Though Hindustan Unilever Limited (HUL) delivered better than expected operating performance in the December quarter for the 2022-23 financial year (Q3FY23), cuts in earnings estimates — on account of a hike in royalty payments — hit investor sentiment.
The royalty hike led to a 2-3 per cent downward revision in earnings by brokerages, which weighed on the investor’s mind and resulted in a 3.84 per cent fall in HUL’s stock on Friday. In the past two trading days, the stock of India’s largest listed fast moving consumer goods company has dipped 5.15 per cent
HUL has approved an 80 basis points (bps) increase in royalty payments to its parent company – Unilever — over the next three years. Royalty will increase over a staggered manner, from 2.65 per cent of turnover in FY22 to 3.45 per cent in FY25. This will start with a 45 bps increase for the February-December 2023 period.
“Royalty would be front ended, which adds to margin pressure in near term. Royalty increase will impact earnings per share (EPS) by 2-2.8 per cent for FY24 and FY25,” says Amnish Aggarwal, head of research, Prabhudas Lilladher.
In addition to the hike in royalty, the termination of distribution contract for GlaxoSmithKline Consumer’s over the counter products was also responsible for the earnings cut.
Says analysts led by Jaykumar Doshi of Kotak Institutional Equities, “The increase in royalty by 80 bps to 3.45 per cent in the next 2-3 years and termination of GSK Consumer OTC products distribution contract drive a 2-3 per cent EPS cut.”
A few brokerages are sceptical on the operational front as well. Analysts, led by Richard Liu of JM Financial Research, say, “Management alluded to rural slowdown likely bottoming out but didn’t sound too convincing about growth acceleration being around the corner. A lot of the hopes are still pinned more on government actions and macros rather than on factors that HUL would drive on its own.”
While the company is one of its preferred staple picks, the stock is likely to take a short-term beating, given the negative sentiments around the royalty angle, believes the brokerage.
Some brokerages have, however, kept faith in the ability of the company to offset the increase in costs. Say analysts at Antique Stock Broking, “Increase in royalty payment by 80 bps over the next three years would be more than offset by operating leverage and premiumisation.”
Over the medium to long term, the brokerage is confident that the company will deliver volume-led growth, backed by strong and sustained growth momentum in core categories, scale-up of nutrition and discretionary business (by market development and innovation) and margin improvement on premiumisation and cost-saving initiatives.
HDFC Securities says that with raw material costs softening, the royalty increase will not pinch much but will limit the margin expansion. The brokerage expects demand to pick up gradually while margin recovery will be faster. The brokerage has made a 1-2 per cent cut over FY24/25.
Going ahead, lower input costs (crude oil and benign palm oil prices) will help the company to boost volume growth. ICICI Securities expects the company to take further price cuts and grammage increase to pass on the benefits, which would help the firm recoup volume growth in the coming quarters.
“We also believe it (the firm) would have leeway to spend higher on advertisement and promotions, which would also help it grow volumes. Gross and operating margins have already started improving sequentially and further improvement in coming quarters is imminent. The volume growth and margin expansion would lead to strong profit growth for the company,” the brokerage said in a note.
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