Acquisition spree in FMCG sector

Transcription

1 Institutional Equity Research FMCG India July 10, 2012 Acquisition spree in FMCG sector We have analyzed the acquisitions made in the sector based on valuations of the target companies, sources of funding the deal, potential synergies of the acquisition and management track record in the past of integrating two businesses. Based on the above evaluation, we strongly push GCPL as the best in the sector in terms of integration and carving out synergies and have a BUY rating on the stock with a target of Rs 650. We are also positive on Jyothy Labs as it has shown early signs of stabilizing Henkel s performance and has now a bigger portfolio with strong brands to market in India. We have a BUY rating on the stock with a target price of Rs 300. On the other hand, we believe that Marico did a very expensive acquisition at 5x sales Paras Pharma, in which we do not see any significant synergies in terms of distribution or manufacturing. The acquisition has also come at a time when the company is reeling under the pressure of copra prices (200bps wiped off from gross margin in F12). We reckon the already declining return ratios will remain muted in the next 4-5 years because Marico will invest strongly in advertising Paras s products and building the brands. We have a SELL rating on the stock with a target price of Rs 125. (SSL) Mafatlal Chambers, A-Wing 2nd Floor, N.M. Joshi Marg Lower Parel, Mumbai /01 sbicapresearch@sbicapsec.com Sagarika Mukherjee Securities Research sagarika.mukherjee@sbicapsec.com SBICAP Research on Bloomberg SBICAP <GO> Please refer to our disclaimer given at the last page.

2 FMCG Sector Table of Contents Executive summary of the major trends in the sector... 3 Sector Note Factors that favour consumption story in India... 4 Levers of growth that have emerged over the last 5-6 years... 5 Why look for acquisitions rather than growing organically?... 6 Indian FMCG companies seeking to increase their footprint overseas: MENA region, LATAM and South Asia... 6 Africa and Middle East: Acquisition of a strong business is the only strategy to enter these markets Companies under coverage Godrej Consumer Products Ltd Investment summary: Best track record so far in acquisitions in FMCG sector Analysing historic performance of GCPL in terms of inorganic growth Major changes in strategy: Conscious effort to shift out of heavily penetrated category to a fast growing category Investment rationale Underlying rationale and selection criteria for acquisitions Valuation and outlook Key concerns Financial summary Jyothy Laboratories Ltd Investment summary: Acquisition of Henkel enabled product diversification and bought in stronger brands in personal care and home care segment Investment rationale Broad summary of the acquisition strategy Major synergies of the acquisition Henkel s turnaround strategy Brandwise strategy for Henkel Brandwise strategy for JLL Valuation and outlook Key concerns Financial summary Marico Ltd Investment Summary: Synergies do not justify the high valuation of Paras Investment rationale Broad summary of the acquisition Snapshot of brands acquired from Paras Synergies between Marico and Paras Negatives about the deal Valuation and outlook Key concerns Financial summary sagarika.mukherjee@sbicapsec.com July 10,

3 FMCG Sector Executive summary of the major trends in the sector Managements of many FMCG companies are bullish about the prospects of consumer staples since it s a defensive sector. The main fundamental driver for this sector is domestic consumption which has remained intact despite destabilizing macroeconomic factors like slowing growth, high inflation and rupee depreciation. All the stake holders of the industry are currently scouting for inorganic growth in India and also internationally. For FMCG companies, one prefers to buy growth through strong brands and wide reach since it s riskier to develop a brand in-house, test market the product and then continuously invest behind brand building to create market presence. The strike rate of a successful brand is abysmally low at 10%. Valuations in India have already sky-rocketed because of positive fundamentals like demographic dividend; high disposable income, low category penetration and high working age population which is willing to experiment. For these reasons, it has practically become unviable to acquire suitable companies in India at a decent price. Many companies have hence forth ventured overseas in countries where the socioeconomic factors and customer demands are similar to that in India, which in turn will ensure a steep learning curve for them. Biggest deals in FMCG sector Value in Rs mn Company Target CY08 CY09 CY10 CY11 CY12 Emami Zandu 7,000 Dabur Fem 2,577 Dabur Hobi Group 2,788 Dabur Namaste Laboratories 4,041 Jyothy Henkel 7,980 Reckitt Benckiser Paras Pharma 32,400 Marico ICP 2550 Marico Code 10 GCPL Kinky 100 GCPL Sara Lee 10,850 GCPL Issue and Argencos 2,025 GCPL Megasari 11,516 GCPL Tura 404 GCPL Darling Group 5,000 Marico Paras Pharma (Only personal care) 7,500 GCPL Cosmetica Nacional 1,756 Total Rs mn No of deals Source: Industry, SSLe We have analyzed the acquisitions made in the sector based on valuations of the target companies, sources of funding the deal, potential synergies of the acquisition and management track record in the past of integrating two businesses. Based on the above evaluation, we strongly push GCPL as the best in the sector in terms of integration and carving out synergies and we have a BUY rating on the stock with a target of Rs 650. We are also positive on Jyothy Labs as it has shown early signs of stabilizing Henkel s performance and has now a bigger portfolio with strong brands to market in India. We have a BUY rating on the stock with a target price of Rs 300. On the other hand, we believe that Marico did a very expensive acquisition at 5x sales Paras Pharma, in which we do not see any significant synergies in terms of distribution or manufacturing. The acquisition has also come at a time when the company is reeling under the pressure of copra prices (200bps wiped off from gross margin in F12). We reckon the already declining return ratios will remain muted in the next 4-5 years because Marico will invest strongly in advertising Paras s products and building the brands. We have a SELL rating on the stock with a target price of Rs 125. sagarika.mukherjee@sbicapsec.com July 10,

4 FMCG Sector Fundamental drivers of consumption in FMCG are unaffected by the macroeconomic scenario India has a demographic dividend which helps boost consumption Many factors in favor of the consumption story in India and the FMCG sector All companies are bullish about the sector mainly because consumer staples (Food & beverages, personal care and fabric care) are typically defensive products and their usage does not reduce in recessionary or high inflationary environments. India s growth was led by the consumption story during period in which higher disposable income and the demographic dividend (72% of the population under the age of 40 years) has led to creation of new categories. This predominance of youth in the population is expected to last until The preferences of the youth of the country, which has recently shifted towards grooming, personal hygiene and they have a very health conscious outlook. All FMCG companies are therefore increasing their presence in personal care (deodorants, hand sanitizers, hair styling gels, post-wash hair care, conditioners, serums), foods & beverages with a conscious tilt towards fruit juices. The young working population is experimental in nature and has high disposable income GDP Growth Rate Projection (%) Over the last 10 years due to higher income levels and greater awareness, new categories were created and have led to up-trading in several categories Growth rate YoY (%) These positive factors have pushed many FMCG companies to grow via the acquisition route. Strong balance sheets and cash throwing nature of the business has aided the progression 0 F 08 F 09 F 10 F 11 F 12 F 13e Source: CSO Per capita personal disposable income growth rate YoY(%) (%) F 08 F 09 F 10 F 11 Source: CSO WPI Inflation YoY (%) (%) Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Source: CSO sagarika.mukherjee@sbicapsec.com July 10,

5 FMCG Sector Levers of growth that have emerged over the last 5-6 years FMCG sector in India has shown strong growth in both urban and rural markets. Companies are rushing to increase their penetration in rural markets and are catering to their demands by coming up with products in small SKUs and catchy price points. Growth is driven by increasing consumption led by rise in incomes, changing lifestyles and favourable demographics As per a study conducted by Booz & Company, FMCG sector is expected to grow in the range of 12% to 17% up to 2020 and touch a market size between of Rs 4000 to Rs 6200bn. 1,700 FMCG Industry Size FMCG Industry Urban FMCG Industry Rural 1,671 1, ,600 1,100 1, (Rs bn) 1,500 1,451 (Rs bn) 1, (Rs bn) , ,300 C 10 C C 10 C C 10 C 11 Source: Industry Data Penetration Levels: Sufficient Headroom (%) ToothpasteShampoo Hair Oil Skin Cream Source: Industry Data Rural Penetration India has low per-capita consumption as compared to other emerging economies 59 Mosquito Repellants Instant Noodles Urban Penetration Hair Dyes 26 Floor Cleaners Skin Care-Per Capita Consumption Shampoo-Per Capita Consumption Toothpaste - Per Capita Consumption (US$) (US$) (US$) China Indonesia India Malaysia Thailand China Indonesia India Malaysia Thailand China Indonesia India Malaysia Thailand Source: Industry Data sagarika.mukherjee@sbicapsec.com July 10,

