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Glaxosmithkline Consumer: Fortified by brand power - Outside View by Luke Verghese

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Glaxosmithkline Consumer: Fortified by brand power
Jun 21, 2013

There is money to be made in the nutrition business if you have the right brand and be in the right place at the right time

A bellwether stock

In the world of FMCG conglomerates-MNC or desi-this is probably the one bellwether company domiciled in India to beat --and the list includes Colgate Palmolive India. The brief summary of the 10 year track record shows a company in fine fettle. The turnover has risen from Rs 9.1 bn in the base year 2003 to Rs 32.58 bn in 2012 while the profit before tax has risen to Rs 6.5 bn from Rs 996 m in the same period of time. The dividend payout has rocketed from Rs 317 m to Rs 1.9 bn while the percentage dividend upped steadily from 70% to 450% on a steady paid up equity capital of Rs 420 m against Rs 453 m in the base period. (There was redemption of preference shares in the interim I believe).The reserves and surplus did a jig of its own rising from Rs 4.46 bn to Rs 13.19 bn reflecting the rising retained earnings even after the hefty dividend payouts. The company does not appear to have any particular dividend payout policy however. It ranges from a payout of 41.6% in 2003, falling to 33.1% subsequently, touching a high of 70% in 2010 and settling at 43.3% in 2012. Not exactly in line with the way the stock price dallied about.

There was zero debt right through the decade with the gross fixed assets growing from Rs 4.9 bn to Rs 8.53 bn-a rise of 74%. That is to imply that that there was a more efficient use of fixed capital as the years rolled by. In 2003 the gross fixed asset to turnover ratio was 1:1.8. By 2007 the ratio was 1:2.6, and by 2012 the ratio moved up to 1:3.8. But it would also appear on the very face of it that compared to some of the better known FMCG companies; GlaxoSmithKline generates less bang for the buck. Probably its operations are more capital intensive than some of the ‘competition’ in the FMCG segment. (But this ratio calculation is skewed somewhat as the gross block in 2012 also includes capital work in progress of Rs 1.97 bn-it refers to the ongoing expansion scheme in one of the three plants that the company makes do with). It is not known whether the gross block in 2007 and 2003 also includes a similar dose of capital work in progress. I may also add here that the gross block is also inclusive of intangible assets (patents and trademarks) of Rs 664 m at end 2012. The vast bulk of the tangible --and in use gross block -at year end of Rs 5.9 bn is made up of plant and machinery of Rs 3.95 bn, with buildings accounting for another Rs 1.02 bn. That is a lot of money to spend on a roof over ones head. The IT equipment accounts for another Rs 300 m.

Top notch financials

This company is precisely the dream company to which lenders of funds would love to lend moneys to. And one would think about the easiest job for the head of finance. But the problem is that given the company’s charter, probably dictated by the bosses operating out of England, it does not have very many avenues to invest the surplus cash and hence the head of finance has a problem on hand in a very real manner of speaking. The bigger issue is that the company suffers from an embarrassment of lucre at the end of the day. As the cash flow statement points out, the company generated cash of Rs 5.5 bn from operations during the year against Rs 3.9 bn previously. The net purchase of fixed assets during the year was a relatively paltry Rs. 837 m. There were no other extraneous expenses on either revenue of capital account to cater to. So the company resorted to such tricks as investing some of the dosh-Rs 25 bn to be exact-- in short term fixed deposits and then drew out Rs 21.1 bn at some point in time during the year. Such an investment proposition does not call for much use of one grey cells -but let that be. Heck, coming to think of it does the company really need a head of finance to start with?

And to think that the company is able to achieve such superlative results - basically on the strength of just one brand-Horlicks and its many extensions. It also sells Boost, Sensodyne toothpaste, Iodex, Eno salt, and biscuits. But its real strength still appears to come from the first named. It is difficult to get an exact measure of the contribution of Horlicks to overall sales as companies do not have to present the details of volume production and sales-so one shall leave the conclusions to mere conjecture. The company also buys and sells traded goods-such sales brought in revenues of close to Rs 2 bn in 2012 against manufactured sales of Rs 30.6 bn-hence traded sales are still a mere flea bite and not much more. What gross margins the traded sales bring in is inestimable as the company has not provided separate quantitative details that are required to make the margin calculation possible. Then there are two intriguing items appended to the revenue schedule - Business auxiliary service commission and, miscellaneous income amounting in all to Rs 1.08 bn. This has not been properly explained. (The business service auxiliary income however has been received from two fellow subsidiaries to which consignment sales have been effected). It is not known the extent of the relationship of these two revenue streams to the main body of the revenues, but there apparently appears to be a pattern of sorts judging from these streams accruing in the preceding year. Neither is it known if there are any expense items attached to this income accretal. But every little bit to the revenue account adds up I guess.

