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HLL: India shining! - Views on News from Equitymaster
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HLL: India shining!
Oct 31, 2005

Introduction to results
FMCG major, HLL, announced its results for the third quarter ending September 2005 a short while ago. The company has reported an enthusing topline growth during the quarter. However, margin contraction of 150 basis points clubbed with lower extraordinary costs resulted in bottomline lagging topline growth. Taking out the interest burden and extraordinary income for both the quarters, bottomline has grown at 4% YoY. Interest costs reducing drastically is due to redeeming of debentures in CY04, issued to its shareholders.

(Rs m) 3QCY04 3QCY05 Change 9mCY04 9mCY05 Change
Net Sales 24,011 27,315 13.8% 73,261 80,742 10.2%
Expenditure 20,625 23,872 15.7% 63,087 71,407 13.2%
Operating Profit (EBDIT) 3,387 3,444 1.7% 10,175 9,335 -8.2%
Operating Profit Margin (%) 14.1% 12.6%   13.9% 11.6%  
Other Income 857 849 -0.9% 2,273 2,389 5.1%
Interest 341 48 -86.0% 977 149 -84.8%
Depreciation 301 325 7.9% 878 953 8.6%
Profit before Tax & extraordinary income 3,601 3,920 8.9% 10,593 10,622 0.3%
Extraordinary item 419 6 -98.5% 219 (267)  
Tax 776 666 -14.2% 2,175 1,777 -18.3%
Profit after Tax/(Loss) 3,243 3,260 0.5% 8,637 8,579 -0.7%
Net profit margin (%) 13.5% 11.9%   11.8% 10.6%  
Effective tax rate (%) 21.6% 17.0%   20.5% 16.7%  
No. of shares (m) 2201.2 2201.2   2201.2 2201.2  
Earnings per share (Rs)* 5.9 5.9   5.2 5.2  
P/e Ratio (x)         31.0  
*(annualised)            

What is the company’s business?
HLL is India’s largest FMCG company with dominant presence in almost all consumer categories. The company’s turnover at Rs 100 bn is over one third of the total branded/organized FMCG market in India. HLL's brand equity remains unrivalled in India. However, in the last couple of years, the company has embarked 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 the initiatives had begun to show in the form of better margins. But 2004 saw competition in its key business of soaps and detergents (45% of revenues), taking a huge toll on margins.

What has driven performance in 3QCY05?
Topline growth no longer a concern: Yet again, the Home and Personal Care (HPC) segment displayed good growth (16% YoY) during the quarter, backed by growth across categories, especially in laundry and hair. Laundry, despite being extremely competitive, recorded strong sales along with market share gains. Also, Lux and Lifebuoy led the gains in the soap’s category. Fair and lovely continued to show double-digit growth during the quarter. Also, it must be noted that HLL had recently launched Lipton Iced Tea in bottled form, which received a good response. Ice cream sales grew by 11% during the quarter, due to new product launches. Growth in processed foods (33% YoY) was possible due to gains from ketchup, jams and soups. In the shampoo category the company launched new products under the Sunsilk and Clinic brands during the quarter. Further, the quarter saw the launch of Brooke Bond Red Label Naturals and the relaunch of Annapurna Salt and Atta with a superior mix.

Segment revenue snapshot
(Rs m) 3QCY04 3QCY05 Change
Soaps and Detergents 11,131 12,429 11.7%
Personal Products 5,853 7,291 24.6%
Beverages 2,914 3,240 11.2%
Processed Foods total 611 815 33.3%
Ice Creams 207 230 11.2%
Exports 2,957 2,731 -7.6%
Others (includes Chemicals, Agri, Plantations etc) 654 894 36.7%
Total Segment Revenue 24,327 27,629 13.6%
Less : Inter segment revenue 47 29 -37.9%
Net Segment Revenue 24,281 27,600 13.7%

Margin woes resurface: HLL's margins had seen a consistent uptrend since 1998. The company's restructuring efforts were focused totally on right sizing its brand folio and on profitability. At the start of 2004, the HLL management had indicated that the company had attained the desired level of profitability and would now like to concentrate on topline growth. But price war in its key businesses of soaps and detergents, initiated by rival P&G, took a toll on this strategy.

Post 2004, it was expected that there would be some semblance of order in profitability. During the quarter under review, margins contracted by 150 basis points due to high investments behind brands and brand building along with cost pressures on raw materials. Although, a part of this price increase could be offset by the company’s cost savings programme, some of it had to be borne by the company. Also, advertising expenditure was higher, which indicates increasing need to push products due to competition.

Cost break-up>
as % of sales 3QCY04 3QCY05
Cost of goods sold 54.3% 55.3%
Staff Cost 6.3% 6.3%
Advertising & promotion 8.2% 8.8%
Other expenses 17.1% 16.9%
Total expenses 85.9% 87.4%

Lower interest costs aid bottomline: It must be noted that extraordinary income was higher in 3QCY04 due to credit on property disposal, which has resulted in the bottomline growth during 3QCY05 being flat. However, lower interest costs helped offset the losses here, which was owing to the company redeeming the Rs 13.2 bn worth of debentures that were issued to shareholders in mid-2003. Had this not been the case, then bottomline growth would have registered a negative growth.

The big picture…
  contribution to
sales (%)
Revenue
growth
PBIT
growth
PBIT
margin (%)
PBIT margin (decline)
/gain (basis points)
Soaps and Detergents 45.8% 11.7% 4.9% 13.9% (89)
Personal Products 24.1% 24.6% 10.6% 29.6% (374)
Beverages 12.0% 11.2% -3.1% 17.5% (258)
Foods (includes Oils and Fats,
Culinary and Branded Staples )
2.5% 33.3% -52.4% -7.6% 1,365
Ice Creams 0.8% 11.2% 0.0% 11.4% 1,334
Exports 12.2% -7.6% -48.6% 0.7% (58)
Others (includes Chemicals,
Agri, Plantations etc)
2.7% 36.7% 0.0% -9.5% (611)

Over the past few quarters…

  3QCY04 4QCY04 1QCY05 2QCY05 3QCY04
Sales growth (YoY) -3.3% 0.7% 6.5% 10.3% 13.8%
Advertising as a % of sales 9.6% 8.1% 8.3% 10.1% 8.8%
EBDITA margin % 14.1% 16.1% 9.7% 12.2% 12.6%
Net profit growth (YoY) -26.7% -32.6% -15.1% 15.2% 0.5%

As can be seen from the table above, the current quarter recorded the highest sales growth over the last few quarters. But at the same time, margin pressure continues to suppress bottomline growth.

What to expect?
At Rs 173, the stock trades at 21 times our estimated CY07 earnings and price to sales of 3.2 times. As far as our full year CY05 estimates are concerned, we had projected a much lower growth in revenues, but an increase in profits. The management has indicated in the past its focus on maintaining market share, even if it comes at the cost of margins. With crude prices showing little signs of easing in the near term, this pressure on profitability could be here to stay.

We have been indicating in the past that HLL is in for tough times in the near term. We foresee the company taking radical steps to improve its performance, but these will be visible over the next 1-2 years. In our view, based on the current situation, investors are better off buying other smaller and growing companies in the FMCG space like Dabur and Essel Propack.

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