HUL royalty fee hike dents stock despite strong Q3, but how much should investors worry

Hindustan Unilever Limited posted a 12 percent hike in its standalone net profit to Rs 2,505 crore for the December quarter, in-line with Street expectations, and brokerage commentary has been upbeat. Still, the firm's stock took a hit of over four percent in Friday's opening trade. The fast-moving consumer goods (FMCG) company's performance was overshadowed by the announcement of an increase in the royalty it pays to parent Unilever. Let's take a look at how royalty payments impact HUL and its shareholders.

HUL said the royalty fee — an amount paid by a third party to an owner of a product or patent for the use of that product or patent — to Unilever PLC will be hiked from 2.65 percent of sales to 3.45 percent (80 basis points) in a staggered manner over three years till 2025. This will be the first such hike undertaken by the parent firm after 10 years.

The new royalty and central services agreement will be signed as the current agreement of HUL with the Unilever group expires this year.

Some experts believe extra royalty payment means shareholders will be left will lower cash, and this might be unfair to minority shareholders.

HUL delivers much value to Unilever – they’re 11 percent of their global sales but 2/3rd of the global market cap. Unilever PLC trades at 18X forward earnings and HUL at 60X. HUL also has aspirations to be the top contributor to global sales. So, for all the value, brand usage and technical expertise that Unilever provides, they get more in return for their investment. Hence, bigger absolute sales and higher valuation are greater than an increase in royalty.

Having said that, both Unilever and HUL have been invested in India and all stakeholders for long enough to not take any hasty or value-destructive steps.

It will be important to see if long-term investors look beyond this 2 percent cut and continue to bet on the big Indian consumption story.

Brokerage firm CLSA has an ‘outperform’ rating on the shares of HUL with a target of Rs 2,950 per share. CLSA said that as per markets regulator Sebi, majority approval of minority shareholders is required only if royalty exceeds 2 percent.

Amisha Vora, CMD, Prabhudas Lilladher, said, “As for FY24, as their part of the hike becomes effective, we estimate that it will have an impact of about 0.52 basis points (bps) on the margin. And for FY25, as the full impact of this hike in royalty comes, overall, it will be 0.70-0.72 bps impact on the margin.”

Vora believes as the cost-to-inflation ratio and the commodity pressures are sobering, the EBITDA margin from hereon would increase in FY24, and they would be able to absorb this 80 bps hike without much worry.

Brokerage firm Citi said that despite an increase in royalty rate, the management had maintained long-term compound annual growth rate (CAGR) guidance. While Jefferies said that the company has clarified that requisite regulatory approvals would be taken for the royalty hike. The management justified the increase based on benefits enjoyed by the company.

Brokerage firm JPMorgan believes that an increase of 80 basis points in royalty and central services can weigh on the near-term stock sentiment. However, it sees a limited impact and is hopeful that other margin levers could mitigate much of it.

HUL has indicated likely improvement in demand and raw material inflation environment going ahead in their post-result commentary. HUL’s growth triggers going forward include scaling up recent acquisitions and premium categories. The D2C universe may also throw up some acquisition opportunities. An imminent change in leadership later this year will be another catalyst to watch.