Multiple margin tailwinds; BUY After maintaining a neutral call on HUVR for past two years, we upgrade it to BUY on the back of (i) multiple margin tailwinds, (ii) slow but steady improvement in volume growth and (iii) reasonable valuations vis-à-vis peers. Our TP of Rs1,010is based on forward P/E of 36x. We see multiple margin tailwinds: (i) benign input cost inflation, (ii) competitive pressure from P&G is lower, (iii) likely GST benefits, (iv)exercising potential pricing power in detergents, (v) premiumization and (vi) cost rationalization as part of Unilever s global strategy. Volume growth should improve to 2-3% in Q4FY17 (vs. 4% decline in Q3FY17) and should see further uptick in FY18E. We estimate net sales/eps CAGR of 13%/18% over FY17-19E. Valuation at FY18EP/E of 39x is not cheap but reasonable vs. peers (Nestle, Marico, APNT trade at ~45x). BUY Target Price: Rs 1,010 CMP : Rs 905 Potential Upside : 12% MARKET DATA No. of Shares : 2,164 mn Free Float : 33% Market Cap : Rs 1,958 bn 52-week High / Low : Rs 954 / Rs 783 Avg. Daily vol. (6mth) : 1.2 mn shares Bloomberg Code : HUVR IB Equity Promoters Holding : 67% FII / DII : 13% / 6% Atleast ~200bps rise in OPM over FY17-20 as multiple margin tailwinds play out: Raw materialinflation: Recent correction in PFAD and crude coupled with rupee appreciation should help margins P&G: Lower competition from P&G as it focuses on profitability vs. earlier strategy of sales growth in D&E markets GST: Cost savings along with higher input credits will help margins and any higher GST rate will be passed on Home Care EBIT margin at 10-11% is much lower than Personal Care (~24%) and Refreshment (15-16%) even though HUVR is very strong in the category. We note prices in key brands like Surf Excel Easy Wash have actually come down over past four years despite no increase in competitive intensity as the company chased market share and premiumization. Home Care margincan go up sharply on the back of price increase ahead of inflation Premiumization:Consumer up trading to premium brands is a secular story with HUVR being the biggest beneficiary, as it has higher market share in premium end of every category. This helps both sales growth and margin and Global cost rationalization:recently (after Kraft s bid on Unilever), Unilever s management has laid down a strategy to improve margin by 370 bps overnext four years. We expect cost rationalization in HUVR will help to drive improvement in EBITDA margin Financial summary (Standalone) Sales (Rs mn) 314,253 312,654 351,461 395,723 Adj PAT (Rs mn) 40,776 42,074 49,992 58,640 Con. EPS* (Rs) - 19.9 22.7 26.1 EPS (Rs) 18.8 19.4 23.1 27.1 Change YOY (%) 5.4 3.2 18.8 17.3 P/E (x) 48.0 46.5 39.2 33.4 RoE (%) 110.0 116.8 135.0 142.5 RoCE (%) 169.2 182.7 207.6 216.1 EV/E (x) 33.3 31.8 27.0 23.1 DPS (Rs) 16.0 17.0 18.0 21.0 Source: *Consensus broker estimates, Company, Axis Capital Key drivers (%) FY16 FY17E FY18E FY19E Volume growth 5.8% 0.0% 7.0% 7.0% Net Sales growth 4.2% -0.5% 12.4% 12.6% RM cost to sales 48.7% 50.1% 49.7% 49.7% EBITDA margin 18.2% 19.2% 20.1% 20.8% Price performance 140 Sensex Hindustan Unilever 120 100 80 60 Jul-16 Oct-16 Jan-17 Apr-17 01
Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-17 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-17 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Slow and steady improvement in volume growth After modest volume growth of 4-7% (CAGR of 5.4%) over FY12-16, HUVR s volume growth came down to 0% in FY17 as slowdown worsened and H2FY17 was hit by demonetization. We expect volume growth to improve to 2-3% in Q4FY17 (vs. 4% decline in Q3FY17) and improve further to 6-7% in FY18, as economy picks up and a better monsoon perks up rural fortunes. Exhibit 1: HUVR Volume