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A Whistle Blower Wednesday 14 July 2010 1 Prof. Sanjay Bakshi Management Development Institute Wednesday 14 July 2010

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Page 1: Hawkins Fundoo

A Whistle Blower

Wednesday 14 July 2010

1

Prof. Sanjay Bakshi

Management Development Institute

Wednesday 14 July 2010

Page 2: Hawkins Fundoo

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

company’s 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 company’s 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

Wednesday 14 July 2010

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Page 3: Hawkins Fundoo

outcome for owners over the long term is going to be very good. The chart below certainly

shows this outcome for Hawkins’s stockholders.

It is our belief that this kind of stupendous stock market performance, reflects, over the long

term, the fundamental improvements in underlying company’s 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. Dutta’s influence over Hawkins. We will then speculate

that these two events i.e. (1) the increase in Mr. Dutta’s influence over Hawkins; and (2) the

fundamental improvement in company’s 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.

Wednesday 14 July 2010

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Page 4: Hawkins Fundoo

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.

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.

Wednesday 14 July 2010

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Operating

Profit

Margin

Raw Material

as % of

Revenue

Advertising

as % of

Revenue

FY97 6.6% 48.2% 8.5%

FY98 5.4% 45.4% 9.7%

FY99 5.1% 42.8% 9.1%

FY00 4.8% 42.2% 8.1%

FY01 2.4% 44.8% 9.2%

FY02 -3.4% 41.0% 12.3%

FY03 -8.8% 32.7% 10.2%

FY04 0.9% 35.5% 7.0%

FY05 3.0% 39.9% 7.1%

FY06 4.8% 34.2% 5.2%

FY07 7.3% 39.7% 4.5%

FY08 9.5% 39.1% 4.8%

FY09 13.2% 37.7% 4.4%

FY10 21.4% 33.3% 4.4%

Page 5: Hawkins Fundoo

See table below:

FY97 to FY04 FY05 to FY09

Price Inflation in Pressure Cookers 2.3% p.a. 5.1% p.a.

Price Inflation in Other Cookware 0.7% 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

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…

Wednesday 14 July 2010

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Advertising

Cost (Rs Mil)

Revenues

(Rs Mil)

Advertising cost

as % of Revenues

FY97 76 892 8.5%

FY98 93 949 9.7%

FY99 92 1,005 9.1%

FY00 87 1,080 8.1%

FY01 97 1,060 9.2%

FY02 116 945 12.3%

FY03 91 891 10.2%

FY04 68 968 7.0%

FY05 76 1,080 7.1%

FY06 65 1,246 5.2%

FY07 72 1,586 4.5%

FY08 89 1,876 4.8%

FY09 97 2,219 4.4%

FY10 115 2,613 4.4%

Page 6: Hawkins Fundoo

Capital Efficiency

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:

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 company’s

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:

Wednesday 14 July 2010

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Revenues

(Rs mil)

Average Capital

Employed (Rs Mil)

Capital Turnover

(Times)

FY98 949 375 2.9

FY99 1,005 430 2.7

FY00 1,080 446 2.8

FY01 1,060 495 2.6

FY02 945 549 2.1

FY03 891 464 2.3

FY04 968 362 3.1

FY05 1,080 348 3.6

FY06 1,246 317 4.6

FY07 1,586 228 8.1

FY08 1,876 212 10.3

FY09 2,219 255 10.0

FY10 2,613 98 30.1

Page 7: Hawkins Fundoo

Growth in Business Volumes

Mr Dutta’s 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

Wednesday 14 July 2010

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Page 8: Hawkins Fundoo

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:

Wednesday 14 July 2010

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Page 9: Hawkins Fundoo

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 company’s 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

Wednesday 14 July 2010

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Page 10: Hawkins Fundoo

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 market’s 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.

Wednesday 14 July 2010

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