Coming through, at last

The final step towards making IDBI viable has been taken

Meleveetil Damodaran has finally pulled it off. He had already accomplished half the task once the government agreed to transfer Rs 9000 crore of IDBI's non-performing assets to a special purpose vehicle, thus cleaning up its books and laying to rest the troubled legacy of the past.

The next logical step was a merger with IDBI Bank, thereby mapping out the road for the future.

No two institutions could be more different, as is strikingly brought out by their June quarter results. While IDBI Bank made a profit of Rs 36 crore on a total income of Rs 260 crore, its parent made Rs 23 crore from total income of Rs 1379 crore.

Operating margin was 7.9 per cent in IDBI, and 49 per cent in IDBI Bank. Non-performing assets at the bank were 0.2 per cent of customer assets, compared to IDBI's net NPAs of 14.2 per cent as at end-March last year, which was when they last declared the NPA levels.

Cost of funds was 3.9 per cent for the bank, while IDBI's incremental cost of funds was 5.6 per cent. IDBI is a retail bank, while its parent gives term loans for projects.

IDBI will get access to low-cost deposits, exposure to the fast-growing retail finance market, a modern technology platform and a private sector culture. IDBI Bank will get over the uncertainty, and it will get capital to expand.

How do the valuations compare? With NPAs transferred to the SPV, IDBI's adjusted book value per share is likely to exceed Rs 100 by September this year, when it finalises its accounts. IDBI Bank's book value per share is Rs 30.40, but that doesn't tell the whole story.

Earnings per share for the June quarter were Rs 1.70 for IDBI Bank and Rs 0.36 for IDBI. IDBI Bank grew its profits by 64 per cent, IDBI's profits fell 55 per cent.

Also, the IDBI scrip already reflects, on a consolidated basis, the bank's valuation. Clearly, IDBI shareholders stand to gain far more from the merger than IDBI Bank shareholders, and the swap ratio needs to recognise that fact.

HLL's profit gets washed away

A big chunk of Hindustan Lever's profit was washed away by the soaps and detergents segment last quarter. Earnings before interest and tax (EBIT) fell over 30 per cent and the soaps and detergents segment accounted for over 67 per cent of this fall.

True, there were a couple of exceptionals, but even after adjusting for these the fall in EBIT was high at 26 per cent.
 

Caustic quarter Hindustan Lever's EBIT margins, per cent
Segment	Q2FY03	Q2FY04	Change#
Soaps & detergents	23.83	14.54	-9.30
Personal products	35.63	32.13	-3.50
Beverages	19.04	18.82	-0.22
Processed foods*	5.99	-15.07	-21.06
Ice creams	6.74	7.95	1.21
Exports	4.56	2.66	-1.91
Others@	-6.08	-13.73	-7.65
* For continuing businesses, and after adjusting for the Rs 15 crore exceptional item; @ includes chemicals, agri, plantations etc.); # percentage points

A look at the above table shows that EBIT margins of all the segments except ice-cream (just 1.4 per cent of sales) have declined. One of the major reasons for this was higher spending on advertising and promotions (A&P), which jumped 270 basis points as a percentage of sales for the whole firm.

But the key problem for HLL is the pricing war that has hit profitability of not only the fabric wash segment, but also the shampoo and oral care segments. While the hit on the shampoo and oral care categories is manageable, the fabric wash segment has been hit really bad.

For some premium detergents it is suspected that the contribution was negative, and unless prices are raised profitability would continue to suffer.
At around 20 per cent of sales, the fabric wash segment can have a significant impact on overall profit, as is evident from the Q2 results.

The year-on-year impact of the price reductions would continue for the next three quarters, and things could be better in the second half of the year only if A&P spend is lower than the Q2 levels of 10 per cent of sales.

With contributions from Mobis Philipose