6 FMCG Sector Why look for acquisitions rather than growing organically? Success rate of launching good products in FMCG sector happens to be at a low 10%. Hence, the management of most FMCG companies would prefer to buy future growth by acquiring proven and well-established brands than to design a product organically and then run the risk of meeting the demands of the end-user. Another strong reason for Indian FMCG companies to scout for acquisitions happens to be the lack of a product pipeline. While their MNC counter parts have a product pipeline available from their parent companies which they can easily launch by paying a certain cut as royalty, home-grown companies don t have such luxuries. Hence, they prefer buying brands in order to capture the growth since any new product will require at least 2 years to establish itself after the launch and would also need extra ad-spends or trade promotions to be done, for the customers to sit-up and take notice. Most FMCG companies are cash rich companies and the nature of the business does not entail heavy amounts of capital (short-term or longterm) to grow. Essentially the businesses are cash throwing that provides them with enough bandwidth to go for small to medium sized acquisitions. The recent trend shows that for large acquisitions,the companies leverage themselves with low-cost overseas debt (interest expense at 3-4% p.a., and leverage goes up to 1:1) which they are able to comfortably pay-off within two years with their cash flow from operations. Hence, the companies were not dissuaded by the rising interest rate scenario in India that prevailed from 2010 to Most FMCG companies are looking for brands and products which may be small right now but have healthy gross margins (45-50%), and are into fast growing categories i.e. volume growth of at least 10-15% and have the potential to grow into a Rs 5bn big brand over the next 5 years. Indian FMCG companies seeking to increase their footprints overseas: MENA region, LATAM and South Asia FMCG companies have zeroed in on these certain geographies as they have common drivers of growth: 1. High economic growth in future as compared to advanced economies Real GDP growth rate(%) World Output (0.5) Advanced Economics (3.4) Emerging Economics Russia (7.8) China India Brazil (0.6) Middle East and North Africa Sub-saharan Africa Source: IMF and World Economic Forum sagarika.mukherjee@sbicapsec.com July 10,

7 FMCG Sector Africa and Middle East: Acquisition of a strong business is the only strategy to enter these markets Middle East and Africa have witnessed stable GDP growth rates Between 2005 and 2015, it is estimated that in Africa, the share of individuals earning above US$ 1000 will grow from 39% to 55% Sub-Saharan Africa s recovery from the crisis-induced slowdown is well underway, with growth in most countries now back fairly close to the high levels of the mid- 2000s. African political environment, infrastructure and sovereign governance continues to improve. Africa will become an integral part of the Chinese and Indian supply chains, which will call for more investments and speedier growth. Some geographies such as Africa are best suited for acquisitions mainly because the MNC s which are present there haven t localized or customized their products. They sell at a premium compared to the local players and cater to only 10% of the market, which leaves a lot of scope for growth. Heritage brands enjoy significant recall value in the market hence building brands becomes very difficult from scratch. The rapidly emerging African middle class could number as many as 300 mn, out of a total population of one billion The sheer volumes and the growth in the number of aspirational consumers with disposable income creates huge opportunities for consumer product companies Middle East and Africa have witnessed stable GDP growth rates. Between 2005 and 2015, it is estimated that in Africa, the share of individuals earning above $1000 will grow from 39% to 55%. The rapidly emerging African middle class could number as many as 300 mn, out of a total population of 1bn. The sheer volumes and the growth in the number of aspirational consumers with disposable income creates huge opportunities for consumer products companies. 2. We believe higher disposable income has created many new categories in India like male grooming segment which has now roped in products like skin creams for men, deodorants, post-wash hair creams and gels etc. Women have started upgrading to high-end products in skin care which has created a catchment area for premium brands like L oreal, Garnier, Olay (P&G) and Ponds Gold Radiance (HUL). We expect similar effects to play out as a result of increasing disposable incomes in the other emerging markets. 3. Most of the competitors in these markets compete on price without making any efforts on brand building. This gives advantage to companies which are strong in brand building. Indian FMCG companies which are into saturated categories like soaps, detergent, shampoos and tea secure their future growth only by brand building or by entering into new categories through brand extensions. 4. Phenomenon of rapid urbanization will add to the size of the market and product categories and will also lead to up-trading by customers. sagarika.mukherjee@sbicapsec.com July 10,

8 FMCG Sector Snapshot of acquisitions done by GCPL Target Year Categories Brands Geographies Sales in Rs (mn) Deal Rs (mn) Valuation multiple(x) Comments Keyline 2005 Cosmetics and Toileteries Cuticura, Provoke Touch of Silver, Salon Selectives, Reimann P20, Bio Oil. UK Rs 1.74bn in FY11 Business has actually paid back for itself in 4-5 years time. It has grown faster than the category and given that UK has been in recession since 2008, it has shown commendable performance. It has grown at 8-10% CAGR for the past 5 years and the growth has accelerated at the bottom line. Leveraged the H1N1 virus phenomenon in 2009 and created a strong brand out of Cuticura Rapidol 2006 Ethnic hair coloring brand Inecto / Sofelene South Africa Rs 340mn in Grown at 20% CAGR for the last 4-5 years. Rs 500mn 1.4x sales Hair coloring market in sub-saharan Africa is much smaller than hair extension market. It's about $200mn and they have an exposure through Inecto. They have 90% market share in Ethnic hair color market. Was 85% when GCPL had acquired. Has become the 4/5th caucasian hair color brand. There are competitors like P&G and Loreal. They have 12-13% market share right now (MAT). Exit market share is much higher. Kinky 2008 Shampoo, hair care, hair extensions, retail chains Kinky South Africa Rs mn Rs mn 1x sales One of the leaders in hair care in SA Sara Lee 2010 Household insecticide Good Knight India Rs 10.72bn Rs 10.85bn for 51% 2x sales Bought the remaining 51% stake from Sara Lee and cancelled the 10year old JV with them. Issue and Argencos May - June 2010 Hair colors/care Issue and Argencos LATAM Rs695mn Rs2.025bn 2.9x sales Largest volume player in LATAM.Hence will provide significant purchase and distribution synergies. Has 20% market share by volume in Argentina. Argencos has strong brands in hair care space. Megasari April, 2010 Household insecticide/ wet tissues and room freshners Megasari Indonesia $120mn in 2009, grew by 20% y-o-y $285mn as per the management 2x sales Tura Mar-10 Soaps Tura Nigeria $10-15mn $10-15mn 1x sales Darling Group Cosmetica Nacional 2011 Hair extensions 2012 Source: Company, SSL Hair coloring and color cosmetics Darling and Amigos Pamela Grant and Ilicit Sub-saharan Africa $200mn / 15% yoy in last 5 years. Africa Rs 5000 mn or had sales of Rs 2 bn $100mn, raised before Darling. By $136mn (Rs 6.85bn) the time the process by selling 5% stake will be over it will be 2.45x sales to Temasek, will use Rs 10 bn plus. it to pay back some Hence it will be debt, or fund the next much bigger than phase of acquisition. previous acquisitions. $38mn for 60% Chile (LATAM) $36-38mn sales in CYstake. Rest owned by the family. 1.66x sales Made GCPL the 2nd largest player in HI in Asia (ex- Japan). It had same operating margins as GCPL. Megasari has 35% share in the $350mn a year HI market in Indonesia in Total HI market in 2012 is $350mn. Very small company in the whole gamut of businesses in Africa. Hair extensions are one of the largest opportunities for GCPL. It's a $1bn industry in Africa and Darling has 20% market share. There are two other major players in the market (Korean and Chinese, other local players which are not pan-african). It is one of the highest involvement categories for the African woman and hence strong brands like Darling enjoy high profitability. Darling business provides a huge platform for sub-saharan Africa in terms of pan- Africa distribution. The business has 18-20% EBITDA margin. Will have supply side benefits in Argentina. It strengthens the LATAM business. They will gain in distribution since they have similar go-to-market channels i.e. modern trade channels. sagarika.mukherjee@sbicapsec.com July 10,

