Equity | India | H & P Products

21 September 2010

Hindustan Unilever
Buy Long-term drivers intact
Target price
Rs312.00
Our recent interaction with HUVR's management gave us no reason to raise our
earnings forecasts, but we came away confident that HUVR was better positioned
Price
Rs293.20 to drive growth in a fast changing consumer market. Its rural initiative will likely
Short term (0-60 days) differentiate it from the competition. We maintain our Buy call.
n/a
Market view Key forecasts
Underweight
FY09A FY10A FY11F FY12F FY13F
Revenue (Rsm) 206,235 177,253 192,048 217,088 241,150
Price performance EBITDA (Rsm) 30,402 27,500 28,942 34,863 40,010
Reported net profit (Rsm) 24,964 22,020 21,992 26,254 29,961
(1M) (3M) (12M)
Normalised net profit (Rsm)¹ 25,007 21,027 21,792 26,254 29,961
Price (Rs) 268.9 257.8 261.6
Normalised EPS (Rs) 11.50 9.64 9.99 12.00 13.70
Absolute (%) 9.0 13.8 12.1
Rel market (%) 0.8 0.4 -5.8 Dividend per share (Rs) 7.50 7.00 8.00 9.00 10.00
Rel sector (%) 5.0 6.7 -19.7 Dividend yield (%) 2.56 2.39 2.73 3.07 3.41
Normalised PE (x) 25.60 30.40 29.40 24.40 21.40
Sep 07 Sep 08 Oct 09
300 EV/EBITDA (x) 20.60 22.60 21.70 17.90 15.90
Price/book value (x) 31.00 24.80 21.10 17.30 14.20
250 ROIC (%) 214.4 363.4 386.3 174.3 163.1

200
1. Post-goodwill amortisation and pre-exceptional items year to Mar, fully diluted
Accounting standard: Local GAAP
Source: Company data, RBS forecasts
150

100
HLL.BO
Market capitalisation
Rs639.67bn (US$14.02bn)
Average (12M) daily turnover
Rs700.95m (US$15.23m)
Sector: BBG AP Personal Care
RIC: HLL.BO, HUVR IN
Priced Rs293.20 at close 20 Sep 2010.
Source: Bloomberg
Management cautious about competitive pressures easing
Sensex The official management view remains that competition is intense and that advertisement
spending will remain high in the medium term. HUVR has raised soap and detergent prices,
but this has only partially neutralised cost pressures.
Moving out of low-margin segments like soaps and tea, despite losing market share
Management clarified that it had consciously moved away from mass-market offerings in
soaps and tea, even at the cost of losing market share, as it did not find commercial business
value in sustaining offerings in the low-margin and highly competitive segments in these
categories. However, it highlighted the success of the Wheel detergent brand in the mass
market, which is delivering superior returns even at lower EBIT margins.

We remain positive on the stock; maintain Buy

The HUVR stock has risen 30.8% over the last six months (vs 14% rise in the BSE Sensex),
and at 24.4x FY12F earnings its valuation no longer looks cheap. However, we believe
HUVR is positioning itself to take advantage of growth acceleration in rural India through the
expansion of its rural distribution network. HUVR is also up-trading in urban India with strong
and sustained innovation in the premium segments across product categories. We believe
there could be a positive earnings surprise after FY11.

Researched by
RBS Equities (India) Limited
Institutional Team

Mafatlal Chambers – C Wing, Ground

Floor, N.M. Joshi Marg, Lower Parel (E),
Mumbai 400 013, India. Tel : +91 022
6754 8411 Fax : +91 022 6754 8420

www.rbs.in/broking Important disclosures can be found in the Disclosures Appendix.

 Long-term drivers intact

We recently met HUVR’s management to discuss general investor concerns regarding the
company’s strategy and growth outlook.

Some key concerns and management’s response to them

Why is the soap segment losing market share, while tea has not reacted similarly?
According to management, over the years the company has lost market share in soaps at the
bottom end of the market, where 80-90% of HUVR's competition sells on promotions. HUVR has
not found it commercially sustainable to compete with local, regional or national players at the
bottom end of the market, as the business is capital intensive (cannot be outsourced). However,
HUVR’s strategy has been to focus on the mid and premium price segments, where it is currently
witnessing volume growth – a multiple of the category market growth. The recently launched Dove
soap at a Rs20 price point is doing exceptionally well, according to management.

