FMCG | India July 10, 2012 Acquisition spree in FMCG sectorrakesh-jhunjhunwala.in/wp-content/files/Acquisition_spree_in... · Equity Research FMCG | India July 10, 2012 Acquisition

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July 10, 2012FMCG | India

Acquisition spree in FMCG sector

We have analyzed the acquisitions made in the sector based on valuations of the target companies, sourcesof 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 andcarving 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 hasnow a bigger portfolio with strong brands to market in India. We have a BUY rating on the stock with a targetprice 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 hasalso 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 SELLrating on the stock with a target price of Rs 125.

SBICAP Securities Ltd (SSL)Mafatlal Chambers, A-Wing 2nd Floor, N.M. Joshi Marg Lower Parel, Mumbai - 400013 + 91-22-4227 3300/01 [email protected]

Sagarika MukherjeeSecurities Research

+91 22 4227 3386 [email protected]

FMCG Sector SBICAP Securities Ltd

[email protected] July 10, 2012 | 2

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. ................................................................................................... 7

Companies under coverage

Godrej Consumer Products Ltd Investment summary: Best track record so far in acquisitions in FMCG sector ........................... 12 Analysing historic performance of GCPL in terms of inorganic growth ........................................ 13 Major changes in strategy: Conscious effort to shift out of heavily penetrated category to a fast growing category ............................................................................................. 13 Investment rationale .................................................................................................................... 14 Underlying rationale and selection criteria for acquisitions .......................................................... 16 Valuation and outlook .................................................................................................................. 19 Key concerns ............................................................................................................................... 19 Financial summary ....................................................................................................................... 20

Jyothy Laboratories Ltd

Investment summary: Acquisition of Henkel enabled product diversification and bought in stronger brands in personal care and home care segment .......................................................... 22 Investment rationale .................................................................................................................... 23 Broad summary of the acquisition strategy .................................................................................. 23 Major synergies of the acquisition ................................................................................................ 23 Henkel’s turnaround strategy ....................................................................................................... 24 Brandwise strategy for Henkel ..................................................................................................... 25 Brandwise strategy for JLL .......................................................................................................... 26 Valuation and outlook .................................................................................................................. 26 Key concerns ............................................................................................................................... 26 Financial summary ....................................................................................................................... 27

Marico Ltd Investment Summary: Synergies do not justify the high valuation of Paras ................................. 29 Investment rationale .................................................................................................................... 30 Broad summary of the acquisition ................................................................................................ 30 Snapshot of brands acquired from Paras .................................................................................... 30 Synergies between Marico and Paras ......................................................................................... 31 Negatives about the deal ............................................................................................................ 32 Valuation and outlook .................................................................................................................. 32 Key concerns ............................................................................................................................... 32 Financial summary ....................................................................................................................... 33



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 socio-economic 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 CY12Emami 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 2550Marico 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 9677 0 64025 15530 9256No of deals 3 0 7 3 2Source: 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.



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 2008-2011 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 2050. 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.

GDP Growth Rate Projection (%)

9.3

6.8

10.6

7.2 7 7.3

0

3

6

9

12

F 08 F 09 F 10 F 11 F 12 F 13e

Gro

wth

rate

YoY

(%)

Source: CSO

Per capita personal disposable income growth rate YoY(%)

10.6

19.6

12.8 13.3

0

5

10

15

20

F 08 F 09 F 10 F 11

(%)

Source: CSO

WPI Inflation YoY (%)

9.4 9.8 10 9.99.1

7.5

0

3

6

9

12

Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11

(%)

Source: CSO

Fundamental drivers of consumption in FMCG are unaffected by the macroeconomic scenario

India has a demographic dividend which helps boost consumption

The young working population is experimental in nature and has high disposable income

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

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



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.