9 FMCG Sector Snapshot of acquisitions done by Marico Target Year Categories Brands Geographies Sales Rs mn Deal Rs mn Valuation multiple(x) Comments ICP 2011 Male grooming/ Female cosmetics/sauces and Condiments X-men (claims 35% market share in shampoos in Vietnam)/L'Ovite/Th uan Phat Vietnam $25mn in 2010 Rs2.55bn 2.04x sales ICP has been growing at a CAGR of 23%. X-men has 35% market share in shampoos in Vietnam. It is a leading brand in its category and is the second most trusted brand in Vietnam. Hair code/ Code Hair oil Code 10 (a little above 10% market share in Malaysia) Egypt/ Malaysia Rs120mn Rs250mn 2.0x The Malaysian hairstyling market is estimated at 150 million Malaysia ringgits (around Rs200 crore). Code 10 is the No. 1 player in the country with a 10% market share and revenues of close to Rs12 crore Ingwe 2010 Ethnic hair care Caivil and Black Chic South Africa Rs150mn Marico s South African business recorded a 34% growth in FY10, with the overall size of the business at Rs63.80 crore. Derma Rx 2010 Personal care retail chain Arbutin Cream, Laminaria Shower Gel, Liposomal Sunscreen Singapore Sales of Rs 500mn, profits of Rs 50mn in FY11. Rs1.374bn 2.69x sales Derma Rx offers solutions to its customers through 4 clinics and medispas in Singapore and Kuala Lumpur (Malaysia). The company adds on to the product portfolio of Kaya and strengthens the products sales side of the business along with drawing in more customers for the retail side. Has a customer base of 37k. Paras Pharma 2012 Male/Female grooming - Deos and hair gels Zatak, Set Wet, Dr. Lips, Recova, Livon, Eclipse India Rs1.5bn Rs 7.5bn 5x sales Bought the personal care busniess from Reckitt Benckiser. Reckitt had bought it at 9x sales value. The deal is considered to be expensive and the synergies are not very clear in terms of strategy or financials. Main bet is to grow Set Wet as a brand and use 3.3mn outlet wide distribution network of Marico to create the required critical mass. Source: Company, SSL sagarika.mukherjee@sbicapsec.com July 10,

10 FMCG Sector Snapshot of acquisitions done by Dabur Target Year Categories Brands Geographies Sales Rs mn Deal Rs mn Valuation multiple(x) Comments Fem Care Pharma Ltd 2008 Skin bleaching cream, hair conditioner, skin firming and anti wrinkle cream. Fem, Oxybleach, Fem Stratum, Saka and Botanica. Exports to South Asia, SE Asia and Middle East. Rs937mn sales and PAT of Rs 46mn Rs2.577b n 2.75x sales, Has deeply entrenched the fairness bleach market. Market leader with market share of 60%. Acquired 72.15% first and then made an open offer for additional 20% stake in FCPL. This acquistion gave sales and costs synergies for Dabur. Gave entry into high growth skin care market with an established brand 'FEM'. Distribution reach covered 1.25 lac retail outlets and parlours directly. The deal valued the equity at Rs 284cr in total. Namaste Labs 2010 Ethnic hair care products company, having products for women of colour. Organic root stimulator USA, MENA, Europe $95mn $100mn 1.05x sales Ethnic hair care products market valued at more than $1.5bn and tap into significant market opportunity in the fast growing, hugely populated (1bn) yet highly underpenetrated consumer markets of sub-saharan Africa. Hobi Kozmetic 2010 Hair, skin and body care products under the brands Hobby and New Era Hobby and New Era MENA - Turkey $27mn $69 mn 2.4x sales The company is a leading manufacturer and marketer of personal care products in Turkey. Hobi has 35% market share in hair gel category. Has wide distribution network covering 15,851 sales points in Turkey including leading retail chains. Exports 10% of t/o to MENA and East Europe. Product range of the company was complementary to their product range and the acquisition provided access to another attractive emerging market and provided a good platform to expand in the whole of MENA region. EBITDA margin of 17%. Source: Company, SSL sagarika.mukherjee@sbicapsec.com July 10,

11 Godrej Consumer Products Ltd July 10,

12 FMCG India Company Update BUY Best track record in acquiring companies Institutional Equity Research Godrej Consumer Products Ltd GCPL IN; GOCP.BO July 10, 2012 Current price Rs 575 Target price Rs 650 Upside/(downside) % 13 Earning estimate Revised Market data Mkt capitalisation Rs bn Average daily vol ' week H/L Rs 689 / 355 Shares O/S mn Free float mn Promotor holding % 64.0 Foreign holding % 25.3 Face value Rs 1.0 Price performance (%) 1m 3m 6m 1yr Nifty (abs) (6.3) Stock (abs) Relative to Index (2.3) Performance (Rs) Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 GCPL Source: Bloomberg, SSL (%) BSE FMCG (10) (20) Consistently strong earnings growth via organic and inorganic routes: GCPL has created value on a sustainable basis, which is evident from the CAGR of 27%/33% seen in Sales/PAT in period. The high quality of earnings shown by GCPL was also rewarded by the markets as the stock price delivered a CAGR of 42%, outperforming the FMCG index which returned 18% CAGR in the same period. For the next 10 years they want to achieve 10x the current sales i.e. 26% CAGR for the next 10 years of which 15-16% will be organic and the rest will be through the inorganic route. Category mix has shifted towards fast growing HI segment: Compared to F09 when 41% of sales was coming from Soaps segment and only 20% comprised HI, the sales mix is now overweight on HI category as it comprised 47% of sales in F12 and soaps were reduced to 22% of sales. Household insecticide has been growing ahead of the market for the last 5 years now. In F12, GCPL/category growth rates were 31%/10% respectively. Management expects the category to grow from Rs 35bn to Rs 60bn in the next three years. Synergies to reflect in international sales growth and margins: We believe that integration of Darling business will bring in a lot of synergies in the form of better sales mix, wider distribution network and more efficient sourcing mechanism. Following the cross-pollination strategy, the management is planning to launch Indian HI products in Africa using Darling s distribution network in the near future. Valuation: We have factored in 12% CAGR growth in Soaps for F12-14 period and 20% CAGR for HI in the same period. We believe that a lot of positive news will flow in future due to reduction in palm oil prices and consequent improvement in soaps margins, margin expansion in international business due to change in sales mix, sourcing efficiency and volume growth. At CMP of Rs 575, the stock is trading at 25.2x/22.3x F13/F14 core earnings estimate of Rs22.9/25.8. We have a BUY rating on the stock with a TP of Rs 650 due to significant growth seen in core domestic categories like soaps, HI and margin expansion in international business arising out of synergies and operational efficiencies. Sagarika Mukherjee sagarika.mukherjee@sbicapsec.com Financial summary Y/E March (Rs mn) F 11 F 12 F 13e F 14e Sales 36,461 48,661 61,938 73,818 Growth(%) EBIDTA margin (%) Core PAT 4,816 5,511 7,770 8,780 Growth(%) Core EPS (Rs) P/E (x) - core earnings EPS (Rs) - Reported Dividend yield (%) RoCE(%) RoE(%) Source: Company, SSLe SBICAP Research on Bloomberg SBICAP <GO>, Please refer to our disclaimer given at the last page.