In the tea business, HUVR has lost volumes in the mass market over the years. The company is
consciously staying away from the low-end, loose tea segment. Instead, HUVR has moved
aggressively into the premium-end with ‘nutritional’ tea offerings in select regional markets. Due to
the product differentiation, the company’s volumes have risen and its new differentiated offerings
are being sold at a premium.

In the detergents segment, with the manufacture of Wheel fully outsourced, it is competing
effectively with local competition in the mass market. Since the capital employed in the Wheel
business is negligible, the business makes commercial sense even with lower margins. According
to management, the Wheel brand is valued at Rs25bn and is currently the company’s largest
brand.

HUVR’s rural network – still competitive?

HUVR is conscious that the rural consumer is now more exposed to media, and hence, is seeking
better choices. To remain competitive, HUVR would need to do more than just make the product
available to the rural masses. HUVR is working on a project to triple its direct access in rural India
by leveraging technology to access information on consumer behavior and needs. According to
HUVR, it will have 750,000 outlets directly serviced by the company, and linked to its IT systems,
to ensure that online information provides the right mix of products to the customer. The project
will be completed by mid-2011 and we reckon HUVR will be uniquely placed to service the market
effectively.

Smaller FMCG companies outperform HUVR; but HUVR not attempting acquisitions?
Smaller FMCG companies have grown faster by expanding categories that are focusing more on
mass markets, such as soaps and tea, which HUVR has consciously chosen to exit. In terms of
inorganic growth, the size (of companies in revenue terms) of acquisitions over the last five years
in India’s FMCG space has been small, and it has not been HUVR's strategy to acquire
companies acquired by its smaller competitors.

Future strategy: is HUVR going the right way?

HUVR is strengthening its position in the premium-end in all its categories and is very conscious
of any loss in market share in the premium segment, reflected in the success of the Dove brand
across the soaps and shampoos category. According to the company, Dove has overtaken
Pantene in terms of market share in the premium segment ytd.

The company believes the consumer trend of “upgrading” will only gather momentum from here;
entry barriers at the top end of the market will be significant due to sustained innovation; and there
will be a high level of “brand loyalty".

Hindustan Unilever | Investment View | 21 September 2010 2

Income statement

Rsm FY09A FY10A FY11F FY12F FY13F

Revenue 206235 177253 192048 217088 241150
Cost of sales -118380 -97416 -106721 -122393 -136661
Operating costs -57453 -52337 -56385 -59831 -64478
EBITDA 30402 27500 28942 34863 40010
DDA & Impairment (ex gw) -1953 -1840 -2239 -2419 -2599
EBITA 28449 25659 26703 32444 37411
Goodwill (amort/impaired) n/a n/a n/a n/a n/a
EBIT 28449 25659 26703 32444 37411
Net interest -253.2 -69.8 -295.6 -391.2 -695.0
Associates (pre-tax) n/a n/a n/a n/a n/a
Forex gain / (loss) n/a n/a n/a n/a n/a
Exceptionals (pre-tax) n/a n/a n/a n/a n/a
Other pre-tax items 2056 1481 1894 2044 2194
Reported PTP 30251 27071 28301 34096 38910
Taxation -5244 -6044 -6509 -7842 -8949
Minority interests n/a n/a n/a n/a n/a
Exceptionals (post-tax) -42.6 993.5 200.0 0.00 0.00
Other post-tax items 0.00 0.00 0.00 0.00 0.00
Reported net profit 24964 22020 21992 26254 29961
Normalised Items Excl. GW -42.6 993.5 200.0 0.00 0.00
Normalised net profit 25007 21027 21792 26254 29961
Source: Company data, RBS forecasts year to Mar

Balance sheet

Rsm FY09A FY10A FY11F FY12F FY13F

Cash & market secs (1) 17773 18922 18922 18922 18922
Other current assets 38236 34756 43725 48437 51413
Tangible fixed assets 20789 24361 25123 25703 26104
Intang assets (incl gw) n/a n/a n/a n/a n/a
Oth non-curr assets 5875 15129 15129 20129 20129
Total assets 82673 93167 102899 113192 116569
Short term debt (2) n/a n/a n/a n/a n/a
Trade & oth current liab 57838 67332 65358 71330 54919
Long term debt (3) 4219 0.00 7167 4870 16514
Oth non-current liab 0.00 0.00 0.00 0.00 0.00
Total liabilities 62057 67332 72526 76200 71433
Total equity (incl min) 20615 25835 30373 36992 45136
Total liab & sh equity 82673 93167 102899 113192 116569
Net debt -13554 -18922 -11755 -14052 -2408
Source: Company data, RBS forecasts year ended Mar

