F FY17F FY18F EBITDA 47,417 54,137 63,418 74,593 87,783 Change in working capital 9,424 1,145 10,625 10,155 12,099 Other operating cashflow -9,018-14,708-16,041-18,341-22,032 Cashflow from operations 47,822 40,575 58,002 66,407 77,850 Capital expenditure -8,113-4,766-6,270-6,446-6,662 Free cashflow 39,709 35,809 51,732 59,961 71,188 Reduction in investments -5,858-1,869-10,000-10,000-10,000 Net acquisitions Dec in other LT assets Inc in other LT liabilities Adjustments CF after investing acts 33,851 33,939 41,732 49,961 61,188 Cash dividends -28,115-32,453-39,600-46,973-55,180 Equity issue Debt issue Convertible debt issue Others CF from financial acts -27,697-32,203-39,410-46,973-55,180 Net cashflow 6,153 1,736 2,322 2,988 6,008 Beginning cash 19,007 25,160 26,896 29,218 32,206 Ending cash 25,160 26,896 29,218 32,206 38,214 Ending net debt -24,705-26,466-28,788-31,775-37,784 Balance sheet (INRmn) As at 31 Mar FY14 FY15 FY16F FY17F FY18F Cash & equivalents 25,160 26,896 29,218 32,206 38,214 Marketable securities Accounts receivable 10,311 10,112 11,488 13,212 15,193 Inventories 29,398 28,488 31,593 36,332 41,782 Other current assets 11,458 13,191 14,374 16,520 19,004 Total current assets 76,328 78,687 86,674 98, ,193 LT investments 28,381 30,251 40,251 50,251 60,251 Fixed assets 31,188 33,373 36,076 38,463 40,685 Goodwill Other intangible assets Other LT assets Total assets 135, , , , ,129 Short-term debt Accounts payable 71,916 66,383 76,589 88, ,289 Other current liabilities 29,725 37,027 43,111 50,386 59,190 Total current liabilities 101, , , , ,479 Long-term debt Convertible debt Other LT liabilities Total liabilities 102, , , , ,909 Minority interest Preferred stock Common stock 2,163 2,164 2,164 2,164 2,164 Retained earnings Proposed dividends Other equity and reserves 31,415 36,059 40,459 45,678 51,809 Total shareholders' equity 33,577 38,222 42,622 47,841 53,973 Total equity & liabilities 135, , , , ,129 Liquidity (x) Current ratio Interest cover Leverage Net debt/ebitda (x) net cash net cash net cash net cash net cash Net debt/equity (%) net cash net cash net cash net cash net cash Per share Reported EPS (INR) Norm EPS (INR) FD norm EPS (INR) BVPS (INR) DPS (INR) Activity (days) Days receivable Days inventory Days payable Cash cycle Source: Company data, Nomura estimates 2

