Emami (HMN IN) Seasonality jinx continues

INSTITUTIONAL EQUITY RESEARCH Emami (HMN IN) Seasonality jinx continues INDIA FMCG Quarterly Update 1 February 2019 Despite gross-margin pressure Emami s 3QFY19 was slightly above our estimates due to a strict vigil on operating overheads. Gross margin declined c.395bps yoy on a sharp inflation in mentha-oil/crude derivatives and a late start to the winter season resulted in lower contribution from the high-margin winter care portfolio (Boroplus brand). We expect gross margin pressure to ease off considerably, as prices of key raw materials have cooled off significantly; Emami has also taken price hikes (blended 3-4%) Domestic volume growth remained subdued (3.5% yoy) despite seeing strong growth in key categories (especially Kesh King and the OTC portfolio). Management attributed delayed winter (Boroplus portfolio) and increased competitive intensity in men s grooming (Fair & Handsome) as key factors for subdued volume growth. Emami stated it has hired BCG (consulting firm) for reviving growth in its Fair & Handsome range but can t do much about seasonality affecting its power brands. Kesh-King s revenue grew 26% yoy (on a favourable base) as: (1) The product was launched with an improved proposition an applicator, (2) market-share gains (260bps yoy) primarily from Patanjali, (3) 8% blended price hikes taken in 2QFY19, (4) solid growth in shampoo (although it has a lower contribution), and (5) renewed campaign on hair growth instead of hair fall. Healthcare range grew 18% yoy mainly driven by Zandu Pancharishta (+30%) after hiring Amitabh Bachchan as the brand ambassador, new packaging, and scaling up of its diabetes portfolio. International business grew 18% yoy as most of the concerns relating to re-jig in distribution structure in the MENA region are over. Management expects momentum in Kesh King, OTC and International portfolio to sustain in the medium term. Conference call takeaways Pledged shares (% of promoter shareholding) has gone up to 47% from the company s guidance of 30-35%, but the management said that it is planning to bring in PE investors from other group business in order to deleverage promoter-related debt. Creme 21 recent acquisition: Has entire range of skin care and body care products Derives 80% of revenue from MENA Gross margin (at 50%) is lower, given manufacturing base in Germany Management plans to increase EBITDA margin to 15-16% from current 9-10%; for additional sales growth, it will focus on geographies where it is strong Consideration value is Rs 1 bn (as per our calculations). Wholesale dependence has reduced to 38% currently from 52% two years ago as it has increased direct reach to 900,000 from 625,000 in the same time span. Maintain Neutral: We believe Emami s performance has been sub-par in the past two years because its core categories (despite being underpenetrated) have limited potential for growth as its customers switch to newer formats. The management is trying hard to better the performance of its power brands by improving formulation, changing packaging, and launching differentiated variants; but we would like to see sustainable performance of Kesh King and OTC portfolio before turning positive. Moreover, higher dependence on a particular season for its power brands adds to the company s woes. In this context, the performance of new launches becomes extremely critical in the long run we await some meaningful output on this front (except for 7 in 1 hair oil). We maintain NEUTRAL with a target of Rs 450 (30x FY21 EPS). Upside risks include a recovery in the wholesale channel, and better-than-expected weather conditions. Downside risk is that Fair & Handsome relaunches do not work as per internal expectations. (Rs mn) 3QFY19 3QFY18 yoy 2QFY19 qoq % PC yoy % Comments Net Sales 8,109 7,552 7.4 6,280 29.1 6.1 EBITDA 2,666 2,647 0.7 1,894 40.8 (1.3) EBITDA margin (%) 32.9 35.1-217 bps 30.2 272 bps -245 bps PAT 1,481 1,472 0.6 827 79.1 (5.8) Neutral (Maintain) CMP RS 415 TARGET RS 450 (8%) COMPANY DATA O/S SHARES (MN) : 454 MARKET CAP (RSBN) : 183 MARKET CAP (USDBN) : 3 52 - WK HI/LO (RS) : 605 / 386 LIQUIDITY 3M (USDMN) : 1.7 PAR VALUE (RS) : 1 SHARE HOLDING PATTERN, % Dec 18 Sep 18 Jun 18 PROMOTERS : 72.7 72.7 72.7 FII / NRI : 10.9 11.7 12.3 FI / MF : 7.5 6.9 5.8 NON PRO : 0.5 0.6 0.5 PUBLIC & OTHERS : 8.3 8.2 8.6 KEY FINANCIALS Rs mn FY19 FY20E FY21E Net Sales 27,227 31,125 34,826 EBIDTA 7,534 8,562 9,551 Net Profit 5,159 6,000 6,783 EPS, Rs 11.4 13.2 14.9 PER, x 36.5 31.4 27.8 EV/EBIDTA, x 24.9 21.6 19.1 ROE, % 8.9 8.7 8.4 Debt/Equity (%) 15.5 19.1 25.8 Vishal Gutka, (+ 9122 6246 4118) vgutka@phillipcapital.in Preeyam Tolia, (+ 9122 6246 4129) ptolia@phillipcapital.in Page 1 PHILLIPCAPITAL INDIA RESEARCH

