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1*1 with Hindustan Unilever

Inflation is good, volatility is even better (for share gains), for larger, well-managed organisations like HUL, in our view. If FY22 was the year of (return) of inflation, FY23 (till now) appears to be a year of volatility (benefiting companies like HUL even more).

Read on - 1) HUL continues to drive market development-led penetration gains while Health Food Drinks (HFD) category continues to be impacted due to external reasons, 2) significant opportunity of premiumisation-led growth across categories including laundry and tea, 3) margin expansion is expected to be moderate going forward, 4) HUL continues to gain market shares in all three divisions, price segments & geographies, and 5) inflation is required to ease down to drive volume & price balanced growth. We had turned more positive on HUL a few months back (link) citing that most of the concerns around the stock (rural slowdown, inflation woes, D2C premiumisation challenges) were priced in.

The potential upside triggers are (1) large players being beneficiaries of inflation in the medium term and (2) likely improvement in rural incomes by 2HFY23 are playing out well. Hopes of some easing of inflationary RM (in 2H) are a positive – the big players have sufficient learnings to protect consumer franchise during such times.

On the concerning part, the nutrition portfolio – the journey for a significant change in trajectory seems slightly long given the category headwinds. Adjacencies should have good potential but need to be balanced well (without hurting the core). We continue to have a constructive view. ADD.

* Health Food Drinks (HFD) category continues to be impacted by external reasons while HUL continues to build the platform for growth once market situation improves:

Top line growth in HFD portfolio over last couple of years has been largely dragged down due to 1) covid impacting consumption as there were options / time to give other alternatives as children were at home and 2) cost of a cup of Horlicks with milk which was Rs12 earlier is now Rs18 (steep inflation of +50%). This led to decline in market volumes for HFD category. However, market development activities continue leading to penetration gains for HUL in this category. HUL continues to focus on 1) market development – 10-12mn households visits every quarter to explain the product and induce trials, 2) expanding the Plus range, and 3) food equivalence communication. As per management, better affordability with easing inflation pressure should drive improvement in category performance. Gross margins continue to be materially margin accretive despite price cuts in Nutrition portfolio.

* Significant opportunity of upgradation and market development: For example, in terms of volume, ~60-70% and ~40-50% of laundry and tea category are at the mass/popular end. A lot of upgradation opportunity still exists in these categories from mass to branded and then to premium products. Strategy to upgrade consumers is to drive premiumisation on one side to drive better margins and simultaneously provide the right price-value equation on the mass product to drive upgradation. The other important lever of growth is by consistently investing in market development of newer formats/benefit spaces like green tea, laundry liquids, etc. to generate trials and indict habits.

* Market share gains in all 3 divisions, price segments and geographies: HUL has had the highest YoY market share gains in FY22 over last decade. Market share gains is in all 3 divisions, and geographies as well. Market shares gains were across mass and premium price segments.

* Margin expansion to be moderate: Margin expansion is expected to be moderate going forward as per management. Margin expansion will be driven by 1) operating leverage and 2) premiumisation. Part of margin expansion will be invested back into the business to drive growth. Advertising and Promotion expenses (competitive investing) are expected to come back once gross margins return with normalisation of input cost. Media inflation continues to be there with recovery in lot of consumption categories like Autos, Ed-tech, gaming etc.

* Volume vs price: Inflation needs to come down to drive volumes. Once inflation comes down, there will be balanced price and volume growth as compared to pricing led growth currently.

* Two tales of recovery in personal care: Recovery in personal care is largely dependent on macroeconomic situation currently. There is a clear difference in consumption patterns across target consumer. Premium products targeting higherincome consumers (Ponds, Lakme, Dove etc.) are performing well while mass products which cater to people with limited disposable incomes (Glow and Lovely) are underperforming as these are the people who are more impacted by inflation.

* Likely no steep price hikes further: HUL’s price increases have not been in tandem with the commodity price increase. When management sees that inflationary trend is reversing, they become more circumspect in taking further pricing in those categories to ensure the right price-value equation for consumers and to remain competitive. Management strategy is that price increases are taken taking small bites and price drops are taken in a larger bite.

* Other highlights: 1) High focus on product superiority (did not compromise on quality during inflationary pressure); 2) HUL now has 2x more superior products when compared to 2019.

* Valuation and risks: Our earnings estimates are unchanged; modelling revenue / EBITDA / PAT CAGR of 12 / 13 / 13 (%) over FY22-24E. Maintain ADD rating with a DCF-based unchanged target price of Rs2,750. Key downside risks are delayed recovery in demand, sustained raw material inflation and irrational competition.

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