Hindustan Lever v/s ITC

The Big Fight

Nikhil Vora
(M) +91 –9821132471 / (Dir) +91-22-56383308
1
nikhilvora@sski.co.in
HLL v/s ITC

Circa 2000…
The Big Fight

HLL: Reaching two third of Indian ITC: Reaching depth and breadth of the
households, best of the brands in its nation, but under constant litigation
kitty, a venerable position among threat and desperately looking for
competitors newer avenues

(Rs m) Gross Revenues

120 HLL = 1.4x ITC
HLL ITC

100

80

60

40
FY96 FY97 FY98 FY99 FY00

Who would you bet on?

2
HLL v/s ITC

Who would you bet on?

The Big Fight

On former

But, we did not…

3
HLL v/s ITC

And we have been proved right…

The Big Fight

Today…
Gross Revenues
(Rs bn)
150

HLL ITC
ITC = 1.2x HLL

130

110

90

70
FY01 FY02 FY03 FY04 FY05

HLL: Core business stagnating, intense ITC: No more just a cigarettes business,
competitive pressure and failure to limited competition, growth derived
identify growth drivers from multiple fronts

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HLL v/s ITC

Why did we bet on ITC?

The Big Fight

HLL ITC
Deflationary cycle Business Model Growth cycle
Margin myopia 3Cs impact

A mere price taker Calling the shots

Ability to call shots Not a single brand has ever
Seen in recent price wars
seen a price decline

Multiple growth drivers

Absence of growth drivers • Core business of cigarettes
• 50% of revenues from - far from saturation point
highly stagnated markets • All businesses highly
Growth drivers
• Personal product - the scalable
only growth driver • As businesses scale up,
• Virtual absence in foods profitability to increase

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HLL v/s ITC

Ability to call shots – the key strength

The Big Fight

Competitive pressure Brand relevance

Ability to call shots/ Pricing power

Resource employment Ability to evolve

Appetite to take risk
and and
and stay invested
excess cash generation enter newer businesses

Cause and impact of the overall business model and competitive strength

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HLL v/s ITC

HLL – A price taker?

The Big Fight

Competition a nuisance value – space too cluttered with small players

Soaps Detergents

Value Market share Value Market share Value Market share Value Market share
59.7% 380bps drop in 5 yrs 38.6% 200bps drop in 5 yrs

HLL HLL HLL HLL

Nirma Nirma Ghadi

Nirma

Nirma Reckitt P&G

Henkel
Reckitt
Godrej
Ghadi
P&G
Godrej Henkel

2000 2005 2000 2005

Have not only eaten market share, but even stripped HLL’s pricing power

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HLL v/s ITC

HLL – A price taker?

The Big Fight

Oral Care Hair Wash

Value Market share Value Market share Value Market share Value Market share
36.4% 380bps drop in 5 yrs 70% 2100bps drop in 5 yrs

Colgate Colgate

HLL HLL

HLL HLL

P&G

Dabur Cavinkare

Anchor P&G
Amar Dabur
Dabur

2000 2005 2000 2005

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HLL v/s ITC

HLL – a mere price taker

The Big Fight

High price elasticity = low brand relevance

Price = functional benefit

Detergents Growth in Realization / tonne Volume Growth

8.0% 6.7%
6.0% 5.0%
4.3%
4.0%
1.2%
2.0% 0.5%
0.0%

-2.0% -0.5%
-1.2%
-4.0% -3.1% -2.8%
-3.4%
FY01 FY02 FY03 FY04 FY05

Only option - follow competitive pricing to protect volume share

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HLL v/s ITC

ITC – a price maker?

The Big Fight

¾ Where is the competition, except from ‘bidis’?

¾ High brand loyalty: low price elasticity
¾ Consistent price increase with no switchovers seen

ITC FY95 FY00 FY05 CAGR - 10 CAGR - 5 years

years (%) (%)
Cigarette volumes (m) 50,609 66,145 69,998 3.3 0.57

Unit realization (Rs/stick) 0.66 1.05 1.43 8.0 6.4

Excise paid (Rs/stick) 0.40 0.60 0.85 7.8 7.2

Net Cigarette price (Rs/stick) 0.26 0.45 0.58 8.4 5.2

Not a single brand has ever seen a price decline

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HLL v/s ITC

Cash generation ability

The Big Fight

HLL: Core business - receding cash

¾ Lower price realization, higher resource employment in soaps & detergents
and higher ASP spends

¾ Negative return on incremental capital employed

¾ Cash generation from overall operations of HLL dropped from Rs21bn to

Rs13bn in two years

ITC: Huge cash generation

¾ Rs20bn generated annually from core business; cash generation from
cigarettes business growing at 10% CAGR
¾ Incremental EBIT on an incline at lower capital employed
¾ Cash generation to improve in the absence of competitive pressures

