VST Industries Ltd BUY. Leader in Lower Price Range Cigarette Products

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1 Consumer Staples - Food Beverage & Tobacco Bloomberg Code: VST IN India Research - Stock Broking Leader in Lower Price Range Cigarette Products Soaring Demand for Lower Price Range Cigarettes to Further Boost Growth Momentum:. has witnessed impressive growth in its topline and bottomline during FY17 on the back of soaring demand for lower price ranged cigarettes and arrested growth in total expenses. The topline has grown at 7.4% from Rs.8831 mn in FY16 to Rs.9482 mn in FY17 while bottomline has grown at 9.2% from Rs.1531 mn to Rs.1672 mn during the same period. Thus, the company has registered steeper growth in its bottomline on the back of sharp rise in other income while tax expenses growing at very moderate rate. The growth momentum so set is likely to get further boosted in view of rising preference for low price ranged cigarettes amongst low income group people who have so far been consuming beedis till late. Besides, driver to this trend has been favorable demographics, increase in consumer disposable income, availability of improved product, innovations etc. Above all, likelihood of GST getting implemented from July 1, 217 may prove to be great respite for organized players into the industry like VST who have been sufferers of price competition from unorganized players who have been avoiding paying tax and causing cut-throat competition at market place. With the implementation of GST, unnecessary price competition will go as every player irrespective of their sizes will have to pay tax thus creating level playing environment. All these developments augur well for tobacco industries in general and VST industries in particular as the company has been focused on value creation by significantly investing product design, innovation, quality marketing and distribution and has been successful in creating leadership position in this segment for itself. Valuation and Outlook Given the backdrop of soaring demand for low priced cigarettes and uniformity in tax rate to be ensured with the implementation of GST, we expect VST industry to register revenue growth at CAGR of 9.6% during FY17-19E. Although we remain long term positive on the company on account of its sound financials, clarity on GST rate would be a key trigger to watch out for. Recently, the stock has good run-up; still we believe that valuation of stock has scope to expand further amidst improving sales and net profit. We have come out with BUY recommendation on the stock for next 9-12 months valuing it at P/E 25.x on its FY19E EPS of Rs with a target price of Rs.3492/share which gives potential upside of 16%. Exhibit 1: Valuation Summary YE Mar (Rs. Mn) FY15 FY16 FY17 FY18E FY19E Net Sales EBITDA EBITDA Margin (%) Net Profit EPS (Rs.) RoE (%) PE (x) ; *Represents multiples for FY15, FY16 & FY17 are based on historic market price For private circulation only. For important information about Karvy s rating system and other disclosures refer to the end of this material. Karvy Stock Broking Research is also available on Bloomberg, KRVY<GO>, Thomson Publishers & Reuters Recommendation (Rs.) May 11, 217 BUY CMP 3 Target Price 3492 Upside (%) 16 Stock Information Mkt Cap (Rs.mn/US$ mn) / wk High/Low (Rs.) 3239 / M Avg. daily volume 3624 Beta (x).6 Sensex/Nifty 3251 / 9422 O/S Shares(mn) 15.4 Face Value (Rs.) 1. Shareholding Pattern (%) Promoters 32.2 FIIs 9.7 DIIs 14.4 Others 43.7 Stock Performance (%) 1M 3M 6M 12M Absolute Relative to Sensex () Source: Bloomberg Relative Performance* May-16 Jun-16 Jul-16 Aug-16 Source: Bloomberg; *Index 1 Analyst Contact Kiran Shankar Prasad Sep-16 Oct-16 Nov-16 kiran.prasad@karvy.com Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 Sensex May-17 1

