Analyst Corner: Maintain ‘add’ on Hindustan Unilever with TP of Rs 2,400

A potential change in stance at HUL in favour of volume growth, in our opinion, could be a key driver for HUL stock’s outperformance in CY2021. We note that this strategy has already started playing out in tea (price hike lower than competition and commodity inflation), soaps (price hikes lower than competition despite steep input inflation (palm prices up over 30% in 6M) and detergents. In India, a “growth market”, investors tend to (rightly) ignore short-term profit sacrifice, provided the trajectory of volume outperformance is clear(as it’s DCF-accretive). Nestlé stock’s 43% outperformance between Oct’18 – Sep’19 driven by volume growth-led valuation rerating, despite weak earnings, is a case in point.

We are amending our FMCG portfolio strategy recommendation of Godrej, Marico, Dabur, Tata Consumer over HUL (post HUL’s 26% underperformance (versus Nifty)over last 6 months).ADD retained.

HUL’s comment in Q2FY21 call. “I think the right thing for us to do is to focus on competitive volume-led growth. And if it means that some of the margin expansion is not at the desired levels or the levels we would like to be, it is absolutely okay with us. We will invest to drive growth.”

Focus on volume growth, even at the cost of margin pointing to a trajectory change: We believe that HUL is likely at the cusp of a period of volume growth acceleration– even if that means sacrificing gross margins to an extent. We note HUL’s comments in Q2FY21 earnings call stating the change in thought process. This strategy is already playing out in tea and soaps, where HUL has taken a much lower price hike versus competition and versus commodity inflation, in a bid to gain market share. Even in detergents, HUL has been quick in passing input cost benefits, again ahead of competition.

Nestle had outperformed peers over Oct’18 toSep’19 period driven by P/E multiple expansion: Recently, overa12- month period(Oct’18 – Sep’19), Nestlé’s stock significantly outperformed peers (see figure 2). However, during this period, Nestlé’s earnings growth significantly lagged peers –a strategic move by Nestlé to delay price increases offsetting diary inflation, thereby driving volume growth at the expense of profitability. We believe that in India, a “growth market”, investors tend to ignore short-term profit sacrifice, provided the trajectory of volume outperformance is clear. Maintain ADD  rating with DCF-based unchanged target price of Rs 2,400. Key downside risks are delayed recovery in demand and irrational competition.