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Rural India in a slowdown; better mix and price increases to support operating margin

Key takeaways from HUVR’s end of the quarter (3QFY22) update

Macro environment and demand

* While the recovery in consumption continued after the lifting of restrictions post the second COVID wave, it has been uneven with urban markets leading growth.

* The resilience of rural India is coming off as demand begins to slow down. The demand for MNREGA jobs is high, indicating higher unemployment levels. Farm input inflation has been higher than output inflation, causing farmer incomes to shrink.

* HUVR’s operating categories have seen a mid-single sales growth overall, with flat growth in rural India. This would suggest that rural volumes saw a decline in 3QFY22.

Category and channel-wise trends

* Modern trade (MT) and e-commerce are doing well, which would help deliver a better sales mix, and is, therefore, margin accretive.

* HUVR has gained market share in 75% of its portfolio, with a volume share in some of its categories being at the highest in a decade.

* Horlicks and Boost have seen handsome market share gains, though some system integration issues affected sales in some pockets.

* While discretionary categories continue to see good momentum, the demand in Hygiene has moderated.

* No evidence of downtrading has been seen thus far.

Costs and margin

* High levels of consumer inflation (driven by price hikes) are affecting volume growth.

* Palm oil, crude oil, and packaging cost witnessed sequential inflation.

* While tea prices have fallen, it is still higher on a two-year basis. HUVR has taken some price reductions in its tea portfolio, which would result in lower realizations.

* Price hikes across the portfolio, especially in Soaps and Detergents, along with a reduction in non-value added costs should help offset input cost inflation to some extent.

Valuation and view

* The transient slowdown in rural India and elevated input cost inflation causes us to remain cautious on the stock in the near term. Nevertheless, the structural story for HUVR remains intact.

* HUVR’s earnings have underperformed that of peers in recent quarters owing to: a) a higher proportion of the Discretionary/OOH portfolio at 15-20% of sales, and b) steep commodity cost inflation in its three largest categories – Soaps, Detergents, and Tea. As mobility continues to improve, HUVR stands to be the biggest beneficiary of an urban recovery v/s its Staples peers. Improvement in the mix and price increases should offset commodity cost pressures to some extent. Beyond the near term, the earnings outlook is likely to be better v/s its Staples peers going forward.

* Earnings growth for HUVR has gained further impetus in recent years (before COVID-19 affected FY21) – it reported ~18% EPS CAGR in the four years ended FY20. This is particularly impressive given the weak mid-to-single digit earnings growth posted by its (much smaller) peers in recent years.

* We maintain our Buy rating with TP of INR2,800 per share (55x Dec’23E EPS).

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