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Aarati Krishnan

Mr. M. S. Banga, Chairman... Profits under a renewed onslaught.

UNTIL 2003, Hindustan Lever (HLL) managed to deliver reasonable profit growth despite a stagnant topline. This appears difficult now, given that the company is relying on strategic price cuts and increased investments to ramp up volume growth. As the operational environment gets more challenging, returns from HLL's formidable investment portfolio are also drying up on account of falling interest rates. This packs a wallop for a company that deploys almost as much capital in its treasury operations, as it does in its core businesses.

Aggressive pricing may be best way to drive growth in the large FMCG categories where HLL operates. But, until volumes expand substantially to compensate for the price cuts, profit growth at HLL could continue to be under siege. Trading at a stiff valuation of about 18 times its 2003 earnings, HLL's stock price does not appear to factor in this possibility. Investors can cut exposures to the stock and contemplate re-entry only on concrete signs of a pick-up in growth rates from HLL's pricing strategy.

Detergent/shampoo wars: Yet to be felt

HLL has unveiled a 20.9 per cent drop in net profit and a 3 per cent growth in net sales for the March 2004 quarter. The home and personal care (HPC) segment, where HLL cut prices of shampoos and premium detergents this quarter, saw a decline of 2.2 per cent in segmental profits.

The price cuts have helped the business improve its volume growth to 7 per cent this quarter; with value growth at 3.5 per cent.

But the moves were unveiled only at the fag end of the March quarter and their impact will be fully captured in the coming quarter.

Profits under siege

The more worrisome aspect of HLL's financials for the quarter is that segmental profits have also deteriorated in each of the non-HPC businesses.

Profits (before and interest and taxes) for the quarter have slipped by 2.4 per cent in beverages and as much as 42 per cent in exports. The ice-creams business slipped from a marginal profit to a loss and the processed foods business widened its losses, all in the March quarter.

Given the uneven spread of marketing and advertising expenses for any FMCG company over the year, a quarter's performance may not accurately capture its prospects for the full year. Lower profits in some businesses for this quarter could indicate that HLL is stepping up its marketing and brand-building investments to grow market share. But, with sales growth rates in the non-HPC businesses stuck in the low single-digits, a sharp improvement in profits appears unlikely, in any case.

Treasury makes an impact

But the competitive pressure on its operations was actually not the key reason for the sharp drop in HLL's profits for the quarter. On a pre-tax basis, HLL's profits for the quarter plunged by 25.8 per cent, or Rs 128.8 crore in absolute terms. Of this drop, the lion's share of Rs 77 crore was accounted for by a drop in `other income', from subsidiaries and treasury operations. The interest obligation on the bonus debentures issued last year also shrunk profits by Rs 30 crore. Only a Rs 21.8 crore drop in HLL's profits for the quarter was a result of its core operations.

Though this has little to do with its core businesses, a lower bounty from treasury and the interest obligation on newly-issued debentures could continue to dampen HLL's year-on-year profit growth for some time to come. HLL is a cash-rich company with minuscule debt on its balance-sheet and has nearly half its capital deployed in fixed-income investments. So, the shrinking returns on treasury operations will continue to leave their mark on the company's profit picture, especially at a time when growth in the core FMCG business seems to be hard to come by.

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