Sailing past its platinum jubilee, Hindustan Unilever (HUL) is suffering an acute 'mid- life' crisis of sorts
An attempt at re-invention
The lodestar and well heeled FMCG behemoth of yesteryears, which browbeat all competition into submission, is now desperately trying to reinvent itself. As a corporate entity Hindustan Unilever is 77 years young today. But that is not the only story behind the story. During the reign of Keki Dadiseth the company was in the market to acquire brands, while the rule of Susim Mukul Datta saw the mergers game in full flow. Fair enough. Given the inputs required to grow a grassroots brand, it made sense to acquire an established brand. But, following the plethora of brands that it collared over years of acquisitions, and through group company amalgamations, it became 'obese' and 'wanting' in the process, given the very size of the task on hand. (Between 1992 and 2009 there were in all 14 mergers with HUL, four demergers from HUL (in hindsight), and five inter-se mergers between group companies which then merged with Lever. These mergers were 'reportedly' bulldozed through at the express instance of the holding company Unilever). The warts are now flowering out of the woodwork. It has been beaten to the draw by brash homegrown regional upstarts, who have much lower input costs, and by direct marketing companies hawking international brands. They now cock a snook at this former bellwether stock. FMCG companies by and large, despite their branding do not attract much brand loyalty).
For sure the company is still a behemoth in sales generation, clocking gross revenues of Rs 203 bn for the 12 months ended March 2011. For comparison purposes it posted revenues of Rs 117 bn in the year 2001.That is a growth of 73% in nine years, over the base year. But it was not all smooth sailing in the intervening period. Between 2001 and 2005 it barely recorded any increase in revenues. As a matter of fact gross revenues jockeyed up and down during this period. But the more interesting development is in the profitability segment. Profit before tax (PBT) in 2001 was Rs 19.4 bn. It then took a bizarre path over the next eight years before recording a PBT of Rs 27 bn in 2009-10. The PBT in 2010-11 was almost stagnant at the level of the preceding year. The message that it is sending out is crystal clear - it is still unable to get more bang for the buck. The share price most definitely is generating less value - the year end closing price of the share at the BSE in 2001 was Rs 224. In March 2011 it closed at Rs 285. In between, it was a little more than on a tipsy path.
A mean trick or two
About the only interesting development in the intervening period was that the paid up equity capital dropped from Rs 2.2 bn in 2001 to Rs 2.1 bn in 2010-11. The company is desperately engineering buy backs of its outstanding permanent capital as a way to keep its stock price from faltering too much. The bonus here is that the foreign principals, Unilever plc, got to increase its hold in the voting stock, (and by using the cash resources of the sibling), albeit in a very insignificant way, and at no cost to them. This is a mean trick that companies are resorting to increasingly, to raise the holding of the principal shareholders.
Whatever, Mr. Harish Manvani, in his chairman's letter to the shareholders commences his missive by saying that 2010-11 has been an eventful and satisfying year for the business. Eventful it most definitely was, but satisfying? The company strengthened its position in a tough and competitive environment he adds. Sure as hell the environment is tough, but did it really strengthen its position? To the company's credit though, inspite of the tough going, it is still able to sell cash down, and gets to corral suppliers into extending dollops of credit for what it purchases. In the process it is able to save large sums of money as working capital interest. Even better still, the provision for bad and doubtful debts on trade debts is a mere flea bite. (It may be loading some of the burden on to its stockists).
Expenses growing faster than growth in sales
But the re-engineering that the company is now putting into its operations, which the management has extolled at length in the directors' report, is yet to impact positively on the company's financial wellbeing. Net sales grew 10.7% to Rs 194 bn, while other income leaped 67% to Rs 5.9 bn . But operating expenses grew 13.7% to Rs 170 bn. After a nominal increase in depreciation, the pre-tax profit was stagnant at Rs 27.3 bn. (Being debt free there is no charge under interest paid account). The saving grace in the maintenance of pre-tax profit was the 67% growth in 'other income' to Rs 5.9 bn. The other income accounted for 22% of pre-tax profit against a much lower 13% previously. The company achieved this growth in other income due to the deft management of its treasury securities, the deployment of excess cash that it generated from operations and the luck of the draw in forex transactions. Or what in bankers' lingo is referred to as making the funds 'sweat'.
