ITC versus Hindustan Unilever: Different tales of their FMCG business

While ITC's non-cigarette FMCG business revenue comprising foods, personal care and retailing, among others, grew at 11 per cent on a comparable basis, the same for HUL was at 16 per cent

Hindustan Unilever (HUL) raced past ITC on Friday to become India’s largest listed fast moving consumer goods (FMCG) company by market capitalisation. Strong March quarter (Q4) results, robust outlook driven by recovery in rural consumption and the company’s brand reach and leadership are expected to keep the volume momentum strong. In fact, after it results last week, the stock has gained 6  per cent, with market cap around the Rs 3.5 trillion mark. 

While both companies have significant overlap across FMCG categories, HUL leads ITC both in volume growth and segment leadership. This coupled with higher profitability in the business has helped HUL pip ITC in the market value race.

Consider the Q4 numbers. While ITC’s non-cigarette FMCG business revenue comprising foods, personal care, stationery and retailing, among others, grew at 11 per cent on a comparable basis, the same for HUL was at 16 per cent, despite the larger base. 

While price cuts post the November GST (goods and services tax) rate rationalisation helped improve volume growth for HUL, margins expanded over 237 basis points to 22.7 per cent on scale benefits and efficiencies. What pegged back sales for ITC is adverse social media rumours against Aashirvaad atta, its single-largest FMCG brand. ITC’s margins, which improved over 110 basis points year-on-year, at 3 per cent is way behind HUL.

The difference in the revenue and margin profile is largely due to the business mix. “ITC makes money in the foods business and is strongly positioned in biscuits (third-largest player), noodles (second-largest) and in wheat flour where they are the market leader. Barring these, they are struggling in areas such as retail, while in personal care the business is sub-optimal given the lower market share,” says Abneesh Roy of Edelweiss Securities. Analysts estimate that personal care and retail are loss-making, though the company does not quantify the margins for each sub-segment. For ITC, quite a few of the segments are relatively new/small (in investment mode) and, hence, don’t add much to the company’s profits currently.

Kaustubh Pawaskar of Sharekhan, too, believes HUL’s presence in mature or well penetrated categories and its domination of the same gives it scale, reach and, thus, higher operating margins. Personal care segment margins for HUL, for example, are at 26 per cent, much higher than the company average of 20 per cent. In addition to soaps and skin care, HUL has a strong presence in detergents, toothpaste, packaged foods and refreshments. 

While ITC does not have products in the detergents and toothpaste categories (dominated by multinationals), it is present in other higher margin segments of deodorants, shower gels and hand wash. In some others, it is lagging behind peers and that is the problem, says an analyst. While in soaps, ITC is number three, its market share is in single digits, keeping the business sub-scale, says an analyst.

In the foods category, however, ITC is a strong player, while at 10.4 per cent, foods is the lowest margin segment for HUL. ITC’s single-biggest brand is Aashirvaad with an estimated revenue of Rs 20-25 billion. While the biscuits business will be of similar size, this is followed by Bingo (snacks), which is estimated to be an Rs 10-billion-plus brand. In the wheat flour business, while the prospects are high given the large presence of unbranded layers, it is an effort to shift people to the branded atta, says another analyst.

Similarly for snacks, the market is at a fairly nascent stage where ITC is looking at making a breakthrough. 

Says Himanshu Nayyar of Systematix Shares, “The food category has inferior margins. It is possible to move beyond the three per cent mark, and reach low teens, which will be upper end for such a business. In the snacks segment, too, it is difficult to go beyond 17-18 per cent.”

While ITC is looking to de-risk its business model away from cigarettes, whose growth is dependent on policies, given the current investment phase and scaling up of its presence in various categories, it will be some time before it can move beyond the low single-digit margins it currently earns in the FMCG business. 

Dairy is another area where ITC has made a beginning. With the rural demand picking up and consumption trends showing an upward bias, analysts believe the company will stand to benefit given its vast distribution reach and brand strength. Analysts believe margins will see an uptick of 100 basis points in the FMCG category (excluding cigarettes) every year, and the consistent rise in the segment’s EBIT (earnings before interest and tax) in the past four quarters is a positive sign. For HUL, analysts expect its volume growth to improve and margins to stay at the current levels.

Coming back to the share price, analysts say, for ITC, even as prospects of its FMCG, cigarette and hotels businesses are improving, the gains will depend on the taxes levied by the government on cigarettes. If there are no tax hikes this year, expect ITC to post at least 15 per cent net profit growth and the price to earnings valuation discount with HUL to reduce.