13 Godrej Consumer Products Ltd Analysing historic performance of GCPL in terms of inorganic growth Consistently strong earnings growth via organic and inorganic routes: GCPL has created value on a sustainable basis, which is evident from the CAGR of 27%/33% seen in Sales/PAT in period. The high quality of earnings shown by GCPL was also rewarded by the markets as the stock price delivered a CAGR of 42%, outperforming the FMCG index which returned 18% CAGR in the same period. For the next 10 years the company wants to achieve 10x the current sales i.e. 26% CAGR for the next 10 years of which 15-16% will be organic and the rest will be through the inorganic route. Sales growth at CAGR of 27% in EBITDA growth at CAGR of 28% in ,759 Sales in Rs bn EBITDA in Rs mn ,190 1,820 2,110 1,500 1,070 4,110 6,438 0 F 02 F 03 F 04 F 05 F 06 F 07 F 08 F 09 F 10 F 11 F 12 0 F 02 F 03 F 04 F 05 F 06 F 07 F 08 F 09 F 10 F 11 F 12 Source: SSLe Major changes in strategy: Conscious effort to shift out of heavily penetrated category to a fast growing category Portfolio mix has now shifted towards high growth category like Household Insecticides (HI). Growth trend in Household Insecticides Growth y-o-y(%) F 08 F 09 F 10 1QF 11 2QF 11 3QF 11 4QF 11 1QF 12 2QF 12 3QF 12 4QF 12 Source: SSLe Soaps as a category saw a spike in F12 across the board despite being a heavily penetrated category in India. Growth trend in Soaps Growth y-o-y(%) F 03 F 04 F 05 F 06 F 07 F 08 F 09 1QF 10 2QF 10 3QF 10 4QF 10 1QF 11 2QF 11 3QF 11 4QF 11 1QF 12 2QF 12 3QF 12 4QF Source: SSLe sagarika.mukherjee@sbicapsec.com July 10,

14 Godrej Consumer Products Ltd Investment Rationale Category mix has shifted towards fast growing HI segment: Compared to F09 when 41% of sales was coming from Soaps segment and only 20% comprised HI, the sales mix has now overweight on HI category as it comprised 47% of sales in F12 and soaps were reduced to 22% of sales. Household insecticide has been growing ahead of the market for the last 5 years now. In F12, GCPL/category growth rates were 31%/10% respectively. Management expects the category to grow from Rs 35bn to Rs 60bn in the next three years. Growth trend in Household Insecticides Growth y-o-y(%) F 08 F 09 F 10 1QF 11 2QF 11 3QF 11 4QF 11 1QF 12 2QF 12 3QF 12 4QF 12 Source: SSLe Gradual change in category mix: HI comprises 47% of sales compared to 20% in F10 F 09 F 10 F 11 F 12 Others 15% Hair Colors 20% Personal Wash 65% Others 19% Hair Colors 20% Household Insecticides 20% Personal Wash 41% Others 13% Hair Colors 12% Personal Wash 32% Household Insecticides 43% Others 12% Hair Colors 19% Personal Wash 22% Household Insecticides 47% Source: SSLe sagarika.mukherjee@sbicapsec.com July 10,

15 Godrej Consumer Products Ltd Synergies of Darling s acquisition to reflect in international sales growth and margins We believe that integration of Darling business will bring in a lot of synergies in the form of better sales mix, wider distribution network and more efficient sourcing mechanism. Following the cross-pollination strategy, the management is planning to launch Indian HI products in Africa using Darling s distribution network in the near future. Darling Group will help improve margins in Africa due to backward integration. It fits into the 3x3 strategy of increasing its traction in hair care, personal care and household insecticides in India and emerging markets like Africa, SE Asia and LATAM The Darling Group is the market leader in hair extensions across Africa and has a 13 year successful track record of running businesses in sub-saharan Africa. Darling group has a market share of 20% in hair extensions and is the only company which is present pan-africa. There are some Korean and Chinese players apart from other local players but none of them are spread across Africa. In calendar year 2010, Darling had revenues of about $200 million and has been growing at about 15% in the last five years. It has full-fledged operations in 14 countries across Africa, such as manufacturing, distribution, sales and marketing. The two brands of the company, Darling and Amigos are ubiquitous household names for the African woman. Darling group s acquisition falls well into GCPL s 3x3 strategy of increasing its traction in hair care, personal care and household insecticide segments in India and emerging markets like Africa, SE Asia and LATAM. The hair extension market is estimated to be valued at over US$1 billion of consumer prices with no multinational presence. It is one of the highest involvement categories for the African woman and consequently strong brands enjoy high profitability. Darling group has an operating margin of 20% and it s a fully integrated business with manufacturing capabilities. Deal structure and valuation Darling Group deal transaction FY12 mid FY13 mid FY14 FY15 Phase 1 Phase 2 Phase 3 Acquired 40% of Darling Group business comprising top 14 countries. GCPL had a stake of 51% at the end of FY12 for roughly 6months. Roughly Rs 200mn accrued as profits in FY12 in GCPL's books. Acquire another 30% of the business with 51% stake in it. Acquire the remaining 30% of the business Phase 4 Exercise the option to increase stake in the business from 51% to 100% over a period of time. Total Source: Company, SSL 51% stake in 40% of the business. Approximate deal valuation was 7-8x sales. GCPL rasied $100mn at a price of 3.5% in 2011 to fund phase 1. 51% stake in 70% of the business. GCPL sold 4.96% stake to Temasek for Rs6.85bn to fund phase 2 and also for Cosmetica Nacional. Debt:equity ratio brought down to % stake in the whole after the capital infusion. company. sagarika.mukherjee@sbicapsec.com July 10,

16 Godrej Consumer Products Ltd Synergies with Kinky: Margin expansion due to backward integration and completes the hair extension portfolio with products in popular and economic segments Kinky is mainly present in South Africa and has a very different business model as compared to Darling. Kinky is into premium hair extension products and is more into front end operation with retail stores. Kinky imports all the products from China and sells them in South Africa. Darling on the other hand is an integrated business with strong manufacturing capabilities. Hence there will be great synergy between Kinky and Darling. We expect overall margins for Kinky to improve due to in-house manufacturing. Secondly, with Darling, GCPL will be able to straddle the whole pyramid in hair extension market since Kinky is into premium segment while Darling covers the economical and popular segment. Thirdly, as it has done in the past, GCPL introduced powder hair color under Rapidol in Africa, from the Indian portfolio, as a result of product crosspollination. Likewise, the company is looking to introduce household insecticides using Darling s distribution network in 14 sub-saharan countries. Cosmetica Nacional is relatively small acquisition made by GCPL in Chile to integrate their LATAM business. GCPL has acquired 60% stake in Cosmetica for $38mn; the company has sales of $36mn (deal multiple of 1.66x sales) and operating margin profile of 18-20%. Cosmetica Nacional has strong brands like Pamela Grant and Ilicit which are into hair coloring and color cosmetics. The company will gain from the supply side benefits and enter Argentina. It will also gain in the distribution since it has similar go-to-market channels i.e. modern trade channels. Underlying rationale and selection criteria for acquisitions Acquisition strategy is to acquire market leaders and strong brands: GCPL buys only large scale businesses which have strong local foothold and have a well known brand name in that product category (for ex. Keyline, Rapidol has 90% market share in ethnic hair color market in Africa, Erstwhile JV with Sara Lee which was turned into GHPL by acquiring the remaining 51% from Sara Lee in 2010 was the market leader in household insecticide with a share of ~39%). GCPL buys brands and products that have relative market share of 0.5x at least to ensure that it buys a strong brand and that is usually a market leader in the category. The company believes in retaining the local talent/management in order to take advantage of the local experience. They supplement the local talent with senior management from India to manage the finances in foreign operations. Enters geographies with strong corporate governance: GCPL believes in choosing targets in countries where there are strong corporate governance rules in order to maintain the reputation that it has created historically. GCPL stays out of countries like China and Brazil due to low corporate governance standards. Targets should always be EPS accretive: GCPL believes in acquiring companies that have similar or better operating margins and hence they are EPS accretive from the beginning. All the major acquisitions like GHPL, Megasari and now Darling Group have been EPS accretive. Valuation should not go beyond 8-12x EBITDA: GCPL does not buy companies that are very expensive (8-12x EV/EBITDA), which according to us is very judicious, since valuations of all FMCG companies in India are currently trading close to 15-18x EBITDA. The company also uses the EVA as a key factor to decide on an acquisition target. In order to apply a stricter criterion it applies the prevailing Indian rates for cost of capital and not the lower overseas rate for the calculation of EVA. The payback period should be within 4-6 years for them to purchase a business. sagarika.mukherjee@sbicapsec.com July 10,

