Investment Focus - Hindustan Unilever: Buy

With the Budget pegging up indirect taxes and inflation showing signs of returning, investors may benefit by focussing on sectors and companies with undisputed pricing power. FMCG makers fit the bill. Hindustan Unilever (HUL) appears the best bet within this space on many counts. With a vast product basket, strengths in both rural retail and modern trade and brands across price points, HUL has navigated the inflation and cost pressures of the last two years exceptionally well. At a price-earnings multiple of 33 times its trailing 12-month earnings and 28 times next year's earnings, the stock is attractive. It trades at a discount to smaller peers such as Nestle India and Procter & Gamble Hygiene.

Even as much of corporate India struggled to maintain margins, HUL closed the nine months ended December 2011, with a 1.1 percentage point improvement in its operating profit margins to 15.1 per cent. A tight rein on material costs, a shift in product mix towards premium brands and cutbacks in advertising and promotional spends have contributed to the company's strong numbers. The company's 16 per cent sales growth in this period came from an even blend of price and volumes, with profits (excluding one-off) vaulting 24 per cent.

HUL's presence across many FMCG categories has given it the flexibility to tweak prices and adspend to deliver a good overall result. For instance, in soaps and detergents where raw material prices spiralled, HUL sharply reduced adspend and raised selling prices. With smaller rivals following suit, price increases balanced out lower volume growth, helping the segment deliver an 18 per cent sales growth with a 36 per cent higher profit in the first nine months. In personal products, the company kept up a hectic pace of new launches and adspends; it also reduced prices. That drove consumer upgrades to better products and helped double digit growth in personal care.

The high inflation scenario also seems to have aided market share gains for HUL across categories. A high-cost scenario is usually negative for local and unorganised players in FMCGs, possibly leading to share gains by larger brands. While FMCG industry growth has been tapering down in the last two quarters (it was 10 per cent in the December quarter), HUL's growth trajectory has been improving (16.5 per cent in December).

Strategic initiatives put in place by the company in recent years have led to much more extensive rural coverage, a higher share in modern trade and a product mix that is increasingly tilting towards higher margin products. Led by scorching growth in brands such as Dove, Pond's and Axe, personal products today bring in nearly 30 per cent of the company's sales and nearly half its profits, a change from 25 per cent and 40 per cent three years ago. This product mix and HUL's presence across price points provide insurance against any slowdown in rural demand caused by an erratic monsoon or rising inflation over the next few months.

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