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GSK Consumer: Health drinks are in the driver's seat - Outside View by Luke Verghese
 
 
GSK Consumer: Health drinks are in the driver's seat


A muted golden jubilee

From the manner in which GSK Consumer Healthcare has decided to celebrate the golden jubilee of its presence in India, it is very clear that the management has affected a sea change in how the company will reward shareholders. The issue of bonus shares has been mothballed in favour of a bumper dividend payout instead. (The company has not issued free shares in the last decade for sure). The percentage dividend payout rocketed to 500% from 180% paid previously. The dividend outflow in turn increased dramatically to Rs 2.5 bn from Rs 886 m. The paid up equity is a mere Rs 420 m (Rs 10 face value), while the reserves and surplus was a phenomenal Rs 9.2 bn. It may be noted that the turnover at Rs 24.3 bn is totally out of sync with the paid up equity. The company has also had a glorious past. Following the buyback and extinguishment of 3.3 m shares in 2005, the present paid up equity is made up entirely of bonus shares. Coming to think of it, by not issuing bonus shares, it in turn leads to a freezing of the floating stock, and with increased investor interest it has the effect of driving up the share price.

The company generated a turnover of Rs 578 per share, or put differently, the turnover was roughly 58 times the paid up equity. This is truly anomalous. But these are mere academic deductions and it is ultimately up to the management to do what it thinks is in the best interest of the shareholders. It will however help if the foreign promoters who control 43% of the outstanding voting stock through Horlicks Ltd made its stand on the subject matter clear. Though Horlicks holds the foreign stake, Horlicks in turn is a subsidiary of GlaxoSmithKline Plc UK. It may be noted here that like all multinational promoter groups there are layers and layers of subsidiaries and fellow subsidiaries within this group too. (This tendency is very perplexing and barring the ability to befuddle and confuse, what other earthly purpose is served here?). This is quite evident from the way the parent accounts for the tithes that the Indian affiliate pays to it. Though the dividend income is recognised by the immediate parent Horlicks Ltd, the royalty (Rs 818 m against Rs 704 m previously) that is paid is accounted for by GlaxoSmithKline Asia Pvt Ltd. The royalty is being paid for the right to use the brand, what? So who owns the brand rights?

Sailing on the high seas

The company continues to sail on the high seas and that too with a smidgeon of a product portfolio. There is the mother Horlicks brand with every conceivable brand extension, and proudly displayed on the inside front cover of the annual report. Then there is Maltova, Boost, and Viva - which are displayed on the back inside cover. There are also some other minor brands. Net rupee turnover grew 20% to Rs 23 bn, with the other income component ratchetting up at an accelerated clip of 32% to Rs 1.2 bn. The other income is a significant contributor to the pre-tax profit (26% vs. 25%) in both years. The schedule of other income includes two large receipts which are not easy to decipher. But more on these receipts later). There was a 78% increase to Rs 1.1 bn in the value of purchased goods for resale. With revenue expenditure well under control, the net profit before tax rose 28% to Rs 4.5 bn. With the provision for tax well under control, the net profit grew 29% to Rs 3 bn.

What is most interesting to note in the revenue expenditure schedule is that the company is spending top dollar to sustain its brands on the one hand, and to keep competition at bay on the other. Expenditure under advertising and promotions accelerated 23% to Rs 3.7 bn during the financial year 2010. Okay, some of this spending may have gone towards promoting the launch of new products such as biscuits, foodles (noodles), and its isotonic sports drink (containing salt and sugar). As is the case with all marketing companies, this is also by far the largest item of expenditure. The company also has a tight grip on the market for what it sells. It literally sells cash down on the one hand, and on the other, it is able to extract large dollops of trade credit for what it buys, which implies that the cash just rolls in. The total cash and bank balances at year end were close to Rs 10 bn. As can well be imagined the company has been totally debt free in the last decade, barring the year 2001 when it had marginal borrowings.

