I received a couple of emails from readers yesterday, asking about my views on Hindustan Unilever (HUL) after the parent Unilever announced an open offer to buy an additional 22.5% stake in the former.
Email 1: I have 300 HUL bought at Rs 400. Given the confidence the parent has shown in the Indian business, do I buy more?
Email 2: Given an MNC’s confidence in the Indian consumption story, does it makes sense to buy other FMCG companies as well, despite their high valuations?
First, a couple of disclaimers…
- I don’t write on specific stock actions (and may not do in the future), but this is an exception given the size of the action and because I have something to say here (it may be nonsense to you!).
- I own HUL’s shares.
Anyways, here are “my” views.
Email 1: Should you buy more of HUL?
Promoters raising stakes usually signals good prospects for the company and its investors.
And when promoters are willing to pay a huge premium to buy more stake, it’s great news.
What is more, Unilever is supposedly spending its entire free cash flow of last year to acquire the additional stake in HUL, which contributes only 7.5% of its sales and 11% of its profits.
This should make me, as an investor in HUL, very happy.
But should I buy more of HUL at almost the price Unilever is willing to pay?
Not really! It’s important to understand the concept of “opportunity cost” in investing.
Opportunity cost is basically the cost of an alternative that must be forgone in order to pursue a certain action. In other words, it signifies the benefits you could have received by taking an alternative action.
Importantly, opportunity costs differ for different investors. So, the opportunity cost for Unilever (cost of an alternative forgone by it when it invests in HUL) will be different than yours’ (cost of an alternative forgone by you).
Maybe, Unilever has no other alternative to use its cash than to buy stake in HUL at such a premium.
Your decision to buy more of HUL is dependent on whether you have another better opportunity to invest or not.
It also depends on how attractive you see the opportunity in HUL in isolation, not what you see through the eyes of Unilever.
When faced with such situations, always remember the three big lessons taught by Graham in The Intelligent Investor:
- Think of a stock as a part ownership of a business – Okay, HUL is a good business.
- The market is there to serve you, not instruct you – Should I buy more of the stock at Rs 600 just because the parent is buying at Rs 600? No! Please avoid anchoring bias.
- Always require a margin of safety – Is there sufficient margin of safety at Rs 600, when HUL’s P/E will be very high at around 35x? Doesn’t seem to me, but please do your own homework!
Simply put, in such situations – or in any situation while investing – go by the value of the business instead of the stock price.
So my answer to the first email is…
If you think that the current price – that reflects the premium that Unilever will be paying – is more than the value of HUL’s business, you should avoid buying the stock and instead (maybe) sell out irrespective of whatever anyone else (including Unilever) is saying or doing.
Email 2: Should you buy other FMCG stocks?
The answer here is simpler!
Here is what Howard Marks has to say on investing success…
Investment success doesn’t come from “buying good things,” but rather from “buying things well.”
What Marks effectively says is that “price” has to be the starting point for any investment decision making.
No stock (or any asset) is so good that it can’t become a bad investment if bought at too high a price.
So when someone says, “I only buy ABC kind of stocks” or “ABC is a superior stock,” that sounds a lot like “I would buy ABC at any price.”
This kind of thinking is dangerous!
No stock has the birthright of a high return. It’s only attractive if it’s priced right.
So, does it makes sense to buy other FMCG companies as well (like people were buying yesterday after the Unilever announcement), despite their high valuations?
No!
As Marks would tell you…
Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price, and no new buyers are left to emerge.
The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price, can only go one way: up.
What do you say?
You are right. I would wait and watch. No need to hurry into it.
Excellent analysis,Vishal
Hello Sir,
I have a different view on the point :
‘Investment success doesn’t come from “buying good things,” but rather from “buying things well’
rather i tend to agree with Buffett on:
‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’
Though I am not very experienced,I feel quality of the company should be the starting point and then the price of the company.I dont mean that you should pay any price for a good company,rather what i mean is when the market crashes everything falls,some shares fall much and some fall a little.That is the time to buy a good company.
