FMCG. Equity Research INDIA. Downgrade HUL; prefer Dabur. Reason for report: Sector update. April 6, 2016 BSE Sensex: 24884

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1 Equity Research April 6, 2016 BSE Sensex: Hindustan Unilever (HOLD) Target price Rs845 Target PE 37.5x FY18E Dabur India (BUY) Target price Rs289 Target PE 31.3x FY18E Research Analysts: Anand Mour Aniruddha Joshi INDIA FMCG Downgrade HUL; prefer Dabur Reason for report: Sector update Lag effect of poor monsoon last year and current water crisis in different parts of the country are likely to have impact on FMCG revenue growth in near term. However, what augurs well for sector is expected rural demand revival with likely normal monsoon. Besides, acceleration in nominal GDP growth, higher disposable income driven by 7 th Pay Commission and One Rank One Pension disbursements shall likely accelerate overall FMCG revenue growth in FY17. At the same time, the key concerns like: 1) increase in competitive pressure due to increasing acceptance of Patanjali products, and 2) rising raw material prices, may impact companies performance differentially. Analysing these macro trends as well as valuation levels of FMCG companies, we believe Dabur offers one of the best risk-reward ratios while HUL appears fully valued with some risks of earnings downgrades. While the effect of Patanjali is seen on Dabur s stock performance over last 3 months, we believe investors seem to be unduly worried about impact of Patanjali on Dabur as only 9% of the latter s portfolio is impacted by Patanjali and the company is on course to report strong FY17 due to: 1) revival of the juice business, 2) improving margins of Namaste, and 3) favourable base. However, ~45% of HUL s portfolio is under competitive threat from Patanjali. While we estimate the impact to be limited on HUL s revenue growth, we moderate our margin expansion estimate for HUL. Key will be if Patanjali adopts aggressive pricing approach during raw materials inflationary environment as that can expound the impact. We tone down our earnings estimates for HUL by 3% for FY17 and 7% for FY18, and downgrade our rating on HUL from BUY to HOLD. At current valuations, Dabur offers a better risk-reward to HUL, with Dabur trading at a 26% discount to HUL, while historically it traded at a 10% discount. Good monsoon to be saviour: While we expect lag effect of sub-normal monsoon and current water crisis to impact FMCG growth in near term, the determining factor for revival has to come from rural demand normal monsoon can turn the tide. Besides, acceleration in nominal GDP growth, 7 th pay commission and OROP disbursements shall also assist in the urban demand revival in FY17. However, Patanjali impact and raw materials inflation will have differential impact across companies. Who will benefit the most? While both HUL and Dabur shall benefit from demand revival in both urban and rural markets, it is the competitive environment and pricing power which will determine the winners. While Dabur s 9% portfolio is under direct line of attack from Patanjali, HUL s portfolio is more exposed at a broader level. With steady increase in acceptance for Patanjali s detergents, dishwash, oral care and soaps, we expect HUL s advertisement spends to intensify in FY17. Rising valuation gap between HUL and Dabur: Dabur has traded at a discount of ~10% to HUL over the past 10 years. However, due to fear of Patanjali, the discount has expanded to 26%. We believe with Dabur expected to report normalcy in growth from Q1FY17, driven by revival in juice, better performance from Namaste, the valuation gap will reverse to the mean. Downgrade HUL; Prefer Dabur: We reduce our earnings estimates on HUL by 3% for FY17 and 7% for FY18 and downgrade our rating on HUL from BUY to HOLD. We prefer Dabur and reiterate BUY on Dabur with a target price of Rs289 (31.3x FY18E). Valuation summary Company Reco CMP (Rs) TP (Rs) RoE (%) CAGR (%) FY15-18 PE (x) FY16E FY17E FY18E FY16E FY17E FY16E FY17E FY18E HUL HOLD Dabur BUY Please refer to important disclosures at the end of this report

