Hindustan Unilever - Motilal Oswal by liwenting


									                                                                                                                                          Annual Report Update
                                                                                                                                                SECTOR: FMCG

                                                                                                                Hindustan Unilever
BSE SENSEX                           BLOOMBERG
17,986                               HUVR IN                          Rs260                                                                          Neutral
S&P CNX                              REUTERS
5,401                                HLL.BO

 Equity Shares (m)                           2,177.5                    FY10 Annual Report Analysis
 52-Week Range (Rs)                         306/218                     Competitive landscape challenging; margins to remain under pressure
 1,6,12 Rel. Perf. (%)                      -2/-5/-35
                                                                        Hindustan Unilever's (HUL) FY10 annual report signifies heightened competitive activity
 M.Cap. (Rs b)                                   566.1
                                                                        and its strong response to it to drive long term growth. We present the key takeaways:
 M.Cap. (US$ b)                                       12.1
                                                                            Increase in commodity costs and food inflation has created an inflationary operating
                                                                            environment. In FY10, FMCG markets grew at a slower pace than in FY09.
                                                                            Strong growth potential and a slowdown in developed economies resulted in the
                                                                            entry of new players and increased aggression by existing MNCs. The resultant
                                                                            competitive intensity led to aggressive pricing action, and media and trade spend.
                                                                            HUL has taken multi-pronged initiatives to defend its leadership through innovation,
                                                                            right pricing and competitive media spends.
                                                                            HUL continues to invest in new categories such as deodorants, hair conditioners,
                                                                            surface cleaners and soupy snacks.
                                                                            HUL has significantly invested in supply chain capability aiming to increase rural
                                                                            and urban distribution.

                                                                        HUL re-launches major brands to regain lost ground: HUL went through a major
                                                                        re-launch exercise in FY10 as major brands like Wheel, Rin, Lux, Lifebuoy, Breeze,
                                                                        Liril, Pepsodent, Clinic Plus and Fair and Lovely were re-launched. The re-launch of
                                                                        some brands was backed by pricing corrections (Rin and Lifebuoy), and the re-
                                                                        launch of others was led by product formulation changes (Wheel, Liril and Lux).
                                                                        Working capital declines Rs12b; higher capex impacts RoCE: Streamlining of
   Others                                    Promoter                   the supply chain has reduced the "decision to execution cycle" time, which lowered
      19.1                                            52.0              the inventory by Rs4b. Net working capital (as a percentage of sales) declined from
                                                                        -13% to -17% due to a Rs10b increase in payables and inventory reduction. A capex
                                                                        of Rs7b (including a new corporate office) lowered RoCE by 680bp.

                                                                        Valuation and view: near term volumes at cost of margins; Neutral: HUL's
Foreign                                                                 near term volumes are likely to come at a cost to margins as rising input costs and
                                                                        media inflation will necessitate price increases. We tweak our earnings model to
                 Dom. Inst                                              factor-in changes in the volume-price mix and input cost pressure. We now estimate
                   14.1                                                 FY11 gross margin decline of 150bp (170bp earlier) and EBITDA margin decline of
                                                                        120bp (180bp earlier) and expansion of 70bp in FY12. We estimate EPS of Rs9.6 for
                                                                        FY11 and Rs11.3 for FY12, below the consensus average of Rs10.6 and Rs11.9. The
                                                                        stock trades at 27x FY11E and 23x FY12E EPS, which is expensive. Neutral.
                               Hind. Unilever
                               Sensex - Rebased                       Financial & valuation summary




                                                                      * EPS for 12 months (April 08-March 09)
Amnish Aggarwal (AmnishAggarwal@MotilalOswal.com); Tel:+9122 39825404/Nikhil Kumar (Nikhil.N@MotilalOswal.com); Tel: +922 39825120
                                                                                                                                                                              Hindustan Unilever

                                                               Inflationary headwinds hit FMCG sector
                                                               "The increased levels of inflation have had a somewhat dampening impact on the
                                                               market growth of some of categories, particularly in the second half of the year".