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HLL v/s ITC

Appetite and willingness to take risk

The Big Fight

HLL: Play in known territory ITC: play where others fear to tread

‰ Willingness and appetite to forego

‰ Has not made successful entry in short-term profits for long-term
any newer business gains
‰ Quick returns or move out – not
‰ Entered capital intensive, low
willing to add businesses making
margin and long gestation
loss in short run
businesses (e-Choupal, Agri,
‰ Moved out of businesses like Hotels)
Bakery, Confectionery, RTE,
‰ Market leader or significant
Healthcare, Services, etc within
player in the businesses that HLL
two years of launch
exited from

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HLL v/s ITC

HLL – dearth of innovation

The Big Fight

2010 ?
2000

Early exit – did not have patience to stay

invested
1990
Years

1980

1970

1960
Rin Bar FAL Skin Close up Clinic Plus Vim Bar Annapurna Atta Max Ayush Kissan Kissan Sangam Pure It
Cream Salt Herbal Bistix Soupy Direct
Snax

Product portfolio unchanged in the past five years

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HLL v/s ITC

ITC – transition to a consumer play

The Big Fight

Sales – Rs135.9bn
Cigarettes – 70%

Sales – Rs118.2bn
EOU - Packaging

Sales – Rs110.2bn 7% share of the biscuits

Launch of Sunfeast market

Sales – Rs98.4bn Atta: Mkt Leader, 36%

Launch of Candyman share. 2nd largest in
Aashirvaad Atta confectionery

Sales – Rs86.8bn Hotels: Rs4bn,

Hotel business re-branding acquired Ansal Hotels
Entry in to foods business Foods: Rs3.6bn

Sales – Rs79.5bn E-choupal:Rs3.5bn

Entry in to Retailing Choupal Sagar: A rural
Launch of e-choupal retail mall

Sales – Rs75.8bn
Cigarettes 87%

1999 2000 2001 2002 2003 2004 2005

Dependence on cigarettes business coming down

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HLL v/s ITC

Redirecting funds towards future growth drivers

The Big Fight

ITC: Funds redirected towards long gestation businesses

Cigarettes Non-cig Hotels Agro-biz Paper/ Total

(FMCG) Pack (Rs m)

Revenues (%) 70 4 3 12 11 143,191

% of EBIT 89 (8) 4 4 11 25,968
EBIT % 23 (35) 25 5 18 20
Capital Employed (%) 23 5 26 14 32 53,878
RoCE (%) 185 (74) 7 13 16 42

HLL: Continued dependence on the core business

Soaps & Personal Beverages Foods & ice Others Total
detergents products cream (Rs m)
Revenues (%) 44.6 24.6 11.9 3.7 15.4 100,607
% of EBIT 44.5 46.4 13.7 (5.0) 0.4 17,418
EBIT % 17.3 32.7 20 (23.1) 0.4 20
Capital Employed (%)* 34.9 36.6 5.7 (1.8) 24.7 20,927
RoCE (%) 106.2 105.6 201.1 NA 1.3 83.2

* Unallocated Capital employed distributed in the proportion of EBIT %

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HLL v/s ITC

The Big Fight

“All products, services and great ideas, no matter how

visionary, eventually become obsolete. But a visionary
company does not necessarily become obsolete”

- James Collins and Jerry Porras in ‘Built to Last’

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HLL v/s ITC

Ability to evolve
The Big Fight

HLL ITC Dabur Marico

Cigarettes – 87%
Soaps & detergents – 40% 100% herbal, Edible and hair oil
2000 Personal Products - 17%
Absence in other
traditional business 100%
FMCG space

Consumer and
Focused consumer play A pure Consumer care
Evolution – power branding consumer play
health care around
and healthcare
herbal proposition

Skin care – products

New Attempted but failed – Biscuits, Fruit Juice, skin care,
Skin care – services
Biscuits, Ayush, Confectioneries, International
businesses Snoupy Snax, RTE, Retailing, business, toothpaste,
Cosmetics
International
Confectioneries other FMCG
business

Soaps & detergents – 45%

2005 Cigarettes New ventures
Personal products–26% NPD
contribution accounting
Shift partly owing to contributing to 18%
down to 70% for over 30%
hiving off of businesses

5 years
0% 11% 15% 10%
CAGR

Evolution – the key to growth

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HLL v/s ITC

The Big Fight

"Unless you try to do something beyond what you have

already mastered, you will never grow“

Ralph Waldo Emerson

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HLL v/s ITC

HLL - what will drive growth?

The Big Fight

Scope for category to grow?

