Indian Shaving Products: Hold/Avoid fresh exposures

Recommendation: Hold/Avoid fresh exposures

Aarati Krishnan

WITH a 16.4 per cent growth in net profits and 16 per cent growth in net sales, the financial performance of Indian Shaving Products for the third quarter was mediocre.

Net profits, which were at Rs 5.62 crore this quarter (Rs 4.83 crore in 1999 third quarter were partly bolstered by a jump in the `other income' component to Rs 2.47 crore (Rs 78 lakh) from contract manufacturing arrangements with Wilkinson Sword India, the parent's unlisted subsidiary. Much of this is likely to be non-recurring, since the latter is to be merged with ISPL in 2000 final quarter. The company claims it continued considerable investments in new products and brand-building in the quarter, which probably indicates that part of the growth slowdown was due to higher adspend.

In the first nine months of 2000, ISPL managed a healthy 26 per cent growth in sales to Rs 208.10 crore, while net profits rose 8.6 per cent to Rs 14.47 crore. Operating profits fell in the first nine months of 2000 to 16.5 per cent from 18.4 per cent in the same period in 1999. This can be explained partly by the rupee depreciation and the higher investments in products promotions. ISPL derives just over half its revenues from re-selling products imported from its parent and the rupee's sharp depreciation over the past six months is likely to costs escalate.

ISPL straddles the upper-end of the male grooming products market with brands such as Gillette Presto, Sensor Excel, Gillette Mach III and Gillette Series Shaving Gel in its portfolio. The company also markets the Oral-B range of oral care products and Braun appliances on behalf of the unlisted subsidiaries of the parent. Each of these businesses has comfortably managed double-digit volume growth in the past three years. This growth is likely to be sustained, given the potential of upgrading users from double-edged razors to the more convenient twin-blade razors.

However, the near-term uncertainties for ISPL lie not in the lack of growth prospects for its business, but in the uncertainties resulting from Gillette Inc restructuring operations in India. In 2000 first quarter, ISPL proposed the merger of two unlisted subsidiaries of the parent -- Wilkinson Sword India and Duracell India -- with itself, at a swap ratio of 2:9 and 2:13 respectively. The consolidated entity is to be renamed Gillette India once the merger takes effect in the fourth quarter of 2000. This merger is likely to raise Gillette Inc's stake in the listed company from 51 per cent to 72 per cent.

Since both subsidiaries are unlisted, not many details are available on the financials of these two entities. However, recent reports suggest that the two companies together reported net losses of Rs 28 crore in 1999 and carry substantial accumulated losses in their balance-sheet. The impact of the merger is likely to be felt in the fourth quarter financial announcement from ISPL, when the merger takes effect. Though ISPL claims the merger takes advantage of the tax shield offered by the accumulated losses, an adverse impact in the fourth quarter financials cannot be ruled out.

In fact, it is the near-term uncertainty resulting from this merger and the opaque structuring of the above transactions that have decimated the ISPL stock's valuation. However, from a more long-term perspective, the addition of the businesses from Wilkinson Sword India and Duracell India benefits ISPL.

One, the addition of lower-end shaving products, 7 O'Clock blades, Wilman Shaving systems from Wilkinson Sword India, and the strong battery business comprising of the Duracell alkaline batteries and the newly-acquired Geep Industrial Batteries, could broad-base ISPL's product portfolio and lend it critical mass. The transfer of the manufacturing facilities now held by the group companies could lower the proportion of trading income in ISPL's revenues and stabilise the operational profile. Second, the merger of the unlisted subsidiaries with the listed company ensures that future product launches from Gillette Inc would be routed through the listed company.

Since growth prospects for ISPL hinge largely on access to the parent's product pipeline, this is a major positive factor. One final confidence-inducing factor is Gillette Inc's 72 per cent post-merger stake in ISPL. This will ensure that the fortunes of the listed company are not seriously compromised.

Even after the sharp decline in the stock price to Rs 674, the valuation for the ISPL stock, at around 48 times the latest earnings, is still at a premium among FMCG stocks. Given the near-term uncertainties, there could be a further downside in the stock in the run-up to the fourth quarter performance announcement. Fresh investments in the stock can, therefore, be avoided at this juncture. Long-term investors can, however, hold in expectation of the benefits from restructuring.