DOUBLE DIGIT FOOD INFLATION (%)                                                                                            FOOD COMPRISES ~40% HOUSEHOLD SPEND

 20                                                                                                                                 Education,                    Misc.
                                                                                                                                    Entertain-                    10%
 15                                                                                                              16.5                                                                       Food
 10                                                                                                                                    4%
  5                                                                                                    7.5
  0                                                                                     2.1










                                                                                                                                        Furinishing       Apparel         Rent, Utilities
                                                                                                                                            4%              5%               12%

                                                                                                                                                                                     Source: MOSL

                                                               We note that ~40% of the average Indian household's expenditure is on food and this
                                                               proportion increases for lower income classes. Over the past 12 months the proportion
                                                               has increased due to food inflation. This has impacted buying power among lower income
                                                               households in rural and urban India, resulting in downtrading in beverages and food.

                                                               Stiffer competition takes a toll on pricing power
                                                               "The strong growth potential of the Indian market has attracted many new competitors
                                                               resulting in a substantial increase in competitive intensity across categories. This
                                                               has resulted in aggressive pricing action as well as heightened media and trade

      Global FMCG majors are                                   Competitive intensity in the Indian FMCG space has increased due to the prominence of
          making a beeline for                                 the Indian consumer market. Major MNCs that have increased their product launches/
      capturing a slice of high                                pricing actions include P&G, J&J, PepsiCo, L'Oreal, Reckitt Benckiser and Beiersdorf.
         growth Indian market                                  Besides, players like Kraft and Danone are expected to expand their portfolio. We highlight
                                                               that the impact is being felt on different fronts like product pricing, adspends and promotions,
                                                               which can impact profit margins.


                 Mar-09           Jun-09             Sep-09              Dec-09             Mar-10          Jun-10                Mar-09    Jun-09       Sep-09      Dec-09     Mar-10      Jun-10
 120                                114                                                                                     120
               100                                  100                                                          100              100             100               100             100
                                                                           94       100                                                      92
  90                                                                                                                         90                              75                71              69

  60                                                                                                                         60

  30                                                                                                                         30

      0                                                                                                                       0
                         Lux                              Lifebuoy                             Breeze                             Wheel Pow der       Wheel Bar     Rin Advanced Surf Excel Bar

                                                                                                                                                                                     Source: MOSL

13 July 2010                                                                                                                                                                                         2
                                                                                                                          Hindustan Unilever

                                       Soap, detergents slip; personal products support margins
                                       HUL's FY10 volumes grew ~5% (FY09 adjusted for 12 months). Segmental volume
                                       growth is unascertainable due to the base of 15 months in FY09. In FY10, soaps and
                                       detergents posted value growth of 1.5% YoY and personal product sales rose 16.2%.
                                       Faster personal products growth enabled a 140bp rise in contribution resulting in a sales
                                       mix improvement.

                                       SEGMENTAL PERFORMANCE

                                                                         CY05            CY06             CY07            FY09           FY10

                                       Net Sales (Rs m)
                                       Soaps and Detergents            49,617          55,959        63,999             81,464          82656
 Soaps and detergents (48%             Personal Products               29,519          33,598        36,866             43,657          50479
                                       Beverages                       12,774          13,307        15,406             18,685          21424
of sales) growth and margins
                                       Processed Foods                  3,137           3,849         5,401              6,563           7308
    have come under pressure           Ice Creams                         981           1,371         1,615              1,983           2310
                                       Exports                         13,478          12,789        13,490             11,772          10053
                                       Others                           2,505           1,803         2,273                651            644
                                       EBIT (Rs m)
                                       Soaps and Detergents             6,837           7,731         9,787             12,492          11853
                                       Personal Products                8,452           9,431        10,204             11,832          12965
                                       Beverages                        2,424           2,205         2,300              2,547            3198
                                       Processed Foods                   -161             129           152                -20              44
                                       Ice Creams                          51             187           128                111             127
                                       Exports                            491             664           469                904             586
                                       Others                            -277            -674          -870               -242           (193)
                                       EBIT Margin (%)
                                       Soaps and Detergents              13.8            13.8             15.3           15.3         14.3
                                       Personal Products                 28.6            28.1             27.7           27.1         25.7
     Personal Products EBIT
                                       Beverages                         19.0            16.6             14.9           13.6         14.9
     margin declined 290bp             Processed Foods                   -5.1             3.3              2.8            -0.3         0.6
           over CY05 - FY10            Ice Creams                         5.2            13.7              8.0             5.6         5.5
                                       Exports                            3.6             5.2              3.5             7.7         5.8
                                                                                                                        Sourc: Company/MOSL

