For the second quarter of fiscal 2015, Hindustan Unilever reported that earnings declined 2.6%; however, upon adjusting for exceptional items, earnings grew 4.4%, in line with revenue. Revenue was up 4.7%, with underlying volume growth of 6.5%, in a deflationary commodity price environment.
The company continues to take price cuts in the soap and detergent segment (48% of sales), which led to a 1.8% fall in pricing growth at an overall level, despite strong volume growth from all segments. Its highest-margin category, personal care, delivered encouraging 11% volume growth, with soaps and detergents 3%, beverages 6%, and packaged foods 13%.
The result has no impact on our narrow economic moat rating, as returns on invested capital for this negative working capital company will continue to outstrip its 10.8% estimated cost of capital for over a decade.
So far our thesis of stable margins and flat earnings year over year is playing out as the exceptional gain of Rs 490 million in last year's same quarter (on account of a property sale) should result in flat normalized earnings for the full year. EBIT margins should also remain flat year over year at 15.9% as the firm increases its advertising budgets to support its brands in a competitive environment and conducts promotional activities to maintain its volume share in the market.
Our outlook for fiscal 2016 is unchanged at Rs 20 in earnings per share, and our fair value estimate of Rs 626 implies a forward price/earnings multiple of 32. The shares continue to trade at a significant premium to our fair value estimate.
