Shobhana Subramanian: Getting close up and personal

To sustain growth and profitability, HUL needs to improve performance of its personal products and foods business.

With a distribution network that is the envy of the industry, you'd imagine Hindustan Unilever Limited (HUL) would have little trouble selling anything. The Rs 13,718 crore fast-moving consumer goods (FMCG) major has the kind of product portfolio that no retailer can afford to ignore. Yet, things have been far from smooth for HUL. After six long years, HUL was able to grow its topline in double digits only in 2005, it lost momentum the next year, and while 2007 saw a better 13.5 per cent growth, a large part was due to the previous year's poor performance.

Segregate the performance by category, and the results are even more telling. Lever's biggest item is soaps and detergents (it comprises 45 per cent of turnover), but the profit margins have been just around 16-17 per cent. In terms of contribution to profit, this segment gives around 40 per cent of Lever's PBIT, which is a bit lower than its sales share.

Personal products, which include toothpaste, shampoos and the top-selling Fair & Lovely skincare range, have the best profit margins "" upwards of 30 per cent, but unfortunately, the growth has been inconsistent, sometimes just in low single digits. In terms of profits, this segment contributes way above its share in sales "" while personal products comprise around 30 per cent of sales, they account for 50 per cent of HUL's PBIT.

Profit margins for food, which were higher at around 14-16 per cent in CY06 and going up to 17 per cent, have started tapering off in CY07 "" one would have expected some economies of scale to start kicking in. The business itself doesn't seem to be scaling up fast enough: contribution to revenues, which was about 15 per cent in the first quarter of 2006, remained more or less at the same levels in the last quarter of 2007. And this segment's contribution to profits has ranged between just 10-15 per cent.

So, if Lever has to grow sales in barely respectable low double digits (with the economy growing at around 7-8 per cent and inflation at 6-7 per cent, that'll be lower than nominal GDP growth) and hope to keep the margins at respectable levels, none of the segments can really afford to slip up. But, with the base going up every year, growing volumes could be a challenge. Take the case of soaps. The competition is only increasing: indeed, it appears that HUL may have cut the prices of soaps "" Lux, Hamam and Rexona "" despite palm oil prices having risen 14 per cent already this year, simply to protect market share. In a market where household use is already up to 80 per cent, perhaps there is little choice Lever has, especially since soap volumes last year have barely grown. Moreover, ITC has recently entered the market and is running attractive promotion schemes. Historically, soaps has been a price-driven business, so unless HUL is able to do something about upping prices, it will be hard to grow soap revenues, not to mention margins. 
 

TABLE I: CONTRIBUTION TO REVENUES
Rs crore	Mar'06	Jun'06	Sep'06	Dec'06	Mar'07	Jun'07	Sep'07	Dec'07
Net sales	2,798	3,083	3,066	3156	3,184	3,481	3,364	3,687
%growth (y-o-y)	12.6	9.95	12.2	6.9	13.8	12.9	9.7	16.8
Soap&Det	1,319	1,456	1,393	1,428	1,445	1,669	1,572	1,689
% growth	16	13	12	10	9.5	14.6	12.8	18.2
PBIT(%)	11.5	14.3	13.2	15.6	12	16	16.7	17.2
Personal products	766	847	854	893	822	898	888	1064
%growth (y-o-y)	27	13.4	17.1	2.5	7.3	6	4	19.1
PBIT(%)	24.4	28.45	26.7	31	24.7	29.3	24.2	33.3
Foods	432	444	474	491	531	555	554	572
%growth (y-o-y)	10.8	3.8	10.7	11	22.8	25	16.9	16.4
PBIT(%)	14.6	12.6	10.8	16.9	10.9	10.3	10.8	13.1
TABLE II: CONTRIBUTION TO PROFITS
Rs crore	Mar'06	Jun'06	Sep'06	Dec'06	Mar'07	Jun'07	Sep'07	Dec'07
PBIT	405	502	457	592	439	571	511	711
Soap&Det	152	208	172	235	174	268	263	291
Contr(%)	38	41	38	39.6	40	47	51	41
Personal products	187	241	228	276	203	263	215	355
Contr(%)	46	48	50	46.6	46	46	42	50
Food	63	56	52	83	64	66	60	74
Contr(%)	15.5	11	11	14	14.5	11.5	11.7	10
TABLE III: CORPORATE REVENUES AND PROFITS
HUL	Mar'06	Jun'06	Sep'06	Dec'06	Mar'07	Jun'07	Sep'07	Dec'07
Net sales(Rs cr)	2,798	3,083	3,066	3,156	3184	3,481	3,365	3,687
Sales growth(%)	12.6	9.9	12.2	6.9	13.8	12.9	9.7	16.8
Gross profit(Rs cr)	1,273	1,439	1,443	1,445	1,416	1,624	1,579	1,787
GPM(%)	45.4	46.6	47	46	44.4	46.6	46.9	48.46
EBITDA (Rs cr)	3,306	4,146	4,029	5,000	3,620	5,120	4,467	5,641
EBITDA  (%)	11.8	13.4	13.1	15.8	11.4	14.7	13.3	15.3
A&P(Rs crore)	304	345	340	284	356	336	355	376
A&P/Sales(%)	10.9	11.2	11	8.9	11.2	9.7	10.5	10.2
A&P growth%	45.5	20.2	41	7	17.5	-2.6	4.4	32

