Despite posting increased profits in the third quarter of FY23 on Thursday, shares of Hindustan Unilever (HUL) fell nearly 4 per cent on Friday. Market analysts point out that increase in royalty and central service fees (by 80 basis points) has been a dampener.

On Friday, the HUL stock closed at ₹2,548.35 a piece — down 3.84 per cent from Thursday’s close of ₹2,650.25 on the BSE.

Short-term impact

The company’s board on Thursday approved a proposal for a new arrangement with the parent, Unilever, for technology, trademark licences and services to HUL. Consequently, the royalty and central services fee will increase and be effected in a staggered manner over a period of three years. Royalty fees is proposed to increase from the current 2.65 per cent to 3.45 per cent (80 bps). Though analysts expect the stock to see a short-term impact due to royalty, they are bullish on the stock for the long term.

JM Financial said: “HUL is one of our preferred staples plays but the stock is likely to take a short-term beating given the negative sentiments around the royalty angle.”

According to ICICI Securities, a silver lining is that HUL’s raw material cost pressure has softened meaningfully; net material inflation declined 400 bps quarter-on-quarter. Hence, gross margin expanded 168 bps q-o-q.. “We upgrade our earnings estimates by about 3 per cent for FY24; modelling revenue / EBITDA / PAT CAGR of 13 per cent / 14 per cent / 15 per cent over FY22-24E. Maintain Add rating with a DCF-based target price of ₹2,850,” adds the brokerage report.

“While HUL gained 10 ppt margins between 2013 and 2023, given current margin band of 23-25 per cent, 80-bp royalty rate increase over three years will curtail margin expansion,” explained a report from Prabhudhas Lilladher, which recommended an “Accumulate” rating on the stock.

However, Axis Securities sounds optimistic in its report when it expects margins to improve going ahead as raw material prices remain on a downward trend. According to the report, HUL’s long-term growth prospects remain strong as the management focuses on: Driving a broad-based portfolio and straddling across the price-value matrix to drive premiumisation; cost savings initiatives; market development and market share gains across the portfolio; and execution capabilities, which displays its strength in diverse product portfolio and financial prowess in this volatile and challenging environment.

HDFC Securities, in its report, says that the softening raw material costs will offset the royalty increase, adding that margin expansion could be limited. “Our view remains the same: demand pick-up will be gradual while margin recovery will be faster. We cut EPS estimate for FY24/25 by 1/2 per cent. We value the stock on 47x P/E on December-24E EPS to derive a TP of ₹2,400. Maintain Reduce.”

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