Would HUL share price underperform in coming years?

 

The bubble of HUL

 

Article published as on Saturday, 10^th October, 2020 at 1:00 p.m.   

Introduction

Does Hindustan unilever (HUL) share deserve the current valuations?

 

Would HUL share price underperform in coming years?

 

While I was reading I came across articles stating how ITC could be better than HUL, so I did my own research to confirm this and here it is.

 

Flow of the article

 

>Introduction

>Explaining flow 

>PE ratios and financial data of companies.

>Using DCF valuation method (no calculations only figures)

>COE (cost of equity) better than return on equity and flaws of current methodology of calculation.

>Finding value through this new method.

>Comparing HUL with global counterparts in terms valuations.

>Conclusion

 

 

 

 

Let me provide my case and research to you 

 

PE ratios and financial data of companies.

 

Hindustan unilever’s PE is high.... (Compared to index)

 

[Stock                         price               /PE (TTM)]

 

HUL                    2138.85      /73.21       

Dmart                  2057.65     /125.26

 

Verses 

 

(Benchmark)

SENSEX              40509.49   /23.32       

 

ITC ltd                 167.85        /14.42

RVNL                   18.70          /4.98

(Rail vikas nigam ltd)

 

Let’s check the growth rate of all these companies in last 5 years.

 

 

After gathering data 

 

Using DCF valuation method

 

 

For

Fair value for HUL                 785 rupees/-

Fair value for ITC                   179 rupees/-

 

We can use DCF only for positive free cash flow companies such as ITC and HUL.

(For dmart and rvnl they are using capital for growth hence we currently won’t be using DCF for them)

 

As we can see I had taken 19.54% growth for HUL (on a higher side)

And 13.19% growth for ITC.

 

These valuation is for getting 15% return on equity (discounting rate taken as 15%)

 

And the results are before you.

 

 

Better thing to use instead of ROE could be COE

 

The formula for ROE 

1) ROE = net earnings (PAT)/ average shareholders’ equity (net worth)

 

 

Return on equity is the amount the book equity generates as net profits

(Here calculations are made on net worth which can be misleading, example given below)

 

Interesting Example: Suppose I BUY a debt security for rupees 100 which yields me 7% rate of return I write off 93 rupees in my books and show its value as 7 rupees of debt security which yields me 7 rupees.

 

I would say Look at this wonderful security earning 100% ROE, buy this 70 times P/E (490 rupees)

 

This way I quote 100 rupees of fair value of debt security for 490 rupees.

 

Problem here is that I cannot reinvest that 7 rupees interest for same 100% return.

 

 

This is what is happening in Hindustan Unilever

 

Some people say ‘OH look at its incredible high Return on equity!’

 

But the problem is that HUL cannot reinvest that money to get compounding growth effect.

 

Now ROE can be misleading instead lets understand what is it and how to calculate cost of equity 

 

Cost of equity for investor is the rate of return s/he expects on investment, for the company it is the cost of raising fund through equity.

It is much more dynamic in nature due to its flexible formula. 

 

Cost of equity= risk free rate of return+ premium expected for risk

 

1) COE= (Dividend/ share price) + growth

2) COE= (Earnings/share price) + growth

 

COE for all the companies are as follows based on their share price 

(As on 9/10/20)

Stocks             share price/ Cost of equity

 

HUL                    2138.85      /1.3659 % 

Dmart                  2057.65     /0.7983 %

ITC ltd                 167.85        /6.9348 %

RVNL                   18.70          /20.0803 %

 

 

Now lower the COE, the more attractive for company to raise funds using equity dilution.

 

And higher the COE, the more attractive for company to buy back its shares

 

 

From the data it’s evident that HUL pays out major portion of its EPS as dividends and is not able to reinvest in its business. So despite having such low COE it won’t be taking advantage of this phenomenon

 

For this dividend pay-outs let’s take it as ‘interest from fixed income security’ and calculate its fair value.

 

Five year forward dividend is expected to be 45.95 [25*(1.1295^5)] assuming 6% yielding debt security (10 year G-sec yield is around 6%) it comes to around 766 rupees.

 

Counter argument: 

 

If HUL is high PE stock, then other FMCG companies also trade at high PE then are they overvalued too? 

 

We can’t be using this formula for all FMCG companies as not all of them pay all of their income as dividend.

 

 

This is the #1 reason why I feel HUL is overvalued.

Because it pays almost all its income as dividend and is not able to reinvest into its business.

 

Some People suggest that it has high growing business.

 

Just because PE is high people will try to justify it by saying high growth business.

 

It has growth, but other companies are also growing which are available at reasonable valuations.

 

 

Another interesting study comping HULS valuations to its global peers:

 

Let’s compare at what valuations do its global peer’s trade at?

 (Stock                                                             price (currency)                    P/E)

 

Hindustan unilever                          2138.85 INR/      73.21

Unilever (UK)                                   4847 GBX/         23.73 P/E

Unilever Pakistan foods ltd              15000 PKR/        29.12 P/E

Glaxo smithKline Bangladesh ltd    2174.90 BDT/     29.12 P/E

 

(GSK Bangladesh is taken because just like in India GSK sold its business to HUL in share swap transaction, similarly in Bangladesh also its business is under process of being sold to Unilever, hence it is taken for comparison)

Now as we see among all the Unilever’s our Hindustan Unilever is trading at much higher premium.

 

One may argue that geography, market size and opportunity is different…

Well this is just a broad comparison which we have to take with a pinch of salt.

And for people interested, they should dig deeper whether Hindustan unilever really is growing faster than its Pakistani and Bangladeshi counterpart.

 

As a matter of fact I just checked the data of year ending 31^st Dec 2015 and 2019 and saw that Unilever Pakistan foods ltd has grown faster than its Indian counterpart yet its trading at cheaper valuations…

 

🙋Now someone will try to bring in inflation point of view into it

           🤣🤣😂😂😆😆      Enough of analysis!!!

I will leave it to you, Comment down to share your thoughts on it

 

 

Conclusion

 

>I have repeated several times and once again I would repeat that HUL seems overvalued because it’s not reinvesting into its business and giving almost all of its income as dividend.

 

>I am buying High P/E stocks for growth and not just dividend otherwise I would be better off owning stock like PFC, REC

 

>In the long term stock prices corrects towards their fair value/ intrinsic value

 

>There was a time when HUL did not move for years and suddenly a spurt came and made investor’s wealthy

 

>Currently price of ITC is similar to what it was 8 years ago.

 

>So in the next 10 years it’s more likely that HUL will underperform ITC*

 

*ITC is just taken for comparison with HUL there are other growth oriented stocks such as dmart and RVNL (psu) and many more which could outperform the returns of Hindustan Unilever (HUL)

 

(Disclosure: I don’t own HUL or ITC, they seemed an interesting case to me, and I have just presented my viewpoints here.)

• Tweet
• Share
• Share
• Share
• Share

Related Post