Categories Market Size Urban Rural Total
Penetration Penetration Penetration
Personal wash 55 97.6 90.7 92.8
Fabric wash 45 89.6 82.9 84.9
Skin care 15 36.6 19.8 24.8
Hair wash 10 40.1 16.3 23.4
Oral care 20 69.8 32.3 43.6
Tea & coffee 35 91.2 82.2 84.9

Incremental scope for HLL within the category?

Categories HLL' share
Personal wash 56
Market leadership in 5 of
Fabric wash 38
the 6 categories
Skin care 60
Hair wash 47
Oral care 33 HLL: Rs100bn company in
Tea & coffee 37 Rs400bn business

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HLL v/s ITC

HLL - what will drive growth?

The Big Fight

¾ Only way to grow – more share of wallets,

Soaps & Detergents penetration more than 85%
¾ Gain market share from unorganised players

¾ Far from saturation - penetration below 50%

Personal Products ¾ PCC in India 1/10th of PCC in comparable countries;
but growing clutter

¾ Rs1500bn business, just 10% branded, growing at

over 20%
Processed Foods ¾ Tremendous potential, but needs patience
¾ HLL hasn’t got the foods strategy right, reduced to
a marginal player in the business

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HLL v/s ITC

HLL – an unimpressive mix

The Big Fight

¾ Soaps &
Detergents the
High

Skin Care least lucrative

business
Market Attractiveness

Processed Foods

¾ Too many cash

Medium

Hair Wash Oral care

cows and few

Soaps stars

¾ Insignificant
Low

Detergents
Tea / Coffee
presence in
Low Medium High
most lucrative
Incremental scope for HLL
foods business

With this product portfolio, HLL can at best expect low double digit growth

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HLL v/s ITC

Broadbased growth potential

The Big Fight

ITC businesses - far from saturation

India
• Cigarettes consumption - 14% of the total tobacco consumption
• Per capita consumption – 141 sticks
Globally
Cigarettes –
• Cigarettes consumption - 85% globally and 65% in comparable still gives kick
countries
• Per capita consumption – 1190 sticks

Market sans competition

• India – 0.35% of the global tourism, ARR much below global standards
• Growing tourist arrivals, increasing ARR – shrinking gap between
Hotels – demand and supply of rooms
significant • Eyeing to be the largest player - organic and inorganic growth plans
‘room’ for
on cards
growth
At a GDP growth over 6%, demand for rooms to double in next
five years

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HLL v/s ITC

Broadbased growth potential

The Big Fight

ITC businesses - far from saturation

• Paperboard consumption – 0.75kg, 1/7th of the global average
• Value added coated board business – growing at 20%, ITC is market
leader Paperboard
• Highly capital intensive business, low competition in the long run and specialty
paper
ITC – Rs15bn investment in next four years, fast paced business
scale up

• Increasing out of home eating and need for convenience

• Highly fragmented and room for ‘Me Too’
• Growing at over 20%
Foods – room
for ‘Me Too’ • Low margins – small players to move out in long run

ITC – Rs3.6bn turnover in two years, doubling every year, 75

products across 4 categories

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HLL v/s ITC

ITC - a heady mix

The Big Fight

Cigarettes Processed Foods

High

Hotels
Agri business
Market Attractiveness

Medium

Other FMCG Paper

Low

Low Medium High

Incremental scope for ITC

Each business – a potential ITC

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HLL v/s ITC

Inorganic growth option

The Big Fight

HLL
• Low entry barriers
• Only available option is buy small
brands
Unimpressive track record - Modern
Foods: bought at Rs1.5bn, size today
< Rs500m
• Best Foods: acquired brands Knorr,
Captain Cook. Captain Cook
discontinued, Knorr’s presence
insignificant
ITC
• High business barriers
• ITC, a mortal competitive fear
Recent acquisitions
• Wimco (safety matches) – competition
killed
• Ansal Hotels – added assets
• BILT (Paper) – added capacity
Scouting for more acquisitions in FMCG,
greetings, paper and hotels

Too less value addition and Buying asset or removing

premium valuations competition: at fair valuations

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HLL v/s ITC

The Big Fight

The two companies have swapped places from where

they were in 2000
ITC deriving growth on multiple fronts
HLL faltering to identify a growth driver

Can HLL still displace ITC? We doubt…

The differentiators have put the two in contrasting business cycles

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HLL v/s ITC

HLL – a deflationary model

The Big Fight

Low ability to
Margin myopia
call shots
High profits luring
competition to
enter and play
price game Low incremental
cash generation
Increased
from core business,
dependence
low risk taking
on core
appetite
business

Stagnant No new
revenues business entry
Absence of scalable
growth drivers

Unless HLL does something drastically different, to remain caught in the cycle

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HLL v/s ITC

ITC – a prosperity model

The Big Fight

High pricing Long gestation

power business entry
High cash
generation from
core business,
appetite to Lower
Reduced redirect funds competitive
dependence pressure
on cigarettes
business

