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Operating performance in line, royalty increase not a concern 

* HUVR’s operating performance in 3QFY23 was in line with expectations. PBT and PAT beat our estimates by ~8%, driven by higher-than-expected other income.

* On the effective 80bp increase in royalty (effective for the next five years) from 2.65% to 3.45%, we are not particularly perturbed if HUVR receives commensurate benefits from the parent. The decision also requires a majority of minority shareholders’ approval and is not a CG risk in our view. Even at 3.45% royalty by CY27, HUVR’s royalty rate will be well below that of NEST/CLGT/PGHH (close to ~5%).

* While rural recovery and commodity cost declines are taking longer than expected, management believes that the worst is over and HUVR will be a clear beneficiary on both fronts. Maintain Buy.

Higher other income leads to PAT beat

* Reported net sales grew 16.3% YoY to INR152.3b in 3QFY23 (in line). EBITDA grew 7.9% YoY to INR35.4b (in line), PBT grew 12.6% YoY to INR34.8b (est. INR32.3b) and PAT (bei) was up 13% YoY at INR25.9b (est. INR23.9b).

* Underlying volumes were up 5% in 3QFY23 (est. 5%).

* Segmental performance: Home Care (32% of total sales) revenue was up 31.6% YoY (3-year/4-year CAGR 16.9%/15.1%). Personal Care (40% of total sales) revenue rose 10.5% YoY (3-year/4-year CAGR 9%/5.9%). Food & Refreshment business sales (26% of total sales) grew 6.8% YoY (3-year/4- year CAGR 25.7%/21%).

* Segmental EBIT: Home Care margin declined 140bp YoY to 19.2%, Personal Care margin contracted 270bp YoY to 25.1%, and Food & Refreshment margin contracted 80bp YoY to 17.9%.

* Overall gross margins for the quarter contracted 460bp YoY to 47.5% (est. 47.1%)

* As a percentage of sales, lower operating expenses (-100bp YoY to 11.9%), ad spends (-120bp YoY to 7.9%) and staff costs (-60bp YoY to 4.4%) restricted EBITDA margin contraction to 180bp YoY to 23.2% (est. 22.8%).

* 9MFY23 sales/EBITDA/PAT (bei) grew 17.1%/9.8%/12.7% YoY to INR442.5b/ INR101.6b/INR72.6b.

Management conference call highlights

* Rural was better in the Dec’22 quarter compared to the Sep’22 quarter. The Rural slowdown seems to be bottoming out, but growth needs to be observed. High rural inflation persists. MNREGA benefits need to be closely monitored, as do eventual Rabi harvest realization and monsoons in the next 6-7 months.

* 3QFY23 net material inflation was 18% v/s 22% in 2QFY23 but remained high YoY. Management expects commodity costs to come down gradually.

* Other income saw a sharp increase because of higher treasury yields and dividends from subsidiaries.

* The current trademark license is valid for 10 years ending on 31st Jan’23 with 2.65% royalty in FY22.

* Royalty was supposed to rise to 3.15% by Jan’23 as per the last decadal agreement, but acquisitions by HUVR in the last few years, especially GSKCH brands for which HUVR owns brand rights, meant that royalty was at 2.65% at the end of the tenure.

* Royalty will go up by 45bp in the Feb-Dec’23 period, 25bp in CY24 and 10bp in CY25 eventually to 3.45% of turnover, a level that will be maintained up to the end of CY27. These royalty changes are included in management’s double-digit EPS growth targets for the medium to long term announced during the investor day in Nov’22.

Valuation and view

* Changes to the model have resulted in a ~2% increase in EPS estimates for FY23/FY24/FY25.

* As highlighted in our investor day note in Nov’22 and our annual report note earlier in Jun’22, HUVR continues to exhibit remarkable dexterity, despite its size, led by 1) its WIMI and cluster-based approach, 2) its technological edge over peers; and 3) funneling massive cost savings back into the business for growth.

* On rural recovery and commodity cost reductions (commentary on both is gradually getting better), we believe that HUVR will get back to the mid-to-high teens earnings growth trajectory that it exhibited for the four years before Covid.

* Maintain Buy with a TP of INR3,100 (55x FY25E EPS).

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