2 FMCG sector, April 6, 2016 Analyzing growth drivers and concerns We believe key headwinds and tailwinds that will drive the course of the consumer sector over next 3-4 quarters are as follows. Factors that will drive growth rates of FMCG sector: Normal monsoon in CY16 post deficient rainfall in CY14 and CY15 leading to demand revival in rural areas. Better nominal GDP growth - As the FMCG sector has strong correlation with nominal GDP growth, revival in nominal GDP will drive growth of the FMCG sector. Factors that will impact FMCG sector: Increase in competitive intensity with increasing acceptance of Patanjali non-food staples. Rising raw material prices, amidst weak demand environment and rising competitive intensity. Who will benefit the most? While both HUL and Dabur shall benefit from revival in consumer demand in FY17, we believe HUL s portfolio is relatively at a higher threat from Patanjali than Dabur, given the increasing acceptance of Patanjali s detergents, soaps, oral care, hair care and dishwash. Monsoon to revive growth in rural markets, benefitting both Dabur and HUL Revival in nominal GDP growth to benefit all the players Rising competitive pressure: HUL s portfolio at more risk due from Patanjali than Dabur Rising inflationary pressures: Rising palm oil prices may impact HUL amidst steep competitive situation Dabur earnings to grow at faster pace in the short term than HUL due to better growth prospects in its international business, juice business and favourable base Demand revival to benefit both Dabur and HUL Normal monsoon in FY17 is the perquisite for demand revival for FMCG industry. Besides, increase in disposable income driven by 7 th Pay commission and OROP disbursements shall also help the urban demand revival. While Dabur is positioned to benefit relatively more from rural demand revival, HUL shall be a higher beneficiary of urban demand revival. 2

3 FMCG sector, April 6, 2016 Chart 1: Urban/ Rural revenue breakup HUL Urban Rural Dabur Source: Company, I-Sec research Healthy nominal GDP growth rates to benefit all Historically, FMCG sector revenue has grown at ~1.1x nominal GDP growth. With deceleration in nominal GDP growth in FY16, FMCG sector saw slowdown in revenue growth. However, with expectations of revival in nominal GDP growth, we expect FMCG sector to report better growth in FY17. Chart 2: FMCG sector has strong correlation with nominal GDP growth (%) FMCG growth Nominal GDP growth Ratio of FMCG growth to Nominal GDP growth (RHS) Ratio of FMCG growht to 2-yr rolling nominal GDP growth (RHS) Dec-11 Mar-12 (%) Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Source: Company, I-Sec research Rising competitive pressure: HUL s portfolio at more risk than Dabur Comparing the portfolios of HUL as well as Dabur, we believe HUL is more at risk due to Patanjali compared to Dabur. Only two segments of Dabur, Chyawanprash and Honey (9% of sales) are under direct line of attack of Patanjali s aggression whereas HUL s soaps, detergents, dish wash, shampoos, oral care as well as some personal care products can face steep competitive pressure from Patanjali. We estimate HUL s 45% of revenue may feel the heat from increase in competitive pressure from Patanjali. 3

4 FMCG sector, April 6, 2016 Table 1: Segments and impact of competitive pressure due to Patanjali Segment Impact on Dabur's segments Impact on HUL's segments Honey Some impact due to low price competition Not present Chyawanprash Loss of 2% market share in Q3FY16 Not present Hair oil Hair oils are growing well. Small presence Shampoos Negligible impact of Patanjali Negligible impact Oral care Gained 1% market share in Q3FY16 HUL losing market share Juices No impact of Patanjali Not present Detergents Small presence HUL impacted drastically Soaps Not present Some impact on HUL Skin care Small presence Some impact on HUL Dishwash Small presence HUL impacted drastically. Patanjali s non-food products are gaining high acceptance in West and East markets, while Patanjali s food products are gaining high acceptance in North and East markets. Even in North India, Patanjali s non-foods portfolio is witnessing good demand. HUL is losing market share in oral care to players such as Patanjali whereas Dabur is gaining market share Dishwash and detergents are among the fastest growing products for Patanjali. But the same products account for a very small component of Dabur s revenues Patanjali soaps are growing at faster rate than HUL in modern trade Dabur is facing competitive intensity only in Honey and Chyawanprash segments, with consumer complaints on Patanjali Honey already started to expound Dabur is better placed in terms of pricing compared to HUL Patanjali is gaining mindshare of consumers on two accounts: 1) appeal of pure quality, trust, and 2) lower prices than existing brands. We believe, compared to HUL, Dabur s products are at relatively small premium to Patanjali s products compared to HUL s products. Chart 3: HUL s products are at steep premium to Patanjali compared to Dabur (%) Dabur - premium over Patanjali products (%) HUL - premium over Patanjali products 0.0 (20.0) Chyawanprash Honey Toothpaste Amla Hair oil Shampoo Facewash Soaps Detergents Detergents powder Dishwash. 4

