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Comments on rural greenshoots unlikely to offset royalty pain

HUL’s Dec-Q report was broadly on expected lines but the Street for now is more focused on estimating the damage that occasional tinkering of royalty rates could do to the intrinsic value of the stock. On 3Q earnings, the segmental construct was pretty much similar to earlier quarters - Home-care continued to do extremely well across brands while BPC and Nutrition remained sub-par vs potential. Management alluded to rural slowdown likely bottoming out but didn’t sound too convincing about growth acceleration being around the corner, in our view. A lot of the hopes are still pinned more on government actions and macro rather than on factors that HUL would drive on its own. The hike in royalty to Unilever (80bps hike over three years) takes near-term earnings down by c.2-3% but sentiments down by likely a few notches more. Management, though, expressed confidence in its ability to offset the incremental charge akin to how it would do to any of the other everyday cost items. HUL is one of our preferred staples plays but the stock is likely to take a short-term beating given the negative sentiments around the royalty angle.

* Yet another Home-care-driven performance: HUL reported 16.2%, 7.9% and 12.6% growth in sales, EBITDA and adjusted net profit to INR149.8bn, INR35.4bn and INR25.8bn. Sales growth was tad better than we expected due to slightly better pricing element. Volume growth of 5% (3-year CAGR of 3.7% - higher than those seen in the last few quarters) was inline with our forecast. Laundry volumes grew double-digit whilst Soaps volume growth was in mid-single-digit. The quarter’s performance was impacted by the winter portfolio that was impacted by delayed onset of the season (Dec’22 was the warmest in India in >120 years). Management cited positive portfolio transition and premiumisation to be the key drivers of the solid Home-care performance in recent times. We believe absence of competitive intensity in the space and likely gain from unorganised players also helped in this regard. The Nutrition portfolio continued to underperform with sales growing just mid-single-digit – inflation in the cost of consumption appears to have kept the market subdued. Tea did well (mid-single-digit volume growth) but value growth was impacted by price-cuts effected earlier in the business

* Gross margin compression remained steep but some offsets from operating leverage and a rather benign A&P environment: Gross margin compressed 477bps yoy to 46.6% (GPM turned out lower vs our expectation of 47.4%) as pricing growth (c.11%) is still lagging material-costs inflation (>20%) by quite a bit. The gap between the two has moderated, though, with reversal in inflationary trend in the costs of certain key inputs (notably palm oil) helping to drive sequential improvement in gross margin. A few of the inputs like soda ash, barley, skimmed milk powder are, however, still highly inflationary. A&P spends rose c.15% qoq but still mostly flattish on yoy comparison, which along with controlled growth in Staff Costs (+2.9%) and Other Expenses (+7.1% including some spends on supply chain restructuring) helped lower the hit on operating margin that fell 182bps vs a way steeper compression of 477bps in gross margin.

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