The Hindu Business Line : `Margins are expanding on improving product mix'

Will the proportion of adspend to our sales go down, from here? I do not think it will, given the competitive scenario we are in. — MR D. SUNDARAM, FINANCE AND IT DIRECTOR, HINDUSTAN LEVER

Despite being such an obvious play on India's consumption theme, FMCG stocks, in general, and Hindustan Lever, in particular, have trailed the broad market over the past year. But with growth gathering steam in large categories such as soaps and toothpastes, do better times lie ahead? Is pricing power really returning to players? Business Line caught up with Mr D. Sundaram, Finance and IT Director for Hindustan Lever, to discuss these issues, as also the company's recent earnings performance.

Many of your competitors in the FMCG space have recorded strong double-digit sales growth in the December quarter. Industry estimates also suggest that categories such as soaps and toothpaste have grown at double digits. Yet, Hindustan Lever's topline growth this quarter doesn't seem to reflect any of this. How do you explain this?

You may not be right in making a comparison of our performance with that of our competitors on a like-to-like basis, because each of our competitors operates only in one or two of the segments we operate in. Being such a large player with a wide presence across the FMCG space, our sales growth captures the overall performance of our portfolio, spanning several categories and price points.

Besides, our sales mix in a particular quarter also influences growth rates. Take the instance of toothpastes. The category recorded double-digit growth this quarter; and so did our toothpaste portfolio. I would say we have done as well, if not better, than the market. In the case of personal wash (soaps), brands such as Lux and Pears, that have seen high activity lately, are positioned at the mid- or premium segment. Within these segments, our brands have fared quite well. The discount segment has recorded a higher growth rate in this particular quarter and this would reflect in our competitors' growth rates, but not to the same extent in ours.

Growth rates in a particular quarter can also be distorted by one-off factors. HLL's personal care sales saw lower growth rates this quarter, because of the late onset of winter and generally higher temperatures, which impacted skin-care. Similarly, growth in the hair care portfolio may appear low for this quarter, because we launched a new All Clear variant during the same period last year, which contributed to a high base effect. But these are one-off issues.

If you look at the sales performance on a running basis, you will find that HLL brands have fared quite well within each category and against competitors. Our market share numbers support this. We have either maintained or made market share gains in categories such as laundry, personal wash, hair and skin care; this shows that our brands are certainly not losing ground in their respective categories.

With interest rates rising and inflation for essential goods spiralling upwards, do you see the share-of-wallet for FMCGs declining? How do you view the growth prospects for FMCG companies?

We have no numbers on such a phenomenon and will have to wait for trends to unfold. All I can say is that we do not see any signs of a slowdown as of now. The market for FMCGs did go through a slump from 2001 to 2004 on the back of declining consumer spends.

But trends have since reversed. We have seen a steady recovery since 2005 that has continued through 2006. We also see improving demand for FMCGs from the semi-urban and rural areas.

In my view, given the low penetration levels for most FMCG products and the fact that we have a market of a billion consumers, long-term growth prospects for FMCGs are bright. At HLL, we have various means to drive that growth. We can improve penetration of our products, improve levels of usage for our products and drive consumer upgradation; each of these can deliver significant growth from current levels.

Hindustan Lever's profit margins have expanded in the December quarter. But how much of this is attributable to lower growth in adspend this quarter?

Our margins have expanded on improved product mix, ongoing cost savings measures and selective price increases on our brands. It would not be right to say that our margins have expanded because of lower adspend. If you look at our adspend-to-sales ratio in the December quarter of 2005, you will find it was almost at the same levels as it is in the recent quarter. I would also like to reiterate that we do not work on the basis of a fixed advertising budget for each year or quarter. Our advertising spends are dynamic, they vary from quarter to quarter based on the level of activity in our brand portfolio.

Our strategy on advertising is also determined by the level of competitive activity in each category. However, as I pointed out earlier, we have been investing heavily behind our brands (HLL has spent Rs 450 crore in brand-building expenses over the past two years), which is why our adspend expanded by 27 per cent this year.

Will the proportion of adspend to our sales go down, from here? Difficult to say, but I do not think it will, given the competitive scenario we are in. There are today a host of players in each category — national, regional and local — that are trying to make headway in the marketplace.

Palm oil prices have spiralled up sharply over the past six months, while input costs linked to the petroleum basket have moderated. What is your outlook on input costs for the coming quarters and how do you propose to manage margins? Do you have a hedging programme to manage input costs?

We see the firm trends in palm oil prices as well as vegetable oil prices continuing for some time. This has been partly neutralised by the prices of linear alkyl benzene and other crude oil linked inputs moderating from their peak. But they are still not at levels that we would be entirely comfortable with. We do not have a hedging programme, but plan our procurement based on price trends that we foresee.

If we see firm trends in palm oil prices, we may buy and stock larger quantities of it to take care of our requirements. We have different tools to manage higher input prices — cost savings — which is an ongoing process, selective price increases and improving our product mix.

Selling prices of FMCG products have risen only by 2-4 per cent annually over the past three years, while inflation has been nudging 5 per cent. Do you see the pricing environment for FMCGs improving now?

I think it may be quite hazardous to look at "average" price increases across categories as you are doing, as the trends may be quite divergent between categories and price points. Our decisions on price increases are taken at the stock-keeping unit (SKU) or brand level, based on several inputs — internal and external. After taking a view on input prices for a particular product, we will try and see if this can be offset through cost savings.

If part of it cannot be offset, we will then evaluate if the markets can absorb a price increase. We actually have a model that measures the price elasticity of demand for each of our products; we track this regularly; this is a key input into our pricing decisions.

Finally, a decision to increase selling prices cannot be taken in isolation. It must factor in the competitive scenario — how many competitors are present in a particular segment, and how they position their products and their pricing strategies relative to our brand.

Hence, I would really not like to hazard a guess on how the overall pricing environment for FMCGs is going to be over the next year or two. However, if you break down the sales growth for FMCG companies into volume growth and price increases, I would say that price increases today are accounting for a higher proportion of growth than they did a couple of years ago.

Given that Hindustan Lever has such a large portfolio, do you have the flexibility to offset escalation in input costs in one brand or category, through price increases in another?

No, we do not believe in cross-subsidisation between our brands and products. We are organised clearly into different business divisions and the head of each business has complete responsibility for the costs and profits of his division.

Brand managers, too are completely accountable for the results delivered by their brands. Therefore, the kind of cross-subsidy that you are talking of is not possible. There are, of course, a few operational synergies that we have at the organisational level, which are passed on to each function and division.

Many Indian FMCG companies have acquired a significant overseas presence through acquired brands and a distribution network. Is there a possibility that HLL will capitalise on this opportunity and emerge as a sourcing base for Unilever, catering to the Asian region?

The potential does exist (for such sourcing) in certain categories. In tea and personal care, for instance, we do have competitive strengths in manufacturing within India. Indeed, we have been stepping up our focus on export of FMCG products over the past few years and this business (at about Rs 900 crore) is fairly big. Our decision to transfer the marine products business is also part of a strategic initiative to focus more on exports of FMCGs.