3 Hindustan Unilever consistently ahead of the pack Hindustan Unilever is by far one of the biggest consumer companies in India and has an extremely successful track record of growing ahead of the market despite its large size. Among the 10 food & beverages and personal product companies under our coverage, HUVR is 3.3x (compared to Nestle) to 14.5x (compared to Emami) bigger than its competitors. Despite being India s biggest consumer company in the FMCG space, over the past five years, HUVR revenue CAGR was 12.3% compared to the sector s growth of 11% over the same period. We believe this is a remarkable track record which has been driven by the company s ability to innovate in new categories (such as surface cleaners, liquid detergents etc.), renovate existing brands and proactive actions to defend and gain market share (eg, recent price cuts ahead of competition when global commodities crashed). As we are now turning positive on the company, in this note we analyse Hindustan s key business transformations currently under way which have led us to rethink our view The story so far We downgraded Hindustan Unilever to Reduce from Neutral at the beginning of 2013 and since then the stock is up ~73% (outperforming the broader markets by ~31%), hence our call did not perform as we had expected. Before we discuss our change in view on the stock, we wanted to first analyse its past performance. One key reason for our rethink and subsequent downgrade at that point was largely to do with the impending earnings trajectory decline which we thought would be driven by: a) demand slowdown in the rural economy; b) worsening macro-economic situation, and c) rising competition in the personal products portfolio particularly in Skin and Oral categories. As far as the numbers are concerned, the macro-economic impact on earnings is quite visible in the charts below where value growth slowed to 8% from 15% and EBITDA growth to 9% from 17%, during the time frame. Fig. 1: Significant slowdown in value growth Fig. 2: had driven the profit growth lower % 15% 10% 5% 0% 30% 20% 10% 0% -10% -20% Dec'12 Mar'13 Jun'13 Sep'13 Dec'13 Mar'14 Jun'14 Sep'14 Dec'14 Dec'12 Mar'13 Jun'13 Sep'13 Dec'13 Mar'14 Jun'14 Sep'14 Dec'14 Volume Growth (RHS) EBITDA Growth (LHS) PAT growth (RHS) Source: Company, Nomura Research Source: Company, Nomura Research However, during the same timeframe, the P/E multiple for the stock went from 25x in early 2013 to 45x in 2015 (on year-forward earnings). This essentially implied that the entire rally over the past couple of years has was driven by P/E multiple expansion, something which we neglected to foresee. 3

4 Fig. 3: HUVR one-year forward P/E multiple chart Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Source: Bloomberg, Nomura Research Improving growth trajectory makes us positive After a soft couple of years, volume growth in the last quarter has started to pick-up. We believe 2HFY16/FY17 will see a marked improvement over the average growth seen in the past eight quarters of ~5%. This improvement should be marked by a pick-up in GDP growth as well as revival in urban growth which has been under pressure over the past couple of years. Fig. 4: Volume growth starting to see a pick up 16% 12% 8% 4% 0% -4% -8% Jun'06 Dec'06 Jun'07 Dec'07 Jun'08 Dec'08 Jun'09 Dec'09 Jun'10 Dec'10 Jun'11 Dec'11 Jun'12 Dec '12 Jun'13 Dec'13 Jun'14 Dec'14 Jun'15 Source: Company data, Nomura Research Growth revival: looks like it is here to stay We believe that all the company s actions like 1) strong innovation; 2) driving distribution, and 3) strong pro-active competitive actions, and the macro economic factors are all aiding growth in the urban or premium portfolio. Our assumptions now build in a strong revival in volume growth over the next two years from 5% average in FY15 to 10% in FY17F. This will likely be driven by personal products (PP), more specifically skin and hair care which should drive growth. We continue to believe that any strong revival in oral care is unlikely. We are building in an average 6% growth in the Soaps & Detergents (S&D) portfolio over the next two years, which is significantly slower than the overall company average. 4

5 Fig. 5: HUVR Volume growth estimates FY11 FY12 FY13 FY14 FY15 FY16F FY17F Source: Company data, Nomura estimates Growth in premium portfolio aiding growth revival HUVR s portfolio largely comprises of two key businesses, ie, S&D which represent ~45% of revenues, and PP ~30% of revenues. However, compared to PP, S&D is a more mature business where penetration levels are higher than 90% and growth is driven by more market share gains or distribution enhancements, both of which are more spend intensive. PP, on the other hand, comprises of businesses such as skin & hair care, which are much less mature and driven more by innovation. The company also, consistently makes 12-14% operating margins in the S&D business as compared to 25%+ in PP. In the past few years, growth was more led by the S&D division of the company as compared to the PP part of the portfolio. In the 13 quarters between September 2011 to September 2014, PP has outgrown S&D only thrice with the average growth in S&D portfolio being 15.7% as compared to 11.4% in PP. This trend has decisively reversed in the past couple of quarters where PP has outpaced S&D significantly. Fig. 6: This leg of growth revival has been led by premium part of the portfolio Jun'11 Sep'11 Dec'11 Mar'12 Jun'12 Sep'12 Dec'12 Mar'13 Jun'13 Sep'13 Dec'13 Mar'14 Jun'14 Sep'14 Dec'14 Mar'15 Jun'15 S&D PP Source: Company data, Nomura Research 5

