HLL: Pare down exposures

Recommendation: Pare down exposures

Aarati Krishnan

IN its financial performance for the first half of 2001, Hindustan Lever has again managed to report a reasonable rate of growth in net profits, despite a barely changing topline.

Net profits grew 19.2 per cent after netting out the impact of the various acquisitions and divestitures between the first half of 2000 and 2001. Turnover, meanwhile, inched up 1.2 per cent, on a comparable basis.

Part of the improvement in net profit was on account of an improvement in operating margins. For the first half of 2001, HLL's OPMs improved to 16.5 per cent from 14.6 per cent in the corresponding previous half.

This is creditable, considering that inputs such as soda ash, oils and linear alkyl benzene registered increases over this period. Raw material costs, accounting for 35.8 per cent of net sales in the first half, certainly absorbed more than in the previous period (34.7 per cent).

However, HLL appears to have kept a tight rein on the cost of goods outsourced from third parties, as purchased finished goods, as a percentage of sales, declined. HLL has also been successful in passing on the higher input costs to consumers, through hikes in selling prices of skin care products, detergents and toothpastes, undertaken in March 2001.

The improvement in margins could have also come from HLL's decision to scale down promotional activities on 80 of the 110 brands that make up its product basket. The company is in the process of putting its marketing might behind just 30 of the 100 brands it has identified as the key contributors to its profitability.

However, part of the profit growth has also come from a higher contribution from ``other income'' and lower business restructuring costs. ``Other income'' _ made up substantially of income from treasury management of HLL's substantial free cash flows _ contributed Rs 193.40 crore for the first half of 2001, against Rs 167.38 crore in the corresponding previous period.

To put this figure in perspective, the ``other income'' for the current period amounts to 3.34 per cent of HLL's gross income for the period, against 2.9 per cent in 2000.

On the other hand, HLL has also taken a lower charge of Rs 22.50 crore for restructuring expenses in the first half of 2001, against Rs 60 crore in the previous half. If one adds back restructuring charges, HLL's net profits before exceptional items, registered a 12.5 per cent increase, lower than the 20.7 per cent growth after restructuring charges.

All this appears to only reinforce that it will take a resurgence in sales growth to push HLL's profit growth into a higher orbit. In this respect, much hinges on how HLL's decision to focus on 30 power brands, pans out.

In fact, in its results announcement for the first half of 2001, HLL has taken care to highlight the performance of the chosen ``power brands'' in relation to the rest of its product basket. For instance, it claims that the `power' brands in home and personal care grew 9 per cent, while HLL's entire portfolio in this category grew 5.3 per cent.

The ``power brands'' in personal wash also managed to grow 6.3 per cent, while the personal wash portfolio declined 2.8 per cent. In foods, the power brands declined 3.3 per cent, doing better than the rest of the portfolio that declined 7.3 per cent.

Since HLL's focus on `power' brands was preceded by a weeding out of some of the poor performers in the product basket, part of the decline in volumes could be temporary. However, what stands out in HLL's recent performance is that the much-hyped foods business substantially underperformed traditional categories such as personal wash, fabric care, and personal products.

Given that foods has always been considered the major growth driver for HLL in the years to come (with HLL itself in the process of stepping up the contribution from this segment), the de-growth of the foods portfolio (especially the power brands) in the first half of 2001 is disturbing.

It, therefore, appears that any near-term revival in HLL's fortunes has to come from a resurgence in rural demand. Though the South-West monsoon has been satisfactory in its first month, it is early days yet to predict a revival in rural FMCG demand (which may also come with a time-lag, if it does).

Apart from the fact that rural incomes would have to recover from three consecutive difficult years, much will also hinge on a recovery in prices of agricultural commodities, that have been pressured by large production surpluses.

The HLL stock has already moved up from Rs 185 to the Rs 220 levels over the past two weeks. Given the high valuation levels (37 times earnings) and modest near-term growth prospects, investors can use any uptrend to pare down exposures.