Investors cheer HUL's improved margins but will the optimism last?

Just like the re-launch of its familiar brand, Vim, using the “100 Nimbuon ki shakti” tagline this year, HUL itself was back with a bang with some pretty commendable second-quarter numbers.

Investors applauded the performance by bidding the company’s stock to an all-time high of Rs 381.50.

So what were the highlights of its Q2 performance?

[caption id=“attachment_120784” align=“alignleft” width=“380” caption=“HUL will have to keep up ad spend to match aggressive competitors like P&G. Photo: HUL website”]  [/caption]

Well, HUL’s net revenues grew 18 percent on the back of 10 percent growth in the domestic fast-moving consumer goods market.

Breaking down the various segments, sales of soaps and detergent, which account for the largest share in HUL’s portfolio, expanded 21.8 percent compared with the same quarter last year. That’s a big deal because the soaps and detergent segments, boasting prominent brands like Lux, Lifebuoy and Vim, had been performing dismally in the recent past because of growing competition.

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This growth, despite rising costs, if maintained, will be crucial for the company.

Its personal care portfolio, another key segment, also grew 18 percent.HUL chairman Harish Manwani noted that this was one of the strongest quarters for the company, boosted by improved operating margins.

Indeed, that’s perhaps the biggest positive for the company: operating profit margin improved by 120 bps (100 bps=1 percentage point) from the same period a year ago, while net profit margin improved by 41 bps.

Profitability of the company could have been much better had it not been for the sharp rupee depreciation.While most of its raw materials are linked to international prices, HUL does not export much. So it suffered some losses on the currency’s losses.

HUL’s continuous efforts to introduce innovations in its brand portfolio and launches have kept the company ahead of its peers: almost 50 percent of its brand portfolio has been refreshed in recent times, a Citi report pointed out, the best in recent times.

Major challenges

First, the company faces stiff competition from global and other domestic players who are also riding high on the growth story in emerging markets like India.

HUL’s biggest contributor to revenues comes from the soaps and detergents segment, traditionally a highly competitive segment offering low pricing power for companies.

In this scenario, HUL will have to keep up ad spend to match aggressive competitors like P&G.Even in the personal care segment, where margins and pricing power are better, new entrants like Marico and ITC are putting up a good fight against HUL. Again, more advertising expenditure will be required.

Second, because of rising food inflation pressures, demand could moderate in rural areas.A Kotak report said that rural demand for the company jumped in the past few years because of higher outlays on NREGA, higher land prices (enhancing the ‘wealth effect’), a farm loan waiver by the government and higher incomes from the Sixth Pay Commission.

Now, with those effects tapering off, demand from the rural sector could dip and hurt consumer goods companies.

What next?

One strategy that HUL could perhaps resort to would involve increasing focus on premium products in the personal care and even the food and beverages segment.

This idea finds support in an IDFC report which says the growing “premiumisastion” is already visible in the Lux relaunch (now positioned as a superior product and salient advertising), the expansion of the personal products range (now includes face washes), and sustained upgradation via Vaseline and Ponds, etc.

“As a result, the company has recorded strong revenue growth across its domestic portfolio, with personal products, beverages and foods recording growth rates of 18 percent, 15 percent and 21 percent”, the report said. And all this, while improving its margins.

The concern, however, remains with the stock price.

While IDFC is optimistic - they believe Rs 340 will become the new base price for the stock - that is by no means certain.

Kotak has revised its target price from Rs 370 to Rs 420, while Citi had given a neutral view on the stock.

HUL is trading at almost 25 times its expected earnings for the next financial year, which is definitely steep. One can, perhaps rightly so, be apprehensive of the returns it can offer from here on for a new entrant into the stock.

Historic earnings multiples are not a good indicator because the demand growth and expansion possibilities are not the same as they were 10 years ago.

But the company might continue to surprise the street with growing revenue and stable margins, and by keeping ad-spends under control despite growing competition. In that case, like wine, this company will only get better as it grows older.