Quick Take | What HUL results say about the consumer economy

Also Read | What should investors do with the HUL stock after in-line Q3 performance?

HUL’s results show that consumer staples are likely to have outsmarted growth in consumer durables, in this quarter at least. At a time when financing problems and other issues may have affected demand for cars and consumer durables, demand for staples was healthy.

Still, the pace of growth was surprising. That may explain why HUL has cautioned that growth could slow down, although the reasons it gave such as elections and concerns on fiscal deficit don’t seem key risks for FMCG demand as yet. The management may want investors to refrain from assuming that 10 percent growth can continue forever.

What explains this level of growth? If its peers don’t exhibit similar strength, then HUL could be taking market share away from them. But, if they too exhibit strong growth relative to past rates, then it signals market demand has shifted up to a higher level.

Why would the market demand shift higher? HUL said that rural growth is ahead of urban growth in this quarter too, a trend that has played out over several quarters despite stories of distress in the farm economy. This signals that while rural distress is indeed real, there are sufficiently large pockets in the rural market that are doing well. The contribution of non-farm income too could be driving growth.

What about urban consumers? These markets are said to be rather ‘well-penetrated’ in industry speak. That is those consumers who can use an FMCG product, say a skin cream, already do so. So the scope for volume growth is limited to the increase in urban population. So it must be the rural market that must be really driving volume growth. But even urban markets have low-income consumers, whose consumption patterns can change with income changes.

Consider HUL’s two main segments. In the home care segment, comprising detergents and household products among others, double-digit volume growth-led sales growth. In beauty and personal care, comprising soaps, shampoos, and cosmetics among others, HUL said growth was led by consumers trading up to more premium products.

One way of interpreting this is that consumers, especially in rural markets or even in low-income urban markets, are contributing to higher growth in essentials. They will then move up to buy more discretionary products such as skin care and cosmetics. This mainly applies to relatively new markets where FMCG companies are entering. Many rural markets are already consumers of all these products.

What may explain this growing market opportunity? Low inflation could be a reason. Consumer inflation has been consistently low, especially food inflation, and this may be putting more money in the hands of some consumers. The Goods and Services Tax is another reason. Consumer products themselves have turned cheaper, due to a lower tax outgo that is passed on to consumers. Low inflation also means that year-on-year, HUL’s price-led growth was to the tune of 2-3 percent in the December quarter.

GST not only contributed to low inflation but gave the bigger companies a cost advantage. Companies such as HUL that are able to comprehensively utilise the input tax benefits that it yields will gain significant savings. HUL appears to be ploughing this back into the business. Both advertising as a proportion of sales and other expenses as a proportion of sales were higher on a sequential basis. This is despite higher sales. If HUL wanted to, it could have taken its EBITDA margin up higher, if it had retained these savings.

The last question is, what next? HUL appears to be in the mood to keep this growth engine chugging. Its next target appears to be the beauty and personal care market for driving volume growth. It is rolling out low-price packs in skin care nationally.

Companies are cautious about low price packs, as they risk cannibalising growth from the higher priced packs. Servicing this market is also difficult, as the frequency of purchasing is higher (a 100ml shampoo will be replaced at a longer interval compared to a 5ml sachet). They also cannibalise some sales from the bigger packs. But the cost savings from GST may give HUL the headroom to service this market and drive volume and profit growth.

Beauty and personal care segment margins are at 25.6% compared to 12.8% for home care. If it can get higher volume growth, even with a slightly lower margin, the effect on overall profitability will still be significant. This also fits the idea of moving consumers up the value chain, one sachet at a time.

Hindustan Unilever’s results indicate an underlying strength in the market for products of mass consumption. The results of its peers will indicate whether this is broad-based or not. That profitability is improving despite a volume-led growth indicates that the structural benefits of the GST regime are flowing through. The risks at this stage appear more theoretical. Of course, valuations already factor in good growth. But then, its performance and strategy do, to an extent, justify these valuations.