From THE HINDU group of publications
Sunday, July 22, 2001


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What's sweet and what isn't


Cadbury India: Pare down exposures

Nestle India: Hold

Parrys Confectionery: Hold

Aarati Krishnan

DESPITE the marked slowdown in the confectionery market, the segment's major players have reported a robust improvement in their profitability last year, thanks to low input prices.

But the recent rally in cocoa prices could change this. The July estimates of the cocoa crop suggest that a strong resurgence in Russian and Asian demand could lead to a record deficit in the world cocoa market for the crop year ending in September. This could push cocoa prices, already 40 per cent higher than the December 2000 levels, into a further upward spiral.

Since Cadbury India sources its cocoa requirements through forward purchases, there is likely to be a time lag before the recent surge in cocoa prices makes itself felt on Cadbury's performance. This is likely to happen over the next few quarters and might make it difficult for Cadbury India, which derives around 80 per cent of its turnover from cocoa-based products, to sustain the present financial performance.

Cadbury India holds a 71.9 per cent share of the chocolate market, with Cadbury's Dairy Milk being its largest brand (29 per cent market share). Perk and 5 Star account for another 20 per cent of the market share. While Cadbury's Dairy Milk has continued to exhibit double digit growth in 2001, both Perk and 5 Star have been stagnating. In the absence of new products to drive volume growth, the topline growth for Cadbury could remain sedate in the near term.

While some volume growth in chocolates could come from the recent migration to low unit packs for brands such as Cadbury's Dairy Milk, Perk and 5 Star, it could be difficult to offset the pressure on margins through hikes in selling prices given the slowdown. Other categories such as malted foods and confectionery are growing at a sedate pace. The option of broadbasing the portfolio with products drawn from the parent does exist, but these are likely to absorb substantial promotional outlays in the initial years.

In the first half of fiscal 2001, Cadbury India reported a 12 per cent growth in sales to Rs 268.40 crore, while net profits before exceptional items grew 18.5 per cent to Rs 21.11 crore.

At the current price of Rs 415, the Cadbury India stock trades at a price earnings multiple of around 27 times its earnings for 2000. The valuations appear high in the light of the unsustainability of the recent earnings performance.

Unlike Cadbury India, Nestle India derives its revenues in equal measure from milk products, coffee and other soluble beverages, culinary products and confectionery. Therefore, the company's earnings are less vulnerable to the slowdown in the confectionery market than Cadbury India. The company is also unlikely to feel the impact of the rally in cocoa prices as much as Cadbury India, given that cocoa accounts for a relatively small portion of its raw material costs. However, with both coffee and cocoa prices at very low levels, Nestle India has also benefitted from soft raw material prices in 2000. This makes it difficult for the company to sustain robust earnings growth over the next year.

For 2000, Nestle India reported a 9 per cent sales growth, coming mainly from a healthy export growth of 16 per cent (domestic sales value grew 7 per cent). A recovery in coffee exports to Russia and low green coffee prices helped Nestle peg up business volumes in coffee.

Culinary products registered a mixed performance, with new products such as vermicelli registering a healthy growth, while ketchups and noodles maintained historical growth rates. Weaning cereals and dairy whiteners fared well. The recovery in exports and price increases on chocolates helped Nestle India report a healthy 23 per cent improvement in net profits, even after taking a higher provision for contingencies and impairment of fixed assets.

Given that raw material prices have been at record low levels, there does exist an unsustainable element to Nestle India's performance for 2000. Growth rates for Nestle India now appear to hinge largely on the success of its recent forays into dairy products (UHT milk, liquid milk and curd) and mineral water (under the Pure Life umbrella). Given the bruising competition, at least in the latter, it could take some time for the payoffs to materialise.

In light of these factors, at the current price of Rs 530 (which discounts the company's 2000 earnings by around 40 times), it is among the most expensive stocks in the FMCG universe. This would normally be a good time to pare down exposures to the stock. However, the company recently mooted a proposal to buy back shares, thus shoring up the parent's stake in the Indian company. Investors can wait for the terms of the buyback to be announced and then re-evaluate their options on the stock.

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Meanwhile, a leading player in sugar-boiled confectionery, Parrys Confectionery has been going through a rough patch over the past couple of years. Sales revenues fell from Rs 155 crore in 1997-98 to Rs 106 crore in 1999-2000, while the company slipped into losses of Rs 16.58 crore at the net level from profits of Rs 9.22 crore.

The company appears to have been caught unawares in 1999 by the aggressive competition on the distribution front, unleashed by new entrants. As competitors pegged up trade margins and credit periods to trade, Parrys found itself edged out of the market -- losing 35 per cent of its business volumes in 1999-2000. The company's retaliatory measures pushed it further into the red, with most of its new launches (Indian, Cricket, Soft Spot) failing to add market share.

In 2000, the company set out to correct these problems. Apart from restructuring its production units and scrapping production at Manapakkam in a cost-cutting exercise, it has retrained its focus on the retail end of the business, after writing off unsold stocks. The company also effected a switch from credit to cash sales, which has temporarily hit sales performance. Parrys Confectionery now plans to focus entirely on widening its distribution reach and pushing the strong brands in its portfolio-Coffee Bite, Lacto King, and Coconut Punch.

These measures appear to have helped the company arrest the steady decline in sales. Net sales improved 10.5 per cent in 2000-01 to Rs 103.90 crore. The company also managed to turn in a profit of Rs 4.75 crore at the operating level, against a loss of Rs 6.09 crore in 1999-2000. While it continued to make net losses, the losses of Rs 5.23 crore for 2000-01 were substantially lower than for the previous period.

Though the company does appear to be well on its way to a turnaround, sustained volume growth holds the key to the company's earnings prospects. Achieving this could be a difficult proposition given the slowing market and the influx of powerful competitors such as Hindustan Lever. However, at the current price of around Rs 50, there appears to be little downside left in this stock. Several MNCs, including HLL, Nestle and Cadbury, have been charting forays into the sugar confectionery segment. Given the company's attractiveness as an acquisition candidate, investors in Parrys Confectionery can hold on to the stock for the present.

Related links:
Parrys Confectionery register Rs 2.09 crore loss
10 pc increase in Cadbury net

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