Stock Fundamentals

HUL Q4 results: Why the road to recovery looks longer

Parvatha Vardhini C | Updated on May 02, 2020 Published on May 02, 2020

With only partial return to normalcy expected, company may continue to be on rough terrain

For 15 days of disruption, Hindustan Unilever has had quite a bit to worry about in the quarter ended March 2020 — with volumes plunging 7 per cent over the March 2019 quarter (year-on-year), sales shrinking almost 10 per cent to ₹8,885 crore and profits dropping by 1 per cent to ₹1,519 crore.

With a complete lockdown in April and only a partial return to normalcy expected in the near term, the company may continue to be on a rough terrain, even as it operates in the ‘defensive’ consumer non-durables (FMCG) space, supplying essentials. HUL’s March 2020 quarter results also foretell what may be in store from other players in this segment.

As it is, private consumption had been in slowdown mode even before the Covid-19-led distruption.

Going by HUL’s numbers, the road to consumption recovery has only become longer.

New low in volumes

The Covid-19 pandemic set in at a time when the FMCG industry itself was seeing a slowdown in volumes. Nielsen estimates show that after growing at 13.5 per cent each in 2017 and 2018, the industry growth slowed progressively through each of the quarters of 2019. Thus, although the overall growth for 2019 stood at 9.2 per cent, growth had actually come down to 6.5 per cent by the October-December 2019 quarter.

This further deteriorated to 5.3 per cent in the three months ended March 2020.

The weakening in HUL’s volume growth over the past few quarters is in line with this.

HUL’s volume growth (year-on-year) plunged to 5-7 per cent in each of the quarters of 2019, compared with the 10-12 per cent growth seen in the five quarters prior to that. The 7 per cent drop seen now is the lowest in recent memory. Despite the impact of demonetisation in the three months ended December 2016, HUL had seen a volume drop of only 4 per cent. In the GST transition during the quarter ended June 2017, the company saw 0 per cent (flat) volume growth.

As against a 7 per cent fall in volumes in the March 2020 quarter, revenues dipped by 9.4 per cent. This is almost a 12 per cent drop from the 3 per cent growth that HUL had expected, if it was business as usual.

HUL attributes half of this fall to reduction in distributor stocks, and the remaining to reduction in retailer stocks and shrinkage in consumer demand.

The top line was also impacted due to 15 per cent price cuts made in hand wash (Lifebuoy) and home cleaners (Domex). Price cuts in hand sanitisers, due to classification as essential commodity, were also put in place.

Margin pressure

Apart from weak volumes and price cuts, higher raw material prices and advertising expenses exerted pressure on margins.

Raw material costs as a percentage of sales moved up to 49.4 per cent from 46.9 per cent a year ago. Although crude prices fell, the company saw cost escalations in inputs such as other oils, skimmed milk powder and tomato paste.

Advertising expenses as a percentage of sales stood at 13.1 per cent vis-à-vis 11.3 per cent.

As a result, operating margins dropped 40 basis points to 22.9 per cent over the March 2019 quarter (160 basis points drop on comparable basis due to Ind AS 116 adjustments).

In the next one or two quarters, a comeback in margins may not be easy. For one, beauty and personal care, the company’s biggest and most profitable segment, is riding on the back seat now. Sales in this segment plunged 14 per cent in the March 2020 quarter, compared with a 4-6 per cent drop in the home care and foods segment, while margins also dropped to 24.8 per cent from 27.7 per cent a year ago. It is notable that this segment was already impacted by the consumption slowdown seen even before the Covid-19 outbreak.

The focus on producing and selling essential goods such as hygiene/home care products and foods, and limited room for price increases could continue to exert pressure on margins.

The emphasis on getting goods to selling/distribution points through third-party partners (Swiggy, Dunzo, HumaraShop) during the lockdown may also impact margins.

However, the company has taken a few measures to mitigate the pain points to an extent.

It is striving to improve its product mix by bringing out new hygiene products such as Lifebuoy/Domex germ kill spray, cloth sanitisers and germ removal wipes. Thanks to the merger with GSK Consumer Healthcare, the company is also pushing nutrition drinks such as Horlicks during this time. Horlicks with added zinc, which supposedly boosts immunity, is already being supplied.

Secondly, cost-cutting efforts are also on, with focus on receivables, inventory management, deployment of credit, pruning advertising expenses, trimming travel spends and deferring some expansion plans.

 

Outlook

For most FMCG compies, the past few quarters have been characterised by rural demand falling sharply behind urban offtakes.

So far, rural India seems to be less impacted by Covid-19. This presents a window of opportunity for HUL, which usually derives 40-45 per cent of its revenues from rural India.

However, according to HUL, rural demand is dependent on factors such as migrants sending back money home, the extent to which direct transfer benefits have reached rural population, as well as the extent to which harvesting and transportation of produce to mandis has been carried out. Hence it is too early to say that rural demand could cushion the urban slowdown.

The restoration of supplies to the extent of 75-80 per cent as of end-April — be it in terms of raw materials or delivery to distributors — is a positive for the company. Production lines, though, have not come back to normal yet. The production of hand sanitisers has gone up 60 times over the average of the December 2019 quarter.

On the other hand, the company re-started manufacturing skin and hair care products recently, and has also got approvals to commence production of beauty and personal care products. Ice-cream production is negligible, despite the scorching sun.

The company is currently not in a position to judge pent-up demand for various products due to the lockdown, and hence, production-demand mismatch in the near term could occur.

Synergy benefits from the merger of GSK Consumer will be a factor to watch out for in the coming quarters.

While the uncertainty continues, the HUL stock hit a one-year high of ₹2,614 in early April, buoyed by relative resilience of consumer non-durables to an economic slowdown, the completion of merger of GSK Consumer, and the acquisition of VWash from Glenmark Pharmaceuticals. Though the stock has corrected 16 per cent since, it now trades at 76 times trailing 12-month earnings, leaving limited room for upside.

Published on May 02, 2020
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