growth 15% 13.0% 12% 9% 6% 3% 3.3% 4.6% 9.3% 6.8% 4.0% 5.0% 5.8% 7% 7% 0% 0% Valuations reasonable vis-à-vis peers At FY18E P/E of 39x, the stock is not cheap but is relatively better off than peers. We note that peers like Marico, Asian Paints and Nestle trade at ~45x and others like GCPL, Colgate and Britannia trade at 40x. The stock has been consolidating in the range of Rs800-930 for the past 30 months, as sales growth was under pressure. With steady improvement in volume growth and margin tailwinds, HUVR is relatively better placed in the sector. We continue to remain negative on the overall sector but relatively prefer HUVR. Exhibit 2: 1-year fwd P/E (on consensus earnings) Exhibit 3: Valuation premium to peers 50 45 40 (x) P/E 10 yr median 50 40 30 Val premium to peers^ (%) 10 yr median 35 20 30 25 20 15 10 0 (10) (20) (30) ^Peers: BRIT, CLGT, GCPL, DABUR, NEST 02
Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Jul-15 Oct-15 Jan-16 Jul-16 Oct-16 Jan-17 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Jul-15 Oct-15 Jan-16 Jul-16 Oct-16 Jan-17 16% 16% 15% 6% 11% 21% 21% 14% 17% 19% 20% 24% 22% 26% 29% 28% 28% 30% Competition quite benign: P&G s focus shifts from topline to margin We see lower competitive intensity from P&G, as it focuses on profitability over the earlier strategy of sales growth in developing and emerging markets. In India, the change in strategy is clearly visible in the topline and margin shift in P&G Hygiene and Healthcare (PGHH). Exhibit 4: PGHH EBITDA margin trend (shift in focus) 29% 27% 25% 23% 21% 19% 17% 15% Topline focus drove margin pressures Focus shifted to profitability FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Exhibit 5: PGHH Net sales growth (influenced by change in strategy) 35% 30% 25% 20% 15% 10% 5% 0% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Pricing power in detergents can come into play We note that prices of key brands like Surf Excel Easy Wash and Rin Advanced have come off in past four years and that of brands like Surf Excel Quick Wash have increased only mildly. This was done to strengthen leadership in the category and drive the premiumization agenda. With no increase in competitive intensity and strong pricing power, we expect HUVR to take price increases ahead of inflation in the laundry category, resulting in sharp improvement in the margin. Exhibit 6: Surf Excel Easy Wash: No price increase for three years to drive premiumization agenda Exhibit 7: Gradual price hikes in Wheelhelp reducing price premium to Rin Advanced 75 70 (Rs/500gm) 95 85 (%) 65 60 75 65 55 55 45 50 35 Source: Axis Capital Source: Axis Capital 03
Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Jul-15 Oct-15 Jan-16 Jul-16 Oct-16 Jan-17 Apr-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Margin tailwinds to aid Raw material costs have risen in H2FY17, but the company has managed to protect the margin by rolling the promotions back and undertaking price actions across most of the segments. We do not see runaway inflation in commodities. Recent correction in PFAD and crude coupled with rupee appreciation should help margins. Exhibit 8: PFAD Exhibit 9: LAB 800 700 (USD/mt) 110 105 (Rs/ kg) 600 100 500 95 400 90 300 85 200 80 Exhibit 10: Crude Exhibit 11: HDPE 70 (USD/barrel) 110 (Rs/kg) 60 105 50 40 100 95 90 30 85 20 80 Source: RIL, Axis Capital 04
Cost rationalization agenda at Unilever Unilever s management has laid down a strategy to improve margin by 370 bps over the next four years. We expect cost rationalization in HUVRwill help to drive improvement in the EBITDA margin. Exhibit 12: Unilever New financial targets USG 3-5% based on current market conditions Cash conversion defined as Free Cash Flow as a % of Net Profit before profits & losses on disposals ROIC defined as Underlying Operating Profit after tax / Average (PPE + Working Capital+ Assets held for sale + Goodwill + Software) Source: Company Exhibit 13: Unilever Underlying operating margin to 20% in 2020 Source: Company 05
