Hindustan Unilever Limited – Annual report analysis – looking for profitable growth (Add, TP: Rs2,219)

FY20 was a challenging year for HUL, characterised by rural slowdown and the outbreak of COVID-19 taking a toll reflecting volumes and revenue growth (~2%), yet 32% FCF growth was strongly led by expansion in margins, flat capital expenditure and positive working capital swing. EBITDA grew 11% resulting EBITDA margin up +216 bps driven by home care (~74% salience in gradual profits), while BPC saw sluggishness affected broadly by falling discretionary and lower share of wallet. RoE improved for third consecutive year to 88% (+339 bps YoY) aided by improvement in margin. The company maintained to chase its strategy of strengthening core brands, WiMi, accelerating ‘premiumisation’, driving market development, plugging white spaces, innovation, scaling naturals and investing in digital transformation. Nonetheless, near term outlook appear to be subdued, it growth strategy to be driven by GSK-CH integration, strong execution, driving M & A and focus on solid cost savings initiatives. We retain our ADD rating with DCF based Target Price of Rs2,219.

Reasonable delivery given the weak environment, yet balance sheet strengthens

Through its initiative reimaging HUL, net operating revenues grew 1.5% YoY with UVG at 2%. Against the challenging backdrop, it is focusing on the long-term health of the business, keeping its savings ambition unchanged. EBITDA margin expanded 216 bps YoY on the back of gross margin increase of 111 bps. Management emphasised that its cost-savings program delivered 7% of net sales as gross savings in FY20. Further balance sheet strength is evident from increase in RoE to 88.4% from 85% in FY19. Reduction in working capital days by 2 days to 41 days and 32% rise in FCF for the year to Rs65.9bn driven by 17% growth in CFO (ex-working capital change), improvement in working capital cycle and broadly flat capex.

Strategic priorities to drive growth

HUL has the right mix of strategic initiatives ranging from WiMi, focus on innovation, driving ‘premiumisation’, market development, scaling up naturals and strengthening core brands that will continue to benefit in the medium to long term. Moreover, organization-wide digital transformation ‘Reimagining HUL’ will give it a competitive advantage. HUL’s People Data Centre picks up consumer signals real-time in analysing consumer sentiments and customer engagement with brands and categories going to be growth engine. The digital initiative would further help the company to be agile in responding consumer needs and sharpening its communication, rather digital focus would help to be future ready.

M&A deals added as another arrow in HUL’s quiver

Management commentary calls out M&A as among the key growth drivers with an emphasis on M&A in fast-growing segments. In our view, inorganic route should be an important component of HUL’s top-line/bottom-line growth. Its impressive cash flows, ability to leverage its strong distribution network and superior market understanding v/s peers shall place it well to benefit from its new found appetite for inorganic expansion.

Valuations are reasonable, better cash-flow, stable return ratios

We expect continued impact on discretionary category (BPC/ OOH) to cap HUL’s volume growth in the near term. We maintain our Add rating and DCF-based target price of Rs2,219, implying 54x FY22E earnings. Risks to our call include significant acceleration in volume/price, decrease in ad-spends leading to margin expansion and lower competitive intensity.

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