Cash flow statement

Rsm FY09A FY10A FY11F FY12F FY13F

EBITDA 30402 27500 28942 34863 40010
Change in working capital -3289 14289 -10943 1259 -19387
Net interest (pd) / rec -253.2 -69.8 -295.6 -391.2 -695.0
Taxes paid -6337 -6617 -6509 -7842 -8949
Other oper cash items -489.5 -848.0 200.0 0.00 0.00
Cash flow from ops (1) 20033 34254 11394 27889 10979
Capex (2) -6361 -5701 -3001 -3000 -3000
Disposals/(acquisitions) 66.4 132.7 0.00 0.00 0.00
Other investing cash flow 15077 -5807 1894 -2956 2194
Cash flow from invest (3) 8782 -11375 -1107 -5956 -806.2
Incr / (decr) in equity 381.2 312.7 0.00 0.00 0.00
Incr / (decr) in debt 3334 -4220 7167 -2297 11644
Ordinary dividend paid -16766 -17827 -17454 -19635 -21817
Preferred dividends (4) n/a n/a n/a n/a n/a
Other financing cash flow 0.00 0.00 0.00 0.00 0.00
Cash flow from fin (5) -13050 -21733 -10286 -21932 -10173
Forex & disc ops (6) 0.00 2.71 0.00 0.00 0.00
Inc/(decr) cash (1+3+5+6) 15765 1149 0.00 0.00 0.00
Equity FCF (1+2+4) 13672 28553 8393 24889 7979
Lines in bold can be derived from the immediately preceding lines. year to Mar
Source: Company data, RBS forecasts

Hindustan Unilever | Key Financial Data | 21 September 2010

Standard ratios Hindustan Unilever Asian Paints ITC

Performance FY09A FY10A FY11F FY12F FY13F FY11F FY12F FY13F FY11F FY12F FY13F
Sales growth (%) 48.7 -14.1 8.35 13.0 11.1 18.9 17.7 17.3 13.6 14.9 17.2
EBITDA growth (%) 46.7 -9.55 5.24 20.5 14.8 13.6 20.2 5.09 17.7 17.3 14.1
EBIT growth (%) 47.1 -9.81 4.07 21.5 15.3 11.2 21.0 5.47 18.6 18.1 14.7
Normalised EPS growth (%) 43.3 -16.0 3.64 20.5 14.1 10.0 20.9 7.82 20.4 15.8 16.0
EBITDA margin (%) 14.7 15.5 15.1 16.1 16.6 18.8 19.2 17.2 34.7 35.4 34.5
EBIT margin (%) 13.8 14.5 13.9 14.9 15.5 17.3 17.8 16.0 31.4 32.3 31.6
Net profit margin (%) 12.1 11.9 11.3 12.1 12.4 13.5 13.9 12.8 23.7 23.9 23.7
Return on avg assets (%) 33.9 24.0 22.5 24.7 26.7 24.2 24.5 22.6 21.0 22.4 22.6
Return on avg equity (%) 142.9 90.5 77.5 77.9 73.0 45.8 42.0 36.2 32.2 32.3 32.4
ROIC (%) 214.4 363.4 386.3 174.3 163.1 42.6 38.8 31.3 30.2 29.6 29.7
ROIC - WACC (%) 204.7 353.7 376.6 164.6 153.4 32.1 28.3 20.8 19.5 18.9 19.0
year to Mar year to Mar year to Mar