FMCG Industry Size FMCG Industry Urban FMCG Industry Rural

1,451

1,671

1,300

1,400

1,500

1,600

1,700

C 10 C 11

(Rs

bn)

960

1,111

800

900

1,000

1,100

1,200

C 10 C 11

(Rs

bn)

496

559

450

480

510

540

570

C 10 C 11

(Rs

bn)

Source: Industry Data

Penetration Levels: Sufficient Headroom

4237

67

18 18

3 2 4

77

57

80

32

59

19

5

26

0

20

40

60

80

100

ToothpasteShampoo Hair Oil Skin Cream

Mosquito Repellants

Instant Noodles

Hair Dyes Floor Cleaners

(%)

Rural Penetration Urban Penetration


India has low per-capita consumption as compared to other emerging economies Skin Care-Per Capita Consumption Shampoo-Per Capita Consumption Toothpaste - Per Capita Consumption

3.2

0.80.3

7.4 7.7

0.0

2.0

4.0

6.0

8.0

Chi

na

Indo

nesi

a

Indi

a

Mal

aysi

a

Thai

land

(US$

)

1.0 1.1

0.3

2.72.4

0.0

1.0

2.0

3.0

Chi

na

Indo

nesi

a

Indi

a

Mal

aysi

a

Thai

land

(US$

)

0.5

1.0

0.4

2.9

2.0

0.0

1.0

2.0

3.0

Chi

na

Indo

nesi

a

Indi

a

Mal

aysi

a

Thai

land

(US$

)




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 long-term) 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 2012.

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(%) 2009 2010 2011 2012 2013World Output (0.5) 5.3 3.9 3.5 4.1Advanced Economics (3.4) 3.2 1.6 1.4 2.0Emerging Economics 2.7 7.5 6.2 5.7 6.0Russia (7.8) 4.3 4.3 4.0 4.1China 9.2 10.4 9.2 8.2 8.8India 6.8 10.5 7.2 6.9 7.3Brazil (0.6) 7.5 2.7 3.0 4.1Middle East and North Africa 1.8 4.9 3.5 4.2 3.7Sub-saharan Africa 2.8 5.3 5.1 5.4 5.3Source: IMF and World Economic Forum



Africa and Middle East: Acquisition of a strong business is the only strategy to enter these markets

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.

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.

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%

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



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 2005-06. 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 100-150mn Rs 100-150mn 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

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 2009. Total HI market in 2012 is $350mn.

Tura Mar-10 Soaps Tura Nigeria $10-15mn $10-15mn 1x sales Very small company in the whole gamut of businesses in Africa.

Darling Group 2011 Hair extensions Darling

and Amigos Sub-saharan

Africa

$200mn / 15% yoy in last 5 years. Africa had sales of Rs 2 bn before Darling. By the time the process will be over it will be Rs 10 bn plus. Hence it will be much bigger than previous acquisitions.

Rs 5000 mn or $100mn, raised $136mn (Rs 6.85bn) by selling 5% stake to Temasek, will use it to pay back some debt, or fund the next phase of acquisition.

2.45x sales

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.

Cosmetica Nacional 2012

Hair coloring and color cosmetics

Pamela Grant and Ilicit Chile (LATAM) $36-38mn sales in CY

$38mn for 60% stake. Rest owned by the family.

1.66x sales

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.

Source: Company, SSL



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/Thuan 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 10 2010 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.




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

Rs2.577bn 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 25000 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%.


Godrej Consumer Products Ltd SBICAP Securities Ltd


SBICAP Research on Bloomberg SBICAP <GO>, www.securities.com Please refer to our disclaimer given at the last page.


Research

Financial summaryY/E March (Rs mn) F 11 F 12 F 13e F 14eSales 36,461 48,661 61,938 73,818Growth(%) 78 33 27 19EBIDTA margin (%) 17.7 18.0 17.1 16.8Core PAT 4,816 5,511 7,770 8,780Growth(%) 34 9 41 13Core EPS (Rs) 14.9 16.2 22.9 25.8P/E (x) - core earnings 38.7 35.5 25.2 22.3EPS (Rs) - Reported 15.9 21.4 21.2 23.3Dividend yield (%) 1.1 0.8 1.1 1.2RoCE(%) 52.1 38.4 18.2 20.4RoE(%) 35.9 23.0 23.4 22.2Source: Company, SSLe

Best track record in acquiring companies

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 2002-12 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.

