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Mixed result despite a profit beat

* HUVR’s 3QFY22 result was broadly in line with our volume, sales, and gross margin estimate, but sharply lower ad spends (down 14.3% YoY and 260bp YoY as a percentage of sales) led to a 8.5-9% beat in our EBITDA, PBT, and adjusted PAT estimates. Since the largest player (also the first to report its result) has cut ad spends, it remains to be seen whether it is a harbinger of a trend that its other Staples peers also adopt to shore up margins in a difficult commodity cost environment.

* Two factors have held back HUVR’s performance over the past few quarters viz: a) higher material cost pressures v/s other Staples, especially with all its three largest categories (Skin Cleansing, Fabric Wash, and Beverages) witnessing sharp input cost increases, and b) a slower than expected recovery in the high margin discretionary portfolio (including growth of ~5% in 3QFY22) where HUVR is over indexed. Both of these are likely to put pressure on earnings over the next two quarters as well, especially given the steep increase in Dec’21 as well as some impact of the third COVID wave in 4QFY22 (albeit temporary) on the discretionary portfolio.

* On the positive side, a) its operating margin base is favorable for the next three quarters, b) continued market share gain in 75% of its portfolio is encouraging, c) the high margin discretionary portfolio will return to normal, and d) potential increase in government allocations towards the rural sector in the upcoming Budget could provide a much needed fillip to demand. We maintain our BUY rating as we see earnings returning to the 15-17% CAGR witnessed in the pre-COVID period.

Performance in line with our estimates

* Reported net sales grew 10.4% YoY to INR130.9b in 3QFY22 (in line with our estimate). EBITDA/PBT/PAT (bei) increased by 14.9%/17.1%/17.5% YoY to INR32.8b/INR30.9b/INR22.9b (est. INR30.1b/INR28.4b/INR21b).

* Sales in the domestic Consumer business grew 11% YoY, with underlying volume growth of 2% (in line with our estimate).

* Segmental performance: Home Care (32% of total sales in 3QFY22) revenue grew up 23% YoY. Personal Care sales (40% of total sales) rose 6.9% YoY. Sale of Foods and Refreshments (26% of total sales) grew 3.3% YoY.

* Segmental EBIT margin: Home Care margin expanded by 170bp YoY to 20.6%. Personal Care margin contracted by 130bp YoY to 27.8%. Margin in the Foods & Refreshments segment expanded by 450bp YoY to 18.6%.

* Overall gross margin contracted by 190bp YoY to 52.1% in 3QFY22 (In line with our estimate).

* As a percentage of sales, lower operating expenses (-60bp YoY to 13%), ad spends (-260bp to 9.1%), and higher staff costs (+30bp to 5%) led to an EBITDA margin expansion of 100bp to 25% (est. 23.5).

* Absolute ad spends fell 14.3%, but rose 3.1 YoY, to INR11.9b/INR34.3b in 3Q/9MFY22. Ad spends, as a percentage of sales, fell 70bp to 9.1% in 9MFY22.

* Sales/EBITDA/PAT (bei) grew 11.4%/10.6%/9.9% YoY in 9MFY22.

Highlights from the management commentary

* Two-thirds of HUVR’s portfolio registered double-digit two-year CAGR including Fabric Care, Beverages, Skin Cleansing, Household Care, and Ice Creams. Skin Care, Hair Care, Foods, and Oral Care (~30% of sales) posted high-mid-singledigit two-year sales CAGR. Growth was weak in Color Cosmetics and Water Purifiers (~3% of the portfolio).

* There has been a 30% increase in the overall material cost basket. The management expects higher inflation sequentially in 4QFY22. Freight inflation and supply chain disruption are expected to have an effect. RM costs are expected to flatten in the 2HCY22, before beginning to taper.

* The Shikhar app now has 0.7m users and are serviced by distributors and not the company. HUVR is investing significantly to improve distributor ROI. Even 10 years from now, distributors will remain the dominant channel for FMCG.

Valuation and view

* Revisions to our model have led to a +2.6%/-0.9%/-0.1% change in our FY22E/FY23E/FY24E EPS estimate.

* Before steeper commodity cost inflation v/s peers and HUVR’s over indexed discretionary portfolio affected earnings in FY21 and FY22, the same had been extremely strong, having reported ~18% EPS CAGR in the four years ending FY20. This was particularly impressive given the weak mid-single-digit earnings growth posted by its (much smaller) Staples peers over the same period. We expect the company to return to the 15-17% earnings growth range.

* We also believe that HUVR is the best prepared among peers, both on the technology front as well as on the e-commerce strategy, to deal with potentially significant disruptions going forward.

* Given all these factors, valuations at 51.9x/45.3x FY23E/FY24E EPS still leave room for an upside. We maintain our BUY rating with a TP of INR2,750/share (55x FY24E EPS).

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