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P&G: High tide!

Sep 8, 2005

Performance Summary
Procter & Gamble Hygiene and Healthcare (PGHH) reported a decent topline growth in 4QFY05 (June ending company) and an enthusing bottomline growth, mainly aided by higher other income to the tune of Rs 300 m, arising from write back of liabilities. If we do not take this one off item into consideration, then profits have actually declined by 34% on a YoY basis. The company closed its books for the year with a mere 2.7% YoY growth in bottomline excluding the write back. The board has declared a dividend of Rs 40 per share including a special one-time dividend of Rs 20. The dividend yield excluding the special dividend works out to 2.4%.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net Sales 1,436 1,717 19.6% 5,772 6,849 18.7%
Expenditure 1,300 1,462 12.5% 4,519 5,515 22.1%
Operating Profit (EBDITA) 136 255 87.1% 1,254 1,334 6.4%
Operating Profit margin (%) 9.5% 14.8%   21.7% 19.5%  
Other Income 60 339 464.5% 150 466 210.2%
Interest - - 4 1 -87.5%
Depreciation 40 48 21.5% 128 124 -3.4%
Profit before Tax 157 546 248.1% 1,272 1,676 31.8%
Tax 30 162 439.3% 350 532 51.9%
Exceptional items - - - 102  
Profit after Tax/(Loss) 127 384 202.8% 922 1,246 35.2%
Net profit margin (%) 8.8% 22.4% - 16.0% 18.2% -
No. of Shares (m) 32.5 32.5 - 32.5 32.5  
Diluted Earnings per share (Rs)* - - - - 38.4 -
P/E Ratio (x) - - - - 21.8 -
*(annualised)            

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 the feminine care segment. The parent has two other 100% subsidiaries in India, which have a dominant shampoo (Pantene, Rejoice) and detergent portfolio. P&G undertakes contract manufacturing for its parent`s detergent portfolio (Ariel, Tide) in India.

In July ‘05, the listed entity, PGHH, sold its detergents manufacturing unit at Mandideep in Madhya Pradesh, to the parent's unlisted subsidiary in India, Procter and Gamble Home Products (PGHP). PGHH carried out contract manufacturing of detergents for PGHP and earned a margin for the same.

What has driven performance in FY05?
Core blues: The company's key business products, Vicks and Whisper, grew by 3% and 14% respectively during the year. Vicks now commands the No. 1 place on the podium, with Vicks Vaporub commanding a 30% share, cough drops 56% and Action 500 a 51% market share. Whisper's value market share stood at 49%. Overall, non-core businesses (contract manufacturing, now sold off) recorded a 38% growth, while core business a slower 8% YoY growth. But one must remember that the anti-cold category is a seasonal business. However, the kicker in this quarter was that of margins of its core portfolio, which stood at a staggering 50%.

Segment snapshot
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Health & Hygiene Products 816 935 14.5% 3,723 4,017 7.9%
PBIT margin (%) 12.4% 50.2%   28.8% 35.0%  
Contract Manufacturing 620 782 26.1% 2,050 2,833 38.2%
PBIT margin (%) 1.4% 6.0%   5.1% 5.0%  
Total revenues 1,436 1,717 19.5% 5,772 6,849 18.7%
PBIT margin (%) 7.6% 30.1%   20.4% 22.6%  

Contract manufacturing lends a helping hand: Support from contract manufacturing continued during the quarter and was the key growth driver for the company`s topline yet again. This division saw a significant 38% growth in revenues during FY05. The parent`s strategy to garner a bigger chunk of the Indian detergent market by slashing product prices to almost half has done wonders for this division. Contract manufacturing accounted for 41% of the company's revenues in the year (36% in FY04). PGHH too has benefited in terms of higher volume of contract manufacturing. However, after the transfer of the detergent plant to P&G's unlisted arm, the listed entity will not enjoy these benefits going forward.

Cost break-up
% of net sales 4QFY04 4QFY05 FY04 FY05
Consumption of raw and packaging materials 54.0% 44.5% 40.0% 45.1%
Purchase of trading material 0.5% 2.6% 5.8% 1.3%
Staff costs 6.0% 5.5% 6.4% 5.5%
Advertising expenses 11.4% 8.1% 8.8% 8.2%
Royalty expenses - 2.8% - 2.6%
Others 18.6% 21.7% 17.2% 17.9%
Total expenditure 90.5% 85.2% 78.3% 80.5%

Margin pressure continues: As can be seen from the table above, margins have improved for the fourth quarter, but for the whole year (FY05), owing to high crude prices, they have reduced by 220 basis points. Also, on the revenue front, the performance of the core business was relatively staid. Contract manufacturing, the margins for which have been between 4.5% to 5% historically, stood at 6% during the quarter. Overall operating margins were also adversely affected owing to the payment of royalty expenses to the parent.

Over the past few quarters…
4QFY04 1QFY05 2QFY05 3QFY05 4QFY05
Sales growth (YoY) 51.4% 10.6% 18.8% 25.6% 19.6%
Advertising as a % of sales 11.4% 8.4% 6.7% 9.8% 8.1%
Health & Hygiene growth % 26.5% -2.9% 6.1% 16.9% 14.5%
Contract manufacturing growth % 104.2% 45.8% 47.9% 38.1% 26.1%
Net profit growth % - 34.3% 6.7% -19.1% 202.8%

What to expect?
At the current price of Rs 837, the stock trades at a price to earnings multiple of 26 times our FY07 estimated earnings and market cap. to sales of 3.2x. Investors need to consider that over 80% of P&G`s total PBIT comes from its core business. We will be updating our research report shortly as the company has sold its detergents manufacturing unit, thus putting brakes on its contract manufacturing process. Now, the focus is on the company`s core operations of health and hygiene. The company has introduced a new variant of Whisper at a lower price point in southern India. This may increase penetration of the product, thereby aiding volume growth.

Going forward, with the contract manufacturing business now out of PGHH, the overall margins of the company would witness an improvement. It must be noted that this business had lower PBIT margins as compared to its core business. Also, the poor per capita consumption for its feminine care folio indicates latent growth potential.

On the flip side, there are many international brands (imports) available now atleast in the key metros that sometimes work out to be cheaper for consumers. In that sense, the space is getting competitive. The parent too has started charging a royalty of around 4.2% on its core business revenues, which will eat into margins.

We had recommended P&G Hygiene in November 2003 as a BUY with a target price of Rs 630. The stock has breached that earlier. At the current juncture, in our view, the stock can be avoided. In short, though P&G may benefit from an uptick in consumption and improved margins, its relatively two-product focus and the parent`s other 100% subsidiaries put it at the bottom of the heap of our valuation matrix. In our view, there are better growth stories available in the FMCG space.

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