Working up a lather

Repeating last quarter's 35 per cent jump in operating profit will be a tall order

The Colgate-Palmolive stock has risen 20 per cent since it announced annual results late last month. As a result, the company's valuation has jumped from around 14 times FY04 earnings to over 17 times in less than a month.

Based on Colgate's June quarter results (announced yesterday), it seems, the rise in valuation is justified.

The company reported a 35 per cent jump in operating profit during the period, and importantly, the increase in profit didn't happen because of a cut in ad spend. (In FY04, profit had risen only because of a 380 basis points cut in ad spend.)

In the June quarter, sales grew 6.8 per cent, which was expected since the company had told analysts last month that the toothpaste market had grown from around 6,500 tonne last June to over 6,800 tonne this May. But what's more important is that operating expenses excluding ad spend fell 410 basis points last quarter, which points to productivity gains.

But it will be tall task for the company to repeat the June quarter performance. Last year's June quarter represented a low base, as the company was hit by an average 17 per cent price cut it had taken on its toothpaste brands.

Besides, ad spend was rather low last year, and is expected to increase this year.

Earnings growth, though, would still be in strong double digits, what with sales now growing at a healthy rate, compared to a CAGR of just 2 per cent in the 5-year period between FY99 and FY04.

A further improvement in performance is expected in FY06, because of cost savings from its new plant in Himachal Pradesh.

Jindal Stainless

The withdrawal of DEPB (duty entitlement passbook benefit) by the erstwhile NDA government and the measures taken by the Chinese government to cool down their economy was expected to hit exports of stainless steel companies.

It's not surprising, therefore, that Jindal Stainless reported a 62 per cent drop in export revenues last quarter. But this was made up by a 90 per cent jump in domestic sales.

This was aided by a hike in domestic stainless prices during the quarter to around Rs 48,000-Rs 50,000 on an average, a growth of around 22 per cent year-on-year. The price increase was only to offset surging prices of key inputs like nickel and ferro chrome.

In fact, despite the price hike, raw material cost jumped 480 basis points as a percentage of sales. Operating margins were maintained only because of a cut in other expenditure and a decrease in power and fuel consumption.

At the profit before tax level, there was a healthy increase of around 30.5 per cent to Rs 50.12 crore.

Things are expected to better on the exports front, with the government recently restoring DEPB to the steel sector.

Besides, the company is implementing its ferro alloys project in Orissa and this should help check a rise in the cost of its key inputs. Finally, it has plans to increase sales of higher value products in the domestic markets, which will also help margins.

Vimta Labs bucks the trend

One stock that has weathered the sell-off in the market is the Hyderabad-based contract research and clinical trials firm Vimta Labs.

The company's stock doubled from around the Rs 150 level last November to Rs 300 by January, and has risen another Rs 130 or so in the last few weeks. Even at these levels, the stock is trading at less than 10 times annualised first quarter earnings.

The current spurt is probably the result of interest from foreign institutional investors, but that's only a reflection of very strong growth, and the unique positioning in the scarcely populated contract research and clinical trials space.

Earnings per share increased from Rs 6 in FY03 to Rs 24 in FY04, and was Rs 10.63 last quarter. It's a small company, with net income from operations being just Rs 12.8 crore in Q1. Revenue growth was 81 per cent in FY04, and 89 per cent last quarter. Small wonder that the stock has soared.

What's the secret of its success? In one word-outsourcing. Vimta is a prime example of high-end outsourcing in contract research.

Apart from contract research, the company is also in the pathological labs business and in analytical and environmental testing. Each of these segments is growing rapidly, thanks to the low cost of contract research in India.

The company does have an early mover advantage, but a key risk would be competition from global contract research organisations setting up a base in India.

But that's well into the future, and in the meantime, with the clinical research market expanding rapidly, there's space for everybody.

With contributions from Mobis Philipose and Amriteshwar Mathur