PERSONAL PRODUCTS CONTRIBUTION UP                                       …ENABLES 250BP GROSS MARGIN RISE (%)

     Toilet Soaps         Detergents            Personal Products
     Beverages            Foods                 Others                                                                                    49.9
                            15.1         14.8      13.8       13.9                                 47.0          47.6       47.4
    17.6         16.4
    24.8         27.1       28.6        28.2       27.7       29.1
    18.9         19.6       20.7         21.6      24.3       22.3
    24.0         23.0       23.2        22.2       21.3       21.3

   CY04        CY05        CY06         CY07      FY09        FY10          CY04        CY05       CY06          CY07      FY09        FY10

FY10 SALES MIX                                                          FY10 EBIT MIX

  Processed         Ice Creams     Exports                Soaps and       Ice Creams     Exports                                 Soaps and
    Foods               1%           6%                   Detergents          0%           2%                                    Detergents
     4%                                                      48%         Processed                                                  41%

 Beverages                                                                  Foods
   12%                                                                       0%

   Personal                                                               Beverages                                                   Personal
   Products                                                                 11%                                                       Products
     29%                                                                                                                                46%

                                                                                                                        Sourc: Company/MOSL

13 July 2010                                                                                                                                     3
                                                                                                     Hindustan Unilever

                              HUL re-launches major brands to regain lost ground
                              HUL went through a major re-launch exercise in FY10 as major brands like Wheel, Rin,
                              Lux, Liril, Lifebuoy, Breeze, Pepsodent, Clinic Plus and Fair and Lovely were re-
                              invigorated so as to regain lost market share in key segments. The re-launch of some
                              brands was backed by price corrections (Rin Advanced, Rin bar, Surf Excel Blue and
                              Lifebuoy), and others were led by product formulation changes (Wheel, Liril and Lux).
                              HUL invested heavily on advertising and promotion to support the re-launch exercise with
                              ASP increasing 340bp to 13.5%.

                              HUL RE-LAUNCHED MAJOR BRANDS IN FY10

 HUL has re-launched ~80%
   of HPC portfolio in FY10

                                                                                                   Sourc: Company/MOSL

                                  The price of Rin powder was strategically lowered to drive up gradation from the
                                  mass market.
                                  Dove shampoo and conditioners delivered strong market share growth.
                                  HUL launched attractive value offerings in up-grader packs to bring oral care within
                                  the reach of mass consumers.
                                  Tea shares suffered due to a lack of strong offerings at the bottom end of the market;
                                  HUL launched Brooke Bond Sehatmand to fill this gap.
                                  Coffee markets decelerated due to adverse weather conditions.

                              HUL ups the ante on new category development in food, skin care
                              We are excited about HUL's recent launches, particularly in the skin care and food
                              categories. In skin care, the Vaseline For Men range, Sure and Dove deodorants were
                              launched during the year. Knorr Soupy Noodles marks the entry in the high growth easy-
                              to-cook snacks segment, which has been growing in high double digits. In the household
                              care segment, HUL launched CIF surface cleaner and in the laundry segment it launched
                              Comfort fabric conditioner. HUL has extended its water purifier brand to Pure IT compact
                              for the economy segment and Pure IT auto fill for the premium segment. But most of
                              these categories are small and HUL will have to drive category expansion in these segments
                              so that they contribute meaningfully to sales and profits over time.

13 July 2010                                                                                                          4
                                                                                                                  Hindustan Unilever


