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Henkel recast: What's the implication?

Nov 25, 2004

As the small and mid cap rally is picking up, Henkel Spic India is also among the key gainers. The company is the third largest MNC in the detergent space in terms of sales and has recently approved a major restructuring proposal. Let us evaluate the merits of the restructuring and the pitfalls for investors who want to cash in on this opportunity.

(Rs m)3QCY033QCY04Change9mCY039mCY04Change
Gross sales979569-41.9%2,6002,530-2.7%
Other income10-100.0%210350.0%
Expenditure934527-43.6%2,4672,422-1.8%
Operating profit (EBDIT)4543-4.3%133108-19.1%
Operating profit margin (%)4.5%7.5% 5.1%4.3% 
Interest 141832.1%5349-7.0%
Depreciation1716-6.0%4846-2.9%
Profit before tax159-41.8%3522-36.4%
Tax - -   - -  
Profit after tax/(loss)159-41.8%3522-36.4%
Net profit margin (%)1.6%1.6% 1.3%0.9% 
No. of shares (m)116.4116.4 116.4116.4 
Diluted earnings per share (Rs)*0.50.3 0.40.3 
P/E ratio (x)    94.4 
*(annualised)      

Just to give a brief background, the company is a 51% subsidiary of Henkel AG, the Euro 9.4 bn German MNC, and is in the business of manufacturing eco-friendly detergents (zeolite based). Tamilnadu Petroproducts also has a 17% stake in the company. Its key brands are Henko, Brisk (detergents), Limeshot, Pril (cleaning solutions), Fa range of personal care products, Margo, Aramusk (toilet soaps) and Neem (oral care). The company is yet to find sustained profitability in its operations. In the recent months the company has been caught in the tug of price war between its bigger MNC peers.

In most of 2004, detergent prices have nearly halved, owing to the price war between key players HLL and P&G. Henkel was thus, forced to follow suit. Though the move seems to have helped volumes and consequently sales, which grew in double digits, profitability declined considerably in the first six months of 2004. The company's detergent's and cleansers segment grew by 15% during the June quarter and by 21% during the first half of the year. But as mentioned earlier, PBIT margins shrunk by two third to 1.4% for this segment. Henkel's cosmetics division too witnessed nearly 20% growth (during the quarter, as well as the first half).But again, margin pressure took a toll on profitability. Margo grew by 9% and Fa soaps and Deodorants grew by 13%, higher than the market growth. The company launched a new brand, Chek Beauty toilet soap, catering to the economy price segment. This too is likely to aid the company's growth going forward. However, the results were quite different for the September quarter of 2004.

During the September quarter, the company announced a restructuring proposal, which involved a reverse merger of Henkel Spic with its own subsidiary (over 90% stake), Henkel India (formerly known as Calcutta Chemicals). The share capital of the company however, will remain unchanged, as each shareholder of Henkel Spic will get an equal number of shares in the new company - Henkel India. That is not all. Henkel Spic will now be involved only in manufacturing and will sell its products to its subsidiary Henkel Marketing India (formerly known as Detergents India).

Cost break-up
as a % to sales2QCY032QCY041HCY031HCY04
Material cost61.0%59.8%60.5%60.9%
Staff cost3.9%8.1%3.6%4.4%
Other expenditure30.5%24.7%30.7%30.4%
Total expenditure95.5%92.5%94.9%95.7%

In our view, Henkel Spic will cease to exist as it is, and the new listed entity will be 'Henkel India'. This entity will sell its products to its subsidiary - Henkel Marketing and its revenues will depend on the transfer price at which the products are sold to the subsidiary. The parent - Henkel AG will hike its stake in the marketing subsidiary and support it. It will also use Henkel Marketing as a vehicle to market and introduce new products and brands from its global folio. The listed entity - Henkel India will receive a dividend income from Henkel Marketing as its gets profitable and grows.

The important thing to note is that because of this restructuring, the consolidated entity's miscellaneous expenditure which had not been written off (stood at Rs 2.5 bn in December 2003) and its accumulated losses of Rs 551 m will get written off against the company's share premium account (Rs 1.8 bn in December 2003) and also through increasing the goodwill and asset values. Though the later part of the deal is largely a book entry, the aforesaid transactions will clean up the company's balance sheet significantly. Another very significant detail is that in the company's new name 'Spic' is absent. This signifies the German parent's growing interest and pro-active role that it wants to play in the Indian region.

Though the restructuring plan is silent on what will happen to the company's preference equity (Rs 680 m), to what extent the German parent will invest in this recast and what will be Spic's role in the future, the longer term implications are encouraging for the shareholders.

Past few quarters trend
 3QCY034QCY031QCY042QCY043QCY04
Sales growth (YoY)6.8%11.1%26.0%16.6%-41.9%
OPM (%)4.5%5.4%3.8%2.9%7.5%
Net profit growth (YoY)-26.4%44.3%17.3%-50.0%-41.8%

In the short term, HLL and P&G's price competition in detergents, shampoos and impending competition in the oral care market, indicates daunting times for Henkel in terms of profitability. But the company can very well utilise this pressure to increase its share in these categories over the long term. The company has done well in 2004 so far, in terms of growth. But profitability concerns are likely to haunt the company till price competition stays. Nevertheless, Henkel AG's involvement is likely to be a positive in the long run. Having said that, considering the intensity of competition, the small size and a weak balance sheet, the risk profile of the stock is significantly higher as compared to its peers.

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