17 Godrej Consumer Products Ltd GCPL has grown its international business through the inorganic route and has been acquiring strong brands since Below is the quarterly snapshot of the various international segments and their margin trends For 1QFY12 International Business Indonesia Africa LATAM UK Total Sales % of Int business 54% 12% 16% 17% Growth (%) 19% 22% 16% EBITDA EBITDA Margin (%) 14% 9% 2% 15% 12% Source: Operating margin for Megasari improved due to favorable mix change, new products launches and cost management Megasari had a sales growth of 35% on back of distribution expansion and healthy performance of new products. Middle east had sales of Rs 5cr In Africa, this was the first quarter in which Darling Group was consolidated. EBITDA margin expansion in Africa was due to favorable format sales mix, good festive season and continuation of low ad-spends by Darling Strong sales growth of 43% by Cuticura. It s the 3rd consecutive quarter of excellent growth by Cuticura For 2QFY12 International Business Indonesia Africa LATAM UK Total Sales % of Int business 55% 15% 16% 13% Growth (%) 26% 48% 13% 10% 24% EBITDA EBITDA Margin (%) 19% 26% 7.4% 11% 17% Source: For 3QFY12 International Business Indonesia Africa LATAM UK Total Sales 2,552 1, ,670 % of Int business 45% 33% 14% 8% Growth (%) 35% 251% 29% 43% EBITDA ,202 EBITDA Margin (%) 21% 31% 9% 6% 21% Source: For 4QFY12 International Business Indonesia Africa LATAM UK Total Sales 2,500 1, ,863 % of Int business 45% 34% 16% 7% Growth (%) 25% 342% 47% 10% EBITDA ,243 EBITDA Margin (%) 21% 31% 9% 6% 21% Source: Superb track record when it comes to carving out synergies and creating brands in foreign markets Keyline brand has paid back for itself in 4-5 years after the acquisition. The brand has managed to grow faster than the category despite the slowdown in UK GCPL believes in cross-pollinating products between geographies for ex. they launched Proteckt in India which is originally Cuticura in UK Keyline, UK Created a strong brand out of Cuticura ; brands grew faster than the category even in recessionary times The company is into toiletries and personal care with brands like Cuticura ( lead volume hand sanitizer in the UK market) and Provoke Touch of Silver which has doubled its turnover in three years after the acquisition. It leveraged the H1N1 virus phenomenon in 2009 and created a strong brand out of Cuticura. GCPL created brand extensions out of Cuticura by introducing talcum powder and soaps etc. Keyline business has paid back for itself in 4-5 years time. It has grown faster than the category and given that UK has been in recession since 2008, it has shown commendable performance. It has grown at 8-10% CAGR for the past 5 years and the growth has accelerated at the bottom line. sagarika.mukherjee@sbicapsec.com July 10,

18 Godrej Consumer Products Ltd GCPL also believes in cross pollination of products. The company launched hand sanitizers in India under the brand name of Proteckt by using the product technology from Keyline. The hand sanitizing market is currently very small ~Rs 250mn but is growing at 50% p.a. and has all the large FMCG players like HUL, Reckitt, Himalaya Herbal Health, Dabur, Purell, Paras, Wipro along with GCPL. We believe it is one of the high margin businesses and will grow very fast for next 5-6 years as more people gain awareness about personal hygiene. It is a category that can afford to have many players at this juncture but once the size of the players reaches a certain critical mass, the market will start consolidating and smaller players will be wiped out. However, this scenario is far away in the future. Post the acquisition, the company has entered into the Caucasian (non-black) hair color market with Renew from GCPL India. The Caucasian hair color market is 3x the Ethnic hair color market in Africa Category growth is 15-16% y-o-y and Rapidol is growing at a phenomenal pace. The company has improved its margin by bps over the past 5 years. Sales CAGR for last 5 years has been 30.3% while EBITDA CAGR is 29.5% Rapidol, South Africa- Made inroads into 3x larger Caucasian hair coloring market despite large players being present in sub-saharan Africa Rapidol is into hair coloring segment with Inecto brand. The brand is a market leader in Ethnic (black population) hair color market in South-Africa. Hair coloring market in sub-saharan Africa is much smaller than hair extension market. It's about $200mn and it has have an exposure through Inecto. Post the acquisition, the company has entered into the Caucasian (non-black) hair color market with Renew from GCPL India. The Caucasian hair color market is 3x the Ethnic hair color market in Africa. In , the sales were affected due to slowing economy and rising competition. They have 12-13% market share (MAT), while exit market share is much higher. Inecto has become the 4 th largest Caucasian hair color brand. There are competitors like P&G and Loreal in the same market. Category growth is 15-16% y-o-y and Rapidol is growing at a phenomenal pace. The company has improved its margin by bps over the past 5 years. Sales CAGR for last 5 years has been 30.3% while EBITDA CAGR is 29.5%. Kinky s products will be manufactured in-house by Darling instead of importing them from China Kinky, South Africa Achieved cost savings through backward integration and complements the portfolio to straddle across the whole pyramid Kinky is into wigs, braids, re-worn, artificial wigs and human wigs etc. The business model is to purchase from China and then brand it in South Africa and sell under its brand name. The goods will be manufactured in Darling s plants now. Hence, the company is expecting some cost savings in future due to backward integration. Kinky products cater to the high end and premium segment of hair extension market through its retail chains. They have in total some 29 stores in sub-saharan Africa. Till now the products were distributed through cash-and-carry outlets and owned stores. Now, Kinky s products will be distributed in 14 countries through Darling s distribution network. Megasari comprises 55% of the international business and around 20% of turnover in the overall business and around an equivalent amount in EBITDA terms Megasari, Indonesia Acquired a market leader and improved margins over time through efficient raw material sourcing Household insecticide market in Indonesia is dominated by the coils market with its share at 50% of the total. However, Megasari was into selling aerosols and liquids. Megasari has 35% market share in the HI market; current market size if $350mn. Megasari is a leading player in its category and contributes roughly 55% to the revenues from international business and an equivalent amount at the EBITDA level. The business has consistently given an operating margin of 18-19%. And the gross margin improved by bps and this was because of its global sourcing team. sagarika.mukherjee@sbicapsec.com July 10,