Financial summary Standalone Profit &loss (Rs mn) Net sales 314,253 312,654 351,461 395,723 Other operating income 5,619 6,061 6,538 7,045 Total operating income 319,872 318,715 358,000 402,769 Cost of goods sold (153,130) (156,790) (174,675) (196,578) Gross profit 166,742 161,925 183,325 206,190 Gross margin (%) 53.1 51.8 52.2 52.1 Total operating expenses (109,443) (101,868) (112,851) (123,983) EBITDA 57,299 60,057 70,474 82,207 EBITDA margin (%) 18.2 19.2 20.1 20.8 Depreciation (3,208) (3,863) (4,066) (4,330) EBIT 54,092 56,194 66,408 77,877 Net interest (2) (200) (150) (125) Other income 5,006 5,429 5,674 6,020 Profit before tax 59,096 61,423 71,931 83,771 Total taxation (17,882) (19,348) (21,939) (25,131) Tax rate (%) 30.3 31.5 30.5 30.0 Profit after tax 41,214 42,074 49,992 58,640 Minorities - - - - Profit/ Loss associate co(s) - - - - Adjusted net profit 40,776 42,074 49,992 58,640 Adj. PAT margin (%) 13.0 13.5 14.2 14.8 Net non-recurring items (390) - - - Reported net profit 40,386 42,074 49,992 58,640 Balance sheet (Rs mn) Paid-up capital 2,164 2,165 2,165 2,166 Reserves & surplus 34,709 33,032 36,705 41,242 Net worth 36,873 35,197 38,870 43,408 Borrowing - - - - Other non-current liabilities (2,309) (2,309) (2,309) (2,309) Total liabilities 34,564 32,888 36,562 41,099 Gross fixed assets 53,787 58,537 63,537 68,737 Less: Depreciation (24,640) (28,503) (32,570) (36,900) Net fixed assets 29,147 30,034 30,967 31,837 Add: Capital WIP 3,860 3,860 3,860 3,860 Total fixed assets 33,007 33,894 34,827 35,697 Total Investment 29,666 32,666 35,666 38,666 Inventory 25,284 27,839 31,776 36,320 Debtors 10,645 8,994 10,592 11,926 Cash & bank 27,588 24,241 26,417 30,006 Loans & advances 12,546 12,493 13,998 15,778 Current liabilities 104,798 107,988 117,514 128,143 Net current assets (28,108) (33,671) (33,931) (33,263) Other non-current assets - - - - Total assets 34,564 32,888 36,562 41,099 Cash flow (Rs mn) Profit before tax 59,096 61,423 71,931 83,771 Depreciation & Amortisation 3,208 3,863 4,066 4,330 Chg in working capital 3,464 2,215 2,436 2,921 Cash flow from operations 41,325 42,724 50,821 59,871 Capital expenditure (5,643) (4,750) (5,000) (5,200) Cash flow from investing 2,477 (2,321) (2,326) (2,180) Equity raised/ (repaid) - 1 1 1 Debt raised/ (repaid) - - - - Dividend paid (41,395) (43,996) (46,599) (54,384) Cash flow from financing (41,589) (43,751) (46,319) (54,103) Net chg in cash 2,213 (3,347) 2,176 3,589 Key ratios OPERATIONAL FDEPS (Rs) 18.8 19.4 23.1 27.1 CEPS (Rs) 20.1 21.2 25.0 29.1 DPS (Rs) 16.0 17.0 18.0 21.0 Dividend payout ratio (%) 85.7 87.5 78.0 77.6 GROWTH Net sales (%) 4.2 (0.5) 12.4 12.6 EBITDA (%) 10.0 4.8 17.3 16.6 Adj net profit (%) 5.5 3.2 18.8 17.3 FDEPS (%) 5.4 3.2 18.8 17.3 PERFORMANCE RoE (%) 110.0 116.8 135.0 142.5 RoCE (%) 169.2 182.7 207.6 216.1 EFFICIENCY Asset turnover (x) (22.4) (21.8) (22.3) (22.6) Sales/ total assets (x) 2.3 2.2 2.4 2.4 Working capital/ sales (x) (0.2) (0.2) (0.2) (0.2) Receivable days 12.4 10.5 11.0 11.0 Inventory days 35.1 39.3 40.3 41.4 Payable days 76.4 78.6 79.5 80.2 FINANCIAL STABILITY Total debt/ equity (x) - - - - Net debt/ equity (x) (1.4) (1.4) (1.5) (1.5) Current ratio (x) 0.7 0.7 0.7 0.7 Interest cover (x) 30,050.9 281.0 442.7 623.0 VALUATION PE (x) 48.0 46.5 39.2 33.4 EV/ EBITDA (x) 33.3 31.8 27.0 23.1 EV/ Net sales (x) 6.1 6.1 5.4 4.8 PB (x) 53.1 55.6 50.4 45.1 Dividend yield (%) 1.8 1.9 2.0 2.3 Free cash flow yield (%) 1.8 1.9 2.3 2.8 06
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