Financial snapshot Emami - Rs mn 3QFY18 3QFY19 % YoY Comments Volume gr (%) 6 3.5 Domestic volume growth remained subdued (3.5% yoy) despite Net sales 7,552 8,109 7.4 seeing strong growth in key categories (especially Kesh King and Expenditure (4,905) (5,443) 11.0 OTC portfolio). EBITDA 2,647 2,666 0.7 Delayed winter (Boroplus portfolio) and increased competitive EBITDA margin (%) 35.0 32.9-217 bps intensity in men s grooming (Fair & Handsome) as key factors Interest (92) (62) -32.6 for subdued volume growth. Depreciation (800) (792) -1.0 Other income 55 55 0.2 PBT 1,810 1,867 3.2 Tax (338) (386) 14.2 Tax rate (%) 18.7 20.7 199 bps EO Items - (98.00) Share of profit from associates (1) (8) Minority Interest 1 2 Rep. PAT 1,472 1,378 Adj. PAT 1,472 1,481 No of shares (m) 454 454 0.0 EPS (Rs) 3.2 3.0-6.4 Gross profit 5,357 5,432 1.4 Raw material inflation in key raw materials(crude & mentha) Gross margins (%) 70.9 67.0-395 bps Cost Heads 3QFY18 3QFY19 % YoY Raw Materials 2,195 2,677 22.0 % of Sales 29.1 33.0 395 bps Staff Costs 680 699 2.8 % of Sales 9.0 8.6-39 bps Advertising Expenditure 1,293 1,291-0.2 % of Sales 17.1 15.9-120 bps Other Expenditure 737 776 5.3 % of Sales 9.8 9.6-19 bps Source: Company, PhillipCapital India Research Page 2 PHILLIPCAPITAL INDIA RESEARCH

Delayed winter led subdued performance in winter portfolio (c.45%) Volume (%) 20.0 15.0 10.0 5.0 0.0 14.8 1.0 0.0 6.5 6.4 10.0 10.0 6.0 10.0 18.0 3.5-5.0-10.0-2.6-1.5-4.0-15.0-20.0-18.0 Source: Company, PhillipCapital India Research Subdued performance in winter portfolio; Kesh King, OTC, International grew strong Revenue growth % 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 3QFY19 Boroplus 38 10 (2) (15) (7) 4 Pain Management (Zandu, Menthoplus) 15 17 13 39 (8) 6 Navratna cooling oil 16 15 14 19 3 10 Male grooming (F&H) 12 22 8 8 12 (2) Kesh King (16) (19) 6 10 2 26 OTC 2 (3) (2) 28 1 18 International 22 16 37 7 4 18 Source: Company, PhillipCapital India Research Page 3 PHILLIPCAPITAL INDIA RESEARCH

