Good morning [%first_name |Dear Reader%],

Every three months, analysts and investors pore over some standard metrics for listed companies—revenue, profits, margins. And some that are specific to certain sectors, like subscribers for telecom, the order book for infrastructure, and attrition for IT services.

For fast-moving consumer goods (FMCG) companies, changes in brand market share, new product launches, and commodity prices are all tracked and discussed quite often.

But it wasn’t any of these metrics that took centre stage on 19 January, when Hindustan Unilever Ltd (HUL), India’s largest FMCG company, announced its financials for the quarter ended December 2022.

Its profits beat expectations, but investors were miffed. The company’s shares fell 4% on Friday, when the Nifty FMCG index slid only 1%.

And the source of all the consternation was a seemingly small number.

HUL and the tiny number making investors jittery

HUL is the Indian arm of London-headquartered consumer products giant Unilever PLC.  It produces and sells a range of Unilever brands in India, including Dove (soap), Sunsilk (shampoo), and Axe (deodorant).

So HUL has to pay Unilever royalty for the “technical know-how” needed to make these products. In addition, since HUL sells certain brands whose trademark in India is owned by its parent, and uses the Unilever corporate logo, HUL has to pay trademark royalty. And then some more for the benefits it gets from Unilever’s centralised procurement and talent management.

And these payments, calculated as a percentage of net sales, are the reason why HUL shares fell last week.

You see, the previous ten-year contract stipulating the rates at which these payments are made ends this month. And last week, the HUL board approved increasing the total royalty it pays Unilever, from 2.65% of net sales to 3.45%, staggered over three years and in effect until 2028.

The hike elicited a knee-jerk response from investors. Knee-jerk because:

1. Even with the hike, HUL’s royalty rate is still considerably lower than the 5% Nestlé India pays and the 5.8% Colgate-Palmolive India pays.
2. HUL, despite its size, has increased its turnover 2X over the past decade to more than Rs 50,000 crore (US$6.1 billion) in the year ended March 2022. And upped its Ebitda 4X to over Rs 12,000 crore (US$1.5 billion).
3. HUL has a range of homegrown brands—either its own or acquired—such as Lakme (cosmetics), Kissan (foods), Wheel (detergent), and Brooke Bond Taaza (tea). And these don’t entail royalty payments, according to brokerage Prabhudas Lilladher.

It’s not clear how much these brands contribute to HUL’s revenue. But if HUL’s next five years is even remotely like its past 10, the increased royalty payment shouldn’t matter.

HUL paid Unilever ~Rs 1,335 crore (US$164 million) in the year ended March 2022 as royalty and payment for “central services”, compared to just over Rs 1,200 crore (US$147 million) the previous year.