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Philips: Growth lies in volumes

Nov 29, 2000

Philips NV has raised its stake in Philips India, its Indian subsidiary, to 74% through an open offer. Despite having strong brands and commitment from the parent company, the performance of the company has been erratic. Philips has posted a net loss of Rs 2 m in 3QFY01 compared to a net profit of Rs 41 m in 3QFY00. Operating margins have dropped to 3.3% in 3QFY01 (5% in 3QFY00). The drop in net profit would have been higher but for lower interest and depreciation costs. The restructuring exercise initiated by the company before two years have also started to pay back in terms of lower expenses, down 3% (primarily due to pruning of workforce). If we consider the performance of the company for the first three quarters of the current year, the company has reported a net loss of Rs 156 m compared to a profit of Rs 97 m last year.

Lower volumes drag bottomline…
(Rs m) 3QFY00 3QFY01 change
Sales 4,258 4,051 -4.9%
Other Income 3 3 0.0%
Expenditure 4,048 3,919 -3.2%
Operating Profit (EBDIT) 210 132 -37.1%
Operating Profit Margin 4.9% 3.3%  
Interest 84 58 -31.0%
Depreciation 88 73 -17.0%
Profit before Tax 41 4 -90.2%
Tax - 6  
Profit after Tax/(Loss) 41 (2) -104.9%
Net profit margin (%) 1.0% 0.0%  
No. of shares (m) 45.5 45.5  
EPS (Rs)* 3.6 - 0.2  

So, where exactly is the problem? Typically in the consumer electronic industry, volumes are critical for growth. The basic underlying factor behind these disappointing results has been lower volume growth. Infact, volume growth has been consistently falling for the last two years (7% in FY98 to 4% in FY99). Operating margins, however, have been on the uptrend from 3% in FY97 to 6% in FY99.

One major drag for Philips India is its consumer electronics business. For instance, volumes have dropped by 5% and 9% in television and music systems respectively in FY99. Prospects in the consumer electronics business do not look promising either. Stiff competition and fear of dumping from China are expected to pressurize sales and realisations in coming years.

Sales mix
Sales mix FY97 FY98 FY99
Lamps 21.0% 22.1% 25.2%
Television 24.0% 22.5% 25.1%
CDs, Tapes etc 19.4% 18.3% 16.2%
Fittings 9.4% 9.4% 9.9%
Domestic appliance 5.0% 4.4% 5.4%
Total 78.8% 76.7% 81.8%

However, Philips is the market leader in the lightning business. Apart from retail sales, it also supplies to automobile companies like Telco. This division has shown impressive sales as well realisation growth in the last two years. We believe that the company has an edge over its competitors since it manufactures glass shelves in-house, which is one of the main components for the lightning division. This is one of the reasons why the lightning division has operating margins of 10%, which is higher than its peers.

Meanwhile, the parent company has increased its stake in the Indian subsidiary from 51% to 74% through an open offer. This is expected to increase the operational efficiency of the company primarily due to the fact that the parent company will have a greater control over the Indian subsidiary. However, a lot needs to be done for the company to emerge as the market leader. Will Philips be able to pull this off remains to be seen?

The stock is currently trading at Rs 93 at a P/E multiple of 15x the FY99 earnings.

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