Unilever Plc wants to look good for its shareholders but not for corporate raiders. It will want every hand on deck in this project, one of them being Hindustan Unilever Ltd (HUL). Two questions arise from Unilever’s business review. If Unilever is setting sights on higher profitability, does that mean its subsidiaries will follow suit? And secondly, will they also return more cash, so that Unilever has more cash to return to its own shareholders?
Unilever’s business review was prompted by a hostile takeover bid by the Kraft Heinz Co., prompting it to examine how it could give better shareholder returns and also bolster its defences. That prompted an organization-wide review.
Some smaller consequences on HUL seem apparent. HUL had separated foods and refreshments into two categories in June 2016. Now, Unilever has decided to merge them. Unilever also plans to lower costs in its supply chain, marketing and overheads (including manpower). Cost-cutting is not a new event but some measures may see changes in India as well.
One number Unilever has committed to is a 20% operating profit margin by 2020, from 16.4% in 2016. In the nine months ended December 2016, HUL had an Ebitda (earnings before interest, tax, depreciation and amortization) margin of 17.5%, and it may feel the pressure to improve. In personal care (soaps, skin and hair care products), HUL’s segment margin is 23% and could improve on the back of higher soap prices. In home care (detergents and household products), however, its margins are in single digits. Taking them to 20% will be difficult, but the attempt will be to take it higher. Expect more focus on premium brands compared to mass brands, such as Wheel.
In food and refreshment, the beverages part is a relatively mature market but with potential in emerging categories such as green and herbal teas. It is a large business too. But the packaged foods business is one where HUL and its rivals are attempting to grow the market. A focus on profitability could stunt HUL’s growth in this segment. HUL may have to work harder to convince its parent why it should remain in categories with potential that don’t meet its profitability criteria. In others, it may just have to exit.
Coming to the cash part, Unilever has said it will deploy it in select bolt-on acquisitions. Unless it has a large acquisition to fund, it will return more cash annually. It intends to return €5 billion to shareholders in 2017 through a buyback. It will raise more debt to be able to do that. Can HUL return more cash? It has been paying out nearly all the net cash it generates from operations as dividend. Even then, as of September 2016, cash and investments amounted to Rs3,153 crore.
HUL’s business runs on negative working capital, meaning it needs this cash only for acquisitions or building factories. If it returns more cash, that will be good for shareholders, as it will improve its return on capital further. In the past, HUL has converted part of its reserves to bonus debentures, creating quasi-debt on its books, and then redeeming it later. Unilever’s desire for cash may lead to some impact on HUL’s balance sheet as well.