HUL's packaged food segment may slowdown in Q2: StanChart

India’s largest FMCG makes,Hindustan Unilever (HUL) would announce its second quarter earnings today. Sanjay Singh of Standard Chartered Securities expects the company’s volumes to grow by 8 percent in Q2. However, he cautions that its packaged food category may see some slowdown.

Meanwhile, HUL’s sales and profit is likely to rise by 18 percent and around 22 percent respectively. The broking firm recently downgraded HUL to in-line rating after 18 months on the back of expensive valuations and earnings growth. 

Other FMCG players like Nestle, Britannia and Glaxo may also see moderation in volume growth, he added.

Also read: HUL Q2 net profit seen up 14% YoY at Rs 785 cr

Below is the edited transcript of Singh’s interview with CNBC-TV18.

Q: What are your expectations from HUL today?

A: HUL numbers are expected to be good. We expect around 8 percent volume growth, 18 percent top line growth and around 22 percent like to like adjusted profit growth.

Q: Do you think this 8 percent kind of volume growth is sustainable going into the next few quarters?

A: Well it is a debatable issue. I feel that the consumption growth will continue for long and last in the few quarters, last year or so, despite slowdown in the economy, consumption growth continued to be quite strong.

In this quarter while we are seeing good numbers and we should see good numbers even in case of HUL, we are talking to our clients about the first signs of slowdown in staples.

So, even in this quarter, we will probably see a mixed bag. We are seeing some kind of slowdown in the packaged food categories. So, any kind of packaged food categories should see some slowdown this quarter, this also includes their food business. For companies like Nestle, Britannia and Glaxo should see some kind of moderation in volume growth.

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Q: Do you think HUL will find it difficult to re-rate further upwards given the kind of valuation levels it is trading at already, given that volume growth might be a little bit more restrained as you are describing?

A: We have downgraded HUL a couple of days back after having it as the top pick for the past 18 months. The reason is firstly valuations and secondly earnings growth.

The turnaround in HUL has played out very well and probably little more than it should have and hence the downgrade. HUL currently trades at 35 times one year forward. If you look at anything in the last 12-13 years, HUL is in the range of around 25 times median valuation. So it is almost 50 percent more expensive than last 10-12 years.

The question a lot of people are asking is; can HUL trade at 35-40 times as it did in the 90’s when investment growth had slowed down and when consumption growth continued? But the point is, HUL in those days used to do a 30 percent plus EPS growth. For 8 years- 1992 to 2000, HUL was at 30 percent plus EPS growth and the median PE was 38 times.

Today, we are looking at a 12 percent EPS growth from FY13 to FY15. FY13 will ofcourse be very good, but FY13 to FY15 we are looking at a 13 percent EPS growth on the back of around 18 percent EBITDA growth. Tax rates are increasing very significantly because some of the tax free locations are going away. Now, this is not factored in by the street. The street is still looking at favorable tax rates going forward. But as tax rates go up and excise rates go up, my sense is earnings growth will be moderate even if EBITDA growth is good. So, a 35 times valuation is not sustainable and hence we have downgraded HUL to inline just a couple of days back.

Q: You have downgraded ITC as well from the same basket?

A: ITC is also downgraded to an inline after the results. Results were good, as usual there were no surprises. It was a good strong robust result but at 29-30 times, ITC is not favourable in terms of valuation. As we go towards the budget, it’s well held over owned stock across the board. As we go towards the budget, we will see some kind of jitteriness with investors and hence valuations should retrace a bit. So, it’s a tactical call on ITC for the next six months or so.

We also afraid of event risk on ITC. We see state level taxation as a huge negative, which as of now street has kind of ignored, because it has been well handled and well managed. Earnings growth have not gone down because of state level taxation, but Rajasthan and Uttar Pradesh are examples where now VAT has gone to 50 percent. But these are low volumes states. If high volume state like Tamil Nadu, Kerala goes to these kinds of VAT numbers, we are in for a significant event risk. So even risks are not priced in, all the positives are priced in here and atleast from a tactical perspective from next six months or so we should see a much softer ITC.

Q: What did you take away from the numbers of Asian Paints?

A: Asian Paints was typically inline with expectations. There were no surprises. People were expecting some surprises in terms of margins because rupee has been soft, crude has been a bit stable, titanium oxide (TiO2- a white pigment used as feedstock in coatings) has come down quite significantly. People were expecting some kind of margin expansion but that didn’t happen Margins disappointed in a way but volumes were pretty okay compared to the last quarter which was very bad.

So, volumes were around 8-9 percent. Standalone volume growth, was pretty okay given the last quarter expectations. So it’s a mixed bag and the stock like most consumers stocks is expensive but there are no significant surprises here to take it forward.