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Aarati Krishnan

A midget in an industry dominated by giants, Henkel SPIC has managed impressive growth rates over the past four years, thanks to acquisitions and active support from its parent. The company has focussed on its strengths at the higher end of the market to register a turnaround in profitability. An improvement in the return ratios will be crucial for a higher valuation of the stock, says Aarati Krishnan.

WITH its turnover barely touching Rs 350 crore in 2001, Henkel SPIC, manufacturer of a range of detergent and cosmetic products, is still a midget in an industry dominated by giants. Hindustan Lever and Nirma — the two key players in the detergent industry — together straddle over 65 per cent share (value) of the market. In 2000, while both companies sold roughly nine lakh tonnes of detergents each, Henkel SPIC registered sales volumes of just 58,000 tonnes.

Yet, Henkel SPIC's financials over the past four years present a much more inspiring picture than those of its big brother. Between 1997 and 2001, Henkel SPIC's net sales grew six-fold from Rs 55 crore to Rs 340 crore. The company profitability performance also improved — from an operating loss of Rs 1.82 crore in 1997 to an operating profit of around Rs 18 crore in 2001.

These growth rates are exaggerated by a small base, but indicate that it has successfully managed to capture market share from its rivals in the industry. This is no mean achievement, given that Henkel SPIC is pitted against the prodigious distribution network and the marketing prowess of giants such as Hindustan Lever, Nirma, and Procter and Gamble. How did Henkel SPIC achieve this?

Bigger product basket

Between 1997 and 2001, after starting out as a marketer of detergent products, Henkel SPIC acquired substantial breadth to its product basket through the acquisition of the ailing Shaw Wallace companies and products drawn from its parent's portfolio. This helped Henkel SPIC gain a foothold in new FMCG categories such as toilet soaps (Margo), household cleaners (Brisk), detergent cakes (Chek) and cosmetics (Fa). These moves helped diversify its revenue streams. Meanwhile, the company also spruced up its operations, putting its idle facilities to use by manufacturing on contract basis for third parties and by exporting products such as zeolite to other arms of Henkel KgaA.

Tinkering distribution

The entrenched distribution network of the market leaders is one of the key entry barriers in the FMCG business. Henkel SPIC addressed this by expanding its distribution reach in stages year after year. By 2001, the company had built up its distribution network, practically from the scratch, to cover 3.3 lakh retail outlets (this compares to the 8.5 lakh outlets serviced by Hindustan Lever). Aware that expanding the rural distribution network would call for large investments with payoffs only in the distant future, Henkel also avoided taking on Hindustan Lever and Nirma on their home turf, in the rural areas. Instead, it focussed on pepping up its distribution network mainly in the urban areas.

Helpful parent

Under normal circumstances, it would be quite difficult for a player of Henkel SPIC's size to finance the large outlays required on promotional and product development expenses for FMCG marketing, leave alone those required for acquisitions. But the company has had some help from its parent — Henkel KgaA. On two occasions in the past two years, the parent has chipped in to prop up Henkel SPIC's finances — through conversion of loans into preference shares and a preferential allotment priced at Rs 89.15 per share in 2000.

More recently, Henkel SPIC indicated that it expected to receive a `support' of $10 million from its parent, possibly as an interest-free loan or a bank guarantee. This apart, Henkel SPIC enjoys free access to the parent's brand's portfolio, and has drawn frequently on this to broaden its product portfolio.

Growth at a price

Bloated equity: However, this does not mean that rapid expansion in Henkel SPIC's businesses has come without a price. For one, the large investments in product development have left the company with a pretty large equity base, by FMCG standards. By end-2001, Henkel SPIC (with a turnover of Rs 340 crore) had an equity base of Rs 116 crore. Hindustan Lever, whose revenues are 30 times those of Henkel SPIC, has an equity base of just Rs 220 crore. The large equity base makes it difficult for Henkel SPIC to tot up a respectable level of per share earnings.

High adspend: Second, as a late entrant to the FMCG market, promotional outlays continue to take away a large chunk of Henkel SPIC's revenues. For instance, in 2001, Henkel SPIC set aside 14 per cent of its sales to finance promotional outlays, whereas the larger players typically spend no more than 8-9 per cent of their sales on promotional spend. The company also carried unamortised deferred revenue expenditure (mainly product development expenses) totalling Rs 65 crore in its balance-sheet by

end-2000, which it hopes to set off against its share premium account at a future date.

Henkel SPIC has tried to work around these handicaps by conserving its resources. For one, it has refrained from trying to put together a rural distribution network, knowing that it would be a hard act to follow in Hindustan Lever. Second, in most product segments, it has focussed on the middle- and higher-end of the market, rather than pitting itself against giants in the mass market. The focus on the higher end of the market could impose a constraint on volume expansion for Henkel SPIC beyond a point. But for now, this has helped Henkel SPIC avoid the intense price competition that determines success at the lower end of the FMCG market.

It would, however, be some time before Henkel SPIC's overall profitability ratios compare favourably to those of its peers. In 2001, the operating profit margins were a measly 5.5 per cent, while most of its peers managed 15-25 per cent. Its return on capital employed hovers at a relatively unimpressive 12.5 per cent.

This is probably why the valuation for the Henkel SPIC stock appears to be on the lower side vis-à-vis some of its established FMCG peers. The company's price earnings multiple is not really relevant as it only recently turned around its operations.

However, the Henkel SPIC stock trades at just around one time sales per share, against three-eight times for competitors such as P&G, Hindustan Lever and SmithKline Consumer. The valuation could improve in line with the profitability parameters.

Near-term blip

Given the decent financial track record and the strong support of the parent, the Henkel SPIC stock would seem to be a good investment proposition for investors willing to wait four-five years.

However, there are some uncertainties to the company's immediate prospects.

The company recently said that its parent is considering bringing the three unlisted Henkel subsidiaries within its fold. The parent has three unlisted Indian arms — Henkel Chembond and Henkel Teroson which are 51 per cent subsidiaries, and Loctite India, a 100 per cent subsidiary.

The three companies, which are in the metal treatment and adhesives businesses, have an estimated total turnover of Rs 80 crore.

Any merger of these companies with Henkel SPIC could alter the latter's product profile and financial contours.

As little information is available about these companies and the swap ratio for the merger, this creates some uncertainty about the near-term prospects for Henkel SPIC India.

Shareholders can wait for a concrete decision on this and then re-evaluate their investment. Fresh exposures can be avoided in the Henkel SPIC stock for now.

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