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HLL: The action continues… - Views on News from Equitymaster
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HLL: The action continues…
Apr 28, 2006

Introduction to results
FMCG behemoth, Hindustan Lever Ltd (HLL), announced impressive results for the first quarter ending March 2006. While the topline has witnessed a respectable growth of 12% YoY, the bottomline has outpaced topline growth by miles, mainly due to higher extraordinary income arising from the sale of ‘Nihar’ to Dabur. Also, during the quarter, margins expanded by 210 basis points, which is visible in the 36% growth in operating profits. Barring the extraordinary income and the tax on it, bottomline has actually grown by 29% YoY in the quarter.

(Rs m) 1QCY05 1QCY06 Change
Net sales 25,064 27,981 11.6%
Expenditure 22,629 24,675 9.0%
Operating profit (EBDITA) 2,435 3,306 35.8%
Operating profit margin (%) 9.7% 11.8%  
Other income 746 694 -7.1%
Interest 46 21 -55.0%
Depreciation 310 339 9.2%
Profit before tax 2,826 3,640 28.8%
Tax 238 700 193.8%
Extraordinary items (85) 1,489  
Profit after tax 2,503 4,429 77.0%
Net profit margin (%) 10.0% 15.8%  
Effective tax rate (%) 8.4% 19.2%  
No. of Shares (m) 2201.2 2201.2  
Diluted earnings per share*   7.18  
P/E ratio (x)   40.4  
(* Trailing 12 months)      

What is the company’s business?
HLL is India’s largest FMCG company with a dominant presence in almost all consumer categories. The company’s turnover at Rs 110 bn is over one third of the total branded/organized FMCG market in India. HLL's brand equity remains unrivalled in India. In the last couple of years, the company has embarked on a major restructuring exercise focusing on improvement in quality of earnings, pruning brand portfolio and securing a viable future for its non-core businesses through JVs, or spin-offs. Barring the unexpected competition witnessed in its soaps and detergents category in 2004, the initiatives taken by the company have yielded positive results.

What has driven performance in 1QCY06?
Topline continues to enthuse: Unlike the previous quarter, this time it was the personal products segment that lifted revenues during the quarter. This was backed by growth in all categories like laundry, shampoo, skin, personal wash and toothpaste, resulting in the health & personal care (HPC) segment growing by 20% YoY in the quarter. All of the company’s brands grew in double digits, and Wheel was re-launched as active colours, which helped matters. Lux, the company’s premium soap offering, grew in high double digits along with it gaining market share of 220 basis points. It can be recollected that the company had launched two new variants in the month of March. Lifebuoy, another successful brand from the company’s stable was entirely relaunched, which improved the brands performance.

On the personal products front, the company’s ‘Clinic’ range of shampoos continued to perform well. As far as ‘Sunsilk’ is concerned, the brand delivered modest growth, as it was re-launched in February this year. Fair and Lovely, led the growth for the skin care segment by growing in double-digits, along with the re-launch of Fair and Lovely ayurvedic.

The growth in foods, the fastest growing segment in the company’s folio albeit on a low base, was backed by processed foods and coffee. It can be recollected that the company had re-launched Kissan in February this year, which has aided growth.

Segment revenue snapshot
(Rs m) 1QCY05 1QCY06 % change
Soaps and Detergents 11,368 13,186 16.0%
Personal Products 6,026 7,659 27.1%
Beverages 3,024 3,177 5.0%
Foods (includes Oils and Fats, Culinary and Branded Staples ) 674 882 30.9%
Ice Creams 204 265 29.7%
Exports 3,421 2,755 -19.5%
Others (includes Chemicals, Agri, Plantations etc) 704 340 -51.6%
Total Segment Revenue 25,421 28,263 11.2%
Less : Inter segment revenue 42 15 -65.2%
Net Segment Revenue 25,378 28,248 11.3%

Margins expand: It must be noted that the company's restructuring efforts were focused totally on right-sizing its brand folio and on profitability. This effort has paid off and is visible from the table below, which indicates a margin expansion of 210 basis points, mainly, achieved through lower cost of goods and staff costs. However, advertising expenditure increased by over 45% YoY in absolute terms during the quarter, indicating the increasing competition and the need to push products.

Cost break-up
As a % of sales 1QCY05 1QCY06
Cost of goods sold 57.8% 54.5%
Staff costs 6.6% 5.6%
Advertising & promotions 8.3% 10.8%
Other expenses 17.6% 17.3%
Total Expenditure 90.3% 88.2%

Once again the extraordinary effect: 1QCY06 has seen the bottomline register a quantum leap of 77% YoY. However, a large part of this was due to the extraordinary income arising from the sale of ‘Nihar’, which the company sold to Marico for Rs 2.02 bn. Adjusting for this and the tax on it, the bottomline has actually grown by a relatively slower pace of 29% YoY, which is nonetheless robust.

The big picture…

  Contribution to
sales (%)
PBIT margin
(%) growth
(basis points)
Soaps & Detergents 44.8% 16.0% 17.1% 11.6% 11
Personal Products 23.7% 27.1% 29.3% 24.4% 42
Beverages 11.9% 5.0% -2.2% 19.5% (144)
Foods (includes Oils & Fats,
Culinary & Br&ed Staples )
2.7% 30.9% - 0.4% 341
Ice Creams 0.8% 29.7% - 3.2% 1,833
Exports 13.5% -19.5% 33.1% 2.9% 115
Others (includes Chemicals,
Agri, Plantations etc)
2.8% -51.6% - -14.8% (1,091)

As can be seen from the table below, bottomline growth for the quarter is the highest since the past five quarters. However this is inflated to the extent of the extraordinary income. As far as the topline is concerned, despite growth on a high base, the company has lost marginal market share during the quarter in its key areas of operation.

Over the past few quarters…
  1QCY05 2QCY05 3QCY04 4QCY05 1QCY06
Sales growth (YoY) 6.5% 10.3% 13.8% 14.4% 11.6%
Advertising as a % of sales 8.3% 10.1% 8.8% 8.9% 10.8%
EBDITA margin % 9.7% 12.2% 12.6% 16.2% 11.8%
Net profit growth (YoY) -15.1% 15.2% 0.5% 56.1% 77.0%

What to expect?
At Rs 290, the stock is trading at a price to earnings multiple of 29.9 times our estimated CY08 earnings and market cap to sales of 4x. The management has indicated in the past its focus on maintaining market share, even if it comes at the cost of margins. However, with crude prices showing no signs of easing in the near term, improving profitability would remain a challenge for the company. We foresee the company taking radical steps to improve its performance, but these will be visible over the next couple of years.

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