5 FMCG sector, April 6, 2016 Rising inflationary pressure: Depends on how Patanjali react Palm oil prices, a major raw material for HUL s soap business, is moving upwards and average prices in Q2FY16 are up 15%, YoY. If we assume the current price as average for FY17, HUL will also see ~16% inflation in palm oil price. We believe HUL may be forced to cut promotions / raise prices amidst rising competitive pressure from Patanjali. We also reckon sugar prices are moving upwards and may hurt Dabur s Chyawanprash segment if the prices remain at elevated levels till Q3FY17. It will be interesting to note how Patanjali reacts on pricing with raw materials inflation, or they focus on aggressive price advertisements to gain market share. Chart 4: Higher prices of palm oil Chart 5: Higher prices of sugar 58 3,600 3,400 (Rs/kg) (Rs/Quintal) 3,200 3,000 2,800 2,600 2, Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 2,200 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Source: NCDEX, I-Sec research 5

6 FMCG sector, April 6, 2016 Dabur s growth to bounce back, ahead of HUL Dabur will be in a position to report better growth rates compared to HUL due to: 1) the juice segment is back on track post resolution of supply chain issues 2) resolution of most issues concerning Namaste, which is set to report strong earnings growth over FY16-FY18, and 3) favourable base of FY16, which was impacted by numerous oneoff issues. Chart 6: Dabur s quarterly revenue growth to revive (%) Dabur HUL Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16. Cushion of international business to Dabur: We believe Namaste, which has been written off by many investors as a lifeless investment, may surprise positively. Key reasons for our optimism are as follows: Namaste s business suffered in FY15 due to drop in demand for relaxers and related products. This led to a sharp drop in Namaste s profitability as its fixed costs remained unchanged. Though Namaste generates gross margins comparable to Dabur s, its EBITDA margin dipped below 0% in FY15 due to higher fixed costs. However, Namaste relaunched some of its products with natural ingredients and this led to double-digit revenue growth in 9MFY16. Once the business reaches a size of ~Rs7bn by FY18E, the fixed costs may remain similar to current levels, hence profit margin will shoot up. As Namaste accounts for 7% and 22% of Dabur s consolidated revenues and International business revenues respectively, we expect a healthy stimulus to Dabur s earnings from revival in Namaste s profitability. 6

7 FMCG sector, April 6, 2016 Table 2: Key financials of Namaste Particulars (Rs mn) FY12 FY13 FY14 FY15 Revenues 5,574 4,905 5,910 4,673 Other operating revenues Total revenues 5,574 4,905 5,926 4,684 Material cost 2,543 2,211 3,080 2,314 Gross profit 3,031 2,695 2,845 2,370 Employee costs Other expenses 1,809 2,104 2,319 2,001 EBITDA (95) Gross margin (%) EBITDA margin (%) (2.0) As % of Net sales Raw Material cost Employee costs Other expenses Source: Company, I-Sec research P/E premium of HUL over Dabur higher than historical, expect to reverse to mean Over last 10 years, Dabur has traded at an average discount of ~10% to HUL. Due to the concerns of Patanjali s impact, Dabur s stock has underperformed over the past six months which has led to the discount shooting up to 26%. We expect the discount to reverse to the mean in the coming quarters with improving earnings growth for Dabur. Chart 7: Dabur s Premium / Discount to HUL s P/E HUL Dabur Average Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Jan-14 Jun-14 Nov-14 Apr-15 Sep-15 Feb-16 7

