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Growth engine intact; widening moats over peers

Hindustan Unilever (HUVR)’s Annual Investor Meet once again underlined the moats the company has and the remarkable nimbleness it continues to exhibit despite being much larger than peers.

Highlights from the session:

* The new sub categories, created over the last 10 years, now contribute ~20% to sales and are much more profitable than the base business.

* The company’s Premium portfolio contributed 33% toward sales in FY22, up from 22% in FY12. Yet, there still lies significant opportunity for growth. In the last 12 months alone, the Premium Beauty Business Unit has grown 2x the market rate.

* India’s per capita FMCG spend of USD46 is extremely low compared to other emerging markets such as Indonesia, China, Thailand, and the Philippines, all of which have a per capita FMCG spend ranging between USD100 and USD440.

* As highlighted in our FY22 Annual report note, the company is building an extremely strong technological backbone. Its B2B app, “Shikhar”, now covers over half of its direct reach outlets. The company’s digital demand capture is growing rapidly and stands at 25% of total demand.

* The management also indicated Winning in Many India (WiMI) based customization with different formulations of Brooke Bond tea, Lux Soap, and Surf Excel to cater to various parts of the country.

* With the uncertainty in rural recovery and no significant correction in commodity costs, barring palm oil and crude derivatives, earnings growth for the next few months is expected to remain muted.

* We maintain our Buy rating on the stock on account of superior moats over consumer staples peers. We believe the moats will help drive healthy midteens to late-teens earnings growth, similar to the levels in the five years before Covid. 

Details from the Analyst Meet:

* Category creation and premiumization: For HUVR, market development (categories created in the last 10 years) have revenues of more than INR100b (~20% of sales). None of the above sales are from M&A and is thus, organic. Notably, INR100b delta that HUVR has created from new businesses is larger than sales of many consumer companies. These sales have also significantly contributed toward margins, apart from being 20% of FY22 sales. In FY22, Premium portfolio is 33% of total sales up from 22% in FY12. The definition of a premium product is a price index of 120 or above over the prevailing rates assumed at 100. Project Shakti generates revenues of USD500m, with 160,000 entrepreneurs.

* Huge opportunity for HUVR in India: 20% of world’s working population is in India. Between 2017 and 2022, the proportion of elite and affluent class increased to 15% from 8% in the country. Penetration in many of their categories is 25% or lower. MFD is at 25% and face wash, body lotion, washing liquids, dishwashing liquid, hair conditioner are lower than MFD and body wash stands at a mere 2%. India has significantly under indexed FMCG spends v/s other emerging markets. India’s spend on FMCG is at USD46 per capita, which is extremely low compared to other emerging markets such as Indonesia, China, Thailand, and the Philippines, all of which have per capita FMCG spends ranging between USD100 and USD440. Urban and Rural Per Capita Spends on FMCG in India are very low at USD82 and USD27, respectively.

* Strengthening digital backbone: HUVR’s B2B app “Shikhar” has rapidly expanded and currently reaches ~1.1m outlets, forming half of the company’s direct reach. Digital capture is growing rapidly, standing at 25% of the total demand. On both these counts, the company is well ahead of its peers, thereby widening the gap. The management believes that with its market shares across categories, a wide portfolio and a host of large brands, it is well positioned to win in the general trade channel compared to conventional and new age competitors. For outlets which operate the “Shikhar” app, 40% of their order is routed through the app. When “Shikhar” is paired with the best of the breed fulfillment, highly nimble manufacturing, and increasingly rapid product development cycle, the combination is even more superior compared to peers.

* Extent of customization: WiMI has led to a large degree of localization of brands such as Brooke Bond, Lux Soap, and Surf Excel to cater to customers in different parts of the country. This customization is also supported by HUVR’s six nano factories set up in recent years, which not only facilitate customized manufacturing close to the markets, but also save on logistics costs and help reduce carbon footprint. The customization in the laundry segment is based on four parameters, i.e. how they wash, the water type used, the fabric type, and weather conditions in the geography. Such customizations could become the trendsetter for other categories as well.

* Growth opportunity in BPC: Sales growth over the last 10 years has been relatively muted in the BPC segment compared to HUVR’s other categories. However, in the three premium categories viz. face cleansing, body lotion, and hair conditioner, the company has been able to drive penetration between 1.5x and 2.6x, and yet, leaving a large runway for growth with penetration levels at less than 22% in all the three categories. In addition, the company is making big bets in its five other premium categories for the next decade viz. light moisturizer, BB and CC creams, sunscreens, body wash, and intimate hygiene. With penetration levels of less than 3% in all these categories, HUVR still is the clear market leader. If HUVR successfully manages to tap the opportunity, the trajectory of sales and profitability for BPC could be much better than over the last 10 years when sales grew ~1.8x and EBIT grew ~2.2x for HUVR’s largest segment, which contributes 38% of sales. HUVR’s second largest segment, HPC (32% of sales), has been a huge beneficiary of early investment in premiumization as a result of which the company’s turnover has grown ~2.6x and EBIT has grown ~7.3x in the past decade.

* Near-term outlook is challenging: Although long-term outlook is attractive, the management highlighted several challenges that can adversely affect near-term earnings potential. High CPI inflation affect rural demand (which is the key driver of volume growth across categories); the government extending the free food grain distribution period to Dec’22 highlights the extent of rural demand slowdown; commodity costs such as that of palm oil have come down sharply and crude derivatives are likely to yield benefits but with a lag, thereby, the overall commodity cost inflation remains high. The management intends to combat these challenges through continued cost savings (~700bp to sales annually) and calibrated price increases. These savings will be reinvested for growth. However, beyond the near term, the management seems confident of elevating EPS growth back to double digits.

Valuation and view

* The company continues to place the building blocks for future growth and has been able to do so ahead of peers. It continues to display the dexterity despite its larger size, even as it continues to grow faster v/s peers.

* HUVR continues to strengthen the key drivers of its success in India over the last decade, including (a) pioneering the use of technology to generate data and facilitate decision making, (b) the Winning in Many Indias (WiMI) strategy, focused on decentralization and localized strategies, (c) recognizing trends and investing in them early on, (d) funneling cost savings back into the business, and (e) its strong execution ability, which has led to positive earnings momentum.

* Historically, HUVR has continued to strengthen its brand, distribution network, and quality of personnel, and thereby, remains ahead of its peers. With its dexterity in decision making, exemplified by WIMI and CCBT, as well as the cost savings being plowed back into the business, the company has revitalized its topline and earnings growth in the last decade, despite being much larger than its peers.

* Finally, with its analytics and R&D initiatives (much ahead of its peers) in the recent years, HUVR is ensuring that it does not get disrupted in a dynamically changing environment.

* The company’s earnings growth had gained further impetus in recent years (before COVID-19 affected FY21) – it reported a ~18% EPS CAGR in the four years ended FY20. This is particularly impressive, given the weak mid-single-digit earnings growth posted by (much smaller) peers in these years.

* There is no material change in our forecasts. In view of near-term challenges for all staples, we bring down HUVR’s target multiples to 55x from 60x. We reiterate our Buy rating with a TP of INR2,900 (55x Sep’24E EPS).

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