The recent change in royalty regulations by the central government has increased the vulnerability of fast moving consumer goods (FMCG) companies to an earnings decline.
In November last year, the central government had eased norms pertaining to royalty payment, lump sum fee for transfer of technology and payments for use of trademark/brand name in the automatic route. The amendment effectively removed the five per cent royalty ceiling on domestic sales and eight per cent ceiling on export sales. The move, according to the government, was aimed at facilitating more tie-ups between foreign and domestic firms and promoting seamless transfer of technical knowhow.
FMCG analysts believe with the ceiling off, there could be an impact on earnings, if royalty payments increase over time.
In a report co-authored by Gaurang Kakkad and Bandish Mehta of brokerage firm Religare Capital Markets, the analysts say a one per cent increase in royalty payment (as a percentage of sales) will impact the operating profit of companies that pay this by 3-7 per cent.
Some key companies that pay royalty include Hindustan Unilever, Nestle, Colgate-Palmolive, GSK Consumer and Procter & Gamble Health & Hygiene.
The report says in 2009-10, P&G paid a royalty of 5.4 per cent of sales, Colgate-Palmolive at 4.5 per cent of sales, GSK at 3.8 per cent of sales and Nestle at 3.4 per cent of sales. HUL’s royalty payout was the least, at 0.7 per cent of sales.
HUL revised its royalty payment to one per cent of sales in January this year. This 0.3 per cent increase in royalty, Religare had estimated, would have impacted earnings by two per cent, Kakkad said in a telephonic conversation with Business Standard. An email whether HUL would revisit its royalty payout policy again elicited no response till the time of going to print.
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Mails sent to Nestle, Colgate-Palmolive and GSK, seeking an answer to the question whether these companies would revisit their royalty payout policies, elicited no reply till the time of going to print. A P&G spokesperson said the company would not be able to comment on the implications of the change in regulations at the moment.
Analysts say HUL is at a greater risk than the others of seeing an impact on earnings should an increase in royalty happen again. According to Kakkad, a further one per cent increase in royalty will impact’s HUL’s operating profit by 7.4 per cent. “That is because the company’s operating profit margins, which is operating profit upon sales, is in the region of 13-14 per cent. P&G, Nestle, and Colgate have operating profit margins in excess of 20 per cent. So, the impact for them will be lower as opposed to HUL,” he says.
HUL, during analyst concalls last week, had said Unilever-owned brands made up 25-30 per cent of its product portfolio. Some of the key Unilever brands in HUL’s portfolio include Surf, Ponds, Dove, Lux, Sunsilk, Lifebuoy, Closeup, Bru and Clinic.