ANALYSIS: HUL Delivers Strong Q2, Margin Expansion Despite Challenging Environment

Hindustan Unilever Ltd (HUL), India’s largest fast-moving consumer goods company, on Thursday reported a resilient performance for the second quarter of fiscal year 2023, beating analyst estimates on bottomline and operating profit.

HUL’s net profit rose 4% year-on-year to Rs 2,717 crore, surpassing analyst expectations of Rs 2,570 crore. Net sales grew 4% to Rs 15,027 crore during the July-September quarter.

The company saw a healthy 130 basis point expansion in EBITDA or operating margin to 24.6% compared to the same period last year, aided by gross margin improvement as input costs softened. EBITDA grew 9% year-on-year to Rs 3,694 crore, again beating analyst estimates of Rs 3,250 crore.

HUL’s gross margin expanded by 700 basis points versus last year to 51.9% in Q2 FY23. This was driven by cooling commodity prices which helped negate the impact of consumption downtrading in some categories. Input costs like crude, palm oil and tea saw sequential easing versus the previous quarter.

The company also increased its advertising and promotions expenditure by 420 basis points year-on-year to 11.4% of sales in a bid to defend market shares amid high competitive activity.

A Tough Environment

HUL’s performance comes amid a turbulent environment for the Indian FMCG sector. While urban demand has been resilient, rural markets continue to reel under the impact of high inflation and consequent reduction in purchasing power.

To add to the woes, HUL has seen intensified competition from smaller players and private labels in the laundry, tea and salt categories. Deep discounting and promotions have led to market share losses for HUL in some of these segments.

The company is responding by recalibrating its pricing and promotion strategies. For instance, HUL took selective price cuts in soaps and detergents even as it hiked prices in coffee and health food drinks during the quarter to maintain affordability while also protecting profitability.

HUL management said rural demand is seeing a gradual recovery aided by moderating commodity inflation but remains subdued compared to urban and semi-urban markets for now. The company expects to recover lost ground in the coming quarters as additional investments in distribution expansion and marketing spend bear fruit.

Across segments, HUL’s largest, Home Care category saw 3% revenue growth, while Beauty and Personal Care grew 4%. Foods & Refreshments also reported 4% growth versus last year. In terms of volumes, Fabric Wash and Dishwash delivered mid-single digit underlying volume growth.

Skin Cleansing saw low single digit volume growth driven by soaps while Skin Care, Colour Cosmetics, Hair Care and Oral Care grew at double-digit rates. Tea continued to witness downtrading even as Coffee witnessed robust double-digit growth.

HUL CEO and Managing Director Rohit Jawa said his team reamins “cautiously optimistic about the demand recovery in the short term but believe growth rates could remain uneven across urban and rural markets in the near term.”

“The festive season should provide a temporary boost but raw material prices and monsoon trends need close monitoring. We are confident of the long term potential of the Indian FMCG sector and HUL’s ability to deliver sustainable, consistent and profitable growth”, he added.

Navigating Challenging Times

Despite the challenging operating context, HUL has navigated the headwinds well thus far, as evident in its Q2 performance. However, concerns around demand slowdown and market share losses linger.

The company’s strategy has been centered around protecting margins in the face of cost pressures while retaining affordability for consumers. Calibrated price hikes across portfolio helped protect profitability and reinvestment behind brands.

Gross margins had declined to a multi-year low of 44.9% in Q2 last year as the company grappled with unprecedented input cost inflation. The sequential easing of commodities has allowed gross margins to recover to pre-pandemic levels now. However, HUL acknowledges gross margin volatility cannot be ruled out if global commodity markets remain turbulent.

Alongside margins, protecting volume market shares was also imperative. Here, HUL increased its advertising and marketing spends substantially to defend against smaller competitors. The proof lies in the competitive volume market share gains made by HUL during the quarter. However, the company conceded that advertisement spends may remain elevated over the next few quarters as competition is unlikely to recede.

On the pricing front, HUL expects a period of price stabilisation after multiple rounds of hikes over the past two years. The company does not expect positive price growth in the next few quarters as cuts in some categories offset hikes in others. Eventually, pricing power is likely to return as input cost risks recede further.

Future Growth Drivers

HUL is betting on premiumisation, market expansion, distribution push and innovation to drive growth across its categories.

In Home Care, upgrade to premium laundry products, market development in Dishwash and aggressive distribution expansion remain key focuses. Natural ingredient-led cleaning products are seeing encouraging response from consumers.

In Beauty & Personal Care, there is big push towards premium skin cleansing products like bodywashes, handwashes and facewashes. Similarly, premium hair care and styling products are growth drivers within that segment. HUL aims to premiumise its Oral care portfolio through new launches. In Colour cosmetics, the company is aggressively targeting younger audiences through contemporary brands like Elle 18.

In Foods & Refreshments, variants like Taj Mahal Elaichi tea and Bru Gold coffee aim to prevent downtrading in the base brands. Expansion of Food Solutions through new regional variants is helping drive recruitment. In Ice creams, HUL plans to pivot harder towards impulse products like sticks and cones versus tubs.

Across channels, HUL continues to drive distribution expansion in rural markets to deepen penetration of its brands. Modern trade, e-commerce and chemist channels are fast growing emerging channels where HUL is increasing direct reach.

The company has a healthy new product launch pipeline ranging from contemporary ingredients to new flavours, clever packaging and format innovations. HUL’s strategy to premiumise its core brands while creating affordable natural-ingredient led sub-brands appears to be paying dividends. Its focus on enhancing distribution reach across urban, rural and emerging channels provides an additional growth lever.

While uncertainties persist in the near term, HUL expressed confidence in the medium to long term outlook of the Indian FMCG sector, based on the country’s demographics, rising disposable incomes and low penetration of branded packaged products. With its transformation into an agile and future-fit organization, HUL is optimistic about tapping into emerging opportunities faster while also consolidating its core business.