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(Re) Investing (margins) for growth

Consensus believes that (1) HUL is prioritising volume over margins (rightly so) and (2) expects operating margin expansion from GSK-synergies – that’s debatable, in our view. See our report highlighting the Horlicks & Boost price cuts / improving value. We like the volume focus and the tight-rope-act in balancing penetration-driven growth (DCF-accretive) vs short-term margins. Note that it had multiple mix headwinds (channel, category, brand). Importantly, during times of hyper-inflation in inputs, retaining volumes of price-pointed packs (LUPs) is a better strategy than moving up coinage prices. Nevertheless, managing the ‘continuous margin expansion’ narrative is difficult from now.

Comparable domestic consumer business sales grew by 12% in Q1; underlying volume grew 9% (2-year CAGR was flat). We liked the continued good performance in health, hygiene and nutrition portfolio with decent recovery in other businesses. We like (1) HUL’s supply chain agility and digital initiatives (incremental Shikhar outlets) in these challenging times, and (2) continuing plans to gain market shares in various categories by partially absorbing input cost inflation in short-term. ADD.

* Overall revenue performance improved: Reported revenue / EBITDA / recurring PAT grew 13% / 8% / 5%. Underlying domestic consumer business revenue (excluding merger of VWash) grew 12% with 9% volume growth (UVG; 2-year CAGR was flat). Health, Hygiene and Nutrition (85% of company portfolio) witnessed 8% revenue growth. Further, discretionary segments of Skin care, Deos and Colour cosmetics (12% of company portfolio) and out of home consumption businesses like water, ice-creams, food solutions and vending (3% of company portfolio) also grew 39% and 91% respectively on a much lower base (continued to be weak on a 2-year CAGR basis). Nutrition volumes grew in mid-single digit in Q1.

* Gross margin impacted due to commodity headwinds: Gross margin declined 140bps to 50.4% due to an inflationary trend in input costs which was partially offset by price hikes. HUL continued with the strategy to not pass on the steep inflation completely through calibrated price hikes in order to gain market share. It continues to believe that sustaining business structures is more important and margin expansion can be achieved over time.

* Lower ad-spends drive operating margin expansion: Reported EBITDA margin contracted 110bps YoY to 23.9% due to normalisation of ad-spends (+100bps YoY), even as absorption was better in other operating expenses (-90bps YoY) and staff costs (-40bps YoY).

* Valuation and risks: We cut our earnings estimates by ~2% for FY22E; modelling revenue / EBITDA / PAT CAGR of 13 / 17 / 16 (%) over FY2021-23E. Maintain ADD rating with DCF-based target price unchanged at Rs2,600. Key downside risks are delayed recovery in demand and irrational competition.

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