6 We think this trend of premiumisation is visible not only between businesses or categories but also within each business or category for instance: in laundry growth has been driven by Surf ahead of Rin, in hair care Dove is a leading category growth and Tresemme has now become a INR1bn brand within its first year of launch, and in soaps growth is being driven by Liril and Pears, all of which are at the top end of the brand construct. This revival in growth in the premium end of the portfolio is good news as this should benefit the company is several ways: 1) it will help it establish its footprint in some more nascent business, e.g., skin care, male grooming & post wash hair care; 2) given the superior margin profile, we believe this will help boost HUVR s profitability and 3) given the rural growth outlook remains weak, this should help boost growth. Going forward, over the next three years, we expect the S&D segment to register value growth in the region of 8-10%, while PP should register growth of 15-17%, remaining significantly ahead of the overall company average revenue growth of 12-15%. Key strategic initiatives that management has taken We have looked at some key strategic initiatives that management has taken recently to have made a positive impact on long-term growth potential on the premium portfolio. Strong innovation/renovation in premium portfolio One key factor that we have recently noticed is HUVR strong innovation and renovation pipeline. Management has been consistently working towards building new categories for the future (e.g., fabric conditioner and surface cleaners), and renovating existing ones. We believe will help the company remain ahead of the competition. Fig. 7: Strong innovation pipeline (last two quarters) Brand Surf Excel Vim Domex Fair & lovely Lakme Ponds Toni & Guy Lakme Magnum Source: Company data, Nomura Research Innovation/renovation Detergent Liquid Launch Anti-germ mix (bar & liquid) Zero Stain Best Ever (re-launch) Youth Infinity Skin cream BB+ Cream Hair care range 9 to 5 range Premium Ice-cream 6

7 Advertising spend picking up The long-term average advertising and promotion (A&P) spend of HUVL has been 11-12% (past 12 years average), which has been moving up in recently This augers well for the company s long-term growth strategy, in our view. Fig. 8: Advertising spend moving up Source: Company data, Nomura Research The company s marketing initiatives lead us believe that a large part of this is now being spent specifically on the premium portfolio: Market development: Recently, HUVR has grown more aggressive in building new categories in India by introducing products from the global portfolio. All these new products/categories are in the premium space. For example; In the beverages business it recently launched Lipton Green Tea, In fabric care it has aggressively marketing liquid detergents and fabric conditioners. Similarly a lot of innovation has happened in the packaged food business under the brand Knorr. Product re-launch: Apart from strong innovation in the premium space and market development, the company is also focused on revival of products in the premium space which is visible by its recent re-launch of brands like Pepsodent and Fair & Lovely. Changing the positioning: One good example of its focus on premiumisation is Fair & Lovely which has now been re-positioned from just a fairness cream to a complete beauty treatment with added benefits like sun protection, complexion clearing, etc. Household inflation expectations starting to moderate Looking at data on household inflation expectations over the past five years, we see that over the past year or so, inflation expectations of households have come down significantly after a period of five years. This has been a key change over the past year and we believe is one key positive for the FMCG sector demand going forward. Over FY12-14, when demand started to slide, management consistently maintained that high inflation was hitting consumers pockets hard and thereby impacting demand for FMCG products. However with inflation expected to be under control, we believe part of the additional savings will start to flow through to higher demand for FMCG products, which particularly augers well for the premium products. 7

