28 June 2011

FMCG (Mkt cap: US$78bn) Sustaining high return ratios: IIFL

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The FMCG sector has seen largely stable ROE over the last nine
years. The key operating metrics of the FMCG business model—
operating margins, low working capital-intensity and low fixed-asset
requirements—have not changed over FY03-11. That said, there is
considerable divergence between MNC companies and domestic
companies.
Multinational FMCG companies have seen significant increases in ROE
on account of consistently high dividend payouts (almost their entire
profits) post 2003, a few share buybacks, capital reduction and lower
tax rates (thanks to an increasing share of manufacturing shifting to
tax-exempt zones).
Amongst MNCs, Hindustan Unilever has seen a sharp rise in its ROE,
from 47% in CY02 to over 100% in CY07. The key reasons were the
high dividend payouts after a period of acquisition in the late 1990s,
discontinuation of non-core businesses and a couple of buy-back
programmes. This increase in HUL’s ROE has been despite operating
margins structurally declining by c500bps over CY02-FY11. Colgate
saw a step jump in ROE in FY07 and FY08, as the company reduced
capital, saw a sharp reduction in tax rates, improved EBITDA
margins and improved working-capital efficiencies. GSK Consumer’s
ROEs have also improved, but its absolute ROE is much lower
compared to other MNC FMCG companies, as GSK has seen only 30-
40% dividend payouts and has high cash on books.


Indian companies, though, have seen mixed trends. Between FY03
and FY08, EBITDA margins moved up structurally and working
capital intensity came down as the companies gained scale and both
helped boost ROE. Post-2008, most domestic Indian FMCG
companies have done a series of acquisitions in the Indian and
international markets. This has caused declines in ROEs of Godrej
Consumer, Marico, Emami and Dabur.
ITC’s ROE has risen over the last two years, as the company has
increased dividend payout from 40-50% to over 80% (including
special dividends). This has become possible as ITC’s capex in noncigarette
businesses (Hotels, Paper) has remained stable, while
operating cash flow has risen strongly, driven by higher profits from
cigarettes. This capex as a proportion of operating cash flow has
come down to 25% from over 50% a few years ago.

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