HUL's expensive ascent

Summary: HUL’s business remained strong, but its stock still delivered disappointing returns. This story examines how a justified re-rating gradually turned into expectations that the business could no longer meet.

Summary: HUL’s business remained strong, but its stock still delivered disappointing returns. This story examines how a justified re-rating gradually turned into expectations that the business could no longer meet. Hindustan Unilever (HUL)’s history offers an unusual titbit. Its profits never compounded at 20 or 25 per cent for long periods, but the share price often did. The appeal was easy to understand. HUL sold everyday products, needed little capital to grow, generated cash regularly and carried little financial risk. In 2011, Rakesh Jhunjhunwala explained the FMCG sector’s premium through three things: growth, return on equity and cash flows. Consumer companies could grow reasonably well, earn high returns and distribute large amounts of cash without continually asking shareholders for more capital. HUL already had those qualities by FY10. What followed was a genuine improvement in profitability, which earned the stock a sharp re-rating. The trouble came later when investors began to price that improvement as though it could continue without limit. Its dismal returns in recent years show what happens when a strong business falls short of even stronger expectations. But the optimism did not begin irrationally. Where the re-rating began Between FY10 and FY17, HUL’s sales grew at 9 per cent annually. EBITDA margin rose