8 Fig. 9: Household inflation expectations Current period 12-months ahead Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Source: Nomura Economics Team Other key long-term growth drivers Strong product portfolio While the company has always had a strong portfolio of brands, over the past three to five years we believe there has been a significant level of innovation and distribution push which has helped drive strong revenue growth. Consistent growth has meant that HUVR had 11 brands with revenues of over INR10bn in 2014 (vs. seven in 2011). As well, the company has seven brands with revenues in excess of INR5bn. We think these large brands indicate that company has been able to leverage its portfolio in the past to drive consistent top-line growth. Some brands, eg, Dove, are from the company s global portfolio of brands which some such as Fair and Lovely have been developed in India. Fig. 10: Unmatched ability to build brands INR 20bn + brands INR 10bn + brands INR10bn+ brands Surf Excel Lux Wheel Active Wheel Active Wheel Active Brooke Bond Dove Lux Lux Lux Wheel Active Clinic Plus Dove Dove Lifebuoy Rin Ponds Ponds Ponds Brooke Bond Lifebuoy Vim Clinic Plus Clinic Plus Fair & Lovely Fair & lovely Vim Lifebuoy Rin Lifebuoy Brooke Bond Surf Excel Brooke Bond Fair & Lovely Fair & Lovely Rin Rin Surf Excel Surf Excel Source: Company data, Nomura Research Presence across pack sizes The company has built a strong portfolio of brands but also of note is that it also has a presence across pack size in most brands. This helps to win consumers first with smaller pack sizes and then over time drive consumption by moving these consumers to buy larger pack sizes of the same brand. For e.g., Dove shampoo has pack sizes ranging from 80ml to 650ml and similarly for all of its other shampoo brands. This strategy is important from a long-term perspective as it allows the company to have enough entry points for the consumer to be recruited into the category and brand. 8

9 Fig. 11: Presence across several pack sizes Brand Variant Size (ML) MRP MRP/1000ML Clear Complete Active Clear Complete Active Clear Complete Active Clinic Plus Strong & Long Clinic Plus Strong & Long Clinic Plus Strong & Long Dove Intense Repair Dove Intense Repair Dove Intense Repair Dove Intense Repair Sunsilk Black Shine Sunsilk Black Shine Sunsilk Black Shine Sunsilk Black Shine Source: Company data, Nomura Research Increased distribution footprint From FY09-13, the company s distribution footprint increased >3x, which has been a significant contributor to driving top-line growth. Management recognised the need to build a better go to market to leverage brand strength, which has now been firmly put into place. In FY09 HUVR had 0.9mn outlets where there was direct distribution, which increased to 3.2mn stores at end-fy13. After the distribution footprint enhancement, the company is now focused on increasing throughput from new stores before it starts the drive to increase footprint again. We believe this is a good strategy that will aid growth in the medium term and is fairly important to grow but also consolidate growth. Fig. 12: Direct distribution reach has increased by >2m outlets FY09 FY10 FY11 FY12 FY13 Source: Company data, Nomura Research Products straddling across the price pyramid HUVR not only has a strong portfolio of brands, but also presence across price points in every category in which it competes. One example is in the shampoo category, where it has a presence across price points starting at INR545/1000ml to INR990/1000ml. This gives the company access to several price points where it can recruit consumers into the category. This phenomenon is true across categories such as soaps and 9

10 detergents as well where HUVR has a presence across price categories to ensure that all segments of the population have product choices available from its portfolio. As highlighted below, the scope for premiumisation in the long term remains significant. In the soap category, e.g., value brands such as Hamam and Rexona are nearly onethird the price of premium brands (e.g., Dove). Fig. 13: Presence across several price points Shampoos Brand Variant Size (ML) MRP MRP/1000ML Dove Daily shine TRESemmé Smooth & shine Clinic Plus Strong & long Sunsilk Thick & Long Clear Complete Active Conditioner Brand Variant Size (ML) MRP MRP/1000ML Dove Intense Repair ,107 TRESemmé Smooth & shine Clinic Plus Milk Protein Sunsilk Thick & Long Toothpaste Brand Variant Size (gram) MRP MRP/1000gram Pepsodent Whitening Close up Diamond Attraction Close up Red hot Soaps Brand Variant Size (gram) MRP MRP/1000gram Dove Fresh Moisturising Lifebuoy Lemon Fresh Liril Lux Soft Touch Pears Pure & Gentle Hamam Bathing soap Rexona Coconut & Olive oil Washing Bars Brand Variant Size (gram) MRP MRP/1000gram Rin Detergent bar Surf Excel Detergent bar Wheel Detergent bar Washing Powder Brand Variant Size (gram) MRP MRP/1000gram Rin Detergent Powder 1, Surf Excel Quick wash 1, Wheel Detergent bar Source: Bigbasket.com 10

