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HLL: Research meet note
Aug 24, 2005

We recently met with the management of HLL to get a feel of how the overall FMCG market is likely to pan out going forward and how is the company geared to take advantage of the same. We got some useful insights, which have been put down in this article. What is the company’s business?
HLL is India’s largest FMCG company with a dominant presence in almost all consumer product categories. The company’s turnover at Rs 100 bn is over 1/3rd of the total branded/organized FMCG market in India. HLL's brand equity remains unrivalled in India. However, considering that the company had faced severe pressure on margins 2002 onwards owing to increased competition, the last couple of years saw the company embark 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 these initiatives had begun to reflect in the form of improving margins. But 2004 saw competition in its key business of soaps and detergents (45% of revenues), taking a huge toll on margins, which has continued as yet.

Margins: how does the picture look now?
It was well known that there was a time when HLL would run after margins and it mattered the most to the company. But everything changed one fine day when P&G nearly halved the prices of its detergents, forcing the major to follow suit, which directly affected its bottomline. This was because, detergents along with shampoos account for close to 45% of the company’s sales. Thus, things have changed and the company’s target is now to protect/capture market share even if it means at the cost of margins. Though it seems that the company is on course towards achieving higher margins, the current inflationary environment will add to the company’s input costs, thereby negating some of those cost saving gains. Rising crude prices continues to be a cause of concern.

Although the FMCG sector is on the path to revival, which is already visible, smaller companies continue to give the larger companies a run for their money, as companies like HLL do not have products at the lower end of the pyramid for the mass market. All it has for that stratum of society are sachets that are priced cheaper e.g. a 50 p sachet of Clinic shampoo. Sachets account for 70% of the companys shampoo revenues, while 30% come from bottles.

Gross margins for its flagship products Lux, Lifebuoy and Breeze are around 30%, 20% and 10% respectively. The company recently re-launched its Lux brand, but it has yet to deliver as volume sales are still recovering. As far as the foods division is concerned, margins are low owing to high competition in this category. Further, considering that the company needs an advertising budget to promote its food products, it has been forced in the recent past to go back to the drawing board to get its balancing right and prevent earning negative returns in this division.

Growth: Anything exciting?
It must be recollected that the FMCG sector barely grew by 2% CAGR in the early few years of this century, and the main reason for this could be attributed to the availability of easy loans. Surprising but true! People were buying houses and cars from their future earnings and hence wanted to curtail their current spending and FMCG and food items (which forms the largest chunk of consumer spending) were the only area’s they realised that could make up for their expenses overhang.

The per capita income in India is US$ 550, as compared at China’s US$ 1,050. However, growth in the FMCG sector is thrice that of India, indicating huge potential for growth. The Chinese market is growing at around 9% per annum.

HLL reported enthusing results for the June quarter, with growth arising mainly from personal products and beverages. It must be noted that this growth was the highest since the past 5 quarters. Though the company continues to consolidate its market share in key categories, the visibility of value growth has just started. The company increased prices of its key brands by about 5%-7%, indicating that pricing power has come back. The presumption for long-term growth scenario continues to be linked to the GDP growth trend going forward. For example, over 60% of the company’s detergent volumes come from the low priced category offering (Wheel) but it contributes only 40% in value terms. In effect, there exists a scope for these users to upgrade to higher price point offerings, but for that to occur, the economic growth momentum should sustain over the long term.

New businesses
The company recently forayed into the water purifying space, by launching ‘Pureit’. Currently it has been launched only in Chennai and it will be some time (around 18 months) before it is available across the country.

Rural Markets
12.2% of the world population lives in the villages of India, which makes a market that no one can overlook. However, penetration levels are currently low as venturing into these markets is an expensive affair owing to infrastructure constraints, thus making distribution a barrier. HLL started Project Shakti, which is aimed for the upliftment of women in areas of population below 2,000 people. It was started in 2001 and currently spans over 50,000 villages. These markets are filled with aspirational people, whose levels touch the likes of Lux and Surf. HLL plans to cover 100,000 villages by the end of this calendar year.

However, shopping in these markets is very different from those in the city and it is the male member who goes to shop for everyone in the house. Hence shopkeepers play a crucial role here as they push those products where they earn higher margins.

Our conclusion
HLL is getting back its competition edge as it now has a well-focused portfolio, which has promising value in the long-term. The company’s investment phase is over and during the glut period (2001-04), the company has improved quality of its products and hence does not need to spend on that front. However, supply chain is currently in the investment phase and will improve efficiencies in time to come.

At the current price of Rs 165, the stock trades at a price to multiple of 34.4 times its annualised 1HCY04 earnings and market cap to sales of 3.4x. In our view, the stock is likely to underperform the indices, owing to continuing competitive pressures and a challenging growth scenario. Based on the current situation, investors are better off buying other smaller and growing companies in the FMCG space.

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