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Gillette: Advertising blues

May 6, 2005

Introduction to results
Shaving products major, Gillette India, started 2005 on a weak note. Although topline has grown by a decent 7% YoY, its bottomline dipped by 14% YoY. The main reason for dip in bottomline was due to high ad spends in the quarter, which pruned operating margins.

(Rs m) 1QCY04 1QCY05 Change CY04 Change
Net Sales 1,006 1,076 7.0% 3,631 -5.2%
Expenditure 688 806 17.2% 2,790  
Operating Profit (EBTDA) 318 269 -15.2% 841  
EBITDA margin (%) 31.6% 25.0%   23.1%  
Other Income 39 37 -5.1% 145 11.0%
Interest 0 0 - 0 -
Depreciation 40 37 -6.1% 182 -11.4%
Profit before Tax 318 270 -15.1% 803 156.7%
Extraordinary items 0 0 - (56) -
Tax 120 101 -16.1% 299 171.9%
Profit after Tax/(Loss) 197 169 -14.4% 448 593.8%
Net profit margin (%) 19.6% 15.7%   12.3%  
No. of Shares (m) 32.6 32.6   32.6  
Diluted Earnings per share (Rs)* 24.2 20.7   13.8  
P/E ratio (x)   32.1   47.8  
*(annualised)          

Background
Gillette India is the 52% subsidiary of US shaving major - Gillette USA. The company's promoter group together holds 88.8% in the company, leaving very little liquidity for the public. The company came back into the black in 2003 after a spate of restructuring in 2001 and 2002. These years saw Gillette hive off its battery manufacturing plant (Duracell) at Manesar. The period also saw cash infusion from the parent, which helped it restructure and pay of all its debt. It is now a focused shaving product major (core business of shaving products - Sensor Excel, Mach 3, 7'O Clock, Vector Plus and toiletries), which also markets the Duracell range of batteries. It also has presence in oral care. The company's parent was recently bought over by P&G globally, which is likely to lead to a merger of Indian operations too.

What has driven topline in 1QCY05?
Grooming:  As can be seen from the table below, grooming (blades, razors and personal care) that accounts for close to 80% of revenues, reported a decent topline growth but margins were hit to a great extent, owing higher advertising push. Gillette India imports Mach3 and Sensor Excel (high end) blades and razors for which it earns only a marketing margin, while Gillette Vector Plus (mid priced), was especially developed to cater to the Indian market, due to its technology that enabled low water usage. The company also caters the lower end market by offering 7'O clock razor systems. Both 'Vector Plus' and “7'O clock” are manufactured in India.

Segment Snapshot
(Rs m) 1QCY04 1QCY05 % change CY03 CY04 % change
Grooming 799 836 4.7% 2,813 3,220 14.5%
PBIT 317 256 -19.3% 932 1,013 8.7%
margin (%) 39.7% 30.6%   33.2% 31.5%  
Portable power 80 57 -28.9% 346 355 2.6%
PBIT 21 10 -53.3% 14 70 410.9%
margin (%) 26.4% 17.3%   4.0% 19.7%  
Oral Care 127 183 43.7% 19 488 2525.3%
PBIT 46 60 31.9% (8.2) 139  
margin (%) 35.9% 33.0%   -44.1% 28.4%  
Total Segment Revenue 1,006 1,076   3,177 4,063  
PBIT 384 326   938 1,222  
margin (%) 38.2% 30.3%   29.5% 30.1%  

Portable power:  The company markets the parents 'Duracell' range of batteries in India. India being a price sensitive market prefers to use regular Zinc batteries rather than Alkaline (Duracell) batteries, which are, priced almost 3 times normal one's. The segment saw a dip in both growth as well as profitability. A couple of years back, Gillette had hived off the Duracell battery plant at Manesar, to cut back on its fixed costs.

Oral care:  Gillette India markets the 'Oral-B' range of products in India and saw a good growth during the quarter. However, margins were marginally lower than in 1QCY04.

Overall profitability:  As can be seen from the table below, raw material costs have declined in the quarter as compared to 1QCY04. The company took a hit due to higher ad spends (up by almost 5%) and indicates that the company is pushing its products hard and results will be evident in the quarters to come. Other miscellaneous expenditure also increased by over 5% aiding to the downfall of profits.

Cost break up
As % of revenues 1QFY04 1QFY05 CY03 CY04
Raw material 31.5% 27.5% 33.3% 33.8%
Advertising expenses 7.1% 12.0% 12.4% 14.3%
Staff 9.2% 9.7% 9.7% 9.6%
Others 20.5% 25.7% 21.5% 18.9%
Total expenditure 68.4% 75.0% 76.9% 76.6%

Over the last few quarters
  1QCY04 2QCY04 3QCY04 4QCY04 1QCY05
Sales growth 17.2% 5.0% 16.0% 9.9% 7.0%
Operating margins (%) 31.6% 29.9% 22.3% 9.6% 25.0%
Advertising to sales (%) 7.1% 10.7% 18.1% 21.4% 12.0%
Net profit growth (%) 140.9% 1.7% -8.2% 694.2% -14.4%
Grooming business growth (%) 20.3% 4.3% 17.3% 17.0% 4.7%

As can be seen from the above table, the company's advertising and promotional spend has been quite volatile during the previous quarters. Since the company is mainly a single product (grooming) company, it will need to spend higher as competition intensifies in order to increase sales.

What to expect?
Just to put things in perspective, Gillette USA (the parent) announced its 1QCY05 results yesterday and reported a 17% YoY topline growth backed by 19% YoY bottomline growth. As per the company, its main growth areas were Russia, Turkey and Eastern Europe.

The stock currently trades at Rs 665, transforming into a rich valuation of 32x annualised 1QCY05 earnings, and market cap to sales of 5x, which is at the higher end of the spectrum. In India, the company is aiming to wean away consumers from the traditional double-edged razor segment to twin blade system through its mid-priced offering 'Vector Plus', and the 'Gillette Presto' range. In India, nearly 90% of consumers' still use double-edged razors, a large part of which Gillette is trying to convert. The management has indicated that advertising costs will be around the current levels in the quarters to come, which is what is to be expected of a limited folio FMCG company.

But all said and done, the low liquidity in the company leaves little on the table for the public investors. By all parameters, it looks that the company may be headed for a delisting and therefore, an open offer. But with valuations already too rich, an upside to this is also limited.

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