The company slices up its revenue generation under several heads. Going by the segment results the top of the pops is still 'Soaps and Detergents' which bring in almost 45% of the rupee top-line. Next in the pecking order is Personal Products with a 30% share. This is followed by beverages with a 12% contribution. Bringing up the rear end are Exports, Foods, Ice Creams and Others. Helping generate these revenues is 'Outsourcing' which is big business. Going by the statistics, and on a rough basis, bought out goods for sale account for almost 50% (56% previously) of volume sales of Personal Products. (The purchase cost per unit of Personal Products was incidentally sharply higher). The contribution of outsourcing in Soaps is 10%, in Synthetic Detergents 34% (33% previously) and in 'Others' 37%. The value addition on sales from outsourcing is not readily available, but could be considerable given the company's overdependence on outsourced sales. Whether third party processing is a part of this outsourcing, or is a separate category by itself, is not known. The point is that given this anomaly, it is difficult to make any comparison between the installed capacities of the different products that it can make, and what it produces.
The seven business heads
The seven business heads contribute varying amounts to the cash flow. At the top of the heap is Personal Products which brings in a considerable slice of the total net cash flow. According to the segment results it contributed some 55% of operating profit. In rupee terms that amounts to close to Rs 15 bn or a margin of 25.6% on sales. Next in descending order is the 'Beverages' business with a margin of 15.3% on sales. The biggest business - soaps and detergents gave a margin of only 9.5%. The foods business (which also boasts the iconic brand Kissan), and which generated a turnover of Rs 9 bn, appears to be a 'maha' washout or something. It generates a bottom-line of only 129 m or a margin of 1.4% on sales. In an apparent act at resuscitation, the company was recently able to convince Geetu Verma of PepsiCo to join to turn this division around, on the home spun logic that women understand this business better than men. If so, how come it took the company (which prides itself about the quality of its market research prowess) forever to understand this business funda please? Keeping fairly good company is the Ice creams (Kwality Walls) business which generated a margin of 7% and so on. This appears to be another millstone around its neck. Thankfully the export business which also appears to be another low yield activity is not being geared up by too much.
If the company is to really grow, it lies in the management's ability to generate more spunk from its soaps and detergents business. For, this will continue to be its biggest generator of the top-line for years to come, unless it is able to over-accelerate some other business line in the interim. The point is also that the soaps business has the highest segmental assets of Rs 26 bn, or roughly 42% of all segmental assets. Unfortunately there is no immediate magic mantra to right this line of activity. By comparison the personal products business has segmental assets of only Rs 15 bn or 24% of all segmental assets.
Where the shoe pinches
The management's effort at re-invigorating the company also has to be seen in the light of where the shoe pinches. As stated earlier the net sales excluding other income grew 10.7%. (From an analysis of the figures and on a rough basis, though it was able to push volumes in the major divisions, the company was unable to obtain even a sliver of a markup in the price of soaps and synthetic detergents that it realized in the market place. On the contrary it appears that it obtained a lower gross unit price per measure in both these items during the year as compared to the preceding year!). Furthermore, tea price realizations are basically the end product of extraneous global factors, even if you own the plantations. Operating expenses on the other hand grew 13.7%.
A peak at the breakdown of expenses under this schedule shows that the biggest costs increases came both from items where the expenditure was discretionary, and where it was not. For example, advertising costs accelerated by close to 16% at Rs 27.6 bn, while carriage and freight rose almost 21% to Rs 10.4 bn. Both sides of the coin accelerated. But the biggest accelerator, albeit small in terms of quantum of outflow, was royalty - by 70% to Rs 2.7 bn. Packing materials consumed rose almost 23% to Rs 16.6 bn, while purchase of goods rose 23% to Rs 28.2 bn. What the company can do to contain cost increases in such expenses as carriage and freight, and packing materials, is difficult to hazard given the products that it sells, and the markets that it caters to.
The company as would be wont has myriad subsidiaries and one joint venture (with Kimberly Clark) but these are more of a cosmetic nature than of the game changer variety. The only exception here of any significance is Unilever Nepal, its 80% subsidiary. It recorded a turnover of Rs 2.1 bn and pre-tax profit of Rs 768 m. The company declared a dividend of Rs 322m, 80% of which would have accrued to the immediate parent. Very surprisingly enough, Lakme Lever, the renamed company that it acquired from the Tatas, appears to a dead loss proposition (negative reserves in excess of its paid up capital), while Ponds Exports appears to be spluttering along in its own bizarre way.
All in all it looks like a cock and bull situation.
Disclosure: I hold 1,237 shares in Hindustan Unilever
This column Cool Hand Luke is written by Luke Verghese. 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.