Hindustan Unilever Rating: Buy- Q2FY21 performance marks an inflection point

Q2 results ahead of expectations marks a turning point: (i) Organic domestic consumer growth of 3% y-o-y (1% underlying volume growth) turned positive in Q2, ahead of expectation. Overall, standalone sales/Ebitda/PAT grew by 16%/17%/11% y-o-y, respectively. Reported sales were c3% ahead of consensus; (ii) HUL’s agility and sharp execution led 80% of the revenue pool (Health, Hygiene, and Nutrition) to grow by 10% in Q2, which marks strong recovery momentum; (iii) the revenue decline for discretionary items such as skin and beauty care (c15% of portfolio) of 25% y-o-y and out-of-home categories (5% of portfolio) of 25% y-o-y was also a significant improvement in sequential terms; (iv) despite the gross margin decline due to adverse mix and RM inflation, the company managed to deliver a modest 28bp Ebitda margin improvement. This was driven by GSK integration, which led to a 90bp increase in Ebitda margin, offseting the 60bps decline in the base business; (v) HUL reported an interim dividend of Rs 14/sh for FY21e.

Several catalysts still at work: (i) The homecare category has seen growth held back as the fabric wash category has been impacted by customers not venturing out often amid the COVID-19 pandemic. However, as the economy is opening up, a return of growth seems imminent in this category, with strong premiumisation trends; (ii) the GSK portfolio was flat y-o-y (in part due to temporary supply disruption at some of its plants). HUL also hasn’t yet fully employed its distribution and market development capabilities, and management seems to be confident of it returning to strong growth in the coming quarters; (iii) While the high margin segments of Skin and Beauty are impacted by COVID-19, we expect that as the revenue mix improves, margin tailwinds will return as well; (iv) in the near term HUL seems determined to push for volume growth (in segments such as Tea, where it is gaining market share) even at the expense of margins. Overall, in our view, Q3 will be stronger than Q2 and we expect growth to fully rebound by Q4.

HUL’s investment case rises above this short-term disruption: HUL is a growth engine with superior cost economics, which is underpinned by its leadership in several large and underpenetrated categories, where it has brands, scale, an innovation pipeline, a strong go-to-market strategy, marketing mix, and deep distribution capabilities.

Maintain Buy and Rs 2,900 TP: We estimate that HUL’s valuation builds in long-term earnings growth expectations of 11-12%, which we believe is undemanding. A recovery in growth will be a key catalyst.