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P&G: The last supper… - Views on News from Equitymaster
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P&G: The last supper…
Oct 25, 2005

Performance Summary
Procter and Gamble Health and Hygiene (PGHH) announced its first quarter results (June ending company) late yesterday. The company reported an enthusing topline growth during the quarter. However, bottomline growth was negative, mainly due to a higher base in 1QFY05, due to an extraordinary income to the tune of Rs 64 m received in that quarter. Royalty fees of Rs 56 m were also paid by PGHH this quarter, which was absent in 1QFY05. Excluding these anomalies, bottomline has grown at a decent 23% YoY.

(Rs m) 1QFY05 1QFY06 Change
Net Sales 1,421 1,917 34.9%
Expenditure 1,054 1,581 50.0%
Operating Profit (EBDITA) 367 336 -8.3%
Operating Profit margin (%) 25.8% 17.5%  
Other Income 34 43 28.8%
Interest - 0  
Depreciation 26 27 4.7%
Profit before Tax 375 353 -6.0%
Tax 143 94 -34.1%
Exceptional items 64 -  
Profit after Tax/(Loss) 296 258 -12.8%
Net profit margin (%) 20.8% 13.5%  
No. of Shares (m) 32.5 32.5  
Diluted Earnings per share (Rs)*   31.8  
P/E Ratio (x)   25.1  

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. It must be noted that 1QFY06 was the last quarter in which PGHH carried out contract manufacturing for its parent’s wholly owned subsidiaries, as the detergents plant has been transferred to the unlisted entity effective 1st October 2005.

What has driven performance in 1QFY06?
Decent show from core business: The company’s key business products, comprising of Vicks and Whisper, grew by 7% and 39% respectively during the quarter. Vicks 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. Growth from this segment was backed by the launch of Vicks honey cough drops and upsizing of Vicks action 500 medicine.

Whisper’s value market share stood at 49%, led by tripling in sales of Whisper choice and double digit growth of its key brands Whisper ultra and maxi. Overall, non-core businesses (contract manufacturing, now sold off) recorded a 62% YoY growth, while core business a slower 19% YoY growth. But one must remember that the anti-cold category is a seasonal business. However, the only negation during the quarter was the revenue mix, which was more skewed towards contract manufacturing, a business that will not exist in the future.

Segment snapshot
(Rs m) 1QFY05 1QFY06 Change
Health & Hygiene Products 902 1,074 19.1%
PBIT margin (%) 35.6% 25.3%  
% of revenues 63.5% 56.0%  
Contract Manufacturing 519 843 62.4%
PBIT margin (%) 4.1% 5.5%  
% of revenues 36.5% 44.0%  
Total revenues 1,421 1,917 34.9%
PBIT margin (%) 24.1% 16.6%  

Contract manufacturing continues to steal the show: 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 62% growth in revenues during the quarter under review. 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 44% of the company’s revenues in the year (37% in 1QFY05). 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 1QFY05 1QFY06
Consumption of raw and packaging materials 43.9% 46.9%
Purchase of trading material 1.7% 1.7%
Staff costs 6.9% 6.1%
Advertising expenses 8.4% 7.6%
Royalty expenses - 2.9%
Others 13.3% 17.3%
Total expenditure 74.2% 82.5%

Margin woos continue: As can be seen from the table above, raw material cost and other expenditure have increased drastically during the quarter, owing to high crude prices. Contract manufacturing, the margins for which have historically been around 4.5% to 5%, stood at 5.5% during the quarter. Overall operating margins were also adversely affected owing to the payment of royalty expenses to the parent for its core portfolio, which was absent in 1QFY05.

Over the last few quarters…
  1QFY05 2QFY05 3QFY05 4QFY05 1QFY06
Sales growth (YoY) 10.6% 18.8% 25.6% 19.6% 34.9%
Advertising as a % of sales 8.4% 6.7% 9.8% 8.1% 7.6%
Health & Hygiene growth % -2.9% 6.1% 16.9% 14.5% 19.1%
Contract manufacturing growth % 45.8% 47.9% 38.1% 26.1% 62.4%
Net profit growth % 34.3% 6.7% -19.1% 202.8% -12.8%

What to expect?
At the current price of Rs 800, the stock trades at a price to earnings multiple of 25 times our FY07 estimated earnings and market cap. to sales of 3.1 times. Investors need to consider that over 85% 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

Going forward, in the absence of the contract manufacturing business, 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) now available 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 3% on its core business revenues, which will eat into margins.

We had recommended a ‘buy’ on P&G Hygiene in November 2003 with a target price of Rs 630. The stock has breached that target earlier. At the current juncture, in our view, the stock must 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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