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In-line results; mix improvement on track

* Hindustan Unilever (HUVR)’s 2QFY22 results were in line with our estimates. While domestic volume growth was weaker than expected at 4% for the quarter, strong realization growth actually led to a small beat on sales.

* While commodity costs remain elevated, we believe mix improvement would lead to continued sequential margin improvement. HUVR’s share of the Discretionary and Out-of-Home (OOH) portfolios (~15% of sales) is higher v/s peers. Moreover, these businesses have much higher margins than the rest of the portfolio. As a result, the earnings growth outlook from 2HFY22 is incrementally better v/s peers.

* We maintain our BUY rating on the stock.

Performance in line with estimates

* Reported net sales grew 11.2% YoY to INR127.2b in 2QFY22 (est. INR125.9b). EBITDA/PBT/PAT (bei) increased 9.2%/7.7%/7.5% YoY to INR31.3b/INR29.5b/INR21.9b (est. INR31.1b/INR29.5b/INR21.8b).

* Sales in the domestic Consumer business grew 11% YoY, with underlying volume growth of 4% (est. 6%).

* Segmental performance: Home Care (30% of total sales for 2QFY22) revenues were up 15.7% YoY. Personal Care sales (39% of total sales) were up 10.3% YoY. Foods & Refreshments business sales (28% of total sales) were up 7.2% YoY.

* Segmental EBIT margin: Home Care margins contracted 150bp YoY to 19%. Personal Care margins contracted 150bp YoY to 27.8%. Foods & Refreshments margins expanded 180bp YoY to 18.3%.

* The overall gross margin contracted 140bp YoY to 51.6% in 2QFY22.

* As a percentage of sales, lower operating expenses (-20bp YoY to 12.9%), ad spends (-40bp YoY to 9.5%), and staff costs (-30bp YoY to 4.6%) led to EBITDA margin contraction of 50bp YoY to 24.6% (in-line).

* 1HFY22 sales/EBITDA/PAT (bei) grew 12%/8.5%/6.2% YoY.

* Cash and cash equivalents (incl. investments) stood at INR63.8b as of Sep’21, up 20.3% YoY and down 8.9% v/s Mar’21.

* The company has declared an interim dividend of INR15 per share for FY22.

Highlights from management commentary

* Like-to-like volume growth is improving sequentially. 1QFY22 was up 9% on an 8% decline (ex-GSKCH), and 2QFY22 volume growth was 4% on a 1% base.

* Discretionary, which reported just a 2% decline v/s 2QFY20 levels, is nearly back at pre-COVID levels. OOH is well ahead of 2QFY20 levels. Discretionary/OOH saw 24%/40% decline in 1QFY22 v/s 1QFY20 levels.

* Health Food Drinks (HFD) volumes grew in the double digits. Sachets (INR2 sachets now launched across South India) and access packs are doing very well. The benefits of higher penetration would be seen over the longer term.

* GSK Consumer Healthcare (GSKCH)’s cost synergies as well as cash generation are ahead of expectations. Moreover, double-digit volume growth offers promise for top-line growth, which was delayed by the COVID impact on market development plans.

Valuation and view

* There is no material change in our forecasts following in-line results. The lowerthan-expected volumes are likely to be mitigated by the ongoing mix improvement trend and higher-than-expected realization growth.

* HUVR’s earnings have underperformed peers’ earnings in recent quarters owing to (a) a higher proportion of the Discretionary/OOH portfolio at 15–20% of sales and (b) steep commodity cost inflation in its three largest categories – Soaps, Detergents, and Tea. With the gradual unlocking, HUVR stands to be the biggest beneficiary of urban recovery v/s staples peers. With mix improvement and price increases, incremental concerns on commodity costs also appear to be lower than before. Thus, the earnings outlook is likely to be better v/s staples peers going ahead.

* The company’s earnings growth has 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 recent years.

* We maintain a Buy rating, with TP of INR3,200 (60x Dec’23E EPS).

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