Godrej Consumer Products LtdGCPL IN; GOCP.BO


Sagarika Mukherjee +91 22 4227 3386 [email protected]

Company Update BUY

Current price RsTarget price RsUpside/(downside) % 13Earning estimate Revised

Market dataMkt capitalisation Rs bn 195.8Average daily vol '000 44.952-week H/L Rs 689 / 355Shares O/S mn 340.3Free float mn 122.6Promotor holding % 64.0Foreign holding % 25.3Face value Rs 1.0

Price performance (%)1m 3m 6m 1yr

Nifty (abs) 4.7 1.2 9.4 (6.3)Stock (abs) 2.4 16.6 48.0 31.5Relative to Index (2.3) 15.5 38.6 37.8

Performance

575650

(20)

(10)

0

10

20

30

350

400

450

500

550

600

Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

GCPL BSE FMCG

(%)(Rs)

Source: Bloomberg, SSL



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 2002-12 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 2002-12 EBITDA growth at CAGR of 28% in 2002-12

4.6 4.7 4.9 5.6 7.09.5 11.0

13.9

20.4

36.4

48.7

0

10

20

30

40

50

F 02 F 03 F 04 F 05 F 06 F 07 F 08 F 09 F 10 F 11 F 12

Sale

s in

Rs

bn

720 820 880 1,070 1,500 1,820 2,190 2,110

4,110

6,438

8,759

0

2500

5000

7500

10000

F 02 F 03 F 04 F 05 F 06 F 07 F 08 F 09 F 10 F 11 F 12

EBIT

DA

in R

s m

n

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

10

15

20

25

30

35

40

45

F 0

8

F 0

9

F 1

0

1QF

11

2QF

11

3QF

11

4QF

11

1QF

12

2QF

12

3QF

12

4QF

12

Gro

wth

y-o

-y(%

)

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

-20

-10

0

10

20

30

40

F 0

3

F 0

4

F 0

5

F 0

6

F 0

7

F 0

8

F 0

9

1QF

10

2QF

10

3QF

10

4QF

10

1QF

11

2QF

11

3QF

11

4QF

11

1QF

12

2QF

12

3QF

12

4QF

12G

row

th y

-o-y

(%)

Source: SSLe



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

10

15

20

25

30

35

40

45

F 08

F 09

F 10

1QF

11

2QF

11

3QF

11

4QF

11

1QF

12

2QF

12

3QF

12

4QF

12

Gro

wth

y-o

-y(%

)

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

Personal Wash 65%

Hair Colors20%

Others15%

Household Insecticides

20%

Personal Wash 41%

Hair Colors20%

Others19%


43%

Personal Wash 32%

Hair Colors12%

Others13%


47%

Personal Wash 22%

Hair Colors19%

Others12%

Source: SSLe



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.

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

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.

Phase 2Acquire another 30% of the business with 51% stake in it.

Phase 3Acquire 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 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 0.7 after the capital infusion.

51% stake in the whole company.


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



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 cross-pollination. 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.



GCPL has grown its international business through the inorganic route and has been acquiring strong brands since 2005. Below is the quarterly snapshot of the various international segments and their margin trends For 1QFY12International Business Indonesia Africa LATAM UK Total Sales 1940 430 560 620 3570% of Int business 54% 12% 16% 17%Growth (%) 19% 22% 16%EBITDA 280 40 10 90 420EBITDA Margin (%) 14% 9% 2% 15% 12%Source:

For 2QFY12International Business Indonesia Africa LATAM UK Total Sales 2300 650 650 530 4190% of Int business 55% 15% 16% 13%Growth (%) 26% 48% 13% 10% 24%EBITDA 446 170 48 58 723EBITDA Margin (%) 19% 26% 7.4% 11% 17%Source:

For 3QFY12International Business Indonesia Africa LATAM UK Total Sales 2,552 1,860 820 430 5,670 % of Int business 45% 33% 14% 8%Growth (%) 35% 251% 29% 43%EBITDA 526 577 74 26 1,202 EBITDA Margin (%) 21% 31% 9% 6% 21%Source:

For 4QFY12International Business Indonesia Africa LATAM UK Total Sales 2,500 1,990 943 430 5,863 % of Int business 45% 34% 16% 7%Growth (%) 25% 342% 47% 10%EBITDA 515 617 85 26 1,243 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, 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.

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

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



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.

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 2010-11, 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 4th 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 200-250bps over the past 5 years. Sales CAGR for last 5 years has been 30.3% while EBITDA CAGR is 29.5%.

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, 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 150-200bps and this was because of its global sourcing team.

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 200-250bps 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

Megasari comprises 55% of the international business and around 20% of turnover in the overall

business and around an equivalent amount in EBITDA terms



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 double-digit 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.



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 14eNet Sales 36,461 48,661 61,938 73,818 PBT 6,118 7,771 9,824 11,330 Growth (%) 78 33 27 19 Depreciation 499 644 824 852 COGS 17,489 23,185 29,730 35,433 Other non-cash adj. 184 658 695 628 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(%) 8 8 8 9 Loans and advances (3,229) 914 (547) (629) A&SP 4,100 4,499 5,853 7,289 Payables 5,072 791 2,046 1,652 Share of Net Sales(%) 11 9 9 10 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(%) 15 17 17 17 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 (%) 57 36 21 16 CFI (25,218) (8,303) (5,355) (1,690) EBITDA Margin(%) 18 18 17 17 Incr. in share capital 5,228 6,510 (0) - Depreciation 499 644 824 852 Incr. in loans 19,434 4,375 (2,500) (2,000) Interest 519 658 695 628 Interst paid (321) (658) (695) (628) Other income 698 520 723 442 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(%) 21 29 21 23 Core PAT 4,816 5,511 7,770 8,780 Extraordinary income 331 2,002 - - Net profit 5147 7267 7213 7915Growth (%) 41 14 41 13 Net profit margin(%) 13 11 13 12 EPS(Rs) 15.9 21.4 21.2 23.3

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 14eShare capital 324 340 340 340 RoCE(%) 52.1 38.4 18.2 20.4 Reserves 16,928 28,151 32,746 37,755 Inventory days 92 123 123 123 Total shareholders' equity 17,252 28,491 33,086 38,095 Receivable days 38 37 43 43 Minority interests - 882 882 882 Payable days 115 121 121 121 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 ValuationsCWIP 154 - - - P/E(x) 38.7 35.5 25.2 22.3 Investments - - - - EV/Sales(x) 5.6 4.3 3.4 2.8 Intangibles 15,404 21,454 25,454 25,454 EV/EBITDA(x) 31.7 24.0 19.9 16.8 Current Assets 15,062 24,710 24,974 29,787 FCF yield (%) (12.4) (1.1) 1.2 3.6 Inventories 4,394 7,839 9,026 10,478 Divident yield(%) 1.1 0.8 1.1 1.2 Receivables 3,840 4,725 6,552 7,606 D/E(x) 1.2 0.8 0.6 0.5 Loans and Advances 4,559 3,645 4,191 4,820 Cash 2,269 8,501 5,205 6,884 Du Pont Analysis - RoECurrent Liabilities 8,673 9,463 11,509 13,161 NPM(%) 13.2 10.8 11.6 10.7 Payables 5,499 7,702 8,868 10,295 Asset turnover 1.5 1.1 1.1 1.3 Provisions 225 1,761 1,940 2,046 Leverage 1.8 2.0 1.8 1.6 Total assets 37,320 52,920 55,014 58,023 RoE(%) 35.9 23.0 23.4 22.2

