Cadbury India: Hold

Recommendation: Hold

Aarati Krishnan

FOR the third quarter of financial year 2000, Cadbury India reported a net profit growth of 30 per cent (to Rs 17.79 crore) while net sales grew a modest 12 per cent (to Rs 186.68 crore).

Net profits for the quarter were boosted by a write-back of taxation provision, of Rs 0.64 crore relating to earlier years. After excluding this item, the growth in sustainable net profits was 26 per cent. While the profit performance was superior to that in the first two quarters of the year, sales growth was lower than in the first half. For the first six months of 2000, Cadbury India reported a 17 per cent growth in sustainable net profits, on an identical growth in sales.

Cadbury's sales performance for this quarter may seem disappointing. However, a comparison of the figures with that of the previous year would be skewed by festival-related sales. While festival-related sales fell in the third quarter in 1999, they were pushed to the fourth quarter of 2000.

Therefore, Cadbury's sales performance for October 2000 quarter is probably understated. The boost from festival-related sales can, probably, be expected to pep up sales growth in the December quarter of 2000. Sales growth for the first nine months of 2000, at 14.7 per cent, appears short of the company's target of sustaining a 20 per cent growth in sales value over the next couple of years. Whether growth rates catch up in the December quarter remains to be seen.

Unlike earlier years, this was one period when Cadbury India actually held or reduced the prices of some of its product categories in an effort to pep up volumes. Chocolates, which contribute over 64 per cent of sales, remain the key product category for Cadbury. Sugar confectionery (Frutus, Gollum, Trebor) and malted food drinks (Bournvita and Drinking Chocolate) contributed around 12 per cent and 24 per cent respectively in 1999.

Over the past one year, while Cadbury has hiked prices of its established brands such as Cadbury's Dairy Milk and Fruit and Nut, it has actually held or reduced the priceline on brands such as Perk and Pinic because of the competition. Cadbury has launched a Rs 5 version of Perk to generate additional volumes.

The most noticeable feature of the company's performance this quarter was the quantum jump in operating profit margins, which improved to 18.8 per cent from 16.4 per cent in the corresponding period of 1999. The OPMs was 15.6 per cent in the first six months of 2000.

The improvement in margins comes partly from savings in manufacturing expenses; but savings in raw material costs undoubtedly helped to a large extent. Raw material costs, which accounted for 44 per cent of sales in the third quarter of 1999, accounted for just 40 per cent in Q3 2000. Cadbury sources a substantial portion of cocoa requirements through imports and the 40 per cent decline in cocoa prices over the past one year is likely to have helped margins. The depreciation in the rupee would have taken away only a part of these gains.

Staff costs and other manufacturing expenses, as a proportion of sales, also declined from 31.03 per cent in the third quarter of 1999 to 29 per cent in 2000. The savings in costs have left Cadbury with larger surpluses to plough back into advertising and promotion. These expenses, as a proportion of sales, rose 11.4 per cent in the third quarter of 1999 to 12.7 per cent in 2000.

Given the incidence of festival-related sales, Cadbury India's sales performance for the fourth quarter of 2000 appears to hold promise. The soft trends in cocoa prices also appear set to continue in the near term, given the surplus situation in the world cocoa markets. Over the long term, the strategy of targeting lower price points in the chocolate segment and the foray into sugar confectionery should help pep up volume growth.

However, at the current price of Rs 600, the Cadbury India stock already trades at a price-earnings multiple of around 40 times the expected earnings for 2000. This is at a premium to the valuation of around 27 times at which the universe of FMCG stocks is now trading. Therefore, fresh investments in the stock need not be contemplated at the current price levels. Shareholders can hold on to the investments in the light of the expected improvement in the fourth quarter performance.