11 Input costs supportive for gross margin expansion Key input costs for the company are LAB, palm oil, polymer and other crude-related derivatives. Given where input prices are currently, gross margins should continue to show some improvement over the next year. We estimate that these inputs together account for nearly 40% of overall input cost basket for the company. Every 1% up move in cost basket should result in a negative earnings impact of 0.4%. Crude oil and related derivatives is another key driver of input cost index for the company. Tea and Coffee are the other major input costs for the company. Across these inputs prices have declined on a y-y basis which will help drive gross margins higher into FY16F. We believe FY16F will see HUVR improve gross margins by 140bps y-y which will moderate into FY17/18F. Apart from lower input prices, gross margin improvement will likely also be helped by improving product mix and higher growth in the personal products business as compared to the soap and detergent businesses. Fig. 14: Palm Oil prices Fig. 15: Polymer prices 4, ,250 3,750 3,250 2,750 2, , ,250 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Source: Bloomberg Source: Nomura Oil and Gas Team Fig. 16: LAB prices have seen a sharp correction from the peak 140, , , , ,000 90,000 80,000 70,000 60,000 50,000 40,000 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Source: Nomura Oil and Gas Team Strong focus on cost savings Over the past four years HUVR has continued to maintain a strong focus on cost save measures to help drive gross margin improvement. These costs save measures have been across all lines of the P&L including the material costs/ non-material costs as well as overheads. 11

12 Management continues to believe that in the long term there will be more cost save measures that can continue to help drive some gross margin improvement from these levels as well, although the incremental savings should be harder to find. Fig. 17: Material cost savings Index 160 Fig. 18: Supply chain cost savings Index FY11 FY12 FY13 FY14 40 FY11 FY12 FY13 FY14 Source: Company data, Nomura Research Source: Company data, Nomura Research We remain bullish on operating margin expansion Given the global commodity scenario and the premiumising portfolio, we are now building in a cumulative 160bps margin expansion over the next three years to 19% which is the highest since CY03. Fig. 19: Operating margin assumptions 20.0% 19.0% 18.0% 17.0% 16.0% 15.0% 14.0% 13.0% 12.0% FY10 FY11 FY12 FY13 FY14 FY15 FY16F FY17F FY18F Source: Company data, Nomura estimates 12

13 Strong EPS growth likely over FY16-18F We expect HUVR to deliver strong EPS growth over the next couple of years led by improving volume growth trajectory and improving margins. We estimate top-line growth of 12% in FY16F and for a pick up to 15% levels in FY17/18F. We expect EBITDA margins to improve by 80bps y-y in FY16F and some more marginal improvement of 40bps each over FY17/18F. We already build in a higher investment behind A&P (13.6% in FY16F vs. 12.6% in FY15) which is why improvement at the EBITDA level is likely to be much lower than at the gross margin level. Over FY16-18F, we expect the company to deliver an EPS CAGR of ~18%, which will be the highest over the past decade for a three-year period. Our earnings estimates change marginally by -1.5% in FY16F and 0.1% in FY17F on the back of incorporation of the FY15 audited numbers in our models. The tax rate moves up from 30% earlier in FY16F to now 32% and that is the biggest impact on FY16F earnings. Fig. 20: Estimate revisions FY16F FY17F Old New Change Old New Change Revenue 368, , % 427, , % EBITDA 64,371 63, % 74,494 74, % Margin (%) PAT 45,718 44, % 52,725 52, % Source: Nomura estimates Valuations continue to remain high Over the past five years, the stock has traded at an average one-year forward P/E of 31.5x. In FY12-13, when top-line growth was the strongest in the past eight years and margins improved by 220bps, the average one-year forward P/E was 28x. Given that context, valuations at 36.1x FY17F earnings are now towards the higher end of the past 10-year trading band. However, we acknowledge that since that period valuations across the consumer universe globally have seen an up move. We have written extensively about this in the past year (please refer to India consumer - Growth pick-up to support high valuations). Fig. 21: One year forward P/E Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Source: Bloomberg 13

