HLL: Pressure on margins

Topline growth returns to HLL in the March quarter

HLL's revenues from continuing businesses grew by 6.9 per cent in the March quarter, the highest in the last 10 quarters. Growth was driven by the home and personal care (HPC) division, which grew 9.6 per cent.

The foods business, on the other hand, declined by 3 per cent, mainly because of a change in company policy, which now requires frequent and timely replenishment of stock, unlike earlier periods when huge stocks would be passed on to the trade in March in anticipation of summer sales.

Within the HPC division, laundry sales grew an impressive 13 per cent in value terms on the back of a 10 per cent growth in volumes. While sachet prices are higher on a year-on-year basis, thanks to the price hike taken in November 2004, prices of large packs were considerably lower.

The 5-6 per cent price hike taken in March this year for the larger packs hardly offset the huge price cuts taken in March last year. The fact that value growth has exceeded volume growth, therefore, indicates a shift in product mix and is a good sign.

Nevertheless, there was no respite on the profitability of the soaps and detergents segment, which reported an 870 basis points drop in EBIT margin, in line with the trend in the previous three quarters. This time around, though, the main reason for the fall was a jump in crude prices, which in turn impacted input costs for detergents, packaging costs and freight costs.

The personal products division, too, saw a 780 basis points fall in margin, because of higher raw material costs and lower prices on a year-on-year basis.

For the company, the March quarter operating margin fell to 9.7 per cent, which is significant since it's the first time HLL has reported a single-digit operating margin in a long, long time.

But things should be better on the margin front going forward, because of the price increases in detergents, shampoo and skin care in the March quarter. Also, on a year-on-year basis, the anniversary impact in the detergents segment has played out in the March quarter.

The anniversary impact in the personal products division will continue till the September quarter, but it was the detergents segment that was really influencing the overall profit margin decline.

For perspective, the profit drop in the soaps and detergents segment stood at Rs 78 crore last quarter, compared to Rs 31 crore for the personal products division.

In any case, the key takeaway from the March quarter results is not that margins continue to be under pressure, but that topline growth has picked up. And it's not only in detergents that this has happened. Shampoo sales grew 20 per cent in value terms, despite prices being lower on a year-on-year basis.

Toothpaste sales grew by 12 per cent, and the personal wash segment grew 6 per cent. While the quantum of growth has beaten market expectations, the broad trend is in line with market expectations.

Hopes of topline growth picking up had resulted in a re-rating of FMCG stocks, including HLL, lately. Yet, despite the fact that HLL has delivered on the topline growth front in the March quarter, it remains to be seen if growth picks up beyond the 7 per cent levels reported last quarter. Otherwise, the forward PE of over 20 times is just too expensive for a company that can grow earnings only in single-digits.

Great Eastern Shipping

The GE Shipping stock has fallen about 10 per cent over the past two months, while the Sensex has declined by around 6.5 per cent. The underperformance is because of the recent easing of freight rates.

That easing is reflected by the fact that, although profit from ordinary items on a year-on-year basis is higher by 39.45 per cent in the March quarter, on a sequential basis, the company has reported a 10.16 per cent decline in its profit from ordinary activities in the March quarter.

The sequential decline is because average freight rates in the VLCC segment had declined about 59 per cent in the March quarter, compared to the December quarter, and in the case of Suezmax, they fell about 50 per cent.

But then the December quarter was extraordinary, because of stratospheric, and unsustainably high, freight rates.

Apart from a healthy cooling off of the rates, Chinese demand for petroleum products in the first two months of CY 05 grew a mere 5 per cent, adding to the pressure.

Nevertheless, the Baltic Clean Tanker Index and the Baltic Dirty Tanker Index, which were at 1285 and 1373 respectively on March 31, 2005 have fallen further to 1180 and 1264 respectively as on April 28.

The company has however, succeeded in expanding the tonnage transported by about 22 per cent and enhancing capacity utilisation levels. These steps have minimised the impact of lower freight rates.

The fact remains that, on a y-o-y basis, earnings per share has grown by a huge 74 per cent, while, at the current price of Rs 162 , the price-earnings ratio is just 3.84.

Going forward, with Chinese oil demand showing signs of recovering, freight rates in the tanker segment are anticipated to recover.

With contributions from and Amriteshwar Mathur