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Most ‘knowns’ (concerns!) in price (somewhat!); time to ADD

HUL’s underperformance of ~60% vs the Nifty over Mar’20-April’22 may be potentially interpreted as the stock already factoring in most of the concerns: (1) rural slowdown-led demand pressure, (2) inflation woes and (3) D2C-led premiumisation challenges (reality and narrative). Technically speaking, some part of the underperformance may also be due to the absorption of GSK’s block stock sale in May’20 (Rs254bn; 5.7% stake; one of the largest-ever secondary sale). Upside triggers: (1) large players (in commodity sensitive categories) are beneficiaries of inflation in the medium term (operating leverage, opportunity to have some ‘price retention’ benefits (in the commodity deflation cycle), ability to play the portfolio and accelerate volume share gains), (2) increasing probability of turnaround in nutrition (Horlicks, Boost), (3) likely improvement in rural incomes by 2HFY23, and (4) opportunities for bolt-ons (link).

That said, the task (ahead) is a tough one – eye on mid-to-long term while navigating multiple (near-term) challenges. Second, we believe there are multiple intermediate markers which leaders like HUL are expected to deliver on: (1) steady premiumisation and category development, (2) enhance digital capabilities including e-commerce salience, D2C brands and fair share in newer distribution models along with maintaining existing competitive advantages. Maintain ADD

HUL has seen a long period of underperformance. HUL has underperformed the broader market by ~60% over Mar’20-April’22 (pre-covid levels). Also, it has corrected by ~20% from its recent peak in Sept’21. Despite fundamental woes (discussed in detail below) during this time, technically speaking, some part of the underperformance may also be due to the absorption of GSK’s block stock sale in May’20 (Rs254bn; 5.7% stake; one of the largest-ever secondary sale)

Near-term demand pressures – a known reality. We believe near-term demand concerns are well appreciated by consensus and it’s not an incremental negative (read low probability of further earnings cut, in our opinion). The demand slowdown in rural markets with commentary of downtrading and volume decline by FMCG companies is the (accepted) base case for consensus for FY23, in our opinion.

Rural in stress for now, may get better through FY23: Our interaction with FMCG CXOs (Consumption conversations – link 1, 2, 3, 4, 5, 6, 7, 8, 9, 10) suggests that a large part of the demand slowdown (in rural markets) is ascribed to inflationary pressure in two ways: (1) share of wallet problem for FMCG and (2) increase in farm input prices leading to lower incomes. While this stress is well known, expectations are shaping up that some of the agri-inflation should start benefiting rural incomes. Saugata Gupta, MD & CEO, Marico highlighted in I-Sec Consumption conversations (link) that rural demand may recover in 2HFY23 (driven by higher realisations in wheat).

Perception of D2C / Internet-first brands disruption is (already) there in the narrative, can potentially improve from here: In our view, D2C / internet-first brands in beauty and personal care (BPC) are definitely hurting performance of large BPC players in a big way (currently) and consensus is (rightly) concerned about the narrative. For sustained stock performance, the consensus (including us) should have confidence of HUL’s ability to premiumise the BPC portfolio

HUL’s narrative has always been premiumisation, even say 15-10-5 years ago. It has delivered well on premiumisation until now; however, a large part of it was supported by the gains in Home Care. We believe that some concerns around the D2C-led disruption (to premiumise) are already factored in the stock underperformance.

Leadership changes? We’ve no (concrete) view; however, recent events are interesting to observe: With HUL separating the Chairman of the Board and MD & CEO roles and Mr Nitin Paranjpe back as non-executive Chairman, some investors believe that more changes are likely. For us, just one simple thought - New CEOs are positive for stock returns. That said, the template may not necessarily work for HUL (stock) given that the execution on long-term markers under Sanjiv continues to be good.

Large players are beneficiaries of inflation in the medium term. Over the last few years, we have witnessed large players benefit from dual tailwinds of formalisation and consolidation. While formalisation (shift from unorganised to organised) has aided growth for consumer companies (for quite some time), we believe it is now coupled with consolidation as well (large players outperforming). We believe the gains for the larger players are on the back of (1) companies prioritising market share gains amidst high inflationary pressure and (2) ability to navigate emerging trends.

GSK portfolio turnaround efforts. While the discretionary part of HUL’s portfolio did witness lower demand in the last two years, we believe a large part of the disappointment for consensus was the weaker-than-expected performance of the nutrition portfolio. We note HUL’s efforts of (1) price cuts (appears an incorrect marketing move, in our view though), (2) efforts to improve affordability and (3) focus on protein nutrition are positive for long-term category development. Being a category leader, HUL’s actions of category development over market share gains can actually be a much better driver of value in the long term.

Valuation and risks: All said, we cut our earnings estimates by ~10% for FY23- 24E; modelling revenue / EBITDA / PAT CAGR of ~13 (%) over FY2022-24E. Maintain ADD rating with a DCF-based revised target price of Rs2,450 (earlier was Rs2,500). Key downside risks are delayed recovery in demand, sustained raw material inflation and irrational competition.

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