Valuation
EV/sales (x) 3.04 3.50 3.27 2.88 2.64 4.51 3.83 3.27 3.21 2.79 2.38
EV/EBITDA (x) 20.6 22.6 21.7 17.9 15.9 23.9 19.9 19.0 9.27 7.89 6.91
EV/EBITDA @ tgt price (x) 21.9 24.1 23.1 19.1 17.0 24.5 20.4 19.5 8.87 7.55 6.61
EV/EBIT (x) 22.0 24.2 23.5 19.3 17.0 26.0 21.5 20.5 10.2 8.64 7.52
EV/invested capital (x) 88.7 89.8 33.7 27.3 14.9 12.6 9.61 7.95 3.98 3.47 3.01
Price/book value (x) 31.0 24.8 21.1 17.3 14.2 13.4 10.1 8.45 8.29 7.18 6.19
Equity FCF yield (%) 2.14 4.46 1.31 3.89 1.25 0.89 1.63 1.79 2.37 3.13 3.51
Normalised PE (x) 25.6 30.4 29.4 24.4 21.4 33.2 27.5 25.5 27.6 23.8 20.5
Norm PE @tgt price (x) 27.2 32.4 31.2 25.9 22.7 34.0 28.1 26.1 26.4 22.8 19.6
Dividend yield (%) 2.56 2.39 2.73 3.07 3.41 1.05 1.05 1.40 1.70 1.98 2.26
year to Mar year to Mar year to Mar

Per share data
Tot adj dil sh, ave (m)
Reported EPS (INR)
Normalised EPS (INR)
Dividend per share (INR)
Equity FCF per share (INR)
Book value per sh (INR)
FY09A FY10A FY11F FY12F FY13F Solvency FY09A FY10A FY11F FY12F FY13F
2180 2182 2182 2182 2182 Net debt to equity (%) -65.7 -73.2 -38.7 -38.0 -5.34
11.5 10.1 10.1 12.0 13.7 Net debt to tot ass (%) -16.4 -20.3 -11.4 -12.4 -2.07
11.5 9.64 9.99 12.0 13.7 Net debt to EBITDA -0.45 -0.69 -0.41 -0.40 -0.06
7.50 7.00 8.00 9.00 10.0 Current ratio (x) 0.97 0.80 0.96 0.94 1.28
6.27 13.1 3.85 11.4 3.66 Operating CF int cov (x) 105.1 586.5 61.6 92.3 29.7
9.46 11.8 13.9 17.0 20.7 Dividend cover (x) 1.31 1.38 1.25 1.34 1.37
year to Mar year to Mar

Priced as follows: HLL.BO - Rs293.20; ASPN.BO - Rs2853.60; ITC.BO - Rs176.65

Source: Company data, RBS forecasts

Valuation methodology

Economic Profit Valuation Rs m % Discounted Cash Flow Valuation Rs m %

Adjusted Opening Invested Capital 32755.5 5 Value of Phase 1: Explicit (2011 to 2013) 40843.3 6
NPV of Economic Profit During Explicit Period 60504.6 9 Value of Phase 2: Value Driver (2014 to 2016) 108227.9 16
NPV of Econ Profit of Remaining Business (1, 2) 292574.3 45 Value of Phase 3: Fade (2017 to 2050) 506288.1 76
NPV of Econ Profit of Net Inv (Grth Business) (1, 3) 264017.0 41 Terminal Value 7261.7 1
Enterprise Value 649851.3 100 Enterprise Value 662620.9 100
Plus: Other Assets 0.0 0 FCF Grth Rate at end of Phs 1 implied by DCF Valuation 9.5
Less: Minorities 0.0 0 FCF Grth Rate at end of Phs 1 implied by Current Price 9.2
Less: Net Debt (as at 14 Sep 2010) -31562.9 -5
Equity Value 681414.2 105 Returns, WACC and NPV of Free Cash Flow
No. Shares (millions) 2181.7 250% 40,000
Per Share Equity Value (Rs) 312 35,000
Current Share Price (Rs) 293.2 200%
30,000

150% 25,000
Sensitivity Table No of Years in Fade Period
20,000
#REF! 15 18 20 23 25
100% 15,000
6.0% 308.79 347.60 373.67 412.93 439.14
WACC

7.0% 282.59 316.34 338.69 371.85 393.69 10,000

50%
8.0% 261.25 290.86 310.20 338.51 356.89 5,000
9.0% 243.33 269.48 286.34 310.70 326.31 0% 0
10.0% 227.94 251.17 265.95 287.04 300.39
2011

