Rising input price tag inflation is a headwind for HUL with the existing input basket close to a decade higher level, on our assumptions. This raises concern on HUL margins, but we see some offsetting variables like item mix normalisation (post pandemic), item price tag hike and operating leverage added benefits. While HUL would be capable to largely keep Ebitda margins, this warrants EPS cuts of 4-5%, regardless of which development would be robust at 14%+ more than FY21-23e Purchase.
Input price tag inflation: HUL’s widespread portfolio tends to make it challenging to track the input price tag inflation but our RM Index points to the highest level in a decade. Inflation is specifically higher in case of palm oil, tea and crude oil derivatives. This implies the next couple of quarters would be difficult for HUL on the input expense front.
Staggered price tag hikes: We note that the effect of input price tag inflation calls for sharp item price tag hikes in soaps & packaged tea but HUL has been staggering the hikes. This is to make certain customer acceptability without the need of a substantial unfavorable effect on volumes. We also consider HUL would like to be confident on competitors reaction. In the previous six months, rates of soaps are up almost 6-14%, with hikes in previous two weeks as effectively packaged tea has noticed 17-23% raise due to the fact Sep-20.
Adverse mix will assistance: Since the Covid-19 induced lockdown, HUL has underperformed some of its listed FMCG peers due to a larger salience of discretionary (& out-of-residence) merchandise. While this had an apparent effect on revenues, the effect has been even larger on the margins as segments like skincare, colour cosmetics, deos have margins much better than the business typical and substantially larger than skin cleansing (soaps) which witnessed robust development.
Case study on Q1FY21: In order to highlight the extent of adverse mix effect on margins, we reanalysed the quarter of Q1FY21. The RM Index in the quarter points to a relatively steady input price tag trend. However, HUL essentially reported an LFL gross margin decline of 350bps, which we think was due to adverse category mix estimated at 300bps, based on our back of the envelope calculations.
Margin concern but not as terrible? While the effect of sharp rise in input rates is inevitable, we think the effect may possibly be reduced than the basic perception. This is due to item price tag hike, mix improvement, self-assistance measures on expenses and operating leverage added benefits. We at present create in c.6% item price tag hike in FY22 and history suggests that HUL could very easily pass this on. While there would be a slight decline in YoY GMs, we forecast close to-steady Ebitda margins.
Our view: We reduce our FY22/23e EPS forecast by 4-5% to element in input price tag surge but anticipate HUL to report a robust 14% EPS CAGR more than FY21-23e. We retain Purchase with Rs 2,650 TP and HUL continues to be in our prime sector picks.