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Worm’s world view #35: Conversations with Hindustan Unilever distributors in Uttar Pradesh

With lower margins and higher landing rates, the general trade dealers are facing continuous conflict with organized wholesale stores - that's the insight from our conversation with HUL distributors in Western Uttar Pradesh. They told us, (1) HUL has raised prices of key SKUs such as Taj Mahal 1kg, Lux sets and Surf Excel 1kg, (2) With many players present in the tea space, Taj Mahal (due to the price hikes) might lose some market share to other organized players in the short term, (3) the company is propelling the dealers to cover the smallest retailers present in the territory, (4) the dealers face negligible need for higher working capital requirements (efficient supply chain of HUL allows (nearly) flat inventory levels for the dealer) and (5) company is aggressively pushing the retailers to order from the mobile application - Shikhar.

Underlying volume growth of HUL has been a tad underwhelming in recent times (volumes increased by 3% in FY21). We note that this underperformance may potentially reverse given HUL’s focus on volume growth even at the expense of gross margins in the near-term (see report). Retain ADD.

* Price hikes: HUL has continued to raise prices of some of its key brands. It has raised prices of key SKUs such as Taj Mahal 1kg (~12%), Lux soap set (~17%) and Surf Excel 1kg (~12%). Considering the steep price hikes and impact of lockdown, the dealers indicated that there is some impact on volumes. However, they remain confident about recovery in next 1-2 months.

* Market share might be affected for Taj Mahal: With many players present in the tea category, the dealers believe Taj Mahal (due to the higher consumer prices) might lose some market share to other organized players in the short term.

* Negligible effect of lockdown: The off-take of the FMCG products was normal, however the dealers indicated slightly lower volumes in their sales compared to lockdown in FY21. Key reasons were: (1) sales from modern trade (which were significantly lower in Q1FY21) were back in lockdown during Q1FY22, (2) panic buying and stocking was absent (unlike FY21). However, dealers opined that this is a very short term effect and the volumes are likely to improve.

* Focus to increase coverage of the small retailers: The company is propelling the dealers to cover the smallest retailers present in the territory. They indicated, earlier small retailers with orders around ~Rs5000 per month were left to be covered by wholesalers, but now the company is pushing the dealers to service such small retailers as well.

* Same day bills discounting by HUL: The company discounts the amount invoiced to the dealer from the bank as soon as the invoice is created. On delivery of goods, the dealer pays the entire billed amount to the intermediary bank and not to HUL’s bank account. It allows HUL optimize the debtor days.

* Steady working capital: Despite inflation and limited working hours due to lockdown restrictions, the dealers face negligible need for higher working capital requirements. The key reasons were: (1) HUL has extremely efficient supply chain and it delivers twice-a-week. It also delivers within 24 hours in case of urgency/shortage of stock. Hence, the dealers do not need to stock goods for more than 3 days, (2) strong demand for HUL products give dealers an advantage to maintain the trade receivables’ days at pre-lockdown levels.

* Rising conflict with organized wholesale stores: With lower margins and higher landing rates, the general trade dealers are facing continuous conflict with organized wholesale stores. Due to presence of same SKUs in both channels but at different prices (because general trade dealers’ landing price is higher), the dealers suffer lost sales and strained relationships with the retailers. Due to this the average life-cycle of a HUL general trade distributor may reduce (mostly verbatim comments).

* Focus on retailer ordering app - Shikhar: The company is aggressively pushing the retailers to order from the mobile application - Shikhar. The mobile app details all the margins, schemes and discounts available to the retailers. Ordering from Shikhar, provides additional discounts to the retailers.

* We do channel checks. We do network checks. However, >20 years of experience has taught this analyst that on-the-ground checks have utility, if and only if, we don't extrapolate it as a national trend (as diversity is high in India). Worm's world view is our periodic product on network checks.

Valuation and risks

We value stocks on DCF (WACC and TG ranging from 10-13%, 3- 6% respectively) except Godrej Cons. and Tata Cons. which we value on SoTP basis. Key upside risk is better-than-expected gross margins due to correction in input prices. Key downside risk is unexpected irrational competition due to deceleration in general consumption demand.

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