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Impressions from a recent meeting with HLL - Margin blues - Views on News from Equitymaster
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  • Aug 14, 2004 - Impressions from a recent meeting with HLL - Margin blues

Impressions from a recent meeting with HLL - Margin blues
Aug 14, 2004

Background

Hindustan Lever Limited (HLL) is India’s largest FMCG company with a dominant presence in almost all consumer categories. The company’s turnover at Rs 100 bn is nearly half of the total branded / organized FMCG business in India. HLL's brand equity remains unrivalled in India. However, in the last couple of years, HLL 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 sure seems different, with competition in its key business of soaps and detergents (44% of revenues) taking a hugh toll on margins.

Key highlights

Soaps & detergents (44% of 1HCY04 revenues) - Margin stress to continue
Our impression from the meeting is that, HLL is still at the crossroads. Its key business i.e. soaps and detergents will continue to be under pressure at the margin level. In management’s own words at the last Analyst meet: “it all depends on P&G’s pricing strategy”.

PBIT margins have come down from over 24% in June quarter last year to 15% in 2QCY04. The company seems unlikely to recover lost ground on this front over the next few quarters. Though the company’s mass-market detergent brand, Wheel, grew by 8% to 9% in volumes during the June quarter, it looks like P&G has taken a marginal edge over HLL in terms of share of incremental growth in the detergent pie. HLL’s key soap brands – Lifebouy and Lux, continue to grow, but the growth rate is likely to slow down.

Personal Products (24% of 1HCY04 revenues) – Prone to competition
Personal products grew 4.5% YoY in 1HCY04, much less than the 15% growth witnessed in 2003. Key categories in this segment are shampoos, oral care, Fair & Lovely, Lakme and Ponds.

Shampoos (Rs 5 bn approx.) – growing at 5%

Key brands: Clinic and Sunsilk
Clinic has grown at 8% in the first half of the year (annual revenues about Rs 4 bn). But the relaunch of Sunsilk is yet to reflect in the topline. Though overall industry volumes grew by around 13% between January to May 2004, HLL’s shampoo folio under performed and grew by 8% during the same period. P&G took the initiative in the shampoo segment as well, with Head & Shoulders and Rejoice as the key gainers. Sunsilk lost out on the incremental volume growth.

Oral care (Rs 6.5 bn approx.) – sluggish growth (36% market share)

Key brands: Pepsodent and Close up
Close up has been the key performer in the recent quarter (about Rs 3 bn revenues). Pepsodent (Rs 3.5 bn plus) has been sluggish.

Fair & Lovely (Rs 6.4 bn approx.)
Has grown at 15% plus in the past, but growth is now stabilizing at 7% to 8%.

Lakme & Ponds (Rs 6 bn approx.)
Lakme continues to grow (clocked 30% growth in June quarter). Pond’s stabilizing. Not only has the topline growth slowed down for the personal products segment, PBIT margins have started to show some pressure too (down by over 2% during the first half). Despite this, margins for the business continue to be high at 31% and are a key contributor to profits (over 45% to total PBIT). Going forward, competition is likely to increase in this segment and therefore, prone to competitive pressure.

Conclusion
With 68% of its key business under pressure in the visible future, HLL has little to be enthused about. The management too, is in a way resigned to the fact that its profitability will be under duress till the P&G onslaught is on. P&G is looking to increase market share aggressively and has already made inroads in the detergents and shampoo segments. It seems to have got the upper hand in gaining sizeable chunk of the incremental growth of the pie.

The management seems to be de-emphasizing on the foods business, especially with competitors like ITC making significant inroads. The problem seems to be further aggravated by the fact that HLL is not able to find a new growth engine.

On the positive side, its exports to parent Unilever have steadily gone up (Rs 7 to Rs 8 bn). This is likely to be around Rs 12 bn by 2008, but margin profile is likely to be about 10%. Also, the company has hinted at a cost cutting programme aiming at saving around 5% of revenues in the next 24 months (almost Rs 5 bn).

Based on the above, we believe that HLL will once again finish the year (2004) with a negative topline growth. Margin pressure is likely to continue. We believe that even if HLL were to cut costs, it will be tough for it to see 2002 and 2003 operating margin levels (19.5%). We have assumed that margins will stabilise at 15% over next 2 years (2006). With the company slated to return Rs 13.2 bn to its debenture holders at the end of 2004, its investments may see some pruning. This along with lower return on investments will translate into lower other income going forward. Already, its other income has taken a hit of over 40% in 1HCY04.

Valuations
As a result of the poor first half results and recent meetings with management, we have cut our earnings estimates for 2004 by 24%. At the current price of Rs 110, HLL trades at 18.8 times our 2004 EPS estimates. The valuations are still at a significant premium to other FMCG peers, especially in light of the 28% earnings decline in 2004 and expectation of lower single digit growth in 2005 and 2006. We foresee a weakening of the stock price to around Rs 90 levels going forward.

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