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HLL: Good ‘food’ - Views on News from Equitymaster

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HLL: Good ‘food’
May 3, 2007

Performance summary
FMCG major, Hindustan Lever Ltd (HLL), has announced decent results for the first quarter of CY07 (January to December fiscal), reporting 14% YoY growth in topline, led by strong performances from its soaps & detergents and exports divisions. Operating margins contracted by 40 basis points (0.4%) due to higher cost of goods sold. Net profits (excluding extraordinary adjustments) grew by 14% YoY.

Financial snapshot
(Rs m) 1QCY06 1QCY07 Change
Net sales 27,981 31,843 13.8%
Expenditure 24,675 28,224 14.4%
Operating profit (EBDITA) 3,306 3,620 9.5%
Operating profit margin (%) 11.8% 11.4%  
Other income 694 908 30.9%
Interest 21 51 150.2%
Depreciation 339 329 -2.8%
Profit before tax 3,640 4,147 13.9%
Tax 700 809 15.5%
Extraordinary items 1,489 590 -60.4%
Profit after tax 4,429 3,929 -11.3%
Net profit margin (%) 15.8% 12.3%  
Effective tax rate (%) 19.2% 19.5%  
No. of Shares (m)   2,206.6  
Diluted earnings per share*   8.2  
P/E ratio (x)   24.0  
(* 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 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 joint ventures 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 1QCY07?
It’s a ‘soapy’ affair: HLL’s soap & detergent business (45% of totals sales) was the lead growth driver for the company’s 1QCY07 topline performance. The business recorded sales growth of 10% YoY during the quarter, led by strong performances from its frontline brands like ‘Surf’, ‘Wheel’, ‘Lifebuoy’ and ‘Lux’. The personal products division also raked in decent growth in reporting a 7% YoY increase in sales during 1QCY07. Together, HLL’s ‘HPC’ (Home & Personal Care) business recorded a sales growth of 10% YoY during the quarter.

Segment revenue snapshot
(Rs m) 1QCY06 1QCY07 Growth
Soaps and detergents 13,186 14,445 9.6%
% of sales 46.7% 44.9%  
PBIT margin 11.6% 12.1%  
Personal products 7,659 8,221 7.3%
% of sales 27.1% 25.6%  
PBIT margin 24.4% 24.7%  
Beverages 3,177 3,705 16.6%
% of sales 11.2% 11.5%  
PBIT margin 19.5% 15.0%  
Processed foods 882 1,311 48.7%
% of sales 3.1% 4.1%  
PBIT margin 0.4% 5.6%  
Ice creams 265 322 21.9%
% of sales 0.9% 1.0%  
PBIT margin 3.2% 4.1%  
Exports 2,755 3,519 27.7%
% of sales 9.7% 10.9%  
PBIT margin 2.9% 3.8%  
Others (includes chemicals, water etc.) 340 631 85.6%
% of sales 1.2% 2.0%  
PBIT margin -14.8% -24.9%  
Total sales 28,263 32,156 13.8%
PBIT margin 14.3% 13.7%  

Coming to the second broader division of ‘foods’, it grew sales by 23% YoY during 1QCY07, led by strong numbers from all its key constituents like beverages, processed foods and ice creams. In the beverages segment, which grew by 17% YoY, the tea business was the key performer with the entire range of ‘Brooke Bond’ brand performing well. The robust 49% YoY growth in the processed foods segment was led by good performance from leading brands like ‘Knorr’ and ‘Kissan’. HLL launched the ‘Moo’ range of ice creams for children during the quarter, which aided the 22% YoY growth in ice cream sales.

Cost pressures depress operating margins: The 40 basis points (0.4%) contraction in HLL’s operating margins during 1QCY07 was result of higher cost of revenue, which increased to 57.9% of sales during the quarter, up from 56.4% of sales in 1QCY06. Advertising and promotion expenses also witnessed a rise, though very marginal.

Cost break-up
(As % of sales) 1QCY06 1QCY07
Cost of goods sold 56.4% 57.9%
Staff costs 5.6% 5.6%
Advertising & promotions 10.8% 11.2%
Other expenses 15.4% 13.9%
Total Expenditure 88.2% 88.6%

‘Extraordinary’ impact on bottomline: At first glance, HLL’s 1QCY07 net profits seem under pressure as they have declined by 11% YoY. However, if one were to exclude the impact of extraordinary incomes in both 1QCY07 and 1QCY06, the bottomline has actually recorded a growth of 14% YoY. As a matter of fact, the extraordinary income in 1QCY06 was on account of sale of ‘Nihar’ to Marico. In the latest quarter, the one time income comprises reduction in tax liability arising from the amalgamation of Modern Foods (an erstwhile subsidiary), profit arising from transfer of two factory units and a land to three separate subsidiaries.

What to expect?
At Rs 196, the stock is trading at 24 times its trailing 12-months earnings. While HLL has begun this year (CY07) at a positive note (as reflected in its topline and bottomline performance as also the performance of its key brands), sustainability remains an issue. This is especially considering that the economy is showing signs of overheating and there might be negative impact of rising interest costs on consumption demand as well. While the company has done well to grow its key brands across segments, the management has agreed to concerns relating to rising input prices and has hinted at ‘judicious’ price increases and drive for an improved portfolio mix.

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