The products that power the top-line

New product launches or not, it is the bread and butter items that continue to rule the roost. The item classifies as malt based food/cereal based beverage/protein rich food accounted for 94% of the gross rupee turnover (95% previously), while biscuits, snack foods and such like brought in a miniscule 5.5% (4.4%). Volume turnover of the former rose 13% to 18.3 m dozens against 16.1 m dozen previously. Not surprisingly - and given the spurt in the value of items purchased for resale, the volume sales of biscuits etc rose considerably faster (40%) to 17.5 m dozens from 12.5 m dozens previously. But this volume increase has scarcely translated into any addition to the rupee value chain. The latter classification of items is entirely bought out for sale. Strictly going on the basis of purchase/resale of items bought for resale, the company made a much lower gross margin on the transaction in 2010, than in the preceding year. In 2009 the average purchase cost was Rs 52.7 per dozen, against an average sale price of Rs 71.5 per dozen. In 2010 the corresponding figures were Rs 65.2 and Rs 77.2 respectively.

In tandem with the increased production and revenue generation, the exports too went in the northerly direction. Export of goods increased to Rs 1.8 bn from Rs 1.6 bn previously. But in line with the ‘diktat’ imposed by the parent, the company can only export to a narrow swath of nations. The vast bulk of the exports (51%) were affected to GlaxoSmithKline Consumer Healthcare affiliates in Sri Lanka and Bangladesh - though the directors’ report states that the exports were also affected to Malaysia, Myanmar, Middle East, Nepal and Bhutan. Some beginning has been made during 2010 by exporting to Nigeria and Kenya. The notes to the accounts also states that it has made consignment sales to the extent of Rs 3.7 bn to two fellow subsidiaries - GlaxoSmithKline Asia Pvt. Ltd and GlaxoSmithKline Pharmaceuticals Ltd. Whether these sales are to the domestic tariff area, or whether they rank as export sales, is not coming out clearly. And, besides, what was the pressing need to book consignment sales through its fellow subsidiaries? And what consignment sales are these? As a matter of fact the company has got three way sweetheart deals going with these two fellow subsidiaries. At year end there are balances due to the company from them, and balances due by the company to them, and separately, there is the Business Service Auxiliary Commission that it received from them and is reflected in the other income schedule.

The other income schedule has a receipt for Rs 544 m (Rs 467 m previously) being Business Auxiliary Service Commission. Such commissions are earned as a result of marketing of goods or on account of sale of goods provided by or belonging to the client. Separately there is another receipt of Rs 80 m (Rs 90 m previously) being ‘release of accruals’. Could the company be a little more specific please? It also booked a profit on sales of fixed assets during the year of Rs 27 m. It sold a variety of fixed assets with a historical value of Rs 100 m for Rs 127 m, realising the profit.

Expanding capacity in the wake of idle capacity

Whatever may be the several incongruities that the accounts reveal, the company is going full steam in ramping up capacity. The directors’ report states that the company has launched a project to enhance capacity, which is expected to be completed by 2012. This will increase the capacity at Sonepat plant by 16,000-18,000 tonnes per annum and service the increased demand for the company’s products. (This additional bit of information is a study in opaqueness, and presumably means that the capacity to make malted foods is being ramped up.) This project is expected to cost Rs 2.2 bn, of which the company has spent Rs 680 m till end December 2010. The problem of course is that one has no idea what the present capacity of the Sonepat plant is. What is more, the installed capacity and the production are shown in metric tonnes, while the volume sales figure is shown in dozens. So no comparisons are ‘willy-nilly’ possible. What we do know for the present is that the installed capacity to make Malt based foods has grown from 103,600 tonnes to 109,200 tonnes over the year. But still, why the company is implementing a capacity expansion at the present juncture is a moot question, considering the large idle capacity on hand. The production of malt based foods was a mere 35% of installed capacity in either year, and that of protein rich foods at 54% of capacity.

Disclosure: Please note that I hold 94 shares in Glaxosmithkline Consumer Healthcare

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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