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HLL: Back in action? - Views on News from Equitymaster
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HLL: Back in action?
Aug 1, 2005

Introduction to results
FMCG major, HLL had recently announced its results for the second quarter and half-year ending June 2005. The company has reported a decent topline and an enthusing bottomline growth during 2QCY05. Bottomline outpacing topline was mainly due to lower interest costs as the company has redeemed the debentures it had issued to its shareholders in CY04. However, margins during the quarter shrank marginally by 20 basis points over 2QCY04.

(Rs m) 2QCY04 2QCY05 Change 1HCY04 1HCY05 Change
Net Sales 25,716 28,363 10.3% 49,250 53,427 8.5%
Expenditure 22,528 24,906 10.6% 42,462 47,535 11.9%
Operating Profit (EBDIT) 3,189 3,457 8.4% 6,788 5,892 -13.2%
Operating Profit Margin (%) 12.4% 12.2%   13.8% 11.0%  
Other Income 703 794 13.0% 1,416 1,540 8.7%
Interest 318 56 -82.5% 635 101 -84.1%
Depreciation 286 318 11.3% 577 628 8.9%
Profit before Tax & extraordinary income 3,288 3,877 17.9% 6,992 6,702 -4.1%
Extraordinary item (119) (188) 58.0% (199) (273) 36.9%
Tax 724 872 20.5% 1,399 1,110 -20.6%
Profit after Tax/(Loss) 2,445 2,817 15.2% 5,394 5,319 -1.4%
Net profit margin (%) 9.5% 9.9%   11.0% 10.0%  
No. of shares (m) 2201.2 2201.2   2201.2 2201.2  
Earnings per share (Rs)* 4.4 5.1   4.9 4.8  
P/e Ratio (x)         35.8  

What is the company’s business?
HLL is India’s largest FMCG company with dominant presence in almost all consumer categories. The company’s turnover at Rs 100 bn is over one third of the total branded/organized FMCG market in India. HLL's brand equity remains unrivalled in India. However, 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. The effects of the initiatives had begun to show in the form of better margins. But 2004 saw competition in its key business of soaps and detergents (45% of revenues), taking a huge toll on margins.

What has driven performance in 2QCY05?
Growth show goes on:  It was the Home and Personal Care (HPC) sales that clearly stole the show with the segment showing a strong 12% YoY growth in 2QCY05. In the Laundry category, the business witnessed double-digit growth in all its brands along with gains in market share. Shampoos also grew by over 20%. During the quarter, HLL relaunched its key brands like Fair and Lovely, Sunsilk and Wheel, which aided overall growth. Brooke Bond and Bru led the foods division’s growth, which also registered a healthy 10% YoY growth. Also, it must be noted that HLL launched Lipton Iced tea in bottled form during the quarter, which received a good response. Ice cream sales grew by 7% during the summer season on the back of new product launches. However, in processed foods, gains from squashes and salt were offset by decline in Atta and Ketchup.

Segment revenue snapshot
(Rs m) 2QCY04 2QCY05 Change
Soaps and Detergents 11,777 12,876 9.3%
Personal Products 6,368 7,474 17.4%
Beverages 2,695 3,122 15.8%
Processed Foods total 822 783 -4.8%
Ice Creams 351 376 7.2%
Exports 3,294 3,225 -2.1%
Others (includes Chemicals, Agri, Plantations etc) 743 786 5.9%
Total Segment Revenue 26,050 28,643 10.0%
Less : Inter segment revenue 56 28 -50.2%
Net Segment Revenue 25,993 28,615 10.1%

Margins back on track:  HLL's margins had seen a consistent uptrend since 1998. The company's restructuring efforts were focused totally on right sizing its brand folio and on profitability. At the start of 2004, the HLL management had indicated that the company had attained the desired level of profitability and would now like to concentrate on topline growth. But price war in its key business of soaps and detergents, initiated by rival P&G, took a toll on this strategy. Post 2004, it was expected that there would be some semblance of order in profitability. Operating margins during the quarter were marginally down by 20 basis points. The increase in raw material costs were offset by lower staff costs, while advertising costs increased by only 10 basis points in the quarter. Overall, all other costs were in tandem with 2QCY04. This indicates that the 5% hike in select product prices has helped the company recover its margins from 9.7% in 1QCY05 to 12.2% in the current quarter.

Cost break-up
as % of sales 2QCY04 2QCY05
Cost of goods sold 55.0% 55.6%
Staff Cost 6.7% 6.1%
Advertising & promotion 10.0% 10.1%
Other expenses 15.9% 15.9%
Total expenses 87.6% 87.8%

Lower interest costs aid bottomline:  The company’s net profit increased by 15% mainly due to lower interest costs and this was owing to the company redeeming the Rs 13.2 bn worth of debentures that were issued to shareholders in the mid of 2003. Also, other income increased by 13% YoY during the quarter arising from higher financial income.

The big picture…
  % contribution
to sales
Revenue growth PBIT margin (%) PBIT margin
(basis points)
Soaps and Detergents 45.2% 9.3% 13.3% (124)
Personal Products 24.4% 17.4% 27.7% (439)
Beverages 10.3% 15.8% 17.3% (155)
Foods (includes Oils and Fats,
Culinary and Branded Staples )
3.2% -4.8% -5.8% 2,754
Ice Creams 1.3% 7.2% 13.5% 550
Exports 12.6% -2.1% 0.7% (200)
Others (includes Chemicals,
Agri, Plantations etc)
2.9% 5.9% -16.8% (392)

Over the last few quarters…

  2QCY04 3QCY04 4QCY04 1QCY05 2QCY05
Sales growth (YoY) -4.5% -3.3% 0.7% 6.5% 10.3%
Advertising as a % of sales 10.0% 9.6% 8.1% 8.3% 10.1%
EBDITA margin % 12.4% 14.1% 16.1% 9.7% 12.2%
Net profit growth (YoY) -45.8% -26.7% -32.6% -15.1% 15.2%

As can be seen from the table above, the current quarter recorded the highest sales growth over the last few quarters and a positive net profit growth. But at the same time, margin pressure continues to suppress bottomline growth. However, it must be noted that the low base in 2QCY04 also had its role to play in the robust numbers of 2QCY05.

What to expect?
At Rs 173, the stock trades at 35.8 times its annualised 1HCY05 earnings and price to sales of 3.6 times. As far as our full year CY05 estimates are concerned, we had projected a much lower 2.4% growth in revenues, but an increase in profits. The management has indicated in the past its focus on maintaining market share, even if it comes at the cost of margins. With crude prices showing no signs of easing in the near term, this pressure on profitability could be here to stay.

We have been indicating in the past that HLL is in for tough times in the near term. We foresee the company taking radical steps to improve its performance, but these will be visible over the next 1-2 years. In our view, based on the current situation, investors are better off buying other smaller and growing companies in the FMCG space like Pidilite (Research), (Research) Dabur and Essel Propack (Research).

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