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9 Equity Research April 6, 2016 BSE Sensex: FMCG Target price Rs845 Earnings revision (%) FY16E FY17E FY18E Sales EBITDA EPS Target price revision Rs845 from Rs916 Shareholding pattern Jun 15 Sep 15 Dec 15 Promoters Institutional investors MFs and UTI Banks, FI s, Insurance co FIIs Others Source: BSE Price chart (Rs) Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Research Analysts: Anand Mour Aniruddha Joshi INDIA Hindustan Unilever Fairly valued HOLD Downgraded from Buy Rs868 Reason for report: Company update and recommendation change While demand revival shall augur well for HUL s revenue growth, but we believe that rising competitive intensity shall keep advertisement spends at an elevated level, impacting its margins. Though Hindustan Unilever (HUL) boasts of enviable financials like 3-digit return ratios and strong FCF generation, we believe the stock appears full valued at current price, amidst 1) rising competitive pressure from spiritual players such as Patanjali, 2) rising raw material prices, and 3) the stock is trading above its mean P/E of the past five years despite lower earnings growth than earlier years. We also expect the street to downgrade earnings in the coming quarters. Hence, we believe the risk-reward ratio is in not in favour and shall wait for better entry points ahead. We revise down our earnings estimates by 3% for FY17 and 7% for FY18, and downgrade our rating on the stock from Buy to HOLD with revised target price of Rs845 (37.5x FY18E). Rising competitive pressure: We believe rising competitive pressure from Patanjali may impact HUL s pricing power in FY17. With increasing acceptance of Patanjali s non-food staples like detergents, dishwash, personal care, we expect HUL to intensify advertisements spends, though we do not build in much impact on its revenue growth. Rising raw material prices: We believe prices some of the raw materials such as palm oil are moving upwards sharply. Rising crude oil prices may also result in higher LAB, liquid paraffin and packaging material prices. Hence, we expect HUL to either raise raw material prices and/or cut promotions, boosting its price led growth. However, if Patanjali opts to play aggressive price advertisements in this environment, margin may come under pressure for HUL. Fairly valued: HUL is currently trading at a P/E multiple of 36.5x on FY18E compared to its average multiple of 34x over the past five years. The company reported 12% earnings CAGR over CY07-FY15 and traded at average 1-year forward P/E multiple of 27.5x. However, despite CAGR of just 10.4% over FY15- FY18, the stock is currently trading at 1-year forward P/E 41.3x. Hence, we believe the upside is limited with the stock currently fairly valued. Downgrade to HOLD. We reduce our earnings estimates by 3% for FY17 and 8% for FY18, factoring higher advertisements. We downgrade the stock to HOLD from Buy with a revised target price of Rs845 (37.5x FY18E). Market Cap Rs1879bn/US$28.3bn Year to March FY15 FY16E FY17E FY18E Reuters/Bloomberg HLL.BO/HUVR IN Net Revenue (Rs mn) 308, , , ,704 Shares Outstanding (mn) 2,163.9 Net Profit (Rs mn) 43,153 41,169 45,714 51, week Range (Rs) 949/768 Dil. EPS (Rs) Free Float (%) 32.8 % Chg YoY FII (%) 13.9 P/E (x) Daily Volume (US$'000) 17,324 CEPS (Rs) Absolute Return 3m (%) 2.4 EV/EBITDA (x) Absolute Return 12m (%) 0.1 Dividend Yield (%) Sensex Return 3m (%) (2.4) RoCE (%) Sensex Return 12m (%) (10.5) RoE (%)

10 Hindustan Unilever, April 6, 2016 Earnings revision Table 1: Earnings revision (Rs mn) FY16E FY17E FY18E Old New % chg Old New % chg Old New % chg Net Sales 320, , , ,147 (0.3) 399, ,704 (1.9) EBITDA 56,845 57, ,653 63,821 (1.3) 76,157 72,689 (4.6) PAT 41,017 41, ,081 45,714 (2.9) 55,799 51,704 (7.3) EPS (Rs) (2.9) (7.3) Source: I-Sec research We marginally tweak our revenue estimates for FY17-FY18 by 0.3% to 1.9%. We factor in higher advertisement spends, driven by higher competitive intensity, resulting in EBITDA margins to be lower than earlier expected. Thereby, we have cut our earnings estimates for FY17-FY18 by %. I-Sec vs consensus estimates Table 2: Our estimates vs consensus (Rs mn) I-Sec Consensus Variance (%) Revenues FY16E 320, ,535 (1.0) FY17E 351, ,007 (2.2) FY18E 391, ,382 (2.4) PAT FY16E 41,169 41,584 (1.0) FY17E 45,714 47,197 (3.1) FY18E 51,704 53,929 (4.1) Source: Bloomberg data, I-Sec research Our revenue estimates for FY16, FY17, and FY18 are 1-2.4% lower than the consensus. We factor higher advertisement spends and adjust for tax rate, resulting in our FY16-FY18 earnings estimates lower than consensus by 1-4.1%. Valuation and risk We expect HUL to report earnings CAGR of 10.4% over FY15-FY18 vs 12% over CY07-FY15 and improvement in volume growth trajectory from 6% in FY15 to ~7% in FY18. We downgrade the stock to HOLD with a revised target price of Rs 845/share, 37.5x FY18E EPS, derived as a triangulated average of P/E (Rs836 35x FY18E EPS), DCF (Rs853 assuming WACC of 10.3% and terminal growth rate of 4%), and FCF yield (Rs % FY18E FCPS). P/E based valuation The stock has traded at 34x 1-year forward earnings over the past five years. With earnings CAGR of 10.4% over FY15-FY18, we believe HUL will continue to trade at a premium to its historical multiple. 10

11 Hindustan Unilever, April 6, 2016 Chart 1: Mean P/E and standard deviations P/E (X) -1 Std Dev Average 1 Std Dev (x) Apr-09 Sep-09 Mar-10 Aug-10 Jan-11 Jul-11 Dec-11 Jun-12 Nov-12 Apr-13 Oct-13 Mar-14 Aug-14 Feb-15 Jul-15 Jan-16 FCF yield based valuation The stock has traded at 1-year forward FCF yield of 3.3% over the past three years. With limited capex and negative working capital, we expect FCF generation to remain strong, hence value the stock at a target price of Rs845 at 3.3% FCF yield on FY18E FCPS. DCF-based valuation Valuing HUL on DCF methodology involves three stages: Stage 1 (FY15-FY18E): During this period, we expect the company to grow its revenue and PAT at CAGRs of 8.3% and 10.4% respectively. We expect RoE to improve from 109.8% at the start of this stage to 504.2% by the end of the stage. Stage 2 (FY18E-FY30E): During this period, we expect the company to post revenue and PAT CAGRs of 12% each. Stage 3 (FY30 onwards): We assume a growth rate of 4% from FY30 onwards. To arrive at WACC of 10.3%, we have assumed cost of equity at 10.3% and cost of debt at 9%. Based on these assumptions, we arrive at a DCF-based valuation of Rs853/share for HUL. 11

12 Hindustan Unilever, April 6, 2016 Chart 2: Cashflow performance and RoE Table 3: DCF calculations Free Cash Flow to the Firm (Rs mn) ROE (%) Rs mn unless otherwise stated 70, % PV of FCF for forecasting period (FY16 FY30) 932,155 60, % Terminal Value 872,622 50, % Fair Value of Investments 32,779 40, % Enterprise Value 1,837,557 30, % Less: net debt/ (cash) at 31st March ,061 20, % Implied equity value 1,845,617 10,000 0% Fully diluted equity shares (mn) 2,164 CY05 CY07 FY10 FY12 FY14 FY16E FY18E Implied equity value (Rs/share) 853 Source: Company, I-Sec research Key risks Steep increase in competitive pressure Steep increase in competitive pressure may impact HUL s earnings. 12

13 Hindustan Unilever, April 6, 2016 Financial summary Table 4: Profit & Loss statement (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Net Sales 308, , , ,704 Operating Expenses 255, , , ,015 EBITDA 52,082 57,067 63,821 72,689 % margins 16.9% 17.8% 18.2% 18.6% Depreciation & Amortisation 2,867 2,982 3,101 3,225 Gross Interest Other Income 6,184 6,184 6,184 6,184 Recurring PBT 55,231 60,101 66,736 75,480 Less: Taxes 16,802 18,932 21,022 23,776 Less: Minority Interest Net Income (Recurring) 38,430 41,169 45,714 51,704 Extraordinaries (Net) 4, Reported Net Income 43,153 41,169 45,714 51,704 Table 5: Balance sheet (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Assets Total Current Assets 72,236 75,646 58,584 71,538 of which cash & cash eqv. 25,376 28,252 8,061 16,673 Total Current Liabilities & Provisions 99, , , ,000 Net Current Assets (26,857) (27,437) (54,370) (54,462) Investments 32,779 32,779 32,779 32,779 Net Fixed Assets 24,575 24,924 25,121 25,165 Capital Work-in-Progress 4,790 4,790 4,790 4,790 Total Assets 35,288 35,057 8,320 8,272 Liabilities Borrowings Deferred Tax Liability (1,960) (1,960) (1,960) (1,960) Minority Interest Equity Share Capital 2,164 2,164 2,164 2,164 Face Value per share (Rs) Reserves & Surplus* 35,084 34,853 8,116 8,068 Less: Misc. Exp. n.w.o Net Worth 37,248 37,016 10,279 10,232 Total Liabilities 35,288 35,057 8,320 8,272 Table 6: Quarterly trends (Rs mn, year ending March 31) Mar-15 Jun-15 Sep-15 Dec-15 Net sales 76,756 81,051 79,554 79,810 % growth (YoY) EBITDA 13,182 15,064 13,084 14,308 Margin (%) Other income 984 1,086 1,702 1,396 Extraordinaries (Net) 1, (525) Net profit 10,181 10,591 9,622 9,714 Table 7: Cashflow statement (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Operating Cashflow 41,297 44,151 48,815 54,928 Working Capital Changes 2,816 3,457 6,742 8,704 Capital Commitments (4,814) (3,330) (3,297) (3,270) Free Cashflow 39,299 44,277 52,260 60,363 Cashflow from Investing Activities (1,838) Issue of Share Capital (1,500) (6,785) (11,873) (8,481) Inc (Dec) in Borrowings Dividend paid (32,453) (34,616) (60,578) (43,270) Change in Deferred Tax Liability (342) Chg. in Cash & Bank balances 3,166 2,876 (20,191) 8,612 Table 8: Key ratios (Year ending March 31) FY15 FY16E FY17E FY18E Per Share Data (Rs) EPS Cash EPS Dividend per share (DPS) Book Value per share (BV) Growth (%) Net Sales EBITDA PAT Cash EPS Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Sales Operating Ratios Raw Material / Sales (%) Employee cost / Sales (%) SG&A / Sales (%) Other Income / PBT (%) Effective Tax Rate (%) Working Capital (days) (32.0) (31.4) (56.7) (50.9) Inventory Turnover (days) Receivables (days) Payables (days) Net D/E (x) Profitability Ratios (%) Net Income Margins RoACE RoAE Dividend Payout Dividend Yield EBITDA Margins

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15 Equity Research April 6, 2016 BSE Sensex: FMCG Target price Rs289 Shareholding pattern Jun 15 Sep 15 Dec 15 Promoters Institutional investors MFs and UTI Banks, FI s, Insurance co FIIs Others Source: BSE Price chart (Rs) Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Research Analysts: Anand Mour Aniruddha Joshi INDIA Dabur India Good price to enter BUY Maintained Rs248 Reason for report: Company update Threat of Patanjali on Dabur s portfolio has led to underperformance of the stock in the past three months. However, only 9% of Dabur s portfolio (Chyawanprash and Honey) are in the direct line of attack. Further, we believe Patanjali s presence is helping these categories grow faster and the recent consumer dissonance about crystallization of Patanjali honey and Dabur s aggressive campaign should help Dabur regain some of its lost consumers. Besides, the reason why Dabur s business suffered in FY16 was related to multiple transitory issues. With prospects of normal monsoon in FY17, Dabur, with about 55% of revenues coming from rural India, will be one of the largest beneficiaries of revival in rural demand. We expect: 1) Dabur s juice business to report healthy growth in FY17 as supplies from Nepal have normalised, 2) sharp jump in Namaste s EBITDA margins in FY16-FY18 - (Namaste reported an extremely poor FY15 but has reported doubledigit growth in 9MFY16). We expect Namaste to witness a sharp jump in EBITDA margins over FY16-FY18 as its fixed costs may remain similar to current levels despite rising revenues, and 3) Dabur s oral care and hair oil segments are gaining market share in spite of steep competition. We expect the company to report 14.7% earnings CAGR over FY15-FY18. Reiterate BUY, with a target price of Rs289. Juice business is on strong footing again: Though Q4FY16 may see some impact as supplies from Nepal were disrupted in Jan 16, we expect Dabur s juice business to report 15% revenue CAGR over FY16-FY18, driven by category growth and favourable base. Namaste to emerge as frontrunner: Post the setback in FY15, Namaste (accounting for 7% of Dabur s consolidated sales), the business is now back on track post relaunch of products with natural ingredients. We expect Namaste to enjoy rapid improvement in its EBITDA margins over FY16-FY18 as its fixed costs will remain similar to current levels in spite of rising revenues. Fear of Patanjali impact overdone: Only 9% of Dabur s revenue portfolio mix is in the direct line of attack from Patanjali. In other common categories of Patanjali s focus, Dabur is consistently able to report strong growth in toothpastes and amla hair oil. We do not expect any structural impact on Dabur s business model and believe Patanjali s presence is boosting penetration in categories like Honey and Chyawanprash, besides boosting the overall demand for herbal/ ayurvedic products.. Retain BUY: We expect Dabur s earnings to grow at a CAGR of 14.7%, over FY15- FY18 supported by revenue CAGR of 10.3% and EBITDA margin expansion of 96bps to 17.8% in FY18. We maintain our BUY rating on the stock with a target price of Rs289 (31.3x FY18E). Market Cap Rs439bn/US$6.6bn Year to March FY15 FY16E FY17E FY18E Reuters/Bloomberg DABU.BO/DABUR IN Net Revenue (Rs mn) 78,272 83,684 93, ,998 Shares Outstanding (mn) 1,759 Net Profit (Rs mn) 10,658 12,166 13,919 16, week Range (Rs) 309/236 Dil. EPS (Rs) Free Float (%) 31.9 % Chg YoY FII (%) 20.4 P/E (x) Daily Volume (US$'000) 5,165 CEPS (Rs) Absolute Return 3m (%) (10.9) EV/EBITDA (x) Absolute Return 12m (%) (7.0) Dividend Yield (%) Sensex Return 3m (%) (2.4) RoCE (%) Sensex Return 12m (%) (10.5) RoE (%)

16 Dabur India, April 6, 2016 I-Sec vs consensus estimates Table 1: Our estimates vs consensus (Rs mn) Revenues I-Sec Consensus Variance (%) FY16E 83,684 84,621 (1.1) FY17E 93,727 95,591 (1.9) FY18E 104, , PAT FY16E 12,166 12,485 (2.6) FY17E 13,919 14,450 (3.7) FY18E 16,092 16,528 (2.6) Source: Bloomberg data, I-Sec research With about 10% impact of supply disruption from Nepal on Dabur s juice portfolio to be visible even in Q4FY16, our revenue expectations for the company are below consensus for FY16 by ~2%. Our FY16-FY18 earnings estimates are also lower than consensus by % in line with our lower revenue estimates. Valuations and risks We expect Dabur s earnings to grow at a CAGR of 14.7% over FY15-FY18, supported by revenue CAGR of 10.3% and EBITDA margin expansion by 96bps to 17.8% in FY18. We value the stock at Rs289 (31.3x, FY18E EPS), derived as a triangulated average of: P/E (Rs277: 30x FY18E EPS), DCF (Rs288: assuming WACC of 11.3% and terminal growth of 4%), and FCF yield (Rs301: 3% FY18E FCF). We maintain our BUY rating on the stock. P/E based valuation Dabur has traded at 27x 1-year forward earnings over the past five years, when its earnings grew at 17% CAGR. We value the stock at 30x FY18E EPS which gives a P/E-based valuation of Rs289/share. Chart 1: Mean P/E and standard deviations 45 DABUR P/E -1 Std Dev. Mean +1 Std Dev (x) Jan-03 Sep-03 Jun-04 Mar-05 Nov-05 Aug-06 May-07 Jan-08 Oct-08 Jul-09 Apr-10 Dec-10 Sep-11 Jun-12 Feb-13 Nov-13 Aug-14 May-15 Jan-16 16

17 Dabur India, April 6, 2016 FCF yield based valuation The stock has traded at an average 1-year forward FCF yield of 3.5% over the past three years. With healthy free cashflow generation ahead, we expect the stock to trade at 3% FY18E FCF yield. DCF-based valuation Valuing the company on the DCF methodology, involves three stages Stage 1 (FY15-FY18): During this period, we expect the company to grow its revenues and PAT at CAGRs of 10.3% and 14.7% respectively. We expect RoE to decline from 35.5% at the start of this stage to 30.9% by the end of the stage. Stage 2 (FY18-FY30): During this period, we expect the company to post revenue and PAT CAGRs of 14%. Stage 3 (FY30 onwards): We have assumed a perpetual growth rate of 4% for the period. To arrive at the WACC of 11.3%, we have assumed the cost of equity at 11.5% and the cost of debt at 12.5%. Based on these assumptions, we arrive at a DCF-based valuation of Rs288/share for Dabur. Chart 2: Cashflow performance and RoE (Rs mn) 20,000 15,000 10,000 5,000 0 Free Cashflow to the Firm ROE (RHS) 65% 60% 55% 50% 45% 40% 35% Table 2: DCF calculations Rs mn unless stated otherwise PV of FCF for forecasting period (FY17 FY30) 234,683 Terminal Value 244,574 Fair Value of Investments 20,134 Enterprise Value 499,391 Less: net debt/ (cash) at 31st March 2017 (6,693) Implied equity value 506,084 (5,000) FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E 30% Fully diluted equity shares (mn) 1,757 Implied equity value (Rs/share) 288 Source: Company, I-Sec research Source: Company, I-Sec research Risks Currency risk with growing weightage of international business With the acquisition of Hobi and Namaste, the weightage of Dabur s international business revenues has increased to 31% of its overall revenues. This increases the forex risk on Dabur s earnings. Any negative movement on this front will add downside risk to our estimates. Steep increase in raw material prices Steep rise in raw material prices may impact Dabur s profit margins. 17

18 Dabur India, April 6, 2016 Financial summary Table 3: Profit & Loss statement (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Net Sales 78,272 83,684 93, ,998 Operating Expenses 65,108 69,002 77,268 86,333 EBITDA 13,164 14,682 16,459 18,666 % margins 16.8% 17.5% 17.6% 17.8% Depreciation & Amortisation 1,150 1,305 1,378 1,451 Gross Interest Other Income 1,581 2,134 2,560 3,072 Recurring PBT 13,194 15,037 17,201 19,884 Less: Taxes 2,509 2,857 3,268 3,778 Less: Minority Interest Net Income (Reported) 10,658 12,166 13,919 16,092 Extraordinaries (Net) Recurring Net Income 10,658 12,166 13,919 16,092 Table 4: Balance sheet (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Assets Total Current Assets 23,655 30,076 39,049 49,002 of which cash & cash eqv. 2,760 7,737 14,029 20,973 Total Current Liabilities & Provisions 19,417 20,137 22,636 25,451 Net Current Assets 4,238 9,940 16,413 23,551 Investments 18,134 19,134 20,134 21,134 Net Fixed Assets 18,771 18,966 19,088 19,138 Capital Work-in-Progress Total Assets 41,646 48,543 56,138 64,326 Liabilities Borrowings 7,336 7,336 7,336 7,336 Deferred Tax Liability Minority Interest Equity Share Capital 1,757 1,757 1,757 1,757 Face Value per share (Rs) Reserves & Surplus 31,785 38,682 46,277 54,465 Less: Misc. Exp Net Worth 33,541 40,438 48,034 56,222 Total Liabilities 41,646 48,543 56,138 64,326 Table 5: Quarterly trends (Rs mn, year ending March 31) Mar-15 Jun-15 Sep-15 Dec-15 Net revenues 19,497 20,695 20,962 21,270 % growth (YoY) EBITDA 3,457 3,218 4,045 3,782 Margin (%) Other income Extraordinaries (Net) Net profit 2,848 2,611 3,411 3,185 Table 6: Cashflow statement (Rs mn, year ending March 31) FY15 FY16E FY17E FY18E Operating Cashflow 11,831 13,471 15,297 17,543 Working Capital Changes (1,074) (725) (182) (194) Capital Commitments (2,538) (1,500) (1,500) (1,500) Free Cashflow 8,219 11,246 13,615 15,849 Cashflow from Investing Activities (7,369) (1,000) (1,000) (1,000) Issue of Share Capital (0) 0 Inc (Dec) in Borrowings Dividend paid (4,216) (5,270) (6,323) (7,904) Change in Deferred Tax Liability Chg. in Cash & Bank balance (2,433) 4,977 6,292 6,944 Table 7: Key ratios (Year ending March 31) FY15 FY16E FY17E FY18E Per Share Data (Rs) EPS Cash EPS Dividend per share (DPS) Book Value per share (BV) Growth (%) Net Sales EBITDA PAT Cash EPS Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Sales Operating Ratios Raw Material / Sales (%) Employee cost / Sales (%) SG&A / Sales (%) Other Income / PBT (%) Effective Tax Rate (%) Working Capital (days) Inventory Turnover (days) Receivables (days) Payables (days) Net D/E (x) Profitability Ratios (%) Net Income Margins RoACE RoAE Dividend Payout Dividend Yield EBITDA Margins

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