Source: Company, SSLe

Jyothy Laboratories Ltd SBICAP Securities Ltd




Research

Financial summaryY/E March (Rs mn) F 11 F 12 F 13e F 14eSales 6,276 9,130 15,750 19,600Growth(%) 4 45 73 24EBIDTA margin (%) 12.8 9.2 13.7 12.7Net Profit 688 446 1,246 1,467Reported EPS (Rs) 8.9 5.5 15.5 18.2Core EPS (Rs) 8.5 5.5 9.9 12.6Growth(%) -17 -35 79 28P/E (x) 28.6 44.1 24.7 19.4Dividend yield (%) 2.0 1.0 2.0 2.1RoCE(%) 10.2 9.5 20.0 23.1RoE(%) 10.4 6.2 10.8 12.2Source: Company, SSLe

Acquisition of Henkel enabled product diversification and bought in stronger brands in personal care and home care segment

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 2011.

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.

Jyothy Laboratories Ltd JYL IN; JYOI.BO



Company Update BUY

Current price RsTarget price RsUpside/(downside) % 23Earning estimate Revised

Market dataMkt capitalisation Rs bn 19.7Average daily vol '000 46.852-week H/L Rs 252 / 125Shares O/S mn 80.6Free float mn 28.0Promotor holding % 65.3Foreign holding % 12.7Face value Rs 1.0


Nifty (abs) 4.7 1.2 9.4 (6.3)Stock (abs) 13.1 51.6 50.3 11.7Relative to Index 8.4 50.4 40.9 17.9

Performance

244300

(60)

(40)

(20)

0

20

100

150

200

250

300


Jyothy Laboratories BSE FMCG

(%)(Rs)




Investment Rationale 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 677.3 (18) 650.9 (7) 857.4 13 962.0 34 3150.3 5Mosquito Repellant 182.5 (35) 389.5 5 281.6 (18) 620.0 32 1477.3 1Dishwashing 293.5 0 397.9 46 427 44 515.0 84 1632.9 43Other products 76.6 (32) 108.2 2 94.4 7 91.2 (0) 367.3 (8)Total 1229.9 (19) 1546.5 7 1660.4 12 2188.2 40 6627.8 10 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)

Fabric care47%

Mosquito Repellant

22%

Dishwashing 25%

Other products 6%

Fabric care46%

Mosquito Repellant

1%

Dishwashing 17%

Other products

36%

Fabric care47%

Mosquito Repellant

14%

Dishwashing 23%

Other products 16%

Source: Company, SSLe

JLL has very successfully put and executed a turnaround plan for Henkel India, which includes both operational and financial overhauling of the

company



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 2011. 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 20-30 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.

Period Net Sales (Rs mn) EBITDA Margin% CY10 5,339 (3.2)Q4FY11 1,192 (6.4)Q1FY12 1,231 8.8Q2FY12 1,075 10.6Q3FY12 769 1.6Q4FY12 1,106 14.2

Henkel's Turnaround Status

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%)



Gradual improvement in profitability of Henkel (Figure for Q4FY12 and lighten the shade)

(3.2)

(6.4)

8.8 10.6

1.6

14.2

(8.0)

(4.0)

0.0

4.0

8.0

12.0

16.0

CY10 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12

EBIT

DA

Mar

gin%

Source: SSL Brand wise strategy for Henkel Brand Sales Comment StrategyPril (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) - Acquired from Henkel AG on 2% Net sales basis for technology support.

Rs 1300mn 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.

Has 5.4% market share in the premium segment and 1.1% of overall detergent market

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.


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.



Brand wise strategy for JLLBrand Sales Comment StrategyUjala 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 gross margins and needs almost nil ad-spends to sell itself. The company has 73.6% all-India market share by value.

We expect 4-5% of volume growth each year and 7-8% increase in net realization.

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 by 43% YoY mainly on the back of the success of Exo Round.