19 Godrej Consumer Products Ltd Issue and Argencos, Argentina Spearheaded product cross pollination by introducing hair color sachets in cream form in India The main synergy that was derived from the acquisition was product cross pollination as a result of technology sharing. It used the technology from Argentina to manufacture creams in sachets. It is about to launch the product in India soon. At constant currency, the sales have grown at the rate of 18-20% CAGR p.a. EBITDA margin is lower than other domestic businesses in GCPL. The steady state margin is around 10% at the operating level. The main reasons for the low operating margin are high labor costs and commodity inflation. Marketing costs are also higher than 10-12% of sales that they spend on the domestic business. Valuation and Outlook GCPL s standalone business (primarily domestic business and marks the core business of the company) grew by 21% in F12 to Rs 48.6bn. In F12, the growth in soaps and HI category accelerated compared to last year due to low base effect, significant brand investments and expansion in distribution network. However, we do not believe that the high pace will continue in F13 and F14 since soaps as a category is heavily penetrated (volume growth of 4-5% for F12). Household insecticide as a category is not heavily penetrated; however, we do not expect that the high doubledigit volume growth will be possible in F13. We believe that the segment will grow at 15% in F13 and F14. We maintain a cautious outlook for hair colours since the segment has not yielded any results despite brand investments and innovations. International business will be led by high growth in Megasari and Darling Group. We believe one will see significant synergies flowing out of the acquisition in F13 in terms of margin expansion. We have factored in 12% CAGR growth in Soaps for F12-14 period and 20% CAGR for HI in the same period. We believe that a lot of positive news will flow in future due to reduction in palm oil prices and consequent improvement in soaps margins, margin expansion in international business due to change in sales mix, sourcing efficiency and volume growth. At CMP of Rs 575, the stock is trading at 25.2x/22.3x F13/F14 core earnings estimate of Rs22.9/25.8. We have a BUY rating on the stock with a TP of Rs 650 due to significant growth seen in core domestic categories like soaps, HI and margin expansion in international business arising out of synergies and operational efficiencies. Key Concerns 1) Further increase in Palm oil prices from these levels will put pressure on the soap business. The company plans to take further price hikes, however, pricing power is limited in their case since they have only 10% market share. 2) Further rupee depreciation will hurt their margins since they purchase raw materials like palm oil from Malaysia and Indonesia in US$. They also carry foreign denominated loans to the tune of Rs 24.4bn. Hence their interest expense could increase if rupee depreciates further. 3) The stock might see sharp de-rating if the growth rate in soaps and HI categories falls below 10%. We believe that the market expects the growth to not be as strong as it was in F12. However, the fundamentals should not deteriorate to an extent where the excellent performance in F12 looks like an aberration. 4) The company is continuously investing in branding and innovations of the hair colouring segment in their domestic business, however their performance has still been below par. GCPL grew by 13% in F12 compared to 22% growth in the category. We believe that the stock might feel some pressure if the performance does not improve. sagarika.mukherjee@sbicapsec.com July 10,

20 Godrej Consumer Products Ltd Financials Income statement Cash flow statement Y/E March (Rs mn) F 11 F 12 F 13e F 14e Y/E March (Rs mn) F 11 F 12 F 13e F 14e Net Sales 36,461 48,661 61,938 73,818 PBT 6,118 7,771 9,824 11,330 Growth (%) Depreciation COGS 17,489 23,185 29,730 35,433 Other non-cash adj Gross Profit 18,972 25,476 32,208 38,385 Receivables (3,065) (885) (1,826) (1,054) Employee Costs 2,845 3,919 5,154 6,275 Inventories (2,509) (3,445) (1,186) (1,452) Share of Net Sales(%) Loans and advances (3,229) 914 (547) (629) A&SP 4,100 4,499 5,853 7,289 Payables 5, ,046 1,652 Share of Net Sales(%) Cash tax (1,420) (2,260) (2,054) (2,550) Other manufacturing costs 5,590 8,300 10,581 12,454 CFO 2,061 6,190 7,776 8,777 Share of Net Sales(%) Capex (13,880) (956) (1,388) (1,804) Total expenses 30,023 39,903 51,317 61,450 Purchase of investments (892) (619) - - EBITDA 6,438 8,759 10,621 12,368 Adj for goodwill (10,271) (6,050) (4,000) - Growth (%) CFI (25,218) (8,303) (5,355) (1,690) EBITDA Margin(%) Incr. in share capital 5,228 6,510 (0) - Depreciation Incr. in loans 19,434 4,375 (2,500) (2,000) Interest Interst paid (321) (658) (695) (628) Other income Dividend paid (incl tax) (1,966) (1,881) (2,521) (2,766) PBT 6,118 7,771 9,824 11,330 CFF 22,374 8,345 (5,717) (5,394) Tax 1,302 2,260 2,054 2,550 Net change in cash (783) 6,232 (3,296) 1,693 Tax Rate(%) Core PAT 4,816 5,511 7,770 8,780 Extraordinary income 331 2, Net profit Growth (%) Net profit margin(%) EPS(Rs) Balance sheet Key ratios Y/E March (Rs mn) F 11 F 12 F 13e F 14e Y/E March (Rs mn) F 11 F 12 F 13e F 14e Share capital RoCE(%) Reserves 16,928 28,151 32,746 37,755 Inventory days Total shareholders' equity 17,252 28,491 33,086 38,095 Receivable days Minority interests Payable days Debt 20,054 24,429 21,929 19,929 Cash conversion cycle (46) 39 (35) (35) Total liabilities 37,320 52,920 55,014 58,023 Net block 15,373 15,839 15,714 15,562 Valuations CWIP P/E(x) Investments EV/Sales(x) Intangibles 15,404 21,454 25,454 25,454 EV/EBITDA(x) Current Assets 15,062 24,710 24,974 29,787 FCF yield (%) (12.4) (1.1) Inventories 4,394 7,839 9,026 10,478 Divident yield(%) Receivables 3,840 4,725 6,552 7,606 D/E(x) Loans and Advances 4,559 3,645 4,191 4,820 Cash 2,269 8,501 5,205 6,884 Du Pont Analysis - RoE Current Liabilities 8,673 9,463 11,509 13,161 NPM(%) Payables 5,499 7,702 8,868 10,295 Asset turnover Provisions 225 1,761 1,940 2,046 Leverage Total assets 37,320 52,920 55,014 58,023 RoE(%) Source: Company, SSLe sagarika.mukherjee@sbicapsec.com July 10,

21 Jyothy Laboratories Ltd July 10,

22 FMCG India Company Update BUY Current price Rs 244 Target price Rs 300 Upside/(downside) % 23 Earning estimate Revised Market data Mkt capitalisation Rs bn 19.7 Average daily vol ' week H/L Rs 252 / 125 Shares O/S mn 80.6 Free float mn 28.0 Promotor holding % 65.3 Foreign holding % 12.7 Face value Rs 1.0 Price performance (%) 1m 3m 6m 1yr Nifty (abs) (6.3) Stock (abs) Relative to Index Performance (Rs) Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Jyothy Laboratories Source: Bloomberg, SSL (%) 20 0 (20) (40) (60) BSE FMCG Acquisition of Henkel enabled product diversification and bought in stronger brands in personal care and home care segment Institutional Equity Research Jyothy Laboratories Ltd JYL IN; JYOI.BO July 10, 2012 Reduced dependence on Maxo; attained a stronger portfolio With this acquisition, JLL broadened its product portfolio in homecare and personal care segment and reduced its dependence on brands like Maxo the combined entity will derive 14% of sales from Maxo while JLL standalone derived 22% of sales from Maxo. Henkel and Jyothy to benefit from complementary networks Henkel and JLL also have complementary distribution networks Henkel is strong in East and South India while JLL is strong in North and West India. Apart from this, Henkel s brands are all very urban centric and are strong in modern trade channels while JLL s brands are popular in the rural markets. JLL aligned the trade margins of both the companies in order to cross-sell Henko products through JLL s distribution network. It s similar to the benefits GCPL derived out of its acquisition of Sara Lee s 51% stake in GHPL, since GCPL was very strong in North India and in urban markets while, GHPL was strong in South India and in rural markets. Early signs of Henkel s turnaround are visible The management of JLL had put key operational and financial milestones in place to turnaround Henkel s performance. JLL reduced the promotional offers (20% extra volumes) given with Margo soaps and stopped offering freebies with Henko White. JLL also cut-down on management costs (more than 40 people in Henkel India were earning more than Rs40lakhs) and got a new task force in place by August Valuation and Outlook: At the CMP of Rs 244, the stock is trading at consolidated P/E multiple of 24.7x/19.4x based on F13/F14 core EPS estimate of Rs 9.9/12.6. We believe that the stock is undervalued significantly and the negative sentiment of acquiring a large loss-making and debt ridden company has weighed heavily on the stock price. Keeping in mind the turnaround of Henkel until now and the aggressive stance taken by the company s management on cost cutting and brand repositioning, we arrive at a target price of Rs 300 for the stock and a BUY rating on the stock. Sagarika Mukherjee sagarika.mukherjee@sbicapsec.com Financial summary Y/E March (Rs mn) F 11 F 12 F 13e F 14e Sales 6,276 9,130 15,750 19,600 Growth(%) EBIDTA margin (%) Net Profit ,246 1,467 Reported EPS (Rs) Core EPS (Rs) Growth(%) P/E (x) Dividend yield (%) RoCE(%) RoE(%) Source: Company, SSLe SBICAP Research on Bloomberg SBICAP <GO>, Please refer to our disclaimer given at the last page.

