Hindustan Lever exiting Modern Foods?

Mohini Bhatnagar
24 January 2005

Sources say Hindustan Lever may divest its stake from the former PSU, Modern Foods Industries, which it had acquired during the NDA government's disinvestment era. It is already looking at various options.

Looking at ways to minimise its losses from its bread manufacturing and distribution operations, Hindustan Lever Limited (HLL) has decided to exit direct bread manufacturing and focus, instead, on franchising.

Five years ago in India's first PSU divestment story, HLL acquired the bread manufacturing PSU Modern Foods Industries (MFIL) for Rs170 crore and later pumped in an additional Rs35 crore in upgrading the production units. Last moth HLL admitted that the acquisition of MFIL was a case of improper due diligence and the company's inherent lack of capability in distributing fresh products. This was the first time HLL was getting into distribution of a product with a shelf life of a few hours at the most.

The problems with Modern Foods really began in 2003 when the UP government disqualified HLL as a potential bidder for supplying supplementary nutritional foods (SNF), a combination of wheat soy and milk to state run institutions. This was unprecedented, as the state had been buying SNF from HLL for the past nine years. Till then, the SNF business was making up for the losses made by the breads business, which since 2000 had constituted over 90 per cent of the total business of MFIL.

The cancellation of orders resulted in a sales loss of Rs96 crore, with a 13 per cent gross margin impact (Rs12.4 crore). Overall sales of MFIL fell from Rs272 crore in 2001-02 to Rs181 crore in 2002-03. With the breads business also in the doldrums MFIL declared a loss of Rs14.4 crore in that period.

HLL says Modern Foods suffers from high wage costs, low productivity and has a considerable number of benched staff. It has 11 owned bread manufacturing units, of which three — in Silchar, Bhagalpur and Ujjain — were already closed before HLL acquired the first tranche of 74 per cent control of the company in February 2000. The closed units with nil output, however, continue to have a number of employees on their payroll.

Additionally, the units at Delhi, Faridabad and Kanpur are believed to have become operationally unviable. That left only four units — at Chennai, Bangalore, Kochi and Kolkata — viable, according to an HLL spokesperson. In the unviable units, the cost of making bread is 100 per cent higher than in other competitive units due to a much higher labour cost. According to a source, "The conversion costs in the industry are Rs0.70 to Rs 0.80 per standard loaf against MFIL's average unit conversion cost of Rs1.40."

The source said that to make bread manufacturing a viable operation, the only way out is to bring down the conversion cost in line with industry average through restructuring and reduction of the workforce. This year, HLL is launching a VRS in four units — the second Delhi unit, Silchar, Bhagalpur and Ujjain — that had been shut before HLL acquired Modern Foods.

Ironically, after acquiring Modern Foods, Hindustan Lever effected a significant wage hike for all employees of MFIL as a result of which its wage bill soared Rs40 million, with an average increase of Rs1,600 per employee per month. The company already had around 2,000 employees at the time. Through stringent cost controls and various improvements, HLL also managed to bring down losses to Rs20 crore in 2000-01 from Rs48.2 crore in the previous year.

It also launched a voluntary retirement scheme at all the 19 factories of Modern Foods, including the four units which had been shut even prior to the divestment to bring down costs.

In fact, until the SNF crisis in 2003, the Modern Foods acquisition had appeared to be a success story.

Post-acquisition, the Modern brand was steadily extended to buns, rusks, doughnuts, biscuits, atta fortified bread, diet bread that contains no added sugar and salt, although most of these new products do not enjoy a national presence. Apart from this, there is the range of the original white bread, small cakes and whole-wheat brown bread priced at Rs14 for 400gm.

Most importantly, post acquisition Modern Bread sales went up to Rs100.2 from Rs78 crore in 1999-2000 and the management expected the company to begin making cash profits by 2003.

After the SNF crisis, Modern bread, which a few years ago was a highly visible brand, is now hardly seen at retail outlets. Sources say that with intense pressure in categories like laundry, tea and toothpaste, Modern is low on HLL's priority.