By Isabella Zhong
Hindustan Unilever's shampoos, detergents and creams aren't the
only things that have gotten more expensive this year. The
fast-moving consumer goods company's share price has surged a
mammoth 45% since May, outpacing the 28% gain clocked by India's
benchmark Sensex index.
Currently at a record high of around 804 Indian rupees a share,
Hindustan Unilever (500696.IN) fetches a steep 40 times projected
earnings. Perhaps too steep. Even vocationally bullish analysts
surveyed by FactSet expect the company's share price to correct
around 13% to an average target price of around INR704. Time to
take some stock off the shelf?
JPMorgan's Latika Chopra thinks so. The Mumbai-based analyst has
an underweight rating on the stock and expects it to retreat to
about INR700. Even after that, the stock price would still be a
rich 31 times earnings, and merely in-line with the average
three-year average valuation multiple.
Hindustan Unilever is India's second largest fast-moving
consumer goods company by market capitalization, behind ITC
(500875.IN). Established in 1933, the company is majority-owned by
the global conglomerate Unilever (UN, ULVR.UK). Household and
personal care products account for around three quarters of the
company's revenue, with packaged foods and beverages making up the
remainder.
For a mature company with limited scope to expand margins, sales
volume growth becomes a key driver of valuations. Hindustan
Unilever will need to grow volume in the high single-digit
percentages to justify its current valuation multiple, notes HSBC
analyst Amit Sachdeva. That's quite a tall order given the 5%
year-over-year volume growth Hindustan Unilever eked out in the
second quarter of the Indian fiscal year, or the three months
ending in September.
The task looks especially taxing given declining volume growth,
which slipped from 6% in the first quarter and an average of 6.8%
in the past two years. Complicating the challenge is an
increasingly sluggish Indian market for fast-moving consumer goods.
"Volume rates continue to be challenged by a weak macro," notes JP
Morgan's Chopra. Volume growth in the overall market was a dull 4%
in the second quarter, and was a long way off the 10% seen back in
2012. The good news: Aggressive targeting of the faster-growing
rural consumer segment has helped to support Hindustan Unilever's
topline growth, but the bad news is that growth in that segment has
also started to flag.
Near double-digit inflation also hasn't helped. With prices
rising faster than incomes, people have been left worse off in
terms of the amount of goods they can buy. The Indian press, for
instance, has stories chronicling how some families are using Neem
tree twigs as a teeth cleanser because toothpaste is no longer
quite as affordable.
Expectations that consumption might get a helping hand from
monetary policy were dashed by the Reserve Bank of India this week.
The central bank opted to maintain its benchmark interest rate at
8%, although it indicated that a cut may be on the cards for its
February meeting if inflation and the government's fiscal deficit
remain in check.
Although a rate cut might buoy consumption, there's a downside
for companies like Hindustan Unilever. Should India begin cutting
rates, the market "will increasingly focus on cyclical and levered
stocks, which can offer high earnings growth relative to the net
cash sector" and that could persuade investors to steer money out
of slower-growing staples like Hindustan Unilever, notes HSBC's
Amit Sachdeva, who has an underweight rating on the stock.
Hindustan Unilever's valuation is also loftier than some of its
better performing peers. Revenue growth averaged an underwhelming
10.5% over the past four quarters, versus an average of 14% for
Colgate-Palmolive (500830.IN), and 12% for Dabur India (500096.IN)
and Britannia Industries (500825.IN).
The same is true when it comes to bottom-line expectations.
Analysts surveyed by FactSet expect Hindustan Unilever to generate
12% annual earnings growth over the next three to five years. That,
JP Morgan's Chopra notes, is among the lowest for India's
fast-moving consumer goods companies.
Yet Dabur India, which is expected to deliver 18% annual
earnings growth over the next three to five years, trades at a
price-to-earnings multiple of 35 times, and Britannia Industries,
which is expected to see 13% annual earnings growth, trades at 36
times - both below 40 times for Hindustan Unilever.
While Hindustan Unilever's EBITDA (or earnings before interests,
taxes, depreciation and amortization) margin improved slightly in
the second quarter, the widening was mainly due to a cut in
advertising and promotional spending on the back of fewer brand
introductions, which could leave a sour after taste for sales in
coming quarters. The company's gross margin actually shrunk
compared to last year as a result of retailers taking a chunkier
cut of sales and a higher excise duty burden. With intensifying
competition in key product categories, Hindustan Unilever will
likely to have to re-elevate advertising spending.
Of course, the company will get a breather from the low price of
crude oil and other raw materials, such as palm oil. But the boost
to gross margins could be offset by wider retail margins and higher
excise duties and royalties.
Hindustan Unilever has laid out plans to carve out a new Central
branch in its operation and distribution structure, which is
currently divided into four geographic regions. That will allow the
company to better target India's Hindi heartland, which has a large
population that currently spends less on consumer goods than other
regions. Rising income levels, which are widely expected for India,
could pave the way for strong growth in the region's demand for
consumer products. But it may be a while before Hindustan Unilever
starts to see benefits from the reorganization.
HSBC's Amit Sachdeva describes Hindustan Unilever as "attractive
from a long term perspective but no significant revival in the
short term." Indeed, rising income levels could help India's
consumer goods companies. But for now, Hindustan Unilever's
exorbitant valuation, along with weak growth in the foreseeable
future, suggest the stock may be best left on the shelf.
---
Email: isabella.zhong@barrons.com
---
Comments? E-mail us at asiaeditors@barrons.com
Subscribe to WSJ: http://online.wsj.com?mod=djnwires