Hindustan Unilever's stock price has remained under pressure after the FMCG major along with its December quarter results announced a hike in the royalty payment to parent company Unilever by 80 basis points to 3.45 percent.
While the Q3 numbers met Street estimates, investors were disappointed with the hike in royalty payment.
However, there is potential for the rate to be revised downwards in the next review, a recent report by Jefferies has said. The foreign brokerage firm recently spoke with Hindustan Unilever's management about the royalty issue.
"An adjustment to the royalty will likely result in an increase of only about €20mn for the parent, which is miniscule in the context of its scale. Hindustan Unilever also does not rule out the possibility of a lower rate in the next review, if situation warrants so," Jefferies said in the report.
This report follows an earlier warning by the brokerage firm that the royalty hike would hurt the company, which is operating at its peak margins.
Also Read: MC Explains: Why has HUL’s 80 bps royalty hike proposal upset shareholders?
The fineprint
The agreement between Hindustan Unilever and Unilever has two components: a royalty for trademark and technology for 1.95 percent of turnover, and fees for central services for 1.5 percent of turnover.
"As per regulations, changes in central service fees will require a minority vote, but brand and technology royalty do not require a vote," Jefferies said.
There is no brand or technology royalty charged on revenue from acquired brands such as Horlicks, Boost, and Indulekha, as HUL owns these brands and there is no technology provided by Unilever.
The current royalty agreement is for five years, compared to 10 years for the previous one. The management is of the view that the rates would be reviewed after five years and re-evaluated based on the context and scope at that time, Jefferies added.
Target price
Jefferies' base case target for Hindustan Unilever is Rs 3,100, a 35 percent increase from current levels. Its bull case target is Rs 3,530, and the brokerage sees the stock at Rs 2,020 in a downside scenario.
Some key risks for the counter include rising raw material costs, rural demand affected by inflation and a pullback in consumer sector multiples, according to the report.
At 12.03 pm, HUL was trading 0.44 percent down at Rs 2,537.30 on the National Stock Exchange.
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