23 Jyothy Laboratories Ltd Investment Rationale JLL has very successfully put and executed a turnaround plan for Henkel India, which includes both operational and financial overhauling of the company Broad summary of the acquisition strategy Jyothy Laboratories acquired 83.65% stake in Henkel India, a homecare and personal care company with brands like Pril, Henko Stain Champion, Fa, Margo, Mr. White, Chek etc, for a total consideration of Rs 7.83bn including Rs 4.25bn debt on the books of Henkel India. At the time of the acquisition, the company had a turnover of Rs 5.34bn and a net loss of Rs 518mn, with accumulated losses running up to Rs 4bn. JLL has very successfully put and executed a turnaround plan for Henkel India, which includes both operational and financial overhauling of the company. Major synergies of the acquisition: Dependence on Maxo reduced largely with the acquisition JLL has been trying to improve the operating margin of Maxo for the past 2 years by shifting the sales mix towards higher margin products like aerosols and liquids. Maxo derived 90% of its sales from low margin coils business and only 10% from aerosols and liquids and was unable to increase its presence in aerosols and liquids since the larger brands like GCPL, Reckitt Benckiser and SC Johnson already had the lion s share of the market. Secondly, the company also tried to remove the high trade margins it gave to its distributors (around 30% of sales in peak season of Feb-June) to increase the profitability. However, JLL has always followed the push strategy to market Maxo while all the other competitors created a brand name for their products. Hence, the product lost its popularity once the company pulled the plug on the heavy trade margins. The product category is dominated by stalwarts like GCPL, SC Johnson and Reckitt Benckiser who have all seen a jump in their sales post the event and even gained 200bps market share from Jyothy. The competitors also gained higher penetration in their coils markets by giving 10% volume discounts in the peak season (Q4F11). With the acquisition of Henkel, the company has reduced its dependence on Maxo which is struggling to improve its margins due to high cost pressures and competitive intensity. Maxo s performance was dismal during the year F12 mainly due to the removal of trade discounts: sales were flat compared to last year and were down by 14% for 9MF12 period. 4QF12 saw a revival in sales mainly as it was the season for coils. Category Q1F12 YoY(%) Q2F12 YoY(%) Q3F12 YoY(%) Q4FY12 YoY(%) FY12 YoY(%) Fabric care (18) (7) Mosquito Repellant (35) (18) Dishwashing Other products 76.6 (32) (0) (8) Total (19) Source: Company, SBICAP Securities Support from Henkel s strong brands like Pril, Margo, Henko and Fa to push sales further; dependence on Maxo reduced Categorywise sales breakdown-jll (FY12) Categorywise sales breakdown of Henkel Categorywise sales breakdown - JLL+Henkel (FY12) Other products 6% Dishwashing 25% Mosquito Repellant 22% Source: Company, SSLe Fabric care 47% Other products 36% Dishwashing 17% Mosquito Repellant 1% Fabric care 46% Other products 16% Dishwashing 23% Mosquito Repellant 14% Fabric care 47% sagarika.mukherjee@sbicapsec.com July 10,

24 Jyothy Laboratories Ltd Henkel s Turnaround Strategy The management of JLL had put key operational and financial milestones in place to turnaround Henkel s performance and turn it into cash profit making company by the end of F12 and net profit making by the end of F13. JLL reduced the promotional offers (20% extra volumes) given with Margo soaps and stopped offering freebies with Henko White. JLL also cut-down on management costs (more than 40 people in Henkel India were earning more than Rs40lakhs) and got a new task force in place by August JLL aligned the trade margins of both the companies in order to cross-sell Henko products through JLL s distribution network. JLL offered 8% margin for days to stockists and ~30% margin at peak season for Maxo. The plan is to bring down the margin to 6% for the extended network (increase the trade margin of Henkel s distributors from 5% on cash to 6% on credit).the company feels that Henkel s brands already command the recall value of a premium product due to its German association. Since the prices of all the Henkel brands were not raised in the last couple of years, JLL is planning to raised the prices of all the Henkel products by 10-12% in the June 12 quarter. After the price increase, Henkel dishwashing products will be slightly more expensive as compared to HUL s Vim. Strategy going ahead 1) Plan to recruit field staff ~200 sales persons. Currently, Henkel s sales force reach 10 shops per day per person compared to 60 done by JLL s sales force. 2) Put a special task force in place at the key positions including CEO, marketing and supply chain. JLL has also started using a supply chain management platform called AREBA which helps in sourcing raw materials efficiently, at competitive rates and is also less heavy on their working capital requirements. 3) Gradually shift all manufacturing units to strategic locations that is closer to the buyer so as to cut down on logistics costs. Plan is to have single low-cost contract manufacturer. JLL has already started manufacturing Henko in its Uttaranchal plant as it was done by Henkel in Karaikal. The company plans to manufacture products very close to its markets, so that distribution becomes less cumbersome. Henkel used to manufacture Henko in Karaikal and distribute it to its main market in North East, thereby increasing overheads. 4) Re-launch and reposition brands in the market. The company is planning to first re-launch Margo and Pril followed by Fa and Henko stain champion. The company has changed the packaging of Margo and launched 4 different variants which will be able to connect with the youth. Henkel's Turnaround Status Period Net Sales (Rs mn) EBITDA Margin% CY10 5,339 (3.2) Q4FY11 1,192 (6.4) Q1FY12 1, Q2FY12 1, Q3FY Q4FY12 1, Due to temporary shut down of Karaikal plant on account of Labour unrest from September 26, 2011 to December 26, 2011, 61 days. Sales of Henko Detergent lost 27 Crores and thereby loss of Rs. 7 crores in EBIDTA (10%) sagarika.mukherjee@sbicapsec.com July 10,

