Hindustan Unilever's fiscal 2015 earnings were up 10%, aided by revenue growth of 10% (6% in volume terms) and supported by buoyant gross margins due to lower commodity prices. HUL is the market leader in consumer products across categories in India, so its revenue growth closely mirrors the overall consumption growth of 8%-9% in rural areas and 4%-5% in urban areas. The firm is usually able to grow modestly ahead of market as the innovator across categories, bringing first products to the market. For example, it was the first to introduce premium-priced ice cream bars last year; competitors have since followed.
The firm's growth and margins are closely linked to those of its dominant category of soaps and detergents, which forms 48% of sales and 38% of its EBIT margins. The category has 90%-plus usage rates in India, so volume growth here tends to be slow. Furthermore, EBIT margins in the category tend to be very volatile due to changes to commodity-led input prices as well as severe competitive intensity from incumbents. In a falling commodity price environment, we foresee competition intensifying further in the soaps and detergents category in the coming two years until the cycle reverses. Keeping this in mind, we see consolidated EBIT margins for HUL to remain range-bound, with a peak margin of 15.5%-16.0% in this low commodity cost environment, where it hovered in 2015. We don't see the picture changing drastically five years out, as the revenue contribution from higher-margin categories of cosmetics will not overtake soaps and detergents. Furthermore, HUL's focus on building another low-margin category of packaged foods will ensure margins remain below 16% over the long run, in our opinion.
Overall, we believe this narrow-moat stock is overvalued at current levels. Despite the increased dividend payouts announced by the firm, the dividend yield at current prices is under 2%, reflecting overvaluation.