2 Company Financial Snapshot (Y/E Mar) Profit & Loss (Rs. Mn) FY16 FY17 FY18E FY19E Net sales Optg. Exp EBITDA Depreciation Interest Other Income PBT Tax Adj. PAT Profit & Loss Ratios EBITDA margin (%) Net margin (%) P/E (x) EV/EBITDA (x) Dividend yield (%) Balance sheet (Rs. Mn) FY16 FY17 FY18E FY19E Total Assets Net Fixed assets Current assets Other assets Total Liabilities Networth Debt Current Liabilities Other liabilities Balance Sheet Ratios RoE (%) RoCE (%) Net Debt/Equity (x) (.14) (.12) (.6) (.4) Equity/Total Assets P/BV (x) Exhibit 2: Shareholding Pattern (%) Company Background Incorporated on Nov 1, 193 under the Hyderabad Companies Act and now governed under the Companies Act 1956, the Vazir Sultan Tobacco Company subsequently came to be known as VST Industries Limited since Apr 3, The company has registered office at Azamabad, Hyderabad and is engaged into activities of manufacturing and sale of cigarettes, unmanufactured and cut tobacco. The company is constructing a primary manufacturing division at Toopran Mandal in Medak Distict. It has collaboration with British American Tobacco which holds 32.16% stake in the company. The major brands include Charminar, Charminar Special Filter, Charms Mini Kings, Charms Virgina Filter, XL Filter, Vijay, Shaan etc. The company s products are targeted at lower income segment where it has dominance. The major chunk of revenue (~87%) comes from the sale of cigarettes while unmanufactured tobacco contributes to (~13%) of total revenue. The company s subsidiary namely Hallmark Tobacco Company has got amalgamated with another wholly owned subsidiary, VST Distribution, Storage & Leasing Company. Cash Flow (Rs. Mn) Exhibit 3: Revenue Segmentation (%) FY16 FY17 FY18E FY19E PBT Depreciation Interest (net) Tax Expenses (651) (796) (92) (139) Changes in WC (411) (192) (189) (75) Others (193) (376) (414) (479) CF from Operations Capex (525) (431) (47) (456) Others CF from Investing (24) (155) (54) 21 Change in Debt Interest Paid Dividend & Dividend Tax (131) (1387) (1387) (1387) CF from Financing (131) (1387) (1387) (1387) Changes in Cash (219) (69) Promoters Others 32.2% 43.7% Cigarettes 86.8% Unmanufactured Tobacco 13.2% DIIs 14.4% FIIs 9.7% Source: BSE, Karvy Research 2

3 Business Outlook: India is world s 2nd largest producer and major exporter of tobacco. It is an important sector which generates enormous socio-economic benefits in terms of agricultural employment, farm income and foreign exchange earnings. As per statistics of Tobacco Institute of India, Chewing tobacco and beedis constitute 9% of the tobacco industry and cigarettes have only 1-11% share. Due to the fact that majority of the Indian tobacco consuming population consumes beedis, gutka, khaini and Zarda, the tobacco market is majorly controlled by the production of snuffs, gutka and others. This is unlike the rest of the world where tobacco is synonymous to cigarettes, representing 9% of total tobacco consumption. Different varieties of tobaccos are grown in India. They are Flue-Cured Virginia (FCV) tobacco and non-fcv tobacco. FCV tobacco is used in Cigarettes and Beedis whereas non-fcv is used in Hookah, Chewing and others. FCV accounts for around 4% of total tobacco produced in India making it 3rd largest producer of FCV tobacco producer in the world. FCV is the main exportable tobacco produced in India and more than 6% of it is exported with the rest is used in domestic cigarettes manufacturing. India is one of the leading exporters of tobacco. The global leaf tobacco trade is valued at US $12 Bn per annum: India s share of the trade is around 7% currently and is poised to increase as India s tobacco production share in the world is more than 12%. Despite accounting for 17% of the world population, tobacco consumption in the form of cigarettes in India is less than 2% of global consumption. However, India accounts for 84% of world s consumption of smokeless tobacco. In terms of annual per capita cigarettes consumption, Russia with 2786 no. of cigarettes per annum is heading the list followed by Japan with 1841 and China 1711 no. of cigarettes per annum. India has the lowest per capita consumption of Cigarettes in the world just 96 compared with the world average of 865 cigarettes per annum. Over the last three decades, the legal cigarettes share of total tobacco consumption has declined sharply to 11% currently while overall tobacco consumption in the country has increased to 38%. This fall in legal cigarettes consumption has to be attributed to sharp rise in excise and other duties making legal cigarettes costlier. People have shifted to illegal cigarettes and that has led to emergence of unbranded products from unorganized sector. With the implementation of GST, there would be tax stability & moderation which will optimize revenue collections from tobacco sector by arresting shift from legal to illegal cigarettes. Past few years of consumption trend suggests to the fact that there has been paradigm shift from beedis to lower price range cigarettes resulting into augmenting cigarettes volume growth. However, the increasing regulations via taxation and bans on advertising, bans on smoking cigarettes in public places, health warning on cigarettes boxes and increasing public campaign against smoking have been discouraging the industry growth. However, tobacco market is expected to witness growth with a range of tobacco products such as cigarettes, cigars, pipes, hookah-cigarettes etc. Exhibit 4: Tobacco Production (Mn Kgs) Exhibit 5: Export Earnings (Rs. Mn) China 28 India Brazil USA Malawi Tobacco Leaf Production 144 Zimbabwe 111 Argentina FTY12 FY13 FY14 FY15 FY16 Tobacco* FCV Tobacco 3485 Source: Universal Leaf Tobacco: UN Trade Database, Karvy Research Source; Tobacco Institute of India, Karvy Research *Tobacco figures include FCV & Non-FCV Tobbaco 3