Higher revenues,
Multiple growth
but lower profits
drivers
in initial years
Increasing profits
with growing scale

3C impact (Cigarettes, Cash, Consumer)

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HLL v/s ITC

On a different growth trajectory

The Big Fight

Gross Sales Net Profit

HLL ITC HLL ITC
35
210.0

190.0 30

170.0
25
150.0

Rs bn
Rs bn

130.0 20

110.0
15

90.0
10
70.0

50.0 5
FY04 FY05 FY06E FY07E FY08E FY04 FY05 FY06E FY07E FY08E

HLL: gradual growth and constrained margins

ITC: multiple growth drivers and profits with scale
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HLL v/s ITC

HLL – gentle climb over the hill

The Big Fight

Year to December (Rs m) CY03 CY04 CY05E CY06E CY07E

Net sales 101,384 99,269 107,165 115,803 123,847
% change 2 (2) 8 8 7
PAT 17,718 11,974 12,894 15,539 17,666
Share in issue (m) 2,201 2,201 2,201 2,201 2,201
EPS (Rs) 8.1 5.4 5.9 7.1 8.0
EPS growth (%) 0.1 (32.4) 7.7 20.5 13.7
PER (x) 19.9 29.4 27.3 22.7 19.9
EV/ EBITDA (x) 17.5 24.2 20.8 17.8 15.6
EV/ sales(x) 3.4 3.5 3.2 3.0 2.8
Book Value (Rs/ share) 8.5 8.5 8.3 9.3 10.7
Price/ BV(x) 18.8 18.9 19.3 17.2 14.9
RoCE (%) 46.9 33.6 43.3 60.5 62.3
RoNW (%) 59.8 55 62.3 72.1 72.9
Dividend yield (%) 3.4 3.1 3.4 3.4 3.8

Capitalising on improving macro dynamics; back to basics approach

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HLL v/s ITC

ITC – growth from multiple fronts

The Big Fight

Year to March 31 (Rs m) FY04 FY05 FY06E FY07E FY08E

Net sales 64,704 76,395 87,914 100,982 114,885
% change 10 18 15 15 14
PAT 15,929 18,371 22,016 26,407 32,379
Share in issue (m) 249 249 249 249 249
EPS (Rs) 64.4 74.2 88.9 106.7 130.8
EPS growth (%) 16.2 15.3 19.8 19.9 22.6
PER (x) 26.9 23.4 19.5 16.3 13.2
EV/ EBITDA (x) 17.7 14.7 12.6 10.3 8.2
EV/ sales(x) 6.5 5.4 4.6 3.9 3.3
Book Value (Rs/ share) 260 329 376 437 517
Price/ BV(x) 6.7 5.3 4.6 4.0 3.4
RoCE (%) 26 26 25 26 27
RoNW (%) 27 26 26 27 28
Dividend yield (%) 1.2 1.8 1.7 2.6 2.9

Robust core business, rapidly growing non-core business

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HLL v/s ITC

Value the trajectory

The Big Fight

ITC HLL
160

120

80
Bigger scale
40
Better growth

0
Sales Turnover EBITDA Net Profit 3 yr Revenue CAGR 3 yr PAT CAGR

ITC HLL
25

20

15

10
Yet… lower
5 Valuations!
0

PER (x) EV/EBITDA (x) EV/Gross sales (x)

ITC ahead on business performance, but disparate valuations

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HLL v/s ITC

Valuation gap bridging

The Big Fight

HLL - PE ITC - PE
70.0

58.0

46.0

34.0

22.0

10.0
Mar-95

Sep-95

Mar-96

Sep-96

Mar-97

Sep-97

Mar-98

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05
As the consumer portfolio increases, ITC to get consumer valuations

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HLL v/s ITC

We still bet on ITC

The Big Fight

(Rs. Mn) HLL - Market cap ITC - Market cap

640

480

320

160

0
Jan-01

Jan-03

Jan-04
Jan-02

Jan-05
Sep-00

Sep-01

Sep-04
Sep-02

Sep-03
May-00

May-01

May-02

May-03

May-04

May-05
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 HLL v/s ITC

The Big Fight

THANK YOU

Nikhil Vora / Bhushan Gajaria

SSKI Securities
(M) +91 –9821132471 / (Dir) +91-22-56383308
<nikhilvora@sski.co.in> / <bhushangajaria@sski.co.in>

This document has been prepared by S.S. Kantilal Ishwarlal Securities Pvt. Ltd. (SSKI) and is meant for use by the recipient and not for circulation. This
document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell, or a solicitation to buy
any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be
relied upon as such. We may from time to time have positions in, or options on, and buy and sell securities referred to herein. We may from time to time
solicit from, or perform investment banking, or other services for, any company mentioned in this document.

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