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P&G: No more contracts, please!
Jul 11, 2005

As per reports, Procter & Gamble Health and Hygiene (PGHH), the listed arm of US FMCG major P&G, will be selling its detergents manufacturing unit at Mandideep in Madhya Pradesh, to the parent’s unlisted subsidiary in India, Procter and Gamble Home Products (PGHP). Currently, PGHH carries out contract manufacturing of detergents for PGHP and earns a margin for the same. In this article, we take a look at the PGHH’s numbers post the sale of the plant.

What is the company’s business?
P&G is a 65% subsidiary of the FMCG major, P&G USA. In India, the company is a focused two-product company, dominating both segments backed by strong brands, namely ‘Vicks’ in the anti-cold segment and ‘Whisper’ in feminine care segment. The parent has two other 100% subsidiaries in India, which have a dominant shampoo and detergent portfolio. P&G undertakes contract manufacturing for its parent's detergent portfolio (Ariel, Tide) in India.

Current Status
(Rs m) FY04 FY05* Change
Net Sales 5,772 6,844 18.6%
Expenditure 4,519 5,404 19.6%
EBITDA 1,253 1,440 14.9%
Operating margin % 21.7% 21.0%  
Net profit after Tax(Loss) 921 1,013 10.0%
Net profit margin % 16.0% 14.8%  
EPS   31.2  
*9mFY05 annualised
Segment snapshot
(Rs m) FY04 FY05* Change
Health & Hygiene Products 3,722 4,109 10.4%
PBIT margin (%) 28.8% 30.6%  
% of revenues 64.5% 60.0%  
Contract Manufacturing 2,050 2,735 33.4%
PBIT margin (%) 5.1% 4.7%  
% of revenues 35.5% 40.0%  
Total revenues 5,772 6,844 18.6%
*9mFY05 annualised

Post sell-off Status
In the post-sell off analysis, we have excluded contract manufacturing for both the years.

(Rs m) FY04 FY05* Change
Net Sales 3,722 4,109 10.4%
Expenditure 2,574 2,798 8.7%
EBITDA 1,148 1,311  
Operating margin % 30.8% 31.9%  
Net profit after Tax(Loss) 816 885 8.5%
Net profit margin % 21.9% 21.5%  
EPS   27.3  
*9mFY05 annualised

As can be seen from the above tables, contract manufacturing accounts for almost 40% of the company’s revenues. However, PBIT margins for the same are in the neighborhood of a meager 5% as compared to around 29% for its Health and Hygiene folio.

However, contract manufacturing has been growing at a scorching pace and PGHH benefited immensely. The parent's strategy to garner a bigger chunk of the Indian detergent market by slashing product prices to almost half has also done wonders for this division. The key growth driver for the company's topline continues to be the detergent contract manufacturing business. Contract manufacturing accounted for 45% of the company’s revenues in 3QFY05 and is on the rise.

In our view, while the decision by PGHH to sell the plant to PGHP will orphan the former of the high growth of the contract manufacturing business, it will, on the other hand, lead to improvement in profitability and return ratios for the company. As a matter of fact, and as seen in the tables above, the company’s operating margins are likely to witness a 10% expansion post the sell-off of the contract manufacturing business. The positives of the sell-off on the growth front are, however, yet to be determined. To that extent, investors should remain cautious.

Also, at the current price of Rs 660, the stock is trading at a price to earnings multiple of 24.2 times its annualised 9mFY05 EPS (excluding the contract manufacturing business), which is at the higher end of the valuation spectrum. Risk, to that extent, is amplified.

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