The stock of Hindustan Unilever (HUL) now trades at 55 times the company’s trailing 12 month earnings. This time last year, the trailing price-earnings multiplewas far lower at 33.8 times. The stock’s average five-year PE is around 35 times.

The HUL stock’s rapid climb has been on the strength of its market dominance, presence across price points in multiple product categories, and a bounce back in performance of the personal products segment.

HUL also benefited from the predictability of sales and earnings in the FMCG sector at a time when the performance of other sectors remained uncertain.

But these positives appear to be factored in the company's stock price, leaving limited room for further gains. HUL closed the December 2014 quarter with meagre growth in sales, and profits received a boost through sale of property.

The next two to three quarters should see the low-growth scenario continue. One, discretionary spending is still weak. And two, the potential for sales growth through product price hikes is dwindling as raw materials are becoming cheaper.

So though HUL is well-positioned to grow over the long term, near-term growth prospects may be capped. A trigger for a fresh valuation re-rating, which can push the stock even higher, seems remote at this point.

Investors can book profits in the stock. From our recommendation last February, the stock has gained 70 per cent.

Growth down

In the recent December quarter, sales grew 7.7 per cent over the year ago. The June and September quarters had seen sales expand 13 and 11 per cent, an improvement from the sub-10 per cent growth of the quarters before. This revival was helped by the personal products segment bouncing back.

A re-launch of the segment’s flagship Fair & Lovely in the September 2013 quarter was primarily responsible for this. But with more than a year gone by after the re-launch and discretionary spending in cosmetics still sluggish, personal products slipped back into low growth.

For the December 2014 quarter, the segment grew 7 per cent over the year ago period, below the 10-12 per cent it managed in the quarters before.

Sales growth in HUL’s other marquee segment — soaps and detergents — also dipped as the company cut product prices nearly 5 per cent.

From a growth of 10-13 per cent in the quarters between January and September 2014, soaps and detergents grew 6 per cent in the December 2014 quarter.

Beverages and packaged foods held on to their sales growth of around 8-13 per cent, but the two segments contribute just under 20 per cent to total revenue. With the primary raw material, palm fatty acids, turning cheaper by over 20 per cent in the second half of 2014, HUL looked to protect its turf.

The company chose to lower product prices for soaps and detergents (which accounts for half its revenue) rather than using cheaper inputs to plump up profit margins.

Limited scope

This is a prudent move, given the still-sluggish market and the high penetration of soaps and detergents. Price cuts by competitors could have also hurt sales, had HUL not slashed its prices.

The price cuts also saw HUL stop sales for a few days to clear the high-priced inventory to make way for lower prices. This led to volume growth dropping to 3 per cent in the December quarter from 4-5 per cent maintained over the last several quarters. But a cut in product price is a double-edged sword in sluggish markets.

While volumes in the soaps and detergents segment will improve, price-driven growth is set to fall. Further, demand is stemming from low-priced packs.

Overall, until consumers increase spending and there is an improvement in sales of premium priced products, growth will be capped.

Rural demand, which had earlier made up for the wary urban consumer, is turning weaker on lower harvest incomes.

Besides palm oil, crude oil derivatives form another key input for the FMCG industry. A stable rupee also keeps costs in check. Benefits from lower input costs can continue in the coming quarters as well, with abundant palm oil supply and a weak outlook for crude oil.

Maintaining margins

HUL can use savings here to raise promotional spending. For the past four quarters, HUL has scrimped on this front.

The proportion of adspend to sales has consistently been lower in the 2014 quarters at around 13 per cent compared to the 14-15 per cent in the year-ago quarters.

With a push needed in oral care and detergent re-launches, the adspend-to-sales ratio is likely to move higher now.

Operating profit margin may, therefore, not improve from the current 13-15 per cent range.

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