4 Investment Rationale: Growing Preference for Low Price Range Cigarettes: Of late, there have been tendencies wherein people from lower income groups have started opting for lower price ranged cigarettes instead of Beedis. The driver to this trend is favorable demographics, increase in consumer disposable income, availability of improved products, innovations etc. Health consciousness amongst the youngsters has led to increased consumption of cigars for their low level of health hazards. All these developments augur well for tobacco industries in general and VST industries in particular as the company has been focused on value creation by significantly investing in product design, innovation, quality marketing and distribution and it has been successful in creating leadership position in this segment for itself. Leveraging on Portfolio Mix to Further Strengthen Margin: In view of changing requirements of tobacco in the domestic and overseas markets, the company has focused on the development of niche varieties. Brands such as 69mm size and addition of 64 mm size have registered growth based on value proposition. However, increase in excise duty on above 64 mm cigarettes resulted into volume decline in this particular segment. This led to shift in sales mix towards lower length and higher margin 64 mm cigarettes. However, in the FY18 Budget, the government of India announced excise duty hike of 6% across all categories of cigarettes, 9% hike on Pan Masala and 8.3% hike on unmanufactured tobacco. For handmade beedis, excise duty of Rs.28/thousand sticks has been increased from Rs.21/thousand sticks; and for machine made beedis, excise duty has been increased to Rs.78/thousand sticks from Rs.21/thousand sticks. Exhibit 6: Excise Duty on Cigarettes in Rs./1 sticks Type/ Length of Cigarettes (Mn) Plains Upto >65 to Filters Upto >65 to >7 to Others ( >75 mm) Source: The Tobacco Institute of India, Karvy Research The company s strong brand has helped VST to successfully pass on the excise hikes through price increases while maintaining volume growth. Existing brands of the company such as Special Moments, Charms, Charminar and Kingston have delivered stronger performance. Thus, leveraging its portfolio mix has enabled the company to minimize volume decline in spite of challenging operating environment. Implementation of GST to be of Great Respite for Organized Players in the Industry: Tobacco industry has been subjected to discriminatory rise in excise and other state duties like VAT and entry duty causing decline in sales volume. The taxes are focused to capture organized business of cigarettes manufacturers while chewing tobacco, beedis etc, remains out of the tax net due to exemptions granted to some of the products and small scale business. Some studies estimate that almost 9% of chewing tobacco remains untaxed through tax avoidance and as much as 7% of total consumptions remain untaxed. As legitimate players are subjected to higher taxes, non duty paid cigarettes are getting a flip, registering exponential growth. This is hurting legitimate players in the industry. With GST implementation, all companies from the sector will be under GST purview which will not only ensure that all companies are taxed under GST at the same level but also to curb the unorganized players in this industry who have been indulging in tax evasion. In the meantime, Council has announced the cap on cess levied on cigarettes and chewing tobacco, which could be either 29% or Rs.417/thousand stick or a combination of both. However, GST rate is still awaited and clarity on growth outlook of industry and for that matter VST Industries would be there once effective tax rate is announced. 4