What I try to do is I first select a company and then have a ‘relative cheaper’ price in mind.And then I wait for it.Only if that price comes,I buy it,else i’ll wait.
Opportunity loss is better than capital loss.
Please correct me if I am wrong.
Hi Vishal,
Agree with your analysis.
One aspect which one will want to look at is the possibility of a) raising the price higher in order to complete the buyback and b) possibility of Unilever actually going for delisting as part of their overall plan/strategy.
In this scenario, could one look at a special situation kind of allocation? Will appreciate your thoughts around this.
Regards,
Ashish
Stock market is a fertile ground where rationality meets irrationality! HUL Stock rises after the announcement of open offer from parent, Unilever( Rational? ). HUL Lifts all FMCG Stocks, including ITC. Now what is common between soaps/detergent and Tobacco!! It is in these situations when the market gives opportunities for one to exit or enter stocks. After all the best time to buy is when there is maximum pessimism and to sell when there is maximum optimism in the stock, all others things being equal. Typical of Vishal to discuss the hot topic of the day and set the cat among the pigeons! Like him i also own HUL ( my first stock pick!!- remember 1978! and that makes it all the more difficult to detach oneself from a great company)
A really apt post Vishal. You are right when you say that just because somebody (in this case the owner) is ready to pay a very high price for something, you shouldn’t go ahead and buy it for future.
We should remember that Ranbaxy never achieved the price of 700+ which Daiichi Sankyo paid for it.
And the line “Unilever has no other alternative to use its cash than to buy stake in HUL at such a premium”, is really an eye opener for people who are planning to invest. Average investors like us may never know about Unilever’s actual reason for this decision 🙂
Thanks Vishal for the wonderful post on HUL. Gives me much required insight on how to go about dealing with HUL & other FMCG stocks in my portfolio.
Keep up the great work. Thanks again! 🙂
Excellent article. While the India “infrastructure / production / real estate” story has died down, the India “consumption” story seems to be taking an upperhand now in the minds of people. Hence the FMCG stocks have become popular, and are also called “defensive” stocks. Due to this, some really great companies have become popular, and expensive (I wish I had bought more of them 5 years back)! I wonder if they are defensive anymore, at these prices.
Unilever is a giant, and it available investment universe is limited. HUL is clearly a great investment for Unilever, given that India will keep growing at about 4 to 5% for a long time (to keep its young population happy, this growth in consumption is imperative). But for small time folks like us, the investment universe is much larger. So I’d rather focus on beaten down sectors like infrastructure, and buy quality companies in those sectors. India has to generate power, supply water, transport more efficiently etc. So going for ethical companies in these sectors is an opportunity, as these companies will provide the backbone for the consumption story.
Another sector could be ancilliary firms that supply to the FMCG sector. People who make plastic / glass bottles, labels, raw material extracts etc.
Anyway, just my thoughts, who knows what the future holds!
Regards,
Rajaram
I may be the odd one out, but I have not been comfortable with FMCG valuations for sometime. While it’s a fact that FMCG companies have historically enjoyed higher valuations, I would not be enthusiastic about buying them at today’s prices.
I have been holding HUL since 2004 (one of the first stocks I bought). Currently, I am more inclined towards selling (at least a part of) my holding in the market (open offer would result in more tax). I might even be tempted to exit the stock if ‘news flow’ takes it to even higher levels.
Gr8 article.
But could can u answer these 2 points also ?
1.Is it the right time to exit for an investor atleast a part holding who has been holding through the period of 2000-2010 where the stock did practically nothing except moving in a range?
2. You haven’t covered about unilever delisting in the long run as a possibility?
Nice points Vishal…indeed we sometimes overlook the ‘limited opportunities’ big investors may have…
If you know risk premium you are willing to pay over and above Fixed deposit with PSU bank like SBI. If you know how much earning and earning growth HUL will give you in times to come ..then you also know, using simple DCF formula what should be the price?
I agree with your views Vishal. Will wait for its fair value. 🙂
Thanks for sharing.
Nice article.. my view is, Promoter is valued his shares at Rs.600/- and buying it from public.
So, this price may be under priced.