As Unilever UN realizes the importance of India in its emerging markets portfolio, there's been renewed focus on investing behind new product introductions and advertising to ensure its products stay familiar and prominent with local consumers. We consider this important, especially given the highly competitive operating environment. Furthermore, its recent announcement to increase its ownership of Hindustan Unilever (HUL) 500696 to its intended 75% (the maximum allowed by the local government, from 52.5%) confirms Unilever’s commitment to this high-growth, low-penetration emerging markets business. With significant distribution scale--reaching over 2 million retail mom-and-pop shops--Hindustan Unilever is a leading player in the Indian consumer products market, and a company that other local firms seek to emulate. As competitors' aspirations grow, and companies like Godrej Consumer Products 532424 and Marico 531642 snap up acquisitions to enhance scale and distribution reach, HUL will have to continue investing in its business to ensure its competitive advantages remain intact. If recent results (which have included continued top-line acceleration and margin improvement) are any indication, we think the firm should maintain its leading market position.
HUL's largest and oldest product segment -- soap and detergents -- accounts for around 47% of sales. However, operating margins lag the firm's consolidated total (only 11.3% for the segment, versus 14.3% for the overall business on average over the past three years). Management has been clear that it is committed to the soap and detergents segment, despite lower profitability, and we've been particularly impressed by the company's ability to leverage the segment's sales (as operating margins expanded to 12.7% in fiscal 2013 from 11.6% the prior year) while still investing in its brands. Competitive pressures from both local (Godrej and Marico) as well as global firms (like Procter & Gamble PG and L’Oreal OR) are unlikely to subside, but we think that HUL's soap and detergents segment should benefit from recent efforts to launch premium products, as more Indian households take to liquid detergents and washing machines.
In its personal products segment, HUL is leveraging the breadth of its parent's product portfolio to introduce global brands locally, such as the recent launch of TRESemme hair products, Lakme Absolute makeup line, and Dove Elixir hair oil. Personal products, which contribute about 28% to revenues, have generated average annual mid-teens topline growth over the past three years, and generate HUL's highest segment margins (25.2% on average over past three years). We believe there is tremendous opportunity here, as the bulk of Indian consumers are just beginning to explore daily use personal care items beyond soaps and shampoos.
HUL’s other segments, such as beverages and food segments, have posted average three-year growth rates of 11.6% and 16.6%, and average EBIT margins of 15.1% and 1.9%, respectively. In our opinion, HUL may slowly deprioritize its beverages and food segments, which account for less than 20% of sales combined, in order to focus on its household and personal care offerings (similar to its parent company). At the moment however, HUL is riding the consumerism trend in India--of rising incomes and a gradual increase in consumer spending--that has created ample demand, so all competitors should be able to experience significant growth and generate ROICs above their cost of capital.
Overall, HUL seems to be gaining some traction, and we expect that the company will continue investing behind product innovation and advertising to support its brands. While we recognize that the firm still faces intense competition, we believe that as the consumer landscape in India evolves, HUL will continue to be at the helm of new product development.