14 Fig. 22: Premium to sensex Source: Bloomberg Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Increase TP to INR1,020 and upgrade to Buy We now increase our TP to INR1,020 (11% implied upside from the current levels) from INR785 earlier. The 30% move in target price is due to: Moving our target valuation multiples higher to 40x from 32x (resulting in 25% move in TP). Rolling forward our TP to June 2017 quarter end (resulting in 3.3% move in target price). We believe the move to 40x multiple is fair given that: It is in line with the past two years average valuation of the company. The sector average P/E multiple is 36.4x FY17F earnings (refer to Fig 24) It is now 19% premium to the 32x multiple that we assign to other mid-cap names in our coverage universe such as Dabur, Marico, GCPL & Emami. We believe this premium is fair given the company s superior brand portfolio and consistent growth. It is still a discount to the target multiple assigned to some of the other MNC s in our coverage universe like Nestle. Given that the parent holding in HUVL is currently ~67%, there is a good chance of the parent increasing its stake to ~75% levels (the maximum possible holding level permitted by SEBI, before they are forced to delist). We have seen the parent company increase its stake in India and Nigeria before and hence cannot be ruled out in future. As well, we have done a FCFE for the company with the following assumptions: Discounting rate of 11x (risk free rate of 7.5%, country risk premium of 5% and Beta of 0.7x) Medium-term growth of 13%, 5bps margin expansion each year, which essentially implies a exit EBITDA margin of 19.6% which is in line with the historically high multiples. Terminal growth of 5% This yields a per share value of INR1,000, which is fairly close to our P/E multiple base TP. Our TP moves from to INR1,020 from INR784. We upgrade the stock to Buy from Reduce. We believe business transformation is under way and will yield results in the near to medium term. 14

15 A look at Unilever Indonesia As a sanity check for our target multiples for HUVR, we compare these to Unilever Indonesia (UNVR IJ, Neutral) where we believe the business dynamics are similar to India in terms of favourable demographics, growing economy & under penetrated products. At IDR40,000 the stock currently trades at 48.9x 2015F EPS of IDR and 42.3x 2016F EPS of IDR Our Indonesia consumer team values UNVR at 50x CY15F EPS of IDR Fig. 23: Unilever Indonesia Source: Bloomberg, Nomura Research Similarities: Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 We forecast earnings growth of 13.2% over the next three years for Indonesia compared to 18.5% CAGR for the India business. We assign higher multiples in Indonesia largely due to: the ability of the company to defend its market share and returns, while improving its working capital requirements (it has negative working capital) given its size, brand and distribution reach. All the arguments hold true for the Indian entity as well. The parent holding in the entity stands at a high 85%, which essentially once again highlights the possibility of corporate action in the Indian company. Key risks P/E Average +1SD -1SD A delay in urban consumption recovery can be a risk to our earnings estimates. However, we assign a low probability of that happening as we are already seeing early signs of demand revival in the urban markets. A sharp rise in commodity prices can cap the upside on gross margins. 15

