Wednesday 14 July 2010

A Whistle Blower

Prof. Sanjay Bakshi Management Development Institute Wednesday 14 July 2010

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The Man Behind Hawkins Transformation Hawkins Cookers is a fifty year old company which manufactures and sells cookware primarily whistling pressure cookers. Over the last six years, Subhadip Dutta, who is now CEO, has transformed Hawkins from a mediocre business to a great one. The Transformation of Hawkins For years before Mr. Dutta became Head of Marketing at Hawkins in August 2004, the companys stock price underperformed broad market indices. See chart below:

However, things changed from August 2004. This can be seen from the chart below which shows how the companys stock performed as compared to the broad market index. Hawkins

stock price soared by a whopping 5,700% as compared to a rise of a mere 214% in Nifty. By any measure this kind of performance is stupendous. How did this happen? Our thesis is that when you combine a mediocre business which has the potential to become a great one, with a brilliant manager who is capable of achieving that transition, then the
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outcome for owners over the long term is going to be very good. The chart below certainly shows this outcome for Hawkinss stockholders.

It is our belief that this kind of stupendous stock market performance, reflects, over the long term, the fundamental improvements in underlying companys operations. That there were major improvements in Hawkins performance is something we will now demonstrate with facts and figures. We will also show that this fundamental improvement in coincided with the increase in Mr. Duttas influence over Hawkins. We will then speculate that these two events i.e. (1) the increase in Mr. Duttas influence over Hawkins; and (2) the fundamental improvement in companys performance, are not coincidental and that one caused the other. That Hawkins has become a great business under the leadership of Mr. Dutta can be seen from the chart below which shows how operating cash flow on capital employed has soared:

This outstanding result was caused due to a combination of (1) higher operating cash flow margins; and (2) higher efficiency of capital invested in the business.

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Higher Operating Cash Flow Margins The chart below depicts how, under the leadership of Mr. Dutta, the operating profit margins of the company have risen over the last few years.

Operating Profit Margin FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 6.6% 5.4% 5.1% 4.8% 2.4% -3.4% -8.8% 0.9% 3.0% 4.8% 7.3% 9.5% 13.2% 21.4%

Raw Material as % of Revenue 48.2% 45.4% 42.8% 42.2% 44.8% 41.0% 32.7% 35.5% 39.9% 34.2% 39.7% 39.1% 37.7% 33.3%

Advertising as % of Revenue 8.5% 9.7% 9.1% 8.1% 9.2% 12.3% 10.2% 7.0% 7.1% 5.2% 4.5% 4.8% 4.4% 4.4%

How was he able to accomplish this feat? There are two key reasons: raw material costs and advertising costs. The table on the left shows that both have fallen quite consistently over the years and explain most of the jump in the operating profit margins. One reason why both costs fell as compared to revenue is pricing power inherent in the Hawkins brand. Our analysis shows that Mr Dutta increased prices of Hawkins Pressure Cookers and other Cookware products soon after he was appointed as Head of Marketing in August 2004.

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See table below: FY97 to FY04 FY05 to FY09 Price Inflation in Pressure Cookers Price Inflation in Other Cookware 2.3% p.a. 0.7% p.a. 5.1% p.a. 7.1.% p.a.

We will later show that these prices increases were accompanied by a rise in volume of sales in both categories which demonstrates the pricing power of the Hawkins brand recognized and put to good use by Mr. Dutta as the figures in the above table demonstrate. Rising product prices combined with falling cost of raw materials which was not passed on to customers, resulted in Advertising Cost (Rs Mil) FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 76 93 92 87 97 116 91 68 76 65 72 89 97 115 Revenues (Rs Mil) 892 949 1,005 1,080 1,060 945 891 968 1,080 1,246 1,586 1,876 2,219 2,613 Advertising cost as % of Revenues 8.5% 9.7% 9.1% 8.1% 9.2% 12.3% 10.2% 7.0% 7.1% 5.2% 4.5% 4.8% 4.4% 4.4% margin expansion. However, as mention earlier, another major contributor to margin expansion was the significant drop in advertising costs as compared to revenues. See table on the left. Notice that the company spent about the same money in Rupees on advertising in FY01 that it did in FY09. However, revenues in FY09 were more than twice the revenues in FY01. This astonishing fact is even more remarkable given that Hawkins is a company which sells consumer products for which demand is largely driven by advertising. Clearly, Mr Dutta knows how to get the best bang for his buck from advertising
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Capital Efciency Another astonishing fact about the performance of Hawkins under the leadership of Mr. Dutta is that revenues increased while capital employed in the business decreased as the table below demonstrates: Revenues (Rs mil) FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 949 1,005 1,080 1,060 945 891 968 1,080 1,246 1,586 1,876 2,219 2,613 Average Capital Employed (Rs Mil) 375 430 446 495 549 464 362 348 317 228 212 255 98 Capital Turnover (Times) 2.9 2.7 2.8 2.6 2.1 2.3 3.1 3.6 4.6 8.1 10.3 10.0 30.1 How did this happen? There are two reasons. One, the company had ample unitized capacity to increase production without any significant investment in plant and machinery. Even at present the companys factories, in aggregate, are operating at less than 50% of installed capacity. Increase in business volume was therefore accomplished without any new net investment in fixed assets. Two, the company has

managed its working capital brilliantly as the chart below depicts:

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Growth in Business Volumes Mr Duttas astute distribution and marketing strategies have resulted in significant rise in business volumes in both pressure cookers and cookware segments. This increased has been achieved despite price rises, as mentioned earlier. See charts below:

Hawkins business volumes have grown at more than twice the rate at which the industry has grown. How, and why did this happen? There are only two national brands in pressure cookers and cookware in India. One, of course is Hawkins and the other one is Prestige. Both these brands enjoy a combined market share of about 50% with the remaining market share distributed amongst a large number of regional players none of which have the scale economics enjoyed by Hawkins and Prestige and none of which can match the quality of the products produced by these two companies. Both companies have about 25% market share and both have been growing faster than the market
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which is growing at about 8% a year. Clearly, both have been successful in taking market share from the smaller players. We believe this trend will continue for many years to come. Consider this. If the market continues to grow at 8% a year and both Hawkins and Prestige continue to grow at 15% a year, then in five years the market would have grown by 47%, but both these large players would have growth by 100%, while their aggregate market share would have risen from 50% at present to 68%. We think, this long-term trend is highly likely to happen as increasingly prosperous Indians move away from cheaper unbranded cookware to these two well-recognized brands. Another reason for the rise in business volumes for Hawkins is the increase in export sales over the years. Amazon.com sells Hawkins Futura Pressure Cookers. Over the last few years exports sales have grown. Before Mr Dutta became Head of Marketing, export sales were non existent. Today the company exports about 5% of its production to an increasingly large segment of Non-Resident Indians as well as non-Indians. See some reviews below:

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The reviewer at Amazon.com who called the Hawkins Futura Pressure Cooker a work of art was right because a Hawkins pressure cooker is the only one ever displayed as an art piece at Museum of Modern Art, New York. The Psychology of the Whistle A whistling pressure cooker is a very Indian idea, one to which many Indians become accustomed to as children. A whistling pressure cooker is found in most Indian kitchens because it offers a very healthy, efficient, and cheap form of cooking. The author knows of no person in India who owns a microwave owen or a grill but does not also own a whistling pressure cooker. The whistle in the pressure cooker has many important psychological attributes. One, it invokes pavlovian association in the form of salivation in expectation of food getting ready to be served. Two, the whistle acts a feedback timing device. Its very common to express time to be taken to cook a recipe in the number of whistles. The cook in the kitchen knows how many whistles it would take to cook chicken curry for example. Moreover, four whistles in a Hawkins pressure cooker is not the same as four whistles in a Prestige one. This results in stickiness of demand. One reason why Prestige is dominant in South India and Hawkins in North India is because of this stickiness. Three, the sound of whistling cooker is often associated with prosperous households in rural India where income levels are low but rising, thereby making Indian branded whistling cookers more affordable. We think given these psychological factors, combined with (1) the absence of any real competition; (2) the increase in the prosperity of India over the next few decades; and (3) the able management of Mr. Subhadip Dutta, it is overwhelmingly likely that Hawkins would be selling far more whistling pressure cookers ten or twenty years from now, than it sells at present. Valuation Hawkins Cookers Limited has 5.3 million shares outstanding. At the current stock price of Rs 1,200 per share, the market is valuing this debt-free company at Rs 6.4 billion. In FY10, the company delivered a pre-tax operating cash flow of Rs 576 million. Given the trajectory of growth at which the companys business happens to be, this valuation does not capture expected future growth in earnings. Consider this: At present pre-tax AAA bond yields are 10% p.a. If Hawkins business was a AAA bond, and it paid Rs 576 million a year in perpetuity, then the value of this non growing perpetuity alone, at present interest rates, would be Rs 5.8 billion. One can therefore see that
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of the total market value of Rs 6.4 billion, Rs 5.8 billion relates to the present value of future earnings if they were to not grow from here. The balance Rs 0.6 billion relates to the growth component of value. Looked another way, one can estimate the markets expectation about Hawkins Cookers earnings at its current stock price of Rs 1,200 per share. This comes to only 1% p.a. We know this because when we estimate the present value of an earning stream which grows at 1% p.a, has a starting value of Rs 576 million, then, at 9%p.a. (AAA bond yield of 10% p.a. less perpetual growth rate of 1% p.a.), we arrive at a value of Rs 6.4 billion, which happens to be the current market value of Hawkins at this time. In other words, at its current market value, the market expects Hawkins to grow its earnings at only 1% p.a. over the long term. Our analysis, however, shows, that its overwhelmingly likely that Hawkins will continue to grow its earrings at a much higher rate of growth for many years to come. Our conclusion is that at its current market value, the very fine business of Hawkins Cookers is an attractive investment for long-term investors because the growth component of this high growth company is virtually free.

Acknowledgement The author would like to thank Mr. Priyank Sanghavi, an Investment Manager in Mumbai, for bringing the Hawkins story to his attention.

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