Con-call key takeaways Delayed winter has impacted winter portfolio which contributes 45% of the domestic sales. It grew only in January 2019. Non-winter portfolio grew 10% yoy. Overall domestic volume growth was 3.5%. Rural growth continues to outpace urban growth. Kesh King: Strong growth in Kesh King (up 26% yoy) was on account of its new communication strategy (hair fall to hair growth), introducing an applicator, and blended price increase of 8% in Q2. Emami has hired BCG as an external consultant to revive Kesh King brand image Kesh King Shampoo grew 100% since its relaunched. Kesh King revenue at the time of acquisition: Rs 3bn (adjusted for IND AS Rs 2.3-2.4bn). Fair & Handsome: Appointed external consultant to revamp the F&H brand and it expects to replicate Kesh King s success. Boroplus: Delayed winter impacted overall winter portfolio Boroplus lotion grew 16% while Boroplus Crème portfolio grew only 4% yoy International: Crème 21 In January 2019, Emami acquired German based skin and body care brand Crème 21 which has a strong market presence in Middle East (c. 80% of the sale). Emami plans to leverage its existing distribution and infrastructure to expand the brand in other international markets (particularly in MENA, SAARC and Russian market) which has strong potential, as per the company. Currently, Crème 21 s Gross margin (at 50%) is lower, given manufacturing base in Germany. EBITDA margins are at 10%, which it plans to increase to 15-16% Competition: Nevia and Dove, but Crème 21 prices are close to Dove. Others: Gross margins to remain under pressure down 395bps yoy largely because of higher crude and mentha prices; however, management has guided that lately raw material prices are easing off and that it could start seeing benefits of this in Q4. Emami has increased prices by 3.5-4.0% on blended basis which should flow through in the coming quarters. MT (c.8% of domestic sales) continued to remain strong (+30% yoy) and Emami plans to increase its contribution to 10% soon. Wholesale channel stabilizing c.38-39% of sales currently, which it plans to bring down to 35%. Slower growth in CSD (up 2% yoy) was largely because it has not been able to introduce new brands in last two years. Direct coverage stands at 925,000 outlets up from 625,000 in FY18. Pledged shareholding has gone up to 47% from 30-35% on share price correction. Management has said that promoter s money has been invested wisely and that it is working on an alternate plan to reduce the pledge and is talking with PE investors to raise money for other business. Amortization: Kesh King amortization till Q1FY21 will be Rs 600mn per quarter (Rs 2,400mn annually). After this Emami will bring down amortization cost to Rs 900mn annually. EO items: Rs 98mn was for VRS that 90% of the employees in its Kolkota plant (small unit) opted for; 10% are close to retirement after they do, the company will close down the plant. Page 4 PHILLIPCAPITAL INDIA RESEARCH