                                                                                                                 Sourc: Company/MOSL

                                      Lower inventories, payables cut working capital, RoCE falls on capex
  HUL is running twin tracks          HUL's efforts to streamline its supply chain have resulted in a cut in the "decision-to-
   in select detergent plants         execution cycle" time and in working capital requirements.
                                         Go to market has been rolled out in 32 Indian cities and has been well received by
                                         customers (stockists). The model aims at zero inventories at the authorized dealer
                                         level. This would reduce stocks in the system for freshness of products and enable
                                         HUL to react quickly to changing market dynamics.
                                         Net working capital (as a percentage of sales) fell from -13% to -17% led by a Rs10b
                                         increase in payables and a Rs4b decline in inventory (mainly raw material inventory).
                                         HUL has empowered each salesman with hand-held devices to ensure easy stock
                                         taking, improved on-shelf availability and product assortment at the store level.
                                         HUL has started running twin-tracks on a single production line in some facilities,
                                         which has enabled it to produce two different detergents at the same time, doubling
                                         production and improving operating efficiencies.
                                         Most of the facilities have developed the capability of quick change over to meet
                                         demand, which would improve product availability.
                                         HUL's Rs7b capex program (including a new corporate office) augmented capacities
                                         by 5-20% in major categories like detergents and personal products but resulted in a
                                         fall in RoCE by 6.8%.
                                         HUL's other income had derivative and forex losses of Rs563m against a gain of
                                         Rs612m a year earlier.
 Royalty payments increased              Royalty payments increased by 15bp due to increased royalty and a technical fee
            by 15bp in FY10              agreement with Unilever from 1 Jan 2010.
                                         HUL transferred Lakme beauty saloons to Lakme Lever to consolidate business focus
                                         in beauty services.

NET WORKING CAPITAL IMPROVES YOY                                       FCF UP ~50% YOY TO ~RS30B

     CY04        CY05      CY06       CY07     FY09     FY10                                                                 29.9

      -5.6                                                                            18.8                19.1      20.3
                 -14.1     -14.3
                                      -19.2    -20.5
                                                        -30.3                9.8

               -13          -12          -14   -13
         Net Working Capital (Rs b)      % of sales                         CY04     CY05      CY06       CY07      FY09    FY10

                                                                                                                 Sourc: Company/MOSL

13 July 2010                                                                                                                        5
                                                                                                                                               Hindustan Unilever

CAPEX OF RS7B IN FY10…..                                                            …RESTRICTS ROCE EXPANSION (RS B)

                                                                   7.0                            181.4

                                    2.1            2.1                                                          56.5
                           0.9                                                         27.7

     CY04      CY05        CY06    CY07            FY09            FY10                CY04       CY05         CY06           CY07               FY09            FY10

                                                                                                                                              Sourc: Company/MOSL

                                  HUL to expand rural reach; Shakti extended to Maharashtra, Orissa
    HUL has extended Shakti       As smaller players expand their reach, HUL aims to take its distribution network to the
    network to Maharashtra        next level to maintain a relative advantage. The rural network is being expanded three-
                 and Orissa       fold to improve the quality of coverage (formerly covered by indirect accounts). HUL
                                  covers 100,000 villages in 15 states through 45,000 Shakti Ammas. HUL has extended the
                                  network to Maharashtra and Orissa. HUL has also started Shakti Vani to increase
                                  awareness about health and awareness in rural areas.

                                  Volumes pick up in 2HFY10; profits might stay under pressure
                                  The impact of aggressive market intervention and re-launches is visible as volume growth
                                  rebounded sharply in 2HFY10. We believe volume growth will remain healthy in the near
                                  term as tactical pricing, trade promotion and product re-launches play out. This has arrested
                                  a declining trend in market share of a few products but significant share gains in soaps,
                                  detergents and toothpaste are not visible.

                                  1HFY10 VOLUMES IMPACTED BY PRICE INCREASE

                                   12      10.4                                                                                                                 11.0
                                    6                                                                                                           5.0
                                                                                        2.3                      2.0           1.0









                                                                                                                                            Source: Company/MOSL

                                  MARKET SHARE LOSS IS STABILIZING

                                  VALUE MARKET SHARE (%)                 MAR-09       JUN-09     SEP-09      DEC-09       MAR-10            CH (BP) 12M        CH (BP) 6M

                                  Detergents                                 37.0        36.2      35.0        36.5         35.5             (150.0)      50.0
                                  Soaps                                      48.2        46.3      44.5        44.6         44.5             (370.0)      0.0
                                  Shampoo                                    44.9        45.4      45.2        44.8         45.2               30.0        0.0
                                  Toothpaste                                 28.0        28.0      27.1        26.1         25.5             (250.0)    (160.0)
                                  Tea                                        23.4        21.8      22.3        21.1         20.5             (290.0)    (180.0)
                                                                                                                            Source:         Company/Media Reports

13 July 2010                                                                                                                                                                    6
                                                                                                                                                                                                                                           Hindustan Unilever

                                                                                  We believe volume growth has been largely at the cost of margins as HUL invested
                                                                                  heavily on advertising and trade promotion. ASP (as a percentage to sales) increased
                                                                                  340bp to 13.5% in FY10 and is likely to remain high due to high decibel advertising and
                                                                                  media inflation. We are cautious about the sustenance of FY12 volume growth as HUL
                                                                                  halts some of the high decibel advertising and trade push. Besides, we see margins being
                                                                                  under pressure due to rising input costs (and the lack of pricing power); media inflation,
                                                                                  increase in royalty (50bp) and freight cost (after the increase in fuel cost).

