In a world where growth is scarce, and top-notch experts are predicting a global recession and sharply cutting India’s GDP growth to multi-year lows, any company offering some stability in earnings is bound to attract investors and command premium valuation. Among the very few to do so is Hindustan Unilever (HUL), India’s largest fast-moving consumer goods (FMCG) company, which has surged 12 per cent in one month, even as the Nifty fell 13 per cent.
HUL is now trading at over 75 times its earnings for trailing 12 months ended December 2019, a 55 per cent premium to its five-year mean and five times higher than the price-to-earnings (PE) valuation of the Nifty50. At these levels, experts say there is a risk to pay such a top-dollar valuation.
Even compared to its parent Unilever, HUL looks richly valued. Ajay Bodke, CEO (PMS), Prabhudas Lilladher, says: “HUL’s valuation displays the irrational exuberance of investors. It shows a kind of hallucination about the fair value of HUL’s franchise, which accounts for 13.8 per cent of Unilever’s profit, but 54 per cent of its market value.” Whereas, Nestle India’s net profit is 2.2 per cent of Nestle SA, and 6.8 per cent of its parent’s market value. Purely from India’s context even Nestle India stock is expensive, but in the global context HUL is trading at a higher premium to its parent, as compared to Nestle India.
HUL’s current market value of Rs 5.14 trillion is also more than the combined Rs 4.20 trillion market capitalisation of India’s top 10 listed automobile companies. Sure, some like Tata Motors, M&M, and TVS Motor have huge debt (combined net debt of Rs 1.34 trillion), but all the others are nearly debt-free or cash surplus. There are nearly 15 such examples where all the listed companies in a sector put together are valued less than HUL, and like the automobile sector, they have also generated more profits. Though this may not be strictly comparable given the different business models, debt levels, capital efficiency and growth expectations, such comparisons give a perspective into the value market is attaching to HUL.
Other experts also echo Bodke’s views. Shirish Pardeshi, analyst at Centrum Broking, says: “Though earnings visibility and growth ability of HUL are better, flight to safety by investors has led to such super-premium valuation.”
Vishal Gutka, vice-president, PhillipCapital, adds: “The weak outlook of other key sectors amidst the Covid-19 pandemic and expectations of economic stimulus package have led to the rally in HUL.”
Apart from robust fundamentals, enviable business model and debt-free balance sheet, HUL’s extensive distribution network, strong brand equity and vast product mix, with a large share of essential products, provide comfort. According to UBS Securities, based on distribution analysis, HUL is amongst very few consumer staple companies that are best-positioned to benefit from the strategy to improve their last-mile reach at a time when many others are facing a distribution disruption. HUL is also expected to gain market share from weaker players in the current situation.
Bodke, though, says if HUL’s underlying earnings were high, it is still understandable. While credit has to be given to its strong balance sheet and high cash generation; the sustainable earnings growth is pegged at just 14-15 per cent (including acquisition of GlaxoSmithKline Consumer Healthcare or GSK).
How the non-essential portfolio (9 per cent of revenue, according to UBS) pans out in the current situation is also monitorable. Besides, there is scepticism on rural and urban demand, given the likelihood of a fall in income because of job losses and pay cuts. The Reserve Bank of India’s monetary policy report, too, says macroeconomic risks held forth by the Covid-19 pandemic will be severe for India. So, there are risks to HUL’s earnings too.
Moreover, in the past too, there have been exuberances, which later were punished by the markets. “Between February 2000 and end-2001, when the TMT (technology, media, telecom) bubble burst, Wipro’s shares plunged from around Rs 6,700 to Rs 1,500, Infosys from Rs 10,960 to Rs 3,300 and Zee Rs 1,350 to Rs 50 levels. In 2008, real estate stocks had collapsed similarly. Investors need to tone down valuations to realistic levels. There is a drastic risk to HUL’s share price,” warns Bodke.
Although 30 of the 42 analysts polled by Bloomberg have a buy on HUL, their average one-year target price of Rs 2,281 indicates a downside of 4 per cent.
At these pricey levels, Gutka says, GSK Plc, which gets HUL’s shares in lieu of sale of GSK to the latter, will find a tempting opportunity to sell its 5.7 per cent stake in the FMCG major. This may put pressure on HUL’s stock. A correction in valuations is also anticipated once growth normalises in other sectors, adds Pardeshi. Nonetheless, HUL, too, will be impacted by the Covid-19 pandemic. Its recent statement to Business Standard said: “Our sales are at 40 per cent of the daily run-rate, up from low single-digits in the last week of March. The factory output is about 40 per cent and our wider supply chain continues to be impacted.”
Clearly, enough signals for investors.