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Where to from here?

The stock may have underperformed in recent times. Will investors be rewarded in the near future for their patience?

Year 2008 was a pivotal one for Hindustan Unliver Limited (HUL). The rapid increase in prices followed by decline caught it offguard. Its volume growth fell 4 per cent in the March 2009 quarter compared to a rise of 10 per cent in the March 2008 quarter. Since then volumes have recovered: at the end of March 2010 they were up by 11 per cent. However, the event exposed the chink in the market leader's armour. The company services one million retailers directly and another six million indirectly. With such a massive supply chain to cater to, it got stuck with high levels of inventory. Its competitors, who have smaller networks to cater to and hence carry lower levels of inventory, were able to quickly introduce cheaper products that ate into the leader's market share.

The company that has taken the maximum advantage of HUL's shortcomings is long-time arch rival Procter & Gamble (P&G). In recent months P&G has upped the ante by aggressively pitting its lower-priced detergent Tide Naturals directly against Rin (the latter is currently the biggest brand in the low-cost detergent segment). Now Jyothy Laboratory wants to take on Surf Excel with its brand Ujala Techno.

HUL has responded aggressively by taking the fight to P&G with bold ad campaigns, though it was forced to stop airing them after a High Court order. But by that time the battle lines were clearly drawn.

In addition, the company also appears to be working on its weaknesses. It has improved its overall capacity utilisation level from 75 per cent in 2009 to 92 per cent in 2010. According to Pradeep Banerjee, supply chain director, HUL, “We have reduced the finished goods and raw materials in the chain dramatically by 30-40 per cent, which means lesser working capital, faster response time and better service.” As reported by Mint, this has led to a drop in the number of days for which stock is held from 90 to 60.

HUL has also halved the time it takes to introduce a new product in the market. In the last one year or so, the company has re-launched 80 per cent of its product portfolio, bringing prices in line with those prevalent in the market. At the end of March 2010 quarter, its total advertising spend stood at Rs 656 crore, 45 per cent higher compared to Rs450 crore in the March 2009 quarter.

The institutional reaction hasn't been positive. As a result, the stock has made little headway after July 2009 and has underperformed the markets since. It has fetched a return of (-)2.51 per cent over the last one year, compared to the BSE FMCG index's 30.77 per cent and the Sensex's 22.03 per cent. The returns would have been worse but for the price surge in the last two months, once the news of share buyback broke.

Most of the country's leading brokerage houses are of the view that the company's aggressive approach (price wars leading to lower margins) will jeopardise its profitability and erode shareholder value. Their advice to investors is to cash out at the time of buyback.

Mutual funds have also dumped the stock: by the end of June 2010 they had sold 2.6 crore shares of HUL over the past one year, reducing the total value of their exposure by approximately 68.44 per cent. Over the past one year, the number of funds holding the stock in their portfolios has declined from 114 to 67.

Disappointing Q1FY11
HUL has been able to push volumes in various segments. In soaps and detergent volume growth was restored to double digits - driven by premium brands. Its skincare segment was also able to post a double-digit volume growth.

Its top line grew year-on-year by 7.1 per cent, on the back of volume growth of 11 per cent. The company's operating profit increased sequentially by 13 per cent but it fell by 2.57 per cent on y-o-y basis. Moreover, the net profit margin was hit by 351 basis points this qurter on account of higher ad spends.

What should you do?
If you observe HUL stock's price trend over the past 10 years, you will find that it has mostly traded below the Rs250 mark with price-earnings ratio (P/E) of around 25. In July 2009, it was trading at Rs290 level, very near its 10-year peak with a P/E of 30 plus.

Hence the fall in the stock price has got more to do with valuation. The correction in the stock may have been triggered by fundamental factors. But the negatives do not appear to be such as to dent its long-term outlook. It is fundamentally still a very strong company.

HUL did a remarkable job of protecting investor wealth during the recent market crash: it gave a return of 17 per cent in 2008. That is the character of this stock: it falls less but at the same it rarely goes up too much (in 2007 the stock gave a return of -1.22 per cent). In other words, it is true to the defensive characterisation of its sector. The buyback, by reducing the number of shares outstanding, will enable the company to post higher earnings per share and return on equity (even if profit levels remain constant). Hence investors should keep a close eye on this stock and accumulate it whenever its price drops.