Royalty issues may not affect HUL; buy on dips: Religare

Hindustan Unilever is likely to face higher royalty payments to Unilever PLC as its Indonesian subsidiary, Unilever Indonesia has agreed to pay a royalty to the parent company. Varun Lochab, Managing Director and Co-Head of Research, Religare Capital Markets said it is very difficult to speculate the royalty amount at the moment as it is the function of a particular entity and just because it has happened in Indonesia, it is not likely to happen in India as well. According to him, it is a market specific activity that varies from one place to the other.

Lochab further added that they had downgraded the stock to hold from buy looking at its valuations. At the moment, he is advising investor utilise any dip as a buying opportunity. The level of Rs 500 could be a good entry point, he feels. Here is the edited transcript of the interview on CNBC-TV18. Q: What have you made of the possibility of a royalty increase, how likely does it seem and what do you think the quantum could go up to for a company like Hindustan Unilever (HUL)?
A: Frankly it's very difficult to speculate on that because every entity in HUL world would operate on its own terms and when the royalty increases or declines, it is very much a function of that particular entity. So just because it has happened in Indonesia, I would not say that it is likely to happen in India as well.
Having said that, you can't rule it out either. There is no periodicity to it where your parent keeps reviewing the terms from time to time and there could possibly be some royalty highs. But, as I said, I would not speculate on that just because it has happened in Indonesia. Q: In the past, what is Unilever's action been like. When they raised royalty in one subsidiary, do they usually follow it up with the review of royalty rates across subsidiaries or have these been one offs in the past?
A: As I said, there is no trend to it. So, if it has happened in one subsidiary, typically it doesn’t mean that it happens in other subsidiaries. In case of India, the last increase had happened in December 2009 so it got implemented from January 1, 2010 and there hasn’t been any increase post that. In case of Indonesia this increase is coming after a longtime.
Frankly, as I said it is very market specific and it is not that they look at all emerging markets in one go and if they do it in one, they will do it in other geographies as well. Q: What is your call on the stock in any case at this price level of Rs 520?
A: We had downgraded the stock to hold from buy. We were quite positive on the name for almost two years but, after the last quarter we had downgraded to hold, more because of valuations because at Rs 550-Rs 560 we believe stocks start getting fully valued. That was the rationale for downgrading, so currently we have a hold with a target price of Rs 540.
We are advising clients to use any declines as a buying opportunity, especially close to Rs 500 levels. We believe it would again be a fairly good entry point. On the business per se, we continue to remain positive. They continue to execute well in terms of market share, growth and even on margins.
_PAGEBREAK_ Q: Apparently even on premisation which I said, it should help their margins along and in most categories they are actually leading. Would you say businesswise Lever is top of the block in the FMCG running?
A: Yes. They clearly have got their act together and are executing very well and premisation has been a big trend in their portfolio which is helping it give a positive lift to the margins. Yes, I would say compared to a lot of other companies, they would be in the top half in terms of business performance. Q: Have you guys sought any clarification from the Lever management or have they reached out to you in order to do any kind of conference call to clarify issues on this royalty because since yesterday, Lever has been under quite a bit of pressure?
A: We spoke to the management yesterday itself and as I said, they would not speculate on what is going to happen in India and it is a completely independent event, if it happens and when it happens. But, if you look at the royalty structure in Indonesia and if you see the sub-parts to it, there is a trademark fee which has gone from 2 percent to 3 percent. It is a technical one which was not there as a separate head earlier and it is now 2 percent. The third one is, centre services which are rendered have gone up from 1.5 percent to 3 percent.
Now in case of India, one, the trademark fee is already there at 1 percent. However, in India a lot of brands are owned by Unilever India itself. So, only for around 35 percent of their portfolio they pay a royalty to the parent. That is one positive for India. Secondly, in case of the centre services, the Indian entity is the net provider of the amount to the parent. Therefore, they get a fee from the parent on that account and comparing it to Indonesia would not be a like to like comparison. Thirdly, the technical fee in India is currently at 1 percent. In Indonesia that has been revised to 2 percent.
If you go into the details, I would not say that one can just broadly paint it with the same brush, one cannot say the extent of hike that happened in Indonesia could possibly happen in India also. Q: Where do you stand on ITC at Rs 300?
A: ITC looks fully valued to us. We had downgraded ITC also post Q2 results. Overall, we had downgraded consumer staples from overweight to neutral. Our target price for ITC is Rs 295, so we downgraded it post Q2 results to around Rs 300 levels for a hold. We don’t see any upside in the near-term on that. It is a good business. They have executed very well and they continue to do well.
But, we believe some of the risks are not getting priced in at these valuations. There could be some sharp disruptive increases in tax rates, in VAT rates. I think risk reward is not favourable at these levels. We are having a hold on both the largecaps which is Unilver and ITC, as of now.