PFAD HAS INCHED UP…                                                                                                                                 LAB RANGE BOUND (TRENDING CRUDE)

                                                               Palm Fatty Acid                                                                                                                            LAB Prices
           750                                                       646.5                                                                                                                                     119
                                                                                                                                            660              120
           650                                                                                                                                                                                                                       109

                                                                                                                                            628.5            105

           550                                                                                                                                                                                                                                             94
           450                                                                                                                                                90
                                                                                                     357.5                                                                                                                                                             86
           350                                                                                                                                                75
           250                                                                                                                                                60


















ROYALTY TO ADD TO MARGIN PRESSURE                                                                                                                   ASP SPEND UNLIKELY TO RECEDE MUCH

                                                     Royalty (% of Sales)                                               1.15               1.20                                                A&P (% of Sales)                        13.6              13.5         13.4

                                                                                                                                                                                            10.5          10.4            10.5
                                                                                                     0.71                                                8.4
                    0.55                0.58                   0.55               0.57

   CY 04          CY 05               CY 06                CY 07              FY09                   FY 10              FY 11E FY 12E                 CY 04             CY 05               CY 06        CY 07            FY09         FY 10        FY 11E FY 12E

                                                                                                                                                                                                                                       Sourc: Company/MOSL

                                                                                  Valuation and view: near term volumes at cost of margins; Neutral
                                                                                  We tweak our earnings model marginally to factor in changes in the volume-price mix and
                                                                                  input cost pressure. We estimate a gross margin decline of 150bp (170bp earlier), EBITDA
                                                                                  margin decline of 120bp (180bp earlier) in FY11 and an expansion of 70bp in FY12. We
                                                                                  estimate EPS of Rs9.6 for FY11 and Rs11.3 for FY12, below the consensus average of
                                                                                  Rs10.6 and Rs11.9. The stock trades at 27x FY11E and 23x FY12E EPS, which is
                                                                                  expensive. Maintain Neutral.
                                                                                  KEY FINANCIALS (RS M)
                                                                                                                                                             FY09                                     FY10                           FY11E                            FY12E

                                                                                  Net Revenue                                                       167,836                                  177,253                         196,663                            220,363
                                                                                    Growth (%)                                                                                                    -14.0                               11.0                             12.1
                                                                                  Gross Margin                                                       80,131                                   88,474                             95,248                         107,648
                                                                                    Margin (%)                                                               47.7                                     49.9                            48.4                             48.9
                                                                                  EBITDA                                                             25,551                                   27,500                             28,079                              33,092
                                                                                    Margin (%)                                                               14.8                                     15.5                            14.3                             15.0
                                                                                  PAT                                                                21,431                                   20,587                             21,038                              24,648
                                                                                    Growth (%)                                                                                                    -16.0                                2.2                             17.2
                                                                                                                                                                                                                                                          Sourc: MOSL

13 July 2010                                                                                                                                                                                                                                                                    7
                            Hindustan Unilever

Financials and Valuations

13 July 2010                                8
                           Hindustan Unilever

               N O T E S

13 July 2010                               9
                                                                                                                                                  Hindustan Unilever

                                                      For more copies or other information, contact
                                                  Institutional: Navin Agarwal. Retail: Manish Shah
                                   Phone: (91-22) 39825500 Fax: (91-22) 22885038. E-mail: reports@motilaloswal.com
                        Motilal Oswal Securities Ltd, 3rd Floor, Hoechst House, Nariman Point, Mumbai 400 021
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MOSt has incorporated a Disclosure of Interest Statement in this document. This should, however, not be treated as endorsement of the views expressed in the report.

       Disclosure of Interest Statement                    Hindustan Unilever
       1. Analyst ownership of the stock                           No
       2. Group/Directors ownership of the stock                   No
       3. Broking relationship with company covered               No
       4. Investment Banking relationship with company covered     No

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13 July 2010                                                                                                                                                             10

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