2014

2017

2020

2023

2026

2029

2032

2035

2038

2041

2044

2047

2050

Performance Summary Phase 2 Avg Phase 1 NPV of FCF (RHS) Phase 2 NPV of FCF (RHS)
2011 2012 2013 (2014 - 2016)
Phase 3 NPV of FCF (RHS) Total Business ROIC
Invested Capital Growth (%) 45.3 11.5 47.3 5.0 Growth Business ROIC Remaining Business ROIC
Operating Margin (%) 14.9 15.9 16.4 16.0 WACC
Capital Turnover (x) 7.4 5.8 5.8 6.0
Source: Company data, RBS forecasts
1. In periods following the Explicit Period i.e. Phase 2 and Phase 3
2. Remaining Business is defined as Capital as at the end of Phase 1 and capex = depreciation thereafter
3. Net Investment is defined as capex over and above depreciation after Phase 1

Hindustan Unilever | Performance and Valuation | 21 September 2010

Company description Buy Price relative to country

Hindustan Unilever is India's largest FMCG company with the deepest distribution access. It is the market leader 230

in India in several large categories like personal wash, detergents, skin care, shampoos and beverages. In 210

categories like skin care and personal wash, its market share is many times that of its nearest competitors. HUVR 190

has consciously strengthened its presence in the premium segment of the market, and in some categories, like 170

soaps and tea, reduced its presence in the low-margin mass market segment. 150

130

110

90

70
Sep Jan Apr Aug Dec Mar Jul Oct Feb May Sep
07 08 08 08 08 09 09 09 10 10 10

Price relative to country

Strategic analysis Average SWOT company score: 3 EBIT composition, 1QFY11

Strengths 3 Beverages Exports

10% 3% Soaps and
HUVR's key strengths are its strong brand portfolio across major FMCG categories and its wide distribution Detergents
37%
network. Due to its scale, it can access deep rural markets at low costs.
Weaknesses 2
47% of HUVR's sales come from detergents and personal wash, where penetration rates are very high and, Personal
Products
hence, growth potential is lower. This could drag down overall sales growth. 50%

Opportunities 3 Source: Company data

Personal products and food, in which penetration rates are low, offer secular growth prospects, and HUVR derives
32% of its sales from these categories. We also see scope to raise consumption in the long term, even in the
Market data
highly penetrated categories.
Headquarters
Threats 2 Unilever House, B D Sawant Marg, Chakala,
HUVR, as the largest FMCG player in India with the highest market shares across most categories, runs the risk Andheri, Mumbai-400099
of losing share to new MNC competition, such as P&G, as well as to regional competition. Website
www.hll.com
Scoring range is 1-5 (high score is good)
Shares in issue
2181.7m
Freefloat
49%
Majority shareholders
Unilever & Affliates (52%), Indian Fis (15%),
FIIs (14%)

Country view: India Country rel to Asia Pacific

The macro picture for India has been constructive recently, with GDP and industrial production tracking in line with 170

expectations, while portfolio allocators continue to favour the market for its domestic consumption orientation. 160

However, these positives have already been priced in and we believe risks are rising from the increasing double 150

deficit, demanding valuations and tightening liquidity. 140

130
The country view is set in consultation with the relevant company analyst but is the ultimate responsibility of the Strategy Team.
120

110

100

90
Sep Jan Apr Aug Dec Mar Jul Oct Feb Jun Sep
07 08 08 08 08 09 09 09 10 10 10

MarketIndex

Competitive position Average competitive score: 3- Broker recommendations

Supplier power 4- 25
HUVR has scale of operations in all its categories and, accordingly, is well-placed to get the best trading terms
20
from its suppliers. Also, due to its parentage, it enjoys good bargaining power.
15
Barriers to entry 3-
Strong brands and distribution network are potent barriers, but India is a price-sensitive market where regional 10

competition poses a threat to HUVR due to its aggressive pricing. 5

Customer power 3- 0
HUVR has lost some of its pricing power over the years due to inroads made by competition, especially regional Buy Hold Sell
players. However, at the premium end it does enjoy good pricing power.
Source: Bloomberg
Substitute products 3-
Most of the products are basic necessities, but substitutes exist in the form of unbranded items, which pose
meaningful risk in the mass market in some categories.
Rivalry 3-
MNCs, like Colgate Palmolive in oral care and P&G in detergents and hair care, are key long-term rivals for HUVR
in the Indian market. HUVR has a strong competitive position vis-a-vis these players.
Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse

Hindustan Unilever | Strategic and Competitive Overview | 21 September 2010

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Hindustan Unilever | Disclosures Appendix | 21 September 2010