Financials Income Statement Y/E Mar, Rs mn FY18 FY19E FY20E FY21E Net sales 25,305 27,227 31,125 34,826 Growth, % 2 8 14 12 Total income 25,305 27,227 31,125 34,826 Raw material expenses -8,098-9,232-10,709-11,995 Employee expenses -2,546-2,750-3,080-3,419 Other Operating expenses -7,466-7,711-8,774-9,862 EBITDA (Core) 7,194 7,534 8,562 9,551 Growth, % (5.2) 4.7 13.6 11.6 Margin, % 28.4 27.7 27.5 27.4 Depreciation -3,109-3,260-3,363-2,344 EBIT 4,086 4,273 5,198 7,207 Growth, % (9.3) 4.6 21.6 38.6 Margin, % 16.1 15.7 16.7 20.7 Interest paid -343-206 -103-51 Other Income 195 146 197 267 Pre-tax profit 3,926 4,214 5,293 7,422 Tax provided -863-927 -1,164-1,633 Profit after tax 3,063 3,287 4,128 5,789 Others (Minorities, Associates) 8 0 0 0 Net Profit 3,071 3,287 4,128 5,789 Growth, % (9.8) 7.0 25.6 40.2 Net Profit (adjusted) 4,946 5,159 6,000 6,783 Unadj. shares (m) 454 454 454 454 Wtd avg shares (m) 454 454 454 454 Balance Sheet Y/E Mar, Rs mn FY18 FY19E FY20E FY21E Cash & bank 795 800 3,313 5,386 Marketable securities at cost 1,281 1,281 1,281 1,281 Debtors 1,559 1,677 1,917 2,145 Inventory 1,940 2,087 2,386 2,669 Loans & advances 30 30 30 30 Other current assets 1,403 1,403 1,403 1,403 Total current assets 7,008 7,278 10,330 12,914 Investments 1,855 1,855 1,855 1,855 Gross fixed assets 26,788 28,788 29,788 30,788 Less: Depreciation -8,767-12,027-15,391-17,735 Add: Capital WIP 305 305 305 305 Net fixed assets 18,325 17,065 14,702 13,358 Non-current assets 790 790 790 790 Total assets 28,007 27,018 27,706 28,946 Current liabilities 7,139 5,042 5,415 5,769 Total current liabilities 7,139 5,042 5,415 5,769 Non-current liabilities 726 726 726 726 Total liabilities 7,866 5,768 6,141 6,495 Paid-up capital 227 227 227 227 Reserves & surplus 19,909 21,017 21,332 22,219 Shareholders equity 20,142 21,250 21,565 22,451 Total equity & liabilities 28,007 27,018 27,706 28,946 Source: Company, PhillipCapital India Research Estimates Cash Flow Y/E Mar, Rs mn FY18 FY19E FY20E FY21E Pre-tax profit 3,926 4,214 5,293 7,422 Depreciation 3,109 3,260 3,363 2,344 Chg in working capital -2,091-2,363-166 -158 Total tax paid -1,026-927 -1,164-1,633 Other operating activities 1,961 0 0 0 Cash flow from operating activities 5,878 4,184 7,326 7,975 Capital expenditure -1,281-2,000-1,000-1,000 Chg in investments -912 0 0 0 Chg in marketable securities -947 0 0 0 Other investing activities 361 0 0 0 Cash flow from investing activities -2,791-2,000-1,000-1,000 Free cash flow 3,087 2,184 6,326 6,975 Equity raised/(repaid) 922 0 0 0 Other financing activities -4,159-1,435-1,435-1,435 Cash flow from financing activities -5,144-3,614-5,248-6,337 Net chg in cash -2,057-1,430 1,078 638 Valuation Ratios FY18 FY19E FY20E FY21E Per Share data EPS (INR) 10.9 11.4 13.2 14.9 Growth, % (9.8) 7.0 25.6 40.2 Book NAV/share (INR) 44.4 46.8 47.5 49.4 FDEPS (INR) 6.8 7.2 9.1 12.8 CEPS (INR) 13.6 14.4 16.5 17.9 CFPS (INR) 5.4 13.9 15.7 17.0 DPS (INR) 3.5 4.0 7.0 9.0 Return ratios Return on assets (%) 12.6 12.7 15.5 20.6 Return on equity (%) 15.3 15.5 19.1 25.8 Return on capital employed (%) 17.4 16.3 19.1 25.7 Turnover ratios Asset turnover (x) 1.4 1.5 1.9 2.3 Sales/Total assets (x) 0.9 1.0 1.1 1.2 Sales/Net FA (x) 1.3 1.5 2.0 2.5 Working capital/sales (x) (0.1) 0.0 0.0 0.0 Receivable days 22.5 22.5 22.5 22.5 Inventory days 28.0 28.0 28.0 28.0 Payable days 48.8 48.3 48.2 48.1 Working capital days (31.8) 2.1 3.8 5.0 Liquidity ratios Current ratio (x) 1.0 1.4 1.9 2.2 Quick ratio (x) 0.7 1.0 1.5 1.8 Interest cover (x) 11.9 20.8 50.5 140.0 Total debt/equity (%) 16.2 4.6 4.5 4.4 Net debt/equity (%) 12.2 0.8 (10.8) (19.6) Valuation PER (x) 38.1 36.5 31.4 27.8 PEG (x) - y-o-y growth (6.3) 8.2 1.8 0.8 Price/Book (x) 9.4 8.9 8.7 8.4 EV/Net sales (x) 7.5 6.9 5.9 5.2 EV/EBITDA (x) 26.3 24.9 21.6 19.1 EV/EBIT (x) 46.4 43.8 35.5 25.4 Page 5 PHILLIPCAPITAL INDIA RESEARCH

Stock Price, Price Target and Rating History 700 650 600 550 500 450 400 350 300 250 B (TP 600) N (TP 475) N (TP 535) N (TP 550) N (TP 545) N (TP 575) N (TP 560) N (TP 595) N (TP 542) N (TP 545) N (TP 540) N (TP 445) 200 J-16 F-16 A-16 M-16 J-16 A-16 O-16 N-16 J-17 F-17 M-17 M-17 J-17 A-17 S-17 N-17 D-17 F-18 M-18 N (TP J-18 J-18 S-18 O-18 D-18 540) Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15% SELL <= -15% Target price is less than or equal to -15%. Page 6 PHILLIPCAPITAL INDIA RESEARCH

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