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Buy Hindustan Unilever; target Rs 254: Citigroup

Tuesday, July 31, 2007

Citigroup has recommended buy rating on Hindustan Unilever with target price of Rs 254. The research firm advices investors not to tender the buyback of the share at Rs 230, which is below the target price of Rs 254.

Strong improvement in operating performance

HUL’s operating performance has shown a dramatic improvement in 2Q despite losses associated with new water business. 2Q EBITDA profit growth of 23.5% is the highest for the last six years. As we anticipated, after significant investment behind brands, HUL seems to be now in a position to scale back its ad spend, which is down 155bps this quarter.

Growth better adjusted for water losses

Adjusting for the new water losses, we estimate that the EBITDA for the core business would have grown by 30.5% yoy. Sales growth of 12.9% is in line with our expectation with HPC growing by 11.1% which was led by soaps and detergents. Slow growth in personal care remains a concern. Growth in the foods segment continues to be strong at 32%.

Net profit aided by non-operating income

Net profit in 2Q grew 24.4%, 10% ahead of our estimates, aided by 30.6% yoy growth in other income. Adjusted for the water business losses, we estimate net profit to have grown by 30%.

Raising target price

We raise our target price to Rs 254 (from Rs 235), rolling forward our 27x P/E multiple to 2008E. Given that we are already in 3Q07, we expect the stock price to increasingly start to reflect 2008E earnings.

Buyback at Rs 230, don’t tender

In its board meeting, HUL has approved a buyback of up to 27.4m at Rs 230 per share. Our analysis shows that this would be marginally dilutive to EPS (1.3% for 07E and 0.9% for 08E). However, we believe that the significant improvement in operating profits overshadows the marginal dilutive and we would advise investors not to tender at Rs 230, which is below our new target price of Rs 254.

Investment thesis

We have a Buy/Low Risk (1L) rating on the stock. HLL's valuations look attractive after the recent sell-off. The stock is trading at the lower end of its historical trading range and offers downside protection, in our view. HLL's fundamentals are looking up, with a significant pick-up in growth on improving demand from the urban as well as rural segments, especially in the rural areas. Management has increased its focus on market-share gains and as a result investment in brands has picked up. The company has been aggressively launching new product variants and has also undertaken product re-launches, which we believe will continue. With the high-end personal-care segment growing faster, the product mix is also improving. We believe margins could also surprise on the upside, driven by price hikes and declines in commodity prices. Margins have been under pressure in the past few quarters, and we believe they have bottomed.

Valuation

HLL's fairly steady stream of earnings makes P/E a good tool to value the stock. Our target price of Rs 254 is based on what we think is a conservative multiple of 27x 2008E P/E, at the mid-end of the stock's historical trading band of 20-35x, over the past 8 years. We choose mid-end as we expect a re-rating for the stock given that its operating parameters are improving. We do not use a top-end multiple, as competitive intensity has increased over last few years and the environment in which HLL operates is not as conducive as before. At 27x P/E, HLL would trade at a 40% premium to the Sensex. The company has historically enjoyed more than a 100% premium to the Sensex owing to its high capitalefficiency ratios and consistent earnings growth. However, we do not expect the stock to re-trace to its historical high premium, given that the company now operates in a different competitive landscape, with higher competitive intensity and a lower margin profile. On EV/EBITDA, we believe the stock should trade at 24x 2008E EV/EBITDA, which gives a fair value of close to Rs 250. The stock's trading band has been 20-30x over the past three years.

Posted by FR at 3:25 AM  

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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.