The Hindu Business Line : HLL: Buy

Hindustan Lever's earnings growth stems clearly from strong volume offtake from domestic consumers, which should deliver predictable earnings growth.

Valuation on a par with FMCG sector
Aggressive on new launches/extensions
Traction in topline, profit growth
Focussed local competition, a concern

Mr Harish Manwani, Chairman

Despite the increasing visibility of India's consumption story, Hindustan Lever is among the laggards in the Nifty basket over the past one year. The stock sports a one-year return of 17 per cent against the Nifty's 33 per cent. Worries about competitive pressures on earnings and the stock's relatively rich valuation levels have trimmed its valuation premium over smaller rivals in the FMCG space.

However, for investors looking for a low-risk investment option, the stock offers a good entry point at the price levels of Rs 220-230. At this price, the stock trades at about 30 times its trailing earnings.

Lever's earnings growth has accelerated in recent quarters on the back of resurgent demand for FMCGs, good cost management and an improving product mix.

A large brand portfolio may help the company negotiate better terms from retailers.

A deep brand portfolio that endows the company with pricing and bargaining power and newfound aggression in product launches promise steady earnings growth. Lever's business model is strongly focussed on organic growth in the domestic market and this makes for greater predictability in earnings than an acquisition-led strategy.

More growth drivers

Lever's sales growth rebounded strongly in the September quarter of 2006 after a blip in June. Topline growth (for continuing businesses), at 11.8 per cent in the first nine months of 2006, compares well against smaller competitors.

In a healthy trend, sales growth is becoming more broad-based. Categories such as beverages and processed foods have been contributing more actively to growth in recent times; the home and personal-care portfolio is no longer the sole growth driver.

After devoting the past few years to pruning and focussing its portfolio, the company has stepped up the pace of product launches and brand extensions in recent months.

The September quarter alone saw product launches/relaunches under major umbrella brands such as Lux, Sunsilk and Lifebuoy, with over 40 new extensions/variants unveiled during the quarter.

While renewed launch activity has sharply expanded outlays on advertising (adspend grew by 34 per cent in 2006, against a sales growth of 11.8 per cent), the aggression appears necessary in the face of heightened competition.

Payoffs from recent brand extensions and launches can be expected to flow in over the next few quarters.

Recent rollouts in cosmetics, personal wash and shampoo have also improved the company's product mix. A large premium portfolio may translate into greater pricing power in an inflationary environment and improve the overall margin profile.

Several FMCG companies faced pressure on profit margins in the September quarter on account of rising input costs, but Lever's profit growth managed to keep pace with its sales, as a result of price increases in a few categories and an improving product mix.

An expanding suite of offerings may also allow the company to garner more shelf space in modern retail stores and capture a higher share of wallet from young urban consumers.

Focus on domestic market

Lever's continued focus on the domestic market, at a time when other FMCG players are on an overseas acquisition spree, is also a point in its favour.

Though an acquisition-led strategy can deliver disproportionate payoffs, overseas acquisitions also bring with them issues of integration and managing cross-border trade, which enhance earnings uncertainty. Lever's earnings growth stems clearly from strong volume offtake from domestic consumers.

Given that the shift in the demographic profile of Indian consumers that is now underway, a focus on the domestic market should deliver secular and predictable earnings growth.

Problem areas

Despite strong earnings numbers, there are quite a few problem areas for Lever. One, the company has lost market share in categories such as fabric wash, soaps and skin care over the past year, due to the onslaught of focussed competitors in the respective categories. With the new entrants to FMCG space steadily expanding, Lever may have to continue making heavy adspends and spend on new launches to protect its turf.

A presence across categories and price points gives Lever the flexibility to offset market share losses in one category through gains and price increases in another. But a continuing slide in market shares will be a cause for concern. The next couple of quarters will bring solid evidence on whether the frenetic pace of new launches in recent months has helped the company make up the slippage in market shares.

Second, the possibility of an increasing share for modern organised retail with the entry of retailing giants such as Wal-Mart into the Indian markets, may also pose a threat to the entrenched FMCG companies.

Indian FMCG players have traditionally enjoyed considerable clout with their distributors, given that the latter are highly fragmented. Strong retailers could wrangle higher distribution margins from FMCG companies and launch private label brands, which could eat into the market shares of organised FMCGs. However, there may be mitigating factors for Lever.

Even if modern organised retail does make significant inroads into the Indian market, Lever, with its large brand portfolio straddling categories and price points, may be better positioned to wrangle favourable terms on shelf space and margins, than local competitors operating in just one or two categories.

An extensive distribution reach outside of the urban centres may also help the company weather the onslaught of modern retail better than its urban-centric competitors. As to private labels, it will certainly take time and significant investments for them to garner market share in the Indian context and the threat may be muted in brand-conscious categories such as personal care and shampoos, which are the key growth drivers for Lever.

Overall, despite problem areas and a relatively rich valuation for the stock, Hindustan Lever appears a reasonable investment option within the FMCG space on account of its improving earnings prospects and ability to piggyback on the domestic consumption theme.

However, given the valuation levels, the stock would only be suitable for investors with a 12-15 return expectation.

More Stories on : Stocks | Recommendation | Personal Products | Hindustan Lever Ltd

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page