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HUL Open Offer: What to do? - Views on News from Equitymaster
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HUL Open Offer: What to do?
Jun 19, 2013

Recently, parent company Unilever announced the biggest ever share buyback program to raise its stake in Hindustan Unilever Ltd (HUL) from 52.5% to 75% at a price of Rs 600 per share. This move is a clear indication of the parent company's belief in HUL's growth potential. The stock is currently trading at more than 30 times (40 times if one excludes extraordinary income) it's trailing twelve months earnings. What should be the shareholder's line of action? Should he sell his shares in the Open Offer making a neat profit or hold on to benefit from the company's long term prospects?

Let us first critically analyze HUL's business

Positives:

Strong focus on personal care

HUL has increased focus on the personal care segment. The revenue share from personal products has risen from 26% in CY07 to 31% in FY12. The company has extended the existing brand equity of personal care products to adjacent categories. For example, the Dove brand has been expanded from soap to other personal grooming categories such as facewash, body wash, body lotion, deos, shampoo, conditioner and hair oils. This helps in straddling the price pyramid. Consequently, three personal care brands of HUL namely Dove, Ponds and Clinic Plus have grown to become Rs 10 bn brands in 2012-13. Apart from this, Fair & Lovely is another personal care brand with a market size of Rs 10 bn. Rin, Surf Excel, Active Wheel, Lifebuoy, Lux and Brooke Bond are other HUL brands having a market size of Rs 10 bn.

Renewed vigour in the soap & detergents market

The soaps & detergent category is fairly penetrated. However through the launch of innovative products and pricing power, HUL has managed to infuse growth in this category. After a measly 6% rise in FY11, this category grew by over 15% in each of the successive two years. In May 2013, the company has launched the first liquid laundry detergent 'Surf Excel Liquid' at a huge premium to existing detergent brands.

Innovation and premiumization on the rise

Access to international portfolio has enabled HUL to introduce innovative & premium products in the Indian market. More than 50% of the company's portfolio was innovated in 2012. During the year, the company launched the newly acquired TRESemme hair care brand from its international portfolio. It, also, forayed into the super premium hair oil brand under Dove. This is expected to reduce its dependence in the price-sensitive mass market product segment.

Robust distribution reach and rural coverage

There are roughly eight million retail outlets (Source: Nielsen) in India. Among FMCG companies, HUL has the widest distribution network covering 6.5 m retail outlets. Of this, the company has a direct coverage in 2 m outlets comprising of 12.5 lakh outlets in urban India and 7.5 lakh outlets in rural India. This huge network virtually shields the company from any new competition.

Negatives:

Royalty payment to rise

A greater alignment with the parent company has led to an increase in the royalty charges that HUL will be required to pay to the parent company. As per the new agreement with parent Unilever, HUL's royalty payments are set to rise by 0.5% for FY14 and thereafter in the range of 0.3%-0.7% until FY18.

Ad-spends to remain high

As the frequency of new product launches has increased, brand investments have risen. The ad-spends to sales ratio grew to over 10% in the past five years. This is likely to remain high in future in the wake of slowdown in discretionary spending and increased competitive intensity.

Slowdown in offtake, a cause of concern

In FY13, HUL's volume growth slowed down to 7% from 9% in the previous year. A substantial part of the sales growth of 16% has been on account of price-hikes. But with discretionary spending showing signs of slowdown, the pricing tool may not be available in future to maintain the sales momentum. This coupled with higher promotional spends and royalty payments may depress the company's profitability in future.

Our view

It should be noted that the 10-year average PE of the stock stands at around 29 times. And if one leaves aside the extraordinary income, the price being offered by the parent is a multiple of around 40x of the trailing twelve month earnings of the company. In other words, the parent seems to be paying a premium of around 37% over the average PE multiple of the company over the last 10 years. Thus, in light of this attractive premium, we believe that it makes sense for an investor to tender his shares for the open offer.

The promoters want to hike their shareholding by 22.5% through the Open Offer. Therefore a total of 47.5% of shareholders comprising of FII's (22%), DII's (8%) and Others (17.5%) are eligible to participate in the Open Offer. In case more shareholders opt to tender their shares for sale then the allocation will be on a proportionate basis which will be decided in consultation with the Manager to the Open Offer.

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