Analyst Corner: Maintain ‘buy’ on Hindustan Unilever with TP of Rs 2,780

We interacted with the management of Hindustan Unilever (HUVR) for an update on overall market conditions. Here are the key takeaways:

Macro environment and sales channels: With various parts of India progressively opening up, the management believes the impact from the second Covid wave would have peaked in May’21 and things will progressively get better. The outlook from Jun’21 onwards is positive, barring the emergence of a third Covid wave. The increase in store operating hours is also a positive development. Rural continues to do better than urban, despite experiencing a higher impact from the pandemic in 1QFY22 v/s last year. Prediction of a normal monsoon, good Rabi harvest, favourably timed kharif sowing, and MNREGA provide prospective support as well. The modern trade (MT) channel was affected.

Segmental demand trends: There was a lower amount of pantry stocking as the availability of essentials was ensured. Preventive measures like hand washing and a focus on hygiene among consumers continues to be seen. Hygiene and in-home categories (80% of HUVR’s portfolio) continue ton witness healthy demand. Demand for discretionary products was impacted as urban and MT sales, which had normalized in 4QFY21, were affected from the second half of Apr’21 till the end of May’21. The impact though is lesser than last year. The management said there would be some impact on the sales of GSKCH products due to temporary destocking on account of distributor integration, which started at the end of Mar’21.

Costs and margin: While there has been some softening of palm oil prices in the last two weeks, Apr’21 and May’21 continued to witness RM inflation. Crude and tea prices have risen sequentially. In the case of tea, there is hope that the new crop, due to arrive in Jul’21, will lead to a softening of prices. HUVR has taken further price increases in soaps, detergents, home products, and tea in 1QFY22. With some impact on discretionary demand sequentially (albeit better than 1QFY21), further RM inflation, and elevated advertising spends, EBITDA margin will be under pressure in 1QFY22.

Valuation and view: While 1QFY22 will be impacted by the second Covid wave, the extent will be far lower compared to last year. Rural continues to remain resilient, and demand in Health, Hygiene, and Nutrition categories remains healthy. While discretionary demand will be affected, we expect the impact to be lower YoY. EBITDA margin is likely to remain under pressure owing to sequential RM inflation and higher A&P spends.

From a medium-term perspective, the outlook remains positive. Growth in earnings has gained further momentum in recent years (~18% EPS CAGR in the four years ended FY20 v/s ~12% CAGR over the 10 years ended FY20). Despite a highly disruptive year, HUVR posted an EPS growth of 11.5% in FY21. This is particularly impressive given the weak mid-single-digit earnings growth posted by (much smaller) peers in recent years.

We maintain our Buy rating with a TP of Rs 2,780 per share.