Nirma: Pare exposures

Recommendation: Pare exposures

Aarati Krishnan

REFLECTING the sluggish conditions prevailing in its core businesses over the past few months, Nirma reported an unimpressive performance for the quarter ended September 30.

After growing at a robust pace over the past three years, both the net sales and net profit figures declined over the previous period, for the second consecutive quarter this fiscal.

For the quarter ended September 2001, Nirma's net profits dropped 28 per cent to Rs 49.89 crore. More disturbingly, net sales too fell 6 per cent to Rs 454.27 crore. Both represent a deterioration over the June 2001 quarter, when sales dropped by around 3.4 per cent and net profit by 13 per cent.

Detergents and soaps and, to a smaller extent, detergent inputs such as soda ash and linear alkyl benzene (LAB), are the key revenue contributors for Nirma. Over the past nine months of 2001, both the soap and detergent markets recorded negative growth. This perhaps impacted Nirma's financials. However, what is disturbing is that the company appears to have fared worse than its arch rival, HLL, in September 2001. For the quarter ended September 2001, HLL managed an 8.3 per cent growth in its soaps and detergents businesses. That the latter could scrape together this growth rate despite its size suggests that it has probably made market share gains at the expense of competitors.

The drop in Nirma's operating profits for the quarter just about mirrors the drop in sales. The margins have not changed much over the previous year. This is in the company's favour, given that prices of inputs such as fatty acids, soda ash and LAB were distinctly higher this quarter than in the corresponding previous period. Nirma's backward integration into soda ash and LAB has probably guarded its margins in the detergents business.

However, in toilet soaps, the continuing rise in vegetable oil prices could be a cause for concern. If Nirma has managed to garner a significant market share in categories such as toilet soaps and detergents, it is largely the result of its aggressive pricing of its products.

Brands such as Nirma Beauty, Nima and Nirma detergent powder have straddled the lower end of the price spectrum. While this strategy has yielded robust volume growth in the past for Nirma, it also makes the company that much more vulnerable to any spike in input prices, restricting its ability to pass on price increases to consumers. With sales growth also dwindling, any sustained rise in input prices could impede future earnings growth.

The newly-announced soda ash expansion project could be another cause for concern. The spate of backward integration projects entered into by Nirma has no doubt helped it keep a tight rein on its operating costs. However, for an FMCG company, Nirma has relatively high levels of leverage in its balance-sheet; interest and financing charges have taken a toll on post-tax profits. Even in the September 2001 quarter, interest costs jumped 69 per cent to Rs 30 crore taking away in the process nearly a fourth of the company's operating profits.

Nirma has asserted that the new expansion of soda ash capacity will be financed mainly through internal accruals. However, with the domestic soda ash market already in surplus, this project could create some uncertainty about Nirma's earnings prospects in the next couple of years.

Even if Nirma manages to get reasonable realisations on its new soda ash capacity, the project is bound to absorb a significant portion of Nirma's cash flows in the near term. This may not be welcome at a time when the FMCG market is in the grip of severe competition.

At its current market price of Rs 245, Nirma trades at a price-earnings multiple of nine times its latest earnings. Though this may appear to be a modest PEM, the difficult conditions in the industry and the uncertain near-term prospects for Nirma may limit scope for appreciation in the stock price.