16 Nomura Hindu stan Unilever 3 August 2015 Peer valuation table Fig. 24: Peer group valuation (July 31, 2015) Company Ticker Rating Price INR TP INR EPS growth (%) P/E (x) FY16F FY17F FY16F FY17F Market Cap US$ mn Nestle * NEST IN Buy 6,357 6,950 0% 22% 46.6x 38.1x 10,215 GSK Consumer * SKB IN Neutral 6,297 6,150 12% 20% 43.6x 36.4x 4,418 Jubilant Foodworks JUBI IN Reduce 1,832 1,120 26% 29% 73.7x 57.4x 1,993 United Spirits UNSP IN Buy 3,706 4,050 N.A 62% 90.1x 55.5x 8,079 Britannia Industries BRIT IN Buy 3,154 2,915 33% 31% 52.4x 40.2x 6,305 F&B Average 60.4x 44.0x Colgate Palmolive CLGT IN Reduce 1,990 1,526 14% 16% 44.0x 37.9x 4,510 Dabur DABUR IN Buy % 20% 38.0x 31.7x 8,500 Godrej Consumer GCPL IN Buy 1,376 1,335 25% 21% 39.9x 33.0x 7,804 Hindustan Unilever HUVR IN Buy 922 1,020 19% 19% 45.3x 38.2x 33,223 Marico MRCO IN Buy % 24% 39.8x 32.1x 4,509 Emami HMN IN Buy 1,311 1,010 19% 23% 51.2x 41.5x 4,959 Eveready Industries EVER IN Buy % 56% 31.3x 20.1x 400 HPC Average 43.6x 36.4x ITC ITC IN Reduce % 11% 25.4x 22.8x 42,933 Asian Paints APNT IN BUY % 30% 40.3x 31.0x 14,116 Pidilite Industries PIDI IN Buy % 16% 41.0x 35.4x 4,510 Titan Industries TTAN IN Reduce % 15% 29.9x 26.0x 4,794 Bata India * BATA IN Buy 1,200 1,320 21% 21% 28.2x 23.2x 1,285 Retail Average 29.6x 25.4x Source: Bloomberg, Nomura estimates, *: Denotes calendar year based valuations, We are reviewing our estimates for GCPL IN, APNT IN, TTAN IN, MRCO IN, BRIT IN, PIDI IN, HMN IN. Prices as at 31 July

17 Appendix A-1 Analyst Certification I, Manish Jain, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies. Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Hindustan Unilever HUVR IN INR Jul-2015 Buy N/A ITC ITC IN INR Jul-2015 Reduce N/A Unilever Indonesia UNVR IJ IDR 40, Jul-2015 Neutral N/A Hindustan Unilever (HUVR IN) Rating and target price chart (three year history) INR 922 (31-Jul-2015) Buy (Sector rating: N/A) Date Rating Target price Closing price 20-Jan Sep Jul Apr Jul Jun Jan-13 Reduce Jan Sep-12 Neutral Sep For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We value HUVR at 40x one-year-forward earnings estimate of INR25.2. The multiple is in line with HUVR's two year average multiple. Our TP is INR1,020. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price Increasing input prices present a risk to our earnings. Slowerthan-expected volume growth in the personal products business is also a risk to our numbers. 17

18 ITC (ITC IN) Rating and target price chart (three year history) INR 326 (31-Jul-2015) Reduce (Sector rating: N/A) Date Rating Target price Closing price 10-Jun-15 Reduce Jun Jan-15 Neutral Jan May Jan Sep For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our target price is INR290. We value the company using a sum-of-the-parts valuation methodology. We value the core cigarettes business at INR207 per share based on a P/E multiple of 17x on on FY17E earnings. Other SoTP valuations: Hotels business at 19x, which gives a value of INR6 per share; the Paper Business EV/EBIT of 8x, which gives a value of INR14 per share; New Ventures at 2x sales, which gives a value of INR35 per share; the Agri Business at 1x sales, which gives a value of INR8 per share; and the Cash and Liquid assets of INR19 per share. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price Lower-than-expected increase in taxes on cigarettes is the upside risk to our view and estimates. Unilever Indonesia (UNVR IJ) Rating and target price chart (three year history) IDR 40,000 (31-Jul-2015) Neutral (Sector rating: N/A) Date Rating Target price Closing price 20-May-15 40, , Oct-14 Neutral 30, Oct-14 32, , Oct-13 Not Rated 32, Apr-13 20, , For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We set our TP at IDR40,925 by assigning a target P/E of 50x to our 2015F earnings estimate of IDR The benchmark index for this stock is MSCI Indonesia. Risks that may impede the achievement of the target price The risks to our view include economic slowdown, commodity price volatility, and currency volatility. Important Disclosures 18

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