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P&G: Contracting saves the day

Oct 27, 2004

Performance summary
P&G Hygiene and Healthcare (P&G) has reported an 11% growth in September quarter revenues (its first quarter for the current year), and over 34% bottomline growth. Though the revenue performance is encouraging, it pales in comparison to FY04, where the company had clocked over 30% growth during the year. The company earned an exceptional income to the tune of Rs 64 m as profit on sale of fixed assets during the quarter. Excluding this, profits before tax still grew by an encouraging 17% YoY.

(Rs m) 1QFY04 1QFY05 Change FY04 YoY Change
Net sales and licence fees 1,285 1,421 10.6% 5,772 30.5%
Expenditure 979 1,054 7.6% 4,519 28.8%
Operating profit (EBDITA) 306 367 20.1% 1,254 37.1%
EBDITA margin (%) 23.8% 25.8%   21.7%  
Other income 40 34 -14.7% 150 1.5%
Interest 0 0 - 4 -27.3%
Depreciation 25 26 1.6% 128 -1.8%
Profit before Tax 320 375 17.3% 1,272 37.3%
Tax 99 143 44.5% 350 42.2%
Extraordinary income/(expense) - 64 - - -
Profit after tax/(loss) 221 296 34.3% 922 35.5%
Net profit margin (%) 17.2% 20.8%   16.0%  
No. of shares (m) 21.6 32.5   32.5  
Diluted earnings per share (Rs)* 27.2 36.5   28.4  
Price to earnings ratio (x)   13.0      

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

What has driven performance in 1QFY05?
Core blues:  The company's key businesses, anti cold (Vicks range) and feminine care (Whisper) underperformed during the quarter. While this business grew by 18% in FY04 (June ending), it has seen a dip of 3% in the September quarter. The company has attributed this staid performance in core categories to temporary supply constraints during the quarter caused by trucker’s strike and packaging related sourcing issues. As per the company's release, the latest AC Nielsen - ORG data indicates significant pick up in value market share on both Whisper (up 5% YoY) and Vicks (up 10% YoY).

Contract manufacturing supports topline:  The key growth driver for the company's topline continued to be the detergent contract manufacturing business. This division saw a significant 46% growth in revenues. 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. It is safe to conclude from the numbers available that the parent has seen a surge in offtake as a result of these price cuts. P&G too has benefited in terms of higher volume of contract manufacturing. Consequently, the division's contribution to overall revenues has gone up from 28% in 1QFY04 to nearly 37% in 1QFY05.

Segment snapshot
(Rs m) 1QFY04 1QFY05 Change FY04 YoY Change
Health and hygiene products 928 902 -2.9% 3,723 18.0%
% of revenues 72.3% 63.5%   64.5%  
PBIT margin (%) 30.0% 35.6%   28.8%  
Contract manufacturing 356 519 45.8% 2,050 61.4%
% of revenues 27.7% 36.5%   35.5%  
PBIT margin (%) 4.7% 4.1%   5.1%  
Total segment revenue 1,285 1,421 10.6% 5,772 30.5%
Total PBIT margin (%) 23.0% 24.1%   20.4%  

Margin mix:  Though the core business performance was relatively staid on the revenue front, its profitability improved significantly during the quarter. PBIT margins of this business went up by nearly 6% during the quarter, thereby strengthening the company's overall operating profit margins. On the other hand, though contract manufacturing put in a strong revenue performance, the business' PBIT margins dipped marginally to 4.1%. The focus on improving efficiencies, as well as the restructuring of employees has helped the company cut costs as a percentage of sales. In 1QFY05, raw material and packaging costs have seen a significant surge. This seems a result of higher volume of contract manufacturing.

Cost break-up
as a % to sales 1QFY04 1QFY05 FY04
Consumption of raw and packaging material 30.7% 43.9% 40.0%
Purchase of trading material 9.6% 1.7% 5.8%
Staff cost 8.5% 6.9% 6.4%
Advertising expenses 7.6% 8.4% 197.9%
Other expenditure 19.8% 13.3% 17.2%
Total expenditure 76.2% 74.2% 78.3%

Over the last five quarters
The company's topline momentum really came in from the March quarter. This was the period when the parent declared a price war in the detergent segment. Operating margins have remained inconsistent during the past five quarters and have shown signs of pressure, ever since the contract manufacturing business has picked up. The reason being that the margins of this business are very meager at around 5%, as compared to nearly 29% in its health and hygiene business. With detergent prices still ruling low, we believe that contract manufacturing fillip will continue. But that could have a bearing on the margins.

  1QFY04 2QFY04 3QFY04 4QFY04 1QFY05
Sales growth (YoY) 20.6% 18.3% 40.5% 51.4% 10.6%
OPM (%) 23.8% 31.9% 20.3% 9.5% 25.8%
Net profit growth (YoY) 13.0% 11.2% 22.7% N C* 34.3%
*Not comparable

Our view
At the current price of Rs 475, the stock trades at a P/E of 13 times 1QFY05 annualised earnings and market cap. to sales of 2.7x. Investors need to consider that over 90% of P&G's total PBIT comes from its core business. Though contract manufacturing will continue to spearhead topline momentum, focus should be on the company's core operations of health and hygiene. The positive thing is that its core business continues to perform well. With the peak cold season coming up, sales growth for its Vicks range is likely to be stronger than seen in the September quarter. 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.

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