How HUL has sustained robust growth: Motilal Oswal analysis

Hindustan Unilever’s (HUVR) FY20 Annual Report highlights the company’s continuous efforts to strengthen its building blocks, thus enabling the sustenance of robust growth. Research analyst Motilal Oswal has presented some key insights highlighted from HUL’s FY20 Annual Report:

Setting up/adapting to key trends keeping HUVR ahead in the game: The Personal Care category witnessed significant effects of the slowdown in H2 FY20, which culminated with the sharp COVID-19 led decline toward the year-end. Despite this, HUVR reported another year of double-digit earnings growth, taking its earnings CAGR over the past 3 years to 16.6%, even as peers (many of whom are much smaller) witnessed revenue deceleration over the same period. If not for the COVID-19 disruption impact, sales growth would have been healthy for the third consecutive year as well.

HUVR’s strengths

  • Sustained strong growth in Detergents, transformation potential in Skin Cleansing: The MGT-9 section in the annual report showcases the importance of the role played by Detergents (22.5% of total sales) in driving overall growth. After contributing as much as ~38%/~47%/~44% to incremental sales in FY19/FY18/FY17, Detergents contributed over 100% of incremental sales growth in FY20, making up for the decline in Soaps and Cosmetics and Toiletries (the other two large product categories). Strong premiumisation and considerable success in growing volumes as part of the company’s ‘Winning in Many Indias’ (WIMI) strategy has led to another year of (near) double-digit sales growth even as the rest of its portfolio has slowed down.
  • While performance of Soaps (~27% of FY20 sales) has been tepid over the past 5 years now, the ‘COVID’ and ‘post-COVID’ scenarios offer an opportunity for transformative growth – not only in terms of sales, but also in terms of premiumisation in the category – both benefits that HUVR is already enjoying in the Detergents business. Thus, the potential resumption of growth in Soaps should provide strong momentum to half of HUVR’s sales.
  • Relentless pursuit of cost savings: HUVR’s annual report indicates that the company was able to generate gross cost savings of 7% of sales in FY20, another remarkable achievement, which also underlines the potential for margin improvement over the longer term, especially with strong synergies from the GSKCH business. While margin expansion may take a backseat in FY21 owing to the COVID-19 fallout, the company’s ability to extract more savings compared to peers should drive continued superior earnings growth.
  • Increasing confidence on inorganic growth: HUVR’s annual report also enumerates its success and/or ambitious plans on the acquisition of Indulekha, Adityaa Ice-cream, GSK CH and potentially V-Wash. This leads us to believe that inorganic growth would remain a highly important part of HUVR’s incremental growth. While HUVR has the skillset, we believe it now seems to be exhibiting increasing confidence on inorganic growth due to: (a) access to impressive cash flows, (b) ability to leverage its wide distribution reach, (c) superior understanding v/s peers on usage of lower unit packs (LUP), and (d) new-found nimbleness in all aspects of decision making.
  • WIMI and superior analytics to continue being significant game changers: While pace of sales growth is likely to slow down temporarily in FY21 due to the COVID-19 impact, HUVR’s annual report again highlights the quantum of their lead v/s peers on the WIMI strategy/ analytics. Both these factors enable HUVR to leverage its overall superiority on total distribution reach as well as direct distribution reach.
  • Sustainability: HUVR’s efforts on a host of critical factors like renewable energy (now 71% contribution), reduction in environmental footprint, 85% reduction in carbon dioxide emissions over 2008 levels, waste water reduction, and more recently sustainable sourcing strengthens its long-term investment case.
  • Valuation and view: Despite being the largest consumer company in India, its 10-year sales/ EBITDA/ PAT growth has been healthy at 8.1%/ 13.3%/ 12.4% CAGR. Earnings growth has consistently gained momentum in recent years, which is particularly impressive given the weak mid-single earnings growth posted by (much smaller) peers in recent years. HUVR has delivered EBITDA/ PAT CAGR of 13%/ 13.1% in the last five years, while both EBITDA/ PAT have reported ~17% CAGR in the last three years ending FY20.
  • HUVR’s best of breed analytics and execution ability (exhibited by successful implementation of the WIMI strategy, cost savings plans, herbals, etc.) are key factors driving this pace of earnings growth. Additionally, our conviction over the medium-term is further strengthened by its: (a) strong balance sheet, (b) robust cash flow generation and increasing willingness in recent years to use cash flow for inorganic growth, (c) excellent management quality/ corporate governance, and (d) proven track record of consistent delivery even in a weak consumption environment.
  • Further, Motilal Oswal remains positive on HUVR from a medium-term perspective due to: (a) robust earnings growth potential beyond the near term owing to its portfolio and execution strengths, (b) significant synergies in FY22E as a result of GSK CH, and (c) its RoCE levels being well ahead of peers. All these factors mean that premium multiples are likely to sustain. Moving its forecasts to merged numbers (which add over 9% to FY22E EPS due to the nature of the GSK merger and synergies), Motilal Oswal values the company at 55x merged EPS, to arrive at a TP of Rs 2,400 and maintains ‘Buy’.

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