Hindustan Lever (HLL), a 51% subsidiary of Unilever, is India’s largest FMCG company with sales of Rs 110 bn (2001). It forms around 5.5% of Unilever’s global turnover and a sizeable 32% of Unilever’s Asia Pacific business. The company’s topline has registered at a CAGR of 20% in the last 10 years. Its profits have logged in CAGR of 36% over the same period.
|If you had invested Rs 10,000 in HLL in 1992, your investment would be
worth Rs 105,860 at current prices (CAGR 29%).This is excluding
the dividends of over Rs 119 that HLL has paid per share in the past 10 years.
However, in the last few years, HLL’s topline growth has shown signs of tiring. In the last 4 years, HLL has recorded a topline CAGR of 5%, which is largely due to the sluggishness prevailing in the economy. Soaps and detergents contribute nearly 48% of HLL’s topline. This segment is one of the worst affected during the slowdown.
Globally, Unilever is changing the way it does business. The Group is no longer interested in having a large number of brands and product offerings in the FMCG spectrum. Instead, it is looking at scaling down and concentrating on those businesses that contribute substantially to its bottomline. It has exited adhesives and specialty chemicals business in the last few years. It is looking at margin expansion in all its businesses.
HLL is following the parent’s strategy of refocusing its efforts on its core business and brands. It has initiated measures to prune the number of brands from 110 down to 40. HLL found that only these 40 brands contributed around 90% to the turnover and over 110% to its bottomline. Apart from this, the company is exiting businesses to lend focus to its business plan. In the last couple of years, HLL has exited the businesses of animal feeds, speciality chemicals and seeds. Leather and marine export businesses are next in line. The hiving off of businesses will bring in extraordinary income for the company going forward. In 2001, HLL has earned Rs 1.6 bn through sale of non-core businesses. These efforts have resulted in margin expansion for the company. Its operating margins have improved from 10.7% in 1998 to 15.6% in 2001. Though this trend is well poised to continue in future too, the margin expansion going forward is likely to slow down.
That said, HLL’s product profile is quite different from the parent. While soaps and detergents contribute only 21% to Unilever’s topline, in HLL’s case the contribution is nearly 48%. Similarly, while the foods business accounts for 55% of Unilever’s total folio, it is only 27% for HLL.
Even within the food portfolio, HLL’s product mix is quite different from its parent. Tea & coffee (beverages) form 59% of HLL’s total food business of Rs 30 bn, while ice creams form only 5.0% of HLL’s food portfolio. On the other hand, for Unilever, ice cream and beverages form 29.4% of the company’s food basket. In effect, tea is smaller globally for Unilever but big for its Indian operations. This clearly indicates that though HLL is attempting to move towards aligning its portfolio with its parent, this may not be possible in entirety due to geographical food habits. (Another example is that while Unilever sold its bakery business in the year 2000, HLL is contemplating spreading its presence in this segment in India).
This detergent skewed mix in the case of HLL will undoubtedly change in the coming years. Going forward, its foods business is going to be the growth driver. This will happen as a result of two main reasons. For one, sales growth in soaps and detergents has slowed down to single digits in the last couple of years. It forms one of the most heavily penetrated FMCG segments in India. On the other hand, processed and staple foods are expected to grow much faster due to the penetration levels being much lower (15%-20%). The second reason in favour of processed food business growth is that the Indian consuming class is slowly but surely changing. Right now, HLL may face hurdles in terms of consumer acceptance of ready to eat and processed staples. However, going forward, with increased promotion, awareness and women entering the workforce, acceptance of these products is likely to rise. India is where the western countries were say 15-20 years ago, and habits are likely to evolve as they did in the western markets (but only much faster).
Source: HLL Investor presentation, CLSA, Hong Kong, May 2001
All the above reasons have contributed to the belief that a turnaround in HLL’s fortunes is around the corner. However, ground realities are different.
While soaps and personal products have grown by 8% and 10% respectively in the first nine months of 2001, ice creams and branded staple foods have shown a YoY decline of 9% and 8% respectively. We did a small exercise wherein we assumed that in the next five years personal products and soaps will grow at a 5% growth rate, staples, culinary, bakery items grow at a stable 10% YoY and ice-cream beverages grow at 5%-8% each year for the next five years. Though these assumptions may deviate from the actual results, they highlight that food is not likely to generate enough impetus for HLL’s topline due to its weightage in the revenue mix. Below is a sample of the sales mix that emerged in 2005E.
|HLL's sales mix
||Unilever in 2001
|Soaps & detergents
|Staples, culinary and processed food
|Ice-cream and beverages
|Oil and dairy based foods and bakery
As we can see, to replicate the parent’s model by 2005, HLL will have to push much harder. In due course, HLL will undoubtedly reflect the parent, but it seems unlikely to happen in the medium term. However, growth can be bought. HLL could mirror the parent in terms of increased food contribution through inorganic growth. ‘Bisleri’ and ‘Bailley’ (bottled water) and Parle (bakery items) are the two likely acquisition targets going forward. One can expect HLL to woo these and others to consolidate its food business. On the flip side, HLL could have to pay a sizeable sum to secure them.
HLL’s growth is directly linked to growth of the Indian economy. Even in a sluggish scenario like 2001, the company has managed to grow its topline (though only in single digits). The company will be the biggest beneficiary when the economy turns around and rural demand picks up. Also, penetration levels for a majority of products, especially in the food business, are still low (between 20%-30%). This indicates immense potential for Unilever in India over the long term.
Though there are no concrete numbers to back this hunch, the feeling is that HLL has already spent a bulk on setting up its distribution infrastructure. It is amongst India’s best technologically connected company internally. So its systems are in place. Before expanding its ice-cream and frozen desserts reach, HLL recognised the need for setting up cold storage chains across India. Therefore, as early as 1998, HLL earmarked Rs 2 bn for setting up cold storage chains. This capex has already been done. Because of its distribution strengths (over 850,000 retail outlets in December 2000), HLL’s new products reach the shop shelf faster as compared to competition. In effect, the cost of launching new products will decline at a faster pace and further aid margin expansion.
Bottomline, though HLL is a solid defensive stock to have in one’s portfolio, acquisitions and recovery in demand are the short-term triggers.