• FEBRUARY 18, 2005

HLL: Where to from here?

Investors are in a quandary over what to do with FMCG major, Hindustan Lever Limited (HLL). Over the years, the HLL stock has seen extremes of investor sentiment, ranging from absolute worship to disgruntlement. In this article, we look at HLL's journey over the past decade and try and get some answers from its history.

About the company
Hindustan Lever is the subsidiary of Unilever Plc., which holds a 53% stake in the company. It 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 FMCG business in India. HLL's brand equity remains unrivalled in India.

The company has a diversified portfolio with products ranging from personal and household care to foods and beverages to specialty chemicals. The company has a commanding market share in most classes it operates, such as toilet soaps, detergents, skincare, hair care, colour cosmetics, etc. It is also the leading player in food products such as packaged tea, coffee, ice cream and other culinary products. The company divested its non-core businesses and has focused on FMCG in recent years. The non- FMCG business now contributes only 8% to its revenues.

Performance over the past 10 years

The company's sales performance in the past 10 years has been quite good. In CY95, the company's sales were Rs 33.7 bn and today (CY04) they stand at Rs 99.3 bn, which translates into a CAGR of 13.0%. Soaps, detergents and household care that contributed 61% to revenues in 1995, now contribute 45% towards it. Personal products, which contributed 12%, now accounts for 25% of revenues. Foods, which formed 7% of sales, now contributes only 3% to sales.

The company's profits have jumped from Rs 2.4 bn in 1995 to Rs 12.0 bn in 2005, a CAGR of 20%. This indicates that profitability has increased and outperformed sales in growth terms when compared over a 10 year period.

Net sales 33,670 99,270 12.8%
Profit after tax 2,392 11,973 19.6%
Net profit Margin 7.1% 12.1%

Now let's look at the company's performance over the last 5 years...

In CY00, the company recorded revenues of Rs 106 bn. However, in CY04 the revenues have shrunk to Rs 99.3 bn, a CAGR decline of -0.6%, as compared to a consistent growth from 1995 to 2001.

Profits in the year 2000 stood at Rs 13.1 bn and are Rs 12.1 bn today (CY04). The company's interest burden increased drastically from Rs 92 m in CY02 to Rs 1,289 m in CY04 due to the issue of debentures to its shareholders.

CY00 CY01 CY02 CY03 CY04
Net sales 106,038 106,676 99,549 101,384 99,270
% growth 4.5% 0.6% -6.7% 1.8% -2.1%
Operating profit 14,641 17,140 19,559 19,767 14,374
Interest 131 77 92 668 1,300
Profit after tax 13,101 16,413 17,557 17,718 11,973

Operating margins
The company saw a consistent up trend in operating margins from 1998 to 2003, but due to increasing competition and the recent price war in the detergent segment, HLL has seen its operating margins decline to 14.5% in CY04, much nearer to margins that were prevalent in CY00.

So, what to make of this....
From the above analysis, we infer that although topline and bottomline have grown consistently at a good rate in the past 10 years, the same cannot be said when the company's past years are compared point to point. Why is that?

During the early 1990's, HLL's pace of growth was peppered with a number of key positives. For one, the FMCG sector in India was growing at a decent 10%-15% per annum. In some categories, the growth was even higher than this. Also, in 1995-96, the company was able to successfully acquire personal care majors' Pond's and Lakme. This acquisition changed the whole profile of the company, from being a pre-dominant soaps and detergents major, to an FMCG behemoth catering to different consumer needs. The company's revenues nearly doubled as a consequence of these acquisitions from Rs 33.6 bn in CY95 to Rs 66.0 bn in CY96. That is why we see the company's personal product contribution rising from 12% of revenues in FY95 to 25% currently.

However, post 1997, the GDP growth slowed down. The FMCG sector key categories like soaps and detergents more or less penetrated the entire populace, and growth slowed. On the other hand, new players, both MNC and domestic started to make their presence felt. This put pressure on HLL to re-think its strategy.

The company's think tank realised that of the 100 plus brands it had, only 40 contributed to around 90% of turnover and 110% to its bottomline. The rest were actually, proving to be a drag on the company's resources and profitability. In a bid to change this, the company initiated a strategy to prune its brand folio to about 40 and divest non-core businesses. The strategy was able to deliver what was desired, i.e., higher profitability. The operating margins of the company improved from 10.8% in 1998 to 19.5% at the end of 2003.

At the start of 2004, the HLL management indicated that the restructuring is complete and desired level of profitability has been achieved. From now on, topline growth was the mantra. However, P&G's strategy of upping its market share by cutting prices of shampoos and detergents to half, forced HLL to follow suit, and margins came back to near 2000 levels, in just one year. So all the toil of last 5 years really became undone.

Where to from here?
Off late, the scenario has been changing and the FMCG sector is on the path to volume recovery. However, despite some price hikes, margins are unlikely to touch the 2003 levels of 19.5% in a hurry. Chasing revenue growth still remains the management motto for 2005.

Among the positives, the company has recently been chosen as a hub for meeting Uniliver's oral care requirements in Philippines The company has also initiated a 10 point programme for cost cutting, which is likely to show its results in the next couple one year. The company has more or less, given its bakery business (Modern Foods) and confectionery (Max) business a quiet burial. 'Atta' is also not on the company's growth radar. This in itself will save profitability for the company. Interest costs are likely to go back to pre-2004 levels. The company has also set up a plant in Himachal Pradesh to avail of tax benefits offered by the state.

At Rs 144 the stock trades at a price to earnings multiple of 26.4 times CY04 earnings and market cap to sales of 3.2 times. Investors need to be wary of the fact that P&G is slated to launch its oral care portfolio in India soon. Also, in urban centers, there is a growing volume of foreign made FMCG goods available, sometimes at much cheaper rates. This indicates that the pricing power of companies especially in relation to soaps and detergents is likely to remain under tremendous pressure. Though rural India can perk up volumes for the company, it continues to remain a long shot, with no clear visibility of when it will commence. In this light, HLL continues to be among our less preferred stocks in the FMCG space in the medium term.

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407