CIMB downgrades HUL; sees FY16 volume growth around 7%

Varun Lohchab of CIMB Equities in an interview to CNBC-TV18 said the house has downgraded Hindustan Unilever with a target price of Rs 800 on back of disappointing third quarter performance.

The FMCG major disappointed on volume growth front, which stood at 3 percent, much lower compared to forecast of 5-6 percent and 4 percent in Q3FY14.They have also downgraded other select consumer staples because according to him the recovery in terms of volume growth for HUL and others would take longer than expected. They expect HUL’s FY16 volume growth to be around 7 percentThe house would again think of reentering the stock at a price 10 percent below the target price, says Lohcab. According to him the recent run up seen in HUL and others was on back of significant fall in crude prices and lower input costs, which was a case of misplaced optimism.

Below is the transcript of Varun Lohchab’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.Latha: The numbers look a little confusing is the volume growth 3 percent or an adjusted 5 percent? Is the number good or is it bad?A: Numbers are definitely bit on the weaker side both on topline and margins; from the topline more on the volume side. Reported volume growth is obviously 3 percent but there was some pipeline destocking because of price corrections been taken in soaps and detergents. The winters have been mild and therefore the onset of winter was delayed, which impacted sales in some of the skincare products.

If you make adjustments for those two things then the volume growth trend is around 5 percent which has been sort of a trend growth rate for last four to five quarters. However, this quarter definitely the volume growth is on the lower side at 3 percent. Sonia: Given the weak volumes and this steep valuation would you expect further downsides on the stock?A: We have a reduce rating on the stock and we have recently also downgraded quite a few staples name. The back of run up which we saw in these stocks over the last couple of months on back of input cost correction. We continue to maintain our view that recovery is going to take longer in terms of both volume growth and value growth now will probably disappoint investors because the pricing element will be missing in the topline. If you see the management commentary also eluded to the fact that you will see pricing element going away in topline. Whenever that happens we believe volumes are unlikely to compensate fully for the lack of pricing. Therefore if your topline trajectory is not strong enough then it is very difficult to get meaningful earning upside also because the cost benefits anyway will have to pass on because of the competitive forces which will be there at play. So if Lever does not do it then somebody else will do it. So, the good thing is from our strategy perspective company is doing right things in terms of taking the price cuts and given a better price value equation to consumers. However, whether it will result in higher earnings trajectory we really have our doubts. So, on that thesis we have downgraded most of the staple stock including Unilever to reduce with the target price of Rs 800.Latha: Was Hindustan Unilever jumping only because of earnings expectations? It was an unnatural climb?A: The entire consumer staple sector has got kind of run up in the last couple of months on back of as big beneficiaries of crude prices correction and consequently other input cost which will come down. Whereas we believe there is some degree of misplace optimism because it is a sector where competitive intensity levels are usually high and therefore these things get passed on. In deflationary times hit becomes all the more difficult for some of these bigger player to maintain market shares. So, they have to be on top of their game to kind of even grow inline with market in these sort of times. So, there was a bit of misplaced optimism on back of input cost correction that every thing could be retained by the company. Then the other bigger issue with the entire sector is valuations which we have been struggling with that for the same earning trajectory which you had over last three years so why should we give a much higher multiple now versus earlier. So, 40 times price-to-earnings (PE) for a 15 percent earning growth just seems unjustified in our view and makes risk reward not in your favour. Sonia: How weak is the demand situation? Even if you adjust for that high price inventory what could the volume trajectory be say in the next couple of quarters? Will it continue to be in low single digits?A: What we are building in for next year is around 7 percent so for FY16. So, there could be some mild recovery but as I said that would only happen if they keep passing on the benefits and execute well, spend a bit more on advertising and promotion (A&P). So, therefore probably there could be a 2-3 percent uptake from the trend growth rate of say 5 percent volume growth. However, it will be more than negated by the lack of pricing in the topline so your topline to go back into double digits will take sometime in our view.Latha: At what price are you a buyer?A: Our target price is Rs 800, so 10 percent below that probably depending on the kind of return one is expecting.