Exo has 26.3% market share by value in South Indian market. All-India market share in Bars is around 11% and will be 13% if Pril bars are 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.


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.



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 F14eTotal Revenues 6,276.4 9,130.0 15,750.0 19,600.0 Net Profit 688 446 1,246 1,467 Growth rate (%) 3.8 45.5 72.5 24.4 Depreciation/Amortisation 130 247 731 720 COGS 3,202.8 5,029.9 9,246.1 11,419.1 Interest expense 20 238 640 582 Gross Profit 3,073.6 4,100.1 6,503.9 8,180.9 Interest income (157) (227) (196) (246) Employee Costs 813.1 1,136.6 1,334.5 1,743.0 (Inc)/Dec in Wcap (706) 867 (491) (322) Share of Net Sales(%) 13.0 12.4 8.5 8.9 CFO 457 1,267 1,410 1,513 Ad-spends 556.5 695.2 1,601.0 2,024.0 Capex (230) (820) (300) (350) Share of Net Sales(%) 8.9 7.6 10.2 10.3 Purchase of investments(net) (638) (574) - - Other manufacturing costs 898.7 1,427.4 1,409.0 1,920.6 Interest Received 157 227 196 246 Share of Net Sales(%) 14.3 15.6 8.9 9.8 Sale of assets - - 450 450 Total expenses 5,471.0 8,289.0 13,590.6 17,106.7 CFI (711) (6,911) 696 696 EBITDA 805.4 841.0 2,159.4 2,493.3 Interest Paid (20) (238) (640) (582) EBITDA Margin(%) 12.8 9.2 13.7 12.7 Dividend Paid (371) (202) (390) (407) Growth rate(%) (17.7) 4.4 156.8 15.5 Proceeds from issue of shares 2,279 - - - Depreciation 130.3 246.5 731.3 720.3 Long term debt 560 4,926 - (500) Interest Expense 19.9 238.3 639.7 582.1 Debt to subsidiaries - - - - Other income 156.5 227.3 196.3 246.1 CFF 2,545 4,277 (1,030) (1,489) PBT 811.7 583.5 984.7 1,437.0 Net change in cash 1,584 (499) 586 398 Tax 154.3 199.3 220.7 440.4 Tax Rate (%) 19.0 20.0 22.4 30.6 Key ratios PAT 657.4 384.1 764.1 996.6 Y/E March F11 F12 F13e F14eMinority Interest 30.3 61.7 32.1 19.9 RoCE(%) 10.2 9.5 20.0 23.1 Extraordinary items - - 450.0 450.0 Inventory Days 79.1 89.5 60.0 60.0 Net Profit 687.6 445.9 1,246.2 1,466.5 Receivables Days 61.3 44.4 30.0 30.0 Core PAT 687.6 445.9 796.2 1,016.5 Loans and Advances Days 31.0 34.0 31.0 31.0 Core PAT Margin(%) 11.0 4.9 5.1 5.2 Payable Days 61.3 179.1 90.0 90.0 Growth(%) (16.7) (35.2) 78.6 27.7 Provision Days 32.5 14.0 8.1 6.5 EPS (Core) 8.5 5.5 9.9 12.6 Cash Conversion Cycle (Days) 110.1 (11.2) 31.0 31.0 EPS - Reported (Rs) 8.9 5.5 15.5 18.2