Let's assume HUL's looking to grow its topline at around 12 per cent. Soaps and detergents, which accounts for 45 per cent of top line, should manage a growth of 12 per cent "" that's a growth of about 5.4 per cent in the overall company kitty. If foods, which accounts for 15 per cent, chips in with 15 per cent, that's another 2.3 per cent; that leaves the balance of 4.3 per cent which means that given its 30 per cent share, personal products needs to come up with over 14 per cent. However, that doesn't seem to be happening "" of the last five quarters, four have seen single digit growth, often in low single digits. Besides, with the base steadily going up to Rs 3,760 crore for 2007, it's not looking easy. But more than contributing to the topline, the performance of personal products is more critical for HUL's bottomline "" while profit margins for soaps and detergents are just around 16-17 per cent, those on personal products are a much healthier 26-30 per cent and more. So, HUL needs to get its act together, possibly revisiting some of its strategies.

Take oral care. HUL hasn't managed to capture a big share, possibly because it doesn't have a product at the lower end where brands such as Colgate's Cibaca are becoming popular. In shampoos too, HUL needs some new ideas if it is to fend off competition from incumbents and newcomers like ITC. Simply pushing its brands and creating extensions "" Dove has been extended to shampoos "" may not be enough though focussing on high-end cosmetics with the Ponds brand is probably the way to go.

But these initiatives need to pay off quickly because the costs involved in launching and sustaining brands are not small. The Ayush brand, introduced in 2002 on the ayurveda platform, failed to take off and had to be withdrawn. With players such as ITC entering the personal care space, adspends will need to be high. Also, with organised retail catching up, and store brands proliferating, margins on soaps and detergents could slip. No doubt, HUL has been able to maintain its market share, but this has been at a higher cost "" in the first quarter of 2007, HUL's adspend grew by more than 17 per cent as compared to sales growth of a much lower 14 per cent. The operating margin has suffered in quarters when adspends have been high.

Growth in the foods business, a big volume area, hasn't been up to the mark either. Throughout 2006 the segment just about grew in double digits "" on a low base "" and while growth picked up in the first half of 2007, it appears to have slackened again in the September and December quarters. In fact, the 25 per cent growth in the June 2007 quarter came on the back of a miserable 3.8 per cent growth in the same quarter the previous year. In many ways, HUL hasn't managed to get a grip on the foods business which was kicked off with acquisitions of Kissan in 1993 from the UB group, Dollops from Cadbury and later, Knorr soups from Bestfoods. After a fairly good start, the business had all but disintegrated "" sales of processed foods dropped from Rs 791 crore in 2001 to Rs 285 crore in 2004, with losses of Rs 82 crore. HUL responded by re-launching the wheat flour brand, Annapurna, in smaller packs (2 kg and below). Peer ITC, on the other hand, has managed to build up volumes for biscuits, snackfoods and the flour brand, Aashirwad.

HUL also failed to make a success of Modern Foods which it acquired for Rs 170 crore in 2000 and on which it spent an additional Rs 35 crore. After all these years, today the foods business is worth about Rs 2,200 crore and accounts for about 16 per cent of revenues. Meanwhile, ITC has already managed a 10 per cent share of the Rs 2,500 crore snack foods market in just over a year. Instead of looking at volume plays like biscuits, where ITC has managed to gain market share with its Sunfeast brand, HUL has now launched Kissan Amaze, a brainfood for children targeting the snackfoods biscuits, chocolate confectionery and malted beverages segment. While these may be high-margin products, HUL may have wanted to tap a bigger segment such as biscuits, like ITC has done, and get the volumes going before moving into niche segments. Also, while the ice creams business is growing, it made less money for HUL in 2007 with profits of under Rs 14 crore compared with profits of under Rs 18 crore in 2006. The FMCG major has gone wrong too often in the past; this time around it needs to come good.