February 20, 2001
Hindustan Lever

BUY
Market price : Rs 216
Market Cap : Rs 475 bn
52week H/L : 325/163
Average Vol : 5440340 nos

Path to profitable growth

Investment rationale

The Chairman of Hindustan Lever, after the results announcement for F12/00, outlined to the investment community his plans for the company and the path for ‘sustainable profitable growth’. Two things clearly emerged from his talk:

1. A greater focus on existing businesses rather than new businesses

2. Profit growth rather than topline growth is likely to drive future management action

The last few years of HLL’s growth were driven inorganically through acquisitions and venture into new businesses. The much harped about Millenium Growth Plan of the company was also based on the same path of growth through expansion. But in sharp contrast to his predecessor Dadiseth, Banga’s growth plan appears to be based on ‘Contraction’ rather than ‘Expansion. For once there was no mention of new brand launches. In fact what the management has outlined is a focus on the best 30 brands out of their portfolio of 110.

Thrust on a few brands will mean better growth and higher profitability

The 30 brands have that been identified cover all key categories and all segments in each category. The selected brands account for more than 2/3rd of total FMCG brand sales of the company. And what is more important is that the profit contribution of these brands is even greater.

So we have a scenario where one will see a greater resource allocation – be it marketing, innovation or people support towards these 30 brands. The advertising and marketing support spread over fewer brands is likely to be more efficient, and will drive volume growth. And stronger growth in the more profitable brand portfolio will aid margin expansion.

More efficient utilization of resources

Besides rationalization, a few brands would be migrated, i.e. these brands would receive a regional rather than a national support, in its specific region of strength. Where the brands can neither be milked nor migrated, the company is also open at the option of divesting the same. So we now have a Hindustan Lever, which is talking of divesting rather than acquiring brands!

New product initiatives put on the backburner

The management did not even discuss, until asked, the status on the nine growth engines that had been previously identified as growth drivers. Already the management has brought down to five the viable options from the nine identified earlier. These are in the areas of Confectionery, Consumer Healthcare, Mineral Water, Direct-To-Home (DTH) distribution and a unique distribution model for rural markets. But the management is still testing and is going rather slow on the new initiatives. The final decision on the entry into these categories will be taken only after rigorous testing of waters throughout the current year. Which essentially means that one is unlikely to see the company venturing into these areas in the very immediate term.

To sum up Banga’s words, the focus will be on "To do what you know best". And that probably is what is required for the company in the current scenario, where competition is at its heels in every segment of operation. Rather than divert resources towards new areas, it makes sense to focus on existing businesses, grow them and make them profitable. And that is what is going to be HLL’s three pronged thrust in the coming year

1. Grow the FMCG business - by expanding the market itself, by growing the company’s share in the market, by generating demand though innovating new channels of consumption, by leverage on existing brand equity by offering services to the customer

2. Work towards making the foods business profitable - Huge investments have been made in developing new food categories and setting up a distribution infrastructure in place for the foods business. Now that the base for the business has been laid, the company expects to drive the profitability of these businesses. Besides the traditional beverages and oils and fats business, the new categories of staple foods, culinary products and bakery products (acquired through Modern Foods) are likely to contribute to the growth.

3. Strengthen the non-FMCG business by acquiring technology support -The non-FMCG product categories include chemicals, fragrances & flavours, specialty chemicals, thermometers, etc The company is taking steps to secure world class technology support in these areas for future growth. This could mean a divestment of these businesses to a separate joint venture in the long term.

The outlined strategy is a significant deviation from the path followed by the company in the past. Rather than grow in breadth at a fast pace, the new strategy appears to be focusing on consolidation of the already expanded businesses, before moving on. And this appears appropriate given the current economic and competitive environment. The overall market demand growth is likely to be constrained by adverse economic factors such as poor agricutural and industrial growth. On the other hand, HLL faces stiff competition from both MNC’s at the premium end and the local low cost producers at the popular end. The proposed measures is likely to lead to the following gains

1. A greater marketing and management focus on rationalized product portfolio would lead to better growth rates for those brands

2. The contribution to profit of the 30 brands being higher, overall profitability would rise, as these brands grow at a faster pace.

3. While the overall expenditure on branding and sales promotions be lower as the number of brands supported decline; also more efficient brands would receive greater support

4. Cost cutting initiatives extended across the supply chain as well as a conscious effort towards lowering fixed overheads would aid margin expansion.

5. A slowdown in investments in new businesses, and improved profitability in existing businesses would mean that ROCE growth would be faster.

We feel that given the economic and competitive environment. HLL stands a much better chance of improving its operating and financial performance with the outlined strategy. At the current price of Rs216, the stock trades at 36x F12/00 earnings. A 25% growth in profitability appears achievable as the portfolio rationalization will drive margin expansion. Lower restructuring costs would also aid higher net profit growth. On an estimated F12/01 EPS of Rs7.4, we set a one-year price target of Rs296, which would yield a 37% return. BUY.

Read our earlier investment idea on HLL

Archives