Balance sheet Y/E March (Rs mn) F11 F12 F13e F14eShare Capital 81 81 81 81 Valuation RatiosReserves 6,230 6,083 6,938 7,998 Y/E March FY 11 F12 F13e F14eTotal shareholder's Equity 6,311 6,164 7,019 8,078 P/E (x) 28.6 44.1 24.7 19.4 Minority interests 5 67 67 67 P/Sales(x) 3.1 2.2 1.2 1.0 Debt 691 5,616 5,616 5,116 EV/EBITDA(x) 21.8 27.3 10.4 8.6 Deferred tax liability 163 161 161 161 P/BV(x) 2.8 2.9 2.5 2.2 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(%) 2.0 1.0 2.0 2.1 Goodwill - 5,745 5,745 5,745 Investments 607 34 34 34 Current Assets 5,104 5,027 6,556 7,812 Inventories 694 1,233 1,520 1,877 Receivables 1,053 807 1,295 1,611 Loans & advances 534 617 785 970 Cash 2,808 2,309 2,895 3,293 Du Pont Analysis - RoECurrent Liabilities 1,097 2,178 2,630 3,166 Y/E March FY 11 F12 F13e F14ePayables 538 1,828 2,280 2,816 NPM(%) 10.5 4.2 4.9 5.1 Provisions 559 350 350 350 Leverage 0.9 0.8 1.2 1.5 Deferred tax asset - 1 - 1 Asset turnover 1.1 2.0 1.8 1.7 Total Assets 7,222 12,055 12,909 13,469 RoE(%) 10.4 6.2 10.9 12.3 Source: Company, SSLe

Marico Ltd SBICAP Securities Ltd




Research

Financial summaryY/E March (Rs mn) F 11 F 12 F 13e F 14eSales 32,102 40,082 48,958 58,404Growth(%) 21 25 22 19EBIDTA margin (%) 15.3 12.1 12.7 13.7Core PAT 3,245 3,238 4,090 5,159Core EPS (Rs) 5.2 5.2 6.3 8.0Growth(%) 33 0 26 26P/E (x) 33.8 33.9 27.8 22.0Dividend yield (%) 0.4 0.5 0.6 0.7RoCE(%) 36.3 28.0 26.3 25.7RoE(%) 41.7 30.6 23.7 22.6Source: Company, SSLe

Synergies do not justify the high valuation for Paras Marico acquired the personal care business carved out of Paras Pharma ,which was acquired by Reckitt Benckiser in 2010 for 8x sales value (CY10 sales was roughly Rs 4bn) at Rs32.4bn. Paras Pharma had two business segments – personal care products and OTC healthcare products with attractive and strong brands in both categories. Marico acquired only the personal care segment and has bought the rights to market Set Wet (gels and deos), Zatak (deos) and Livon (leave-on hair conditioner). It was done 5x sales value of Rs 1.5bn (F12e by company management) which is one of the most expensive deals done on the street. MRCO has raised Rs5bn through equity dilution to fund the deal. Presence of Paras is currently limited to small and nascent categories: Its products are into very small categories and it will be some time before they contribute significantly to the bottom line. Assuming a blue–sky scenario of 10-15% bottom line margin for Paras’s business, it will contribute only 5.6% to the bottom line.

Heavy overlap in distribution network; no benefit from cross-selling products: There is about 80% overlap between the erstwhile Paras reach and that of Marico, so there won’t be benefits in terms of complementary distribution networks.

Paras will be in an investment mode which will keep the return ratios depressed: Return ratios (ROCE & ROE) have been declining due to high copra prices. Although they have corrected by 26% in Mar qtr, they are still up 20% YoY. The management believes it will take some time before copra prices see a secular decline. We believe that the company will spend more on ad-spends and distribution costs for Paras to do justice to the acquisition and carve out synergies. Hence we believe that the return ratios will be depressed for next 4-5 years.

Valuation and Outlook: At the CMP of Rs 182, Marico is trading at 28.7x and 22.8x EPS estimate of Rs 4.9/6.5 per share for F12/F13. It is one of the most expensive companies in the sector (apart from Colgate and Nestle) and it is trading at 50% premium to its historical 1-yr forward P/E multiple. We believe the recent run-up because of the Paras deal and also the high single digit volume growth that it has shown in its base business despite steep price increase of 30% (wtd average) is over-rated and is well priced in. We understand that Marico has once again proven to be an inflation cover by not losing volumes to small local players in situations of high inflation; however we feel that these fundamentals are priced in completely. We maintain our SELL rating on the company with a target price of Rs 125/share.

Marico Ltd MRCO IN