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Henkel: Margin blues dampen 'Brisk' sale

Aug 17, 2004

Performance summary
Henkel Spic India, the third largest MNC in the detergent space in terms of sales, continues to be caught in the tug of price war between its bigger MNC peers. For the first time in many years, the company reported strong double digit topline growth in the first half of 2004. However, pricing war took a toll on the company's margins (nearly halved), which saw profits shrinking significantly.

(Rs m) 2QCY03 2QCY04 Change 1HCY03 1HCY04 Change
Gross sales 882 1,029 16.6% 1,622 1,961 20.9%
Other income 1 9 1171.4% 1 10 800.0%
Expenditure 829 999 20.5% 1,533 1,895 23.7%
Operating profit (EBDIT) 53 30 -44.1% 89 65 -26.5%
Operating profit margin (%) 6.0% 2.9%   5.5% 3.3%  
Interest 24 16 -32.9% 39 31 -20.7%
Depreciation 16 15 -1.3% 31 31 -1.3%
Profit before tax 14 7 -50.0% 20 13 -32.1%
Tax - -   - -
Profit after tax/(loss) 14 7 -50.0% 20 13 -32.1%
Net profit margin (%) 1.6% 0.7%   1.2% 0.7%  
No. of shares (m) 116.4 116.4   116.4 116.4  
Diluted earnings per share (Rs)* 0.5 0.2   0.3 0.2  
P/E ratio (x)         72.9  

What is the company's business?
A 51% subsidiary of Henkel AG, the Euro 9.4 bn German MNC, Henkel Spic India, is in the business of manufacturing eco-friendly detergents (zeolite based). Tamilnadu Petroproducts also has a 17% stake in the company. Its key brands are Henko, Brisk (detergents), Limeshot, Pril (cleaning solutions), Fa range of personal care products, Margo, Aramusk (toilet soaps) and Neem (oral care). The company is yet to find sustained profitability in its operations.

Price cut led growth
Volumes Vs margins: Detergent prices have nearly halved in the past six months. Key players, HLL and P&G, have led this price war. Henkel was thus, forced to follow suit. Though the move seems to have helped volumes and consequently sales, which grew in double digits, profitability declined considerably. In the detergent space, Henkel's gains on the topline front seem more visible than its peers. However, with the price war threatening to continue in the foreseeable future, margin blues seem here to stay.

Cost break-up
as a % to sales 2QCY03 2QCY04 1HCY03 1HCY04
Material cost 60.5% 62.5% 60.2% 61.3%
Staff cost 3.0% 2.7% 3.5% 3.3%
Other expenditure 30.4% 32.0% 30.8% 32.1%
Total expenditure 94.0% 97.1% 94.5% 96.7%

Segment snapshot: The company's detergent's and cleansers segment grew by 15% during the June quarter and by 21% during the first half of the year. But as mentioned earlier, PBIT margins shrunk by two third to 1.4% for this segment. Henkel's cosmetics division too witnessed nearly 20% growth (during the quarter, as well as the first half), but again margin pressure took a toll on profitability. Margo grew by 9% and Fa soaps and Deodorants grew by 13%, higher than the market growth. The company has launched a new brand, Chek Beauty toilet soap, catering to the economy price segment. This too is likely to aid the company's growth going forward.

(Rs m) 2QCY03 2QCY04 Change 1HCY03 1HCY04 Change
Segment Revenues            
Detergents & Cleansers 538 619 15.0% 1,026 1,243 21.1%
PBIT margin 4.3% 1.4%   3.6% 1.8%  
Cosmetics 344 410 19.3% 595 718 20.5%
PBIT margin 4.2% 1.5%   3.6% 1.8%  
Total Revenues 882 1029 16.6% 1,622 1,961 20.9%
Total PBIT margin (%) 4.3% 1.4%   3.6% 1.8%  

Over the last four quarters
Henkel had reported nearly 5% topline growth in 2003. The performance was enthusing as compared to 2002, where it grew by only 1%. The company's topline really began to grow from June quarter of 2003. It gathered steam in the December quarter clocking over 11% growth for the first time in many quarters. Cosmetics (which form nearly 37% of revenues) led this growth trend. Since then, Henkel has not looked back, atleast in terms of revenue growth (see table). The improvement seems to have come on the back of the company widening its distribution to the non-south markets.

3QCY03 4QCY03 1QCY04 2QCY04
Sales growth (YoY) 6.8% 11.1% 26.0% 16.6%
OPM (%) 4.5% 5.4% 3.8% 2.9%
Net profit growth (YoY) -26.4% 44.3% 17.3% -50.0%

Our view
HLL and P&G's price competition in detergents, shampoos and impending competition in the oral care market, indicates a daunting times in the short term for Henkel in terms of profitability. But the company can very well utilise this pressure to increase its share in these categories over the long term.

At Rs 17, the stock trades at a P/E of over 70x and market cap. to sales of 0.5x. The company has done well in 2004 so far in terms of growth. But profitability concerns are likely to haunt the company till price competition stays. In our view, anyone who invests in this company has to be patient and should do so with a 3 to 5 year perspective. Having said that, considering the intensity of competition, the small size and a weaker balance sheet, the risk profile of the stock is significantly higher as compared to its peers.

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