A Fall From Grace.

     For the past 4 years, India’s largest FMCG (fast moving consumer goods) company, Hindustan Unilever Limited (HUL) was indeed the toast of the market. Quarter after quarter, HUL clocked double-digit growth rates in terms of both turnover and net income. On the volume front, HUL didn’t disappoint the Street either and its scrip constantly outperformed those of rivals like ITC, Marico and Dabur. Most brokerage houses had strong ‘buy’ and ‘outperform’ ratings on HUL, with ambitious price targets that predicted an annual return of over 30%. For many years, HUL was indeed the undisputed darling of the stock market but like that old saying goes, all good things must come to an end. And true to that saying, Q3 of FY13 was when HUL’s time in the sun ended.

     Unilever, the Anglo-Dutch parent company of HUL, has seen a slowdown in most of its developed markets in recent years and it has turned to emerging markets like India, Indonesia and Brazil to power its growth engines. As far as India goes, Unilever has lofty ambitions for its Indian subsidiary. Paul Polman, the chairman of Unilever, has stated that HUL will grow its turnover multi-fold and treble its profits over the course of the next decade. But at the press conference following the release of HUL’s Q3 results, HUL’s board made an announcement that not only sent its scrip crashing, but also signalled far-reaching consequences for the company for several years to come.

     HUL declared that it was enhancing its royalty payments to Unilever from 1.4% to 3.15% of its annual turnover. The increase would be affected in a staggered manner over the next 5 years, with the new arrangement fully coming into play in 2018. HUL’s royalty outgo, which currently stands at 1.4% of its sales, adds up to a figure in excess of 10% of its annual net profit. Furthermore, that royalty, as a percentage of the company’s net profit, is only going to see a steep increase in the years to come. An increase in royalty payments is not something that the stock market takes too kindly to and sure enough, HUL’s scrip has been hammered in recent weeks and the overhang on the stock still persists.    

     With pressure growing from Unilever to magnify its profits, HUL has resorted to price increases in virtually all of its product categories in the recent past. The price-sensitive Indian market, however, has not reacted favourably to the move and HUL’s volume growth, which used to be in the range of 15%, has already collapsed to 5%. Customers are shifting to products of rival companies such as Procter & Gamble (P&G) and Reckitt Benckiser. Tide and Ariel, a pair of flagship P&G brands, are already growing at a faster clip than Surf, HUL’s market-leading detergent brand. In recent times, in what can be pinpointed as a direct result of the undertaken price increases, HUL’s turnover growth rate has slowed to 10% and the company has been ceding market share in several segments to its rivals. In order to arrest its falling profit margins and to offset its rising input costs, HUL has embarked on a strategy of premiumization. With launches of new, higher-priced variants of its best-selling brands and with brand launches such as the likes of TRESemmé, HUL is endeavouring to take its consumers to a higher level on the price realization and value chains. The price increases and the premiumization strategy may pay off in the long run but for now, HUL’s profit figures are witnessing a tepid rate of growth. HUL’s competitors are turning up the heat and making their move to wrestle away market share from the Anglo-Dutch colossus. In spite of being the dominant player in the FMCG sector in India, HUL indeed has its work cut out for, in the years to come.    

     The exalted 35-times price multiple that the HUL scrip once enjoyed is now history. Today, HUL is placed on the same pedestal as most of the other FMCG companies. Many brokerages have downgraded the counter and the market seems to be leaning towards its rival, ITC. After all, ITC’s FMCG business is showing tremendous growth, especially in the soaps and shampoos space, and it happens to be a mere quarter or two away from breakeven. The end result is that HUL has lost both the premium valuation and the reverence that it once used to command on the bourses. With its two-pronged move of enhancing royalty payments to Unilever and raising prices, HUL has virtually succeeded in picking up a shotgun, loading it, taking careful aim and strategically shooting itself in the foot.  

     As far as HUL is concerned, a few quarters of robust, Street-beating numbers would be just what the company needs to enable it to reclaim the glory of its heyday. HUL will have to impress the Street on the volume, turnover and profit fronts, if it has any hope of giving its image a makeover. It certainly is a tall order and the next 3 quarters will go a long way in determining the market’s perception of HUL and the outlook on the consumer major. Today, the stock market is almost a mirror image of what it was half a decade ago. The Sensex continues to oscillate wildly in these choppy and turbulent times and the FMCG sector continues to be the pick of the market. The only difference, however, is that HUL is no longer its blue-eyed boy.