25 Jyothy Laboratories Ltd Gradual improvement in profitability of Henkel (Figure for Q4FY12 and lighten the shade) EBITDA Margin% (4.0) (8.0) CY10 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 (3.2) (6.4) Source: SSL Brand wise strategy for Henkel Brand Sales Comment Strategy Pril (Dishwashing liquid+ bar) Rs 700mn Present only in metros currently. Dishwashing market is around Rs11.5bn in size of which Rs10bn consists of bars and Rs1.5bn is into liquids. Pril Liquids contributes 70% of total Pril sales while rest comes from bars. Pril is currently available in all the metros and is available in 2lac retail outlets only. JLL plans to distribute Pril in the 30lac outlets it has under its distribution network. Will focus on liquid soaps under Pril brand and will market bars under Exo. Margo (Personal care) Rs 1000 mn Sales have come down from Rs 1.20bn to Rs 800mn in last 1.5 years. Management believes that it is present in a growing market of specialized soaps and is planning to launch ad-campaigns in a month s time to curb the loss of sales. JLL has removed '20% extra' offers on the bathing soap as it feels the soap will sell itself and does not need offers to attract customers. Has 1.2% market share of the overall soap market. Fa (Personal care) Acquired from Henkel AG on 2% Net sales basis for technology support. Rs 150 mn Historically has underperformed its potential even after having a great brand name. It has 5% market share in the deodorants space. It s into a fast growing category(50%+ yoy) The company has competitively priced it along with other players like GCPL, HUL, Vini etc. The deodorant market is currently very small in India but is growing very fast hence there is space for many different players. The company wants to emulate Yardley's performance which was just Rs 100mn brand 3 years ago and has now a sales of Rs 1bn.JLL plans to turn it into a Rs 1bn brand in next 2-3 years. Axe, Yardley and Set Wet are all Rs 1bn+ brands. Henko (Washing powder) - Rs 1300mn Acquired from Henkel AG on 2% Net sales basis for technology support. Total category size is Rs 120bn of which Henko falls into the premium category and is makes 20% of the total. Medium category which constitutes 30%, is growing fast along with Premium, while Popular is seeing a de-growth due to uptrading. JLL plans to take Henko to all metros, tier 1 and 2 cities in a short span. Henkomatic (only washing powder for both top loading and front loading machines) has performed excellently well historically. In terms of price, Henko is present in the premium category along with the likes of Ariel from P&G. The company has plans to expand it pan-india. Has 5.4% market share in the premium segment and 1.1% of overall detergent market Source: Company, SSL Strategy for JLL: Roll-out of detergent stalled for now, Henko s brands to take over the segment. Maxo discontinues being the focus product of the company. sagarika.mukherjee@sbicapsec.com July 10,

26 Jyothy Laboratories Ltd Brand wise strategy for JLL Brand Sales Comment Strategy Ujala Supreme (Fabric whitener) Rs 1.91bn in F12 down by 1% YoY mainly due channel cleaning in 2Q and 3QF12. Cash cow of JLL. Has the highest We expect 4-5% of volume growth each year and 7-8% increase in gross margins and needs almost nil net realization. ad-spends to sell itself. The company has 73.6% all-india market share by value. Ujala Detergent Rs 850mn in F12 The detergent is placed in the medium category along with Mr. White. Total category size is Rs 120bn, of which medium category is 30%. The company plans to take it to the 4 states in South India in which the distribution is strong. Maxo (Mosquito repellant) Rs 1.47bn in F12. Up by 1% YoY. The performance picked up in 4QF12 since it was the season and networks were in place. Category size is Rs 20bn, of which 60% is coils and 40% is liquids and aerosols. Urban India forms 60% of the coils market, while 70% of the liquids is sold in Urabn markets. JLL is mainly present in coils - 90% of sales comes from coils. They have 22% market share overall and 33% in the rural markets. Maxo's sales were suffering in first three quarters of F12 mainly due to overhaul of the distribution network. For 9MF12, Maxo sales were down by 14% on YoY basis. The sales picked up in 4QF12 and it grew by 32% YoY. For F12, the company ended up with flat sales. For F13, the management is guiding for at least 15% volume growth. The company plans to market Maxo liquids in modern retail chains. Exo (Dishwashing bar and liquid) Rs 1.6bn in F12. Up Exo has 26.3% market share by by 43% YoY mainly on value in South Indian market. Allthe back of the India market share in Bars is around success of Exo 11% and will be 13% if Pril bars are Round. included. Category size if Rs 10bn for bars only. Liquids have a category size of Rs 1.5bn, of which Pril Liquid has 30% share. Exo-round is performing exceptionally well and the company is diverting more capacity towards it s production in Baddi. The product is being rolled-out nationally and the focus will be on bars rather than liquids. Exo has garnered Rs 1.6bn in sales by selling in only 4 states down South. Dishwashing is a fast growing category - 25% p.a. 65% of India still uses mud and ash to clean utensils. Rural penetration for Exo is very low, leaving alot of room for growth. Source: Company, SSL Outlook and valuation At the CMP of Rs 244, the stock is trading at consolidated P/E multiple of 24.7x/19.4x based on F13/F14 core EPS estimate of Rs 9.9/12.6. We believe that the stock is undervalued significantly and the negative sentiment of acquiring a large loss-making and debt ridden company has weighed heavily on the stock price. Keeping in mind the turnaround of Henkel until now and the aggressive stance taken by the company s management on cost cutting and brand repositioning, we arrive at a target price of Rs 300 for the stock and a BUY rating on the stock. Key concerns The company faces execution risk. It has set profitability benchmarks for Henkel i.e. to make it profitable by the end of F13. JLL has so far achieved all its milestones; however, it needs to re-position all the products from Henkel in markets where the stalwarts of the industry such as HUL are present. Input costs pressures remain a concern. sagarika.mukherjee@sbicapsec.com July 10,

27 Jyothy Laboratories Ltd Financials Income Statement (Y/E March ) Cash Flow Statement (Y/E March) Y/E March (Rs mn) F11 F12 F13e F14e Y/E March (Rs mn) F11 F12 F13e F14e Total Revenues 6, , , ,600.0 Net Profit ,246 1,467 Growth rate (%) Depreciation/Amortisation COGS 3, , , ,419.1 Interest expense Gross Profit 3, , , ,180.9 Interest income (157) (227) (196) (246) Employee Costs , , ,743.0 (Inc)/Dec in Wcap (706) 867 (491) (322) Share of Net Sales(%) CFO 457 1,267 1,410 1,513 Ad-spends , ,024.0 Capex (230) (820) (300) (350) Share of Net Sales(%) Purchase of investments(net) (638) (574) - - Other manufacturing costs , , ,920.6 Interest Received Share of Net Sales(%) Sale of assets Total expenses 5, , , ,106.7 CFI (711) (6,911) EBITDA , ,493.3 Interest Paid (20) (238) (640) (582) EBITDA Margin(%) Dividend Paid (371) (202) (390) (407) Growth rate(%) (17.7) Proceeds from issue of shares 2, Depreciation Long term debt 560 4,926 - (500) Interest Expense Debt to subsidiaries Other income CFF 2,545 4,277 (1,030) (1,489) PBT ,437.0 Net change in cash 1,584 (499) Tax Tax Rate (%) Key ratios PAT Y/E March F11 F12 F13e F14e Minority Interest RoCE(%) Extraordinary items Inventory Days Net Profit , ,466.5 Receivables Days Core PAT ,016.5 Loans and Advances Days Core PAT Margin(%) Payable Days Growth(%) (16.7) (35.2) Provision Days EPS (Core) Cash Conversion Cycle (Days) (11.2) EPS - Reported (Rs) Balance sheet Y/E March (Rs mn) F11 F12 F13e F14e Share Capital Valuation Ratios Reserves 6,230 6,083 6,938 7,998 Y/E March FY 11 F12 F13e F14e Total shareholder's Equity 6,311 6,164 7,019 8,078 P/E (x) Minority interests P/Sales(x) Debt 691 5,616 5,616 5,116 EV/EBITDA(x) Deferred tax liability P/BV(x) Total liabilities 7,222 12,055 12,909 13,469 FCF yield (%) (2.5) 5.5 (0.1) 1.3 Net block 2,607 3,427 3,205 3,045 Dividend Yield(%) Goodwill - 5,745 5,745 5,745 Investments Current Assets 5,104 5,027 6,556 7,812 Inventories 694 1,233 1,520 1,877 Receivables 1, ,295 1,611 Loans & advances Cash 2,808 2,309 2,895 3,293 Du Pont Analysis - RoE Current Liabilities 1,097 2,178 2,630 3,166 Y/E March FY 11 F12 F13e F14e Payables 538 1,828 2,280 2,816 NPM(%) Provisions Leverage Deferred tax asset Asset turnover Total Assets 7,222 12,055 12,909 13,469 RoE(%) Source: Company, SSLe sagarika.mukherjee@sbicapsec.com July 10,

28 Marico Ltd July 10,