Leveraging on one brand and its extensions

It is not that it is a cakewalk for the company as it soldiers on. The cost of materials consumed including third party processing costs amounted to 39.7% of net revenues from operations against a marginally higher 40.2% previously. Employee costs rose in line with the percentage increase in net revenues. The other big expense item is ‘Other expenses’ which rose more sharply by 18.2%. The biggest constituent in this expenditure head is ‘advertising and promotion’ which rose only 13.5% to Rs 5 bn. Looked at it another way this cost factor accounted for 15.6% of net revenues against a higher 15.8% previously. Hence there was a slowdown in advertising spends relative to revenue gains during the year. But, again, this is the kind of loot that the company has got to spend to keep the brands ticking in high voltage mode. On the plus side though given the ample surplus funds at its disposal the interest earned on surplus dosh enabled ‘other income’ to account for 17.5% of net pre-tax profit against 15.8% previously. So essentially it is the other income factor and the growth in rupee revenues which help push up the profit figures.

Top notch financials

But far more significant is the message that is coming out of the year end financials. The inventories by value account for a mere 11% of gross revenues from operations suggesting perhaps that the company follows the just in time (JIT) route here. The company sells almost cash down showing the demand for its products on the one hand and the clout that it holds in the market for what it makes and sells. As a matter of fact the trade payables at year end is a much larger figure than the trade receivables-which helps the company save even more on working capital costs. And if one excludes the cash and bank balances from its current assets schedule (since cash is the end product of any business) then the current assets at year end is lower than the current liabilities - a point which the company chortles about in the annual report to the shareholders. This again is a one of a kind performance in the Indian corposphere and places it along with the likes of Bajaj Auto and a few other corporate heavyweights who can flex their biceps. For the matter of record the company boasted a cash lode of Rs 14.6 bn at year- end, up from Rs 10.80 bn previously.

Fortunately for the Indian shareholder the buyback of the shares that it suddenly announced to the surprise of all concerned was not financed from this cash lode. The parent was kind enough for whatever reason to do the honours from its own cash pile and acquire the shareholding of domestic shareholders or such like-plonking down close to a zillion bucks (Rs 52 bn) to increase the stake from 43% to 75%. So the share capital base remains the same, unlike some buybacks where the share capital base also depletes in a buyback. The principal reason for hiking the stake to 75% appears to be the point that passing vital shareholder legislation becomes a lot easier when the company exercise voting right on 3/4 of the paid up equity capital.

The future perfect?

What this forebodes is as yet not known. Like all MNCs the sibling presently has several inter-se deals going with the parent on an ongoing basis. For example it involves paying tithes in the form of royalty to the parent. In 2012 it paid out Rs 1 bn against Rs 930 m previously. The royalty is paid to yet another fellow subsidiary-Glaxo SmithKline Asia Pvt. Ltd. That is for starters. (The holding in the share capital of the Indian sibling is through a pyramid structure. The shares in the sibling are held by Horlicks Ltd the immediate holding company-but the royalty is paid to another fellow subsidiary. Why should this be so? Correctly speaking the royalty should be paid to the holder of the brand. So who holds the brand please?). The other substantive deals in a manner of speaking are sales affected to group companies of finished products and marked as forex earnings. The total forex earnings during 2012 amounted to Rs 1.95 bn against Rs 1.82 bn previously. The export earning emanated from sales effected to Sri Lanka and Bangladesh. There appears to be a strict pecking order as concerns which countries group entities can export to, and besides it is small beer as yet. But there is a larger picture to contend with here. The company has also booked consignment sales valued at Rs 6.23 bn against Rs 4.78 bn previously. Such sales were directed to Glaxo SmithKline Asia Pvt. Ltd, and GlaxoSmithKline Pharma-the latter appears to be the Indian pharma sibling.

The dictionary defines consignment sales as a trading arrangement in which the seller sends goods to the buyer who pays the seller only as and when the goods are sold. The seller remains the owner of the goods till the sales are effected and the monies are paid, and the unsold goods are taken back by the seller after a period of time. For whatever reason these sales especially those made to the Asia Pvt. Ltd fellow subsidiary does not appear to have been recorded as forex earnings. There are other transactions too both on revenue and capital account that are not particularly large in value. The company is also due some moneys from the Kenyan sibling as receivables-but it does not appear to have made any sales to that company during the year. Additionally, the company is shouldered with a disputed income tax liability of Rs 1.32 bn which is now lying with the IT appellate tribunal.

Inter- se group transactions

The royalty payments and the other inter-se deals may well up in the future -though by how much is pure conjecture at this point in time. Presumably such deals will also be to the mutual benefit of the Indian sibling. The dividend policy of the parent too is also uncertain as the equations have undergone a change. But it is safe to aver that the company will continue to tick at the same speed that it is travelling now as the parent ahs to make good the investments that it has just affected. Besides, the plus point in favour of the remaining Indian shareholders is that the floating stock had reduced drastically following the buyback. Thus even small volumes can lead to dramatic spurts -both up and down. Already those shareholders who have not tendered have benefitted from a double whammy. The price increase following the open offer, and, the subsequent further rise following the issue closure.

But inspite of the many questions that will naturally arise, the share looks like a good bet for the immediate future.

Disclosure: I hold 94 shares in the company

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.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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