HUL's volumes to grow 6-7% in Q4

Hindustan Unilever, the country's largest fast moving consumer goods company, has been in focus for the last few months. The company's shares have risen 17% over the last three months, as analysts expected a sharp improvement in its margins on lower input costs.

The stock has outperformed the broader market by a long shot. The Sensex has risen 3.32% in the same period. The steady increase in the stock price has pushed up its valuation to a new high. The stock is trading at 43 times its FY16 earnings and 36 times its FY17 earnings. By no means is the valuation comforting, yet it is one of the stocks that has stayed firm.

There are several factors that are driving investor optimism, despite sky-high valuations. Undoubtedly, the company's volume growth is likely to be unimpressive in the March quarter (5-7% according to estimates), but investors are expecting the company to reap rich dividends from the investments it has made in expanding direct distribution.

Through the slowdown, HUL has expanded its distribution and sharper focus on product innovations. Both these have worked for the company and the results will be visible when demand picks up. According to Motilal Oswal Securities, Hindustan Unilever has initiated a cluster strategy and expects benefits from this to manifest in second half of calendar year 2015. The company has carved out 14 consumer clusters against the four branch sales structure, which will help drive growth in the medium term, adds the brokerage.

However, in the March quarter the company is unlikely to see material improvement in revenues as volumes will grow in single digit. The 6-7% volume growth expected in the March quarter would be largely due to a low base in the corresponding quarter last year. The company has undertaken some price cuts in its soaps and detergents portfolio, but the management has conveyed to analysts that this is unlikely to impact volumes in the quarter. The company's also building an e-commerce platform for its products in urban areas.

Even though promotional activity has picked up across categories where input prices have declined -- tea, soaps, detergents and shampoos -- analysts do not expect the company's margins to be impacted, as the company is dealing with price cuts in a rational way.

Kotak Institutional Equities says: "Promotional intensity remains high even as we did not notice any meaningful pick-up at the margin level." Input prices have fallen 35% year-on-year, which would benefit the company's margins as volumes pick up. Given that the price cuts have not driven up volumes, margins would not be meaningfully impacted in the March quarter. The company's earnings have averaged at nine% in the last six quarters and analysts expect it to improve to 19% over the next two years.