5 Exhibit 7: Tax Collection from Cigarettes FY12 FY13 FY14 FY15 FY16 Tax including Excise & State Taxes (Rs. Mn) Source; Tobacco Institute of India, Karvy Research Exhibit 8: Share in Tobacco Consumption and Tax Revenue Share of Tobacco Consumption Share of Tax Revenue 87% 85% 11% 13% Legal Cigarettes Other Tobacco Products Source: Ministry of Finance, Govt. of India and Industry estimates, Karvy Research Sound Financials Make VST Industries an Attractive Investment Proposition: The company has registered CAGR growth rate of 6.7% over the period of FY12-17 and YoY growth of 7.4% in FY17. EBITDA margin for FY17 came at 26.% whereas PAT margin was at 17.6%. The company is cash rich and has zero debt. It enjoys high returns on equity (36.9%), on asset (2.6%) and capital employed (54.4%). EPS of the company for FY17 stands at Rs.18.3 which is substantially high. The management announced final dividend of Rs.75 per equity share capital for FY17. Thus, sound financials of the company make it attractive investment proposition. Increased Geographical Presence to Ensure Growth with Stability: Exhibit 9: Geographic Segments % 92.5% 9.4% 88.7% 9.9% Source; Tobacco Institute of India, Karvy Research FY12 FY13 FY14 FY15 FY Domestic Sales (Rs. Mn) Overseas Sales (Rs. Mn) Domestic Sales as % of Total Sales (RHS) Overseas Sales as % of Total Sales (RHS) 1% 8% 6% 4% 2% % The company continues to invest in infrastructure to increase geographic presence. The company has substantial operations all over the country and competes on the basis of brand appeal and loyalty, product quality and taste, packaging, marketing and price. The company generates revenue between 9-93% from sales within India and 7-1% from overseas markets. International markets offer significant opportunity for cigarettes industry to consolidate its position in view of withdrawal/reduction of agricultural subsidy and escalating cost in traditional cigarettes exporting countries. 5

6 Exhibit 1: Business Assumptions Y/E Mar (Rs. Mn) FY16 FY17 FY18E FY19E Comments Consolidated Revenue Revenue Growth (%) EBITDA EBITDA Margins (%) PAT EPS (Rs.) EPS Growth (%) Net CFO We expect the company revenue to grow at CAGR of 9.6% during FY17-19E. EBITDA margin is likely to be maintained in view of leveraging on portfolio mix. Improved EBITDA, no finance cost and stable tax expenses may drive PAT to grow at CAGR of 13.6% during FY17-19E. Capex (525) (431) (47) (456) We expect capex to be at maintenance level. Debt Free Cash Flow Exhibit 11: Karvy vs Consensus Revenues (Rs. Mn) Karvy Consensus Divergence (%) Comments FY18E (2.4) Ahead of GST implementation, we remain cautiously positive on sales growth and hence FY19E (1.4) conservative outlook. EBITDA (Rs. Mn) FY18E (11.8) FY19E (13.) Cautiously positive on EBITDA growth. EPS (Rs.) FY18E (3.8) FY19E (7.4) Cautiously positive on EPS growth. Source: Bloomberg, Karvy Research 6

7 Exhibit 12: Revenue & Revenue Growth % 2% % 5.6% 7.4% 9.2% 1.% % FY14 FY15 FY16 FY17 FY18E FY19E 15% 1% 5% The company has posted revenue growth at CAGR of 6.7% over the period of FY12-17 and is likely to improve upon its revenue on the back of soaring demand for low price ranged cigarettes and more operational efficiency likely to be brought in with implementation of GST. We expect that revenue for FY17-19E should grow at CAGR of 9.6%. Revenue (Rs. Mn) Growth (%) Exhibit 13: EBITDA & EBITDA Margin % 2181 FY14 29.% 2426 FY % 2374 FY % 26.% 2462 FY FY18E 28.% 319 FY19E 3% 28% 26% 24% The company has been able to maintain its EBITDA margin over and above 26% and it is likely to continue with the trend or further improve upon it on the back of reduced cost of goods and leveraging on portfolio mix. EBITDA (Rs. Mn) EBITDA Margin (%) Exhibit 14: PAT & PAT Margin % 152 FY % 18.1% 17.6% 18.2% 17.3% 1522 FY FY FY FY18E 2157 FY19E 2% 18% 16% The company has no debt and hence required no interest to pay. Further, tax expenses of the company is likely to reduce substantially with the implementation of GST. These two facts have potential to positively contribute to the bottom line. PAT (Rs. Mn) PAT Margin (%) Exhibit 15: RoE & RoCE 8% 6% 4% 2% 67.8% 63.2% 54.4% 49.4% 51.2% 47.5% 45.1% 42.7% 36.9% 33.4% 34.6% FY14 FY15 FY16 FY17 FY18E FY19E RoE (%) RoCE (%) We expect the company to confront with inventory related issue wherein ahead of GST, focus would be on utilizing inventory instead of building the same in next 1-2 years following implementation of GST which along with rise in capex may moderately adversely impact RoE and RoCE of the company. 7

8 Exhibit 16: RoA (%) 27% 23% 25.3% 19% 2.% 19.3% 18.5% 2.6% 23.1% The company is likely to experience improved RoA on the back of improving net profit. 15% FY14 FY15 FY16 FY17 FY18E FY19E RoA (%) Exhibit 17: Current Ratio Average current ratio of 1.4x has been maintained over FY12-17 and we expect it to rise further. This is reflection of the fact that the company has enough liquid assets to meet its short term obligations..5 FY14 FY15 FY16 FY17 FY18E FY19E Current Ratio (x) Exhibit 18: Dividend Per Share & Payout Ratio FY14 FY15 FY16 FY17 FY18E FY19E Dividend Per Share (Rs.) Dividend Payout Ratio (%) The company has been generous in paying dividend and we expect management to continue with this policy in view of improving net profit. Exhibit 19: Company Snapshot (Ratings) Low High Quality of Earnings 33 Domestic Sales 33 Exports 33 Net Debt/Equity 33 Working Capital Requirement 33 Quality of Management 33 Depth of Management 33 Promoter 33 Corporate Governance 33 8

9 Valuation & Outlook Given the backdrop of soaring demand for low priced cigarettes and uniformity in tax rate to be ensured with the implementation of GST, we expect VST industry to register revenue growth at CAGR of 9.6% during FY17-19E. Although we remain long term positive on the company on account of its sound financials, clarity on GST rate would be a key trigger to watch out for. Recently, the stock has good run-up; still we believe that valuation of stock has scope to expand further amidst improving sales and net profit. We have come out with BUY recommendation on the stock for next 9-12 months valuing it at P/E 25.x on its FY19E EPS of Rs with a target price of Rs.3492/share which gives potential upside of 16%. Exhibit 2: PE Band Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 P/E Avg. PE 1 SD 2 SD -1 SD -2SD Source: BSE, Karvy Research Key Risks ythreat of growing illegal cigarette trade. yvarious NGO forums against use of tobacco. yextreme regulations undermine legal cigarettes industry. 9

10 Financials Exhibit 21: Income Statement YE Mar (Rs. Mn) FY15 FY16 FY17 FY18E FY19E Revenues Growth (%) Operating Expenses EBITDA Growth (%) 11.2 (2.1) Depreciation & Amortization Other income EBIT Interest Expenses PBT Tax Adjusted PAT Growth (%) Exhibit 22: Balance Sheet YE Mar (Rs. Mn) FY15 FY16 FY17 FY18E FY19E Cash & Cash Equivalents Trade receivables Loans & Advances Investments Net Block Other assets Total Assets Current Liabilities Debt Other Liabilities Total Liabilities Shareholders Equity Reserves & Surplus Total Networth Total Networth & Liabilities

11 Exhibit 23: Cash Flow Statement YE Mar (Rs. Mn) FY15 FY16E FY17 FY18E FY19E PBT Depreciation Interest Expense Tax Paid (796) (651) (796) (92) (139) Inc/dec in Net WC (466) (411) (192) (189) (75) Others (169) (193) (376) (414) (479) Cash flow from operating activities Inc/dec in capital expenditure (238) (525) (431) (47) (456) Interest Received Others (1) 2 (2) Cash flow from investing activities 31 (24) (155) (54) 21 Inc/dec in borrowings Dividend & Dividend Tax (1265) (131) (1387) (1387) (1387) Interest Paid Cash flow from financing activities (1265) (131) (1387) (1387) (1387) Net change in cash (59) (219) (69) Exhibit 24: Key Ratios YE Mar FY15 FY16 FY17 FY18E FY19E EBITDA Margin (%) EBIT Margin (%) Net Profit Margin (%) Dividend Payout Ratio (%) Net Debt/Equity (x) (.16) (.14) (.12) (.6) (.4) RoE (%) RoCE (%) Exhibit 25: Valuation Parameters YE Mar FY15 FY16 FY17 FY18E FY19E EPS (Rs.) DPS (Rs.) BVPS (Rs.) PE (x) P/BV (x) EV/EBITDA (x) EV/Sales (x) ; *Represents multiples for FY15, FY16 & FY17 are based on historic market price 11

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