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Among FMCGs, Dabur could prove to be a dark horse: Naveen Kulkarni, Reliance Securities

There is an investment case in Dabur from a medium- to long-term perspective.

ET Now|
Oct 14, 2019, 12.20 PM IST
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Naveen Kulkarni, Reliance Sec-1200
We are not much worried about HUL margins. Going ahead how the revenue trajectory takes shape and whether the company is able to meet the earnings expectations for FY21 is going to be the key factor, says Naveen Kulkarni, Head of Research, Reliance Securities. Excerpts from an interview with ETNOW.

Are we in for routine numbers from HUL where volume growth would be a subject of slowdown or can HUL spring in a surprise and beat the Street?
I am a bit sceptical though they can still surprise on the margin front because raw material costs have been benign and competition activity has been on the softer side. From that perspective, the margins could be better. The EBITDA growth could be quite strong. But the key factor is nominal growth rate is sluggish and we see HUL cutting the prices of its products further. We will start seeing the impact of that in the forthcoming quarters.

The demand scenario remains to be seen in the commentary of management and that is critical. Also the GSK acquisition and integration will be quite closely watched by the market.

The rest of the consumption pack probably would be hoping to get its cues from this. But let us just break this down a little further. Could we see price cuts in select portfolios? Is there a possibility of margin expansion and if yes, how much?
The margin expansion is very likely because what happened was in the last quarter, there was a significant amount of margin expansion. From that perspective, even this quarter, it may not be any different in terms of margin expansion. A 100 bps plus margin expansion on YoY basis is very likely and that is what is going to aid the EBITDA growth rate which is likely to show a double digit trajectory.

Margin expansion is happening because competition is soft and there are savings in the advertising expenses. If HUL is cutting prices in some of its soaps categories, then it may not spend more on advertising in those categories. Definitely, there will be savings in terms of advertising. Raw material costs have been benign and the growth margins should also expand.

So margin expansion is pretty much given. I do not think there is much doubt whether margins will expand or not. If margins do not expand, according to market expectations, then that will be a negative surprise more than anything else. I do not think we are much worried about the margins, but going ahead how the revenue trajectory will take shape and whether the company will be able to meet the earnings expectations for FY21 is going to be the key factor. Right now, the expectations built into the numbers are quite aggressive. That is going to be the key challenge that HUL will have to deliver upon.

At Rs 2,000 plus, is HUL pricing in a constructive scenario?
Yes very likely so. HUL does not have a significant amount of benefit of the corporate tax rate cut, that is one. Second, the synergy benefits which that GSK will bring in, are getting factored at around Rs 2,000-odd levels. A lot of positives are already factored into the price right now. An important thing from here is the revenues have to start growing at a much faster pace than what they are growing right now, for the company to justify the current valuations.

Is ITC underperforming because markets are confused about where the FMCG business is heading or is it a global disenchantment towards tobacco stocks that will keep ITC under pressure?
ITC is not performing because of mix of multiple factors. One is of course there is a lot of global PSU funds which have a very clear cut screeners about not investing in a tobacco company.

Which would be the dark horse then from the FMCG space? Which is the company that is looking attractive right now given the recent slowdown is available at a good price point?
Not much foreign investment is happening in the tobacco sector. Of course, there are regulatory challenges and that is essentially keeping the stock down. What looks to me like a dark horse or what could be an interesting company that can create a lot of value over the next two to three years is Dabur.

Dabur has a reasonably decent portfolio of brands. It is one of those companies which is now looking at investing and focussing and building on brands, whereas the market is going in a different direction. So Dabur has the capability to turn around and build in this slowdown kind of a scenario. Valuation wise, it is cheaper than the MNCs like Nestle or HUL. There is an investment case in Dabur from a medium- to long-term perspective.

Dabur, Nestle, ITC, HUL are giant companies. Is there any niche FMCG company where the business is growing and the management is decent?
Most of the FMCG companies have become quite large over the last 10 years odd. From that perspective, finding a mid-size FMCG company might be a challenge. A $1-billion company is going to be in an altogether different kind of FMCG space.

Most of the FMCG companies are still quite sizable and I would say that the secular growth story still lies with the staples, in terms of penetration. We will still go with names that are doing pretty well and then one can look at some of the retail companies which can deliver sustainable growth over longer periods.

Are Indian retail stocks the most expensive retail stocks in the world? Trent is at a PE of 100, plus minus 10, depending on the estimates; D-Mart is at 60-70 times PE multiple one year forward. India must the only place where the retail stocks are at a very large premium. Globally all retail stocks are under pressure because of ecommerce.
One of the ways to look at retail stocks is the valuation aspect and the second aspect is essentially the business model. Some of these companies like Titan or D-Mart have a very robust business model in terms of the per store turnaround time that these companies can deliver. If, the per store turnaround time is quite good, three to four-year timeframe, you are making a return of close to 20% plus kind of an IRR. That generates a lot of cash to deliver intrinsic growth for a very long period. Because the market opportunity in India is so large, that always will continue to look very attractive.

The important aspect will whether the business model can generate sustainable cash or not on a per store basis. The challenge has been not many people have been able to replicate the model. That is what stands for these companies and over a longer period of time, these companies are likely to generate significant cash flows. That is why the valuations continue to be sky high for these companies and growth rates also continue to be quite high.

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