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Research meeting excerpts: HLL - Views on News from Equitymaster
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Research meeting excerpts: HLL
Nov 30, 2004

We met the HLL management recently to get a feel of what’s happening in the FMCG market and how do they read the situation from here on. We got some useful insights into the company’s prospects, which we now share with you.

What is the company’s business?
Hindustan Lever Limited is India’s largest FMCG company with a dominant presence in almost all consumer categories. The company’s turnover at Rs 100 bn is nearly half of the total branded/organized FMCG business in India. HLL's brand equity remains unrivalled in India. However, in the last couple of years, HLL 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.

Margins: What’s the scene?
As is known, the company’s key businesses of detergents (fabric wash) and shampoos has been facing competitive pressure from P&G. To wade through this margin pressure on its key businesses, the management had some time back indicated that it is looking to cut costs that will have a direct 5% addition to the bottomline over the next couple of years.

Though it seems that the company is on course towards achieving that, the current inflationary environment will add to the company’s input costs, thereby negating some of those cost saving gains. On the personal products side (24% of 9mCY04 revenues), margin pressure is likely to be lesser as compared to the detergents business (around 21% of 9mCY04 revenues).

Growth: What’s cooking?
The management is continuing its focus on volume growth. Key categories like Shampoos saw 40% volume growth during the September quarter. Toothpaste, skin care and personal wash (soaps) have also seen some amount of positive volume growth (though only in lower single digits). The management felt that if this trend continued for another quarter, then probably it might be sustainable.

Though the company continues to consolidate its market share in key categories, the visibility of value growth till date, is daunting. The presumption for long term growth scenario continues to be linked to the GDP growth trend going forward. For example, over 60% of the company’s detergent volumes come from the low priced category offering (Wheel), but only 40% in value terms. In effect, there exists a scope for these users to upgrade to higher price point offerings, but for that to occur, the economic growth momentum should sustain over the long term.

Foods story
The company had bought Modern Foods from the government in a bid to increase its focus towards the bakery segment (breads, biscuits). But after initial improvement on profitability, things are now lacklustre. Modern Foods has lost a government contract to make some nutrient foods. It is also not looking to enter the biscuit segment.

Exports/outsourcing
The exports / outsourcing business of the company is between Rs 7 bn to Rs 8 bn. Though the parent Unilever continues to indicate a bigger share of the outsourcing pie to the Asia Pacific region, our interaction left us with the feeling that this will take some more years to really make a significant impact to the company’s topline. There continues to be internal impediments within the Unilever countries, wherein Unilever Europe region or the US region are showing reluctance to outsource. For example, Unilever Russia has decided to make its own tea bags and not outsource to its Indian or Chinese counterpart.

Though we believe this resistance to outsource eventually will fall by the way side, as competition will force the ‘outsourcing’ benefits to take shape, it is a long term story, as of now.

What to look for?
Based on our interaction, we believe that margin pressure is unlikely to ease over the next few months. Though margins are likely to improve from the current levels, value growth is a tough proposition over the next couple of years.

At Rs 142, the stock trades at 21 times CY06 earnings and market cap to sales of 3x. In our view, the stock is likely to Underperform the indices, owing to the continuing competitive pressure and tough growth scenario. In our view, based on the current situation, investors are better off buying other smaller and growing companies in the FMCG space like Marico.

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