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Decent performance given the context; 'narrative' building appears long-gestation

Two important takeaways from HUL's 2Q results – (1) Focus (now) on ‘profitable volume growth’ after prioritising market share at (some) cost of margins and (2) Improvement in product innovation after a brief lull (in line with our expectations. On the industry, some fresh concerns around rural deceleration – HUL, particularly, should be largely fine given recovery in other pockets (urban and discretionary). Consensus will now have (fresh) concerns on nutrition outlook (both sales and synergies) – we have been highlighting on the Horlicks & Boost price cuts / improving value. On nutrition, we like the tight-rope-act in balancing penetration-driven growth (DCF-accretive) vs short-term margins (notwithstanding near-term concerns). Domestic consumer business sales grew by 11% YoY in Q2; underlying volume grew 4% (2-year CAGR was 2.5%). 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 (enabling Shikhar outlets, e-commerce focus), and (2) re-starting the product innovation and category development engines. Maintain ADD.

* Overall revenue performance improved: Reported revenue / EBITDA / recurring PAT grew 11% / 9% / 7% YoY. Underlying volume growth came in at 4% YoY (I-Sec: 5%) – 2-year CAGR improved to 2.5% from flattish in Q1. Health, Hygiene and Nutrition (85% of company portfolio) revenue grew 7% YoY. 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 31% (-2% vs Sept’19) and 74% (31% vs Sept’19) YoY respectively on a much lower base. For nutrition business, management highlighted double-digit volume growth with penetration gains.

* Pricing action to offset commodity headwinds: Gross margin declined 140bps YoY to 51.6% with continued inflationary pressures. However, on a sequential basis, there was a 120bps recovery in gross margins. Improved mix and pricing action (hikes) underpinned gross margin print. Further, we believe, with improvement in discretionary categories (including premium detergents and color cosmetics), the gross margin trajectory should improve going forward.

* Steady EBITDA margins: Reported EBITDA margin contraction was limited to 50bps YoY to 24.6% due to leverage benefit (better absorption) even as there was normalisation of other operating expenses and ad-spends. We believe renewed NPD focus (after a lull last year – mostly focused on hygiene category) could lead to higher investments in brand-building going forward.

* Valuation and risks: We cut our earnings estimates by ~1-2% for FY22-23E; modelling revenue / EBITDA / PAT CAGR of 12 / 16 / 16 (%) over FY2021-23E. Maintain ADD rating with DCF-based revised target price of Rs2,700 (earlier was Rs2,600) as we roll forward. Key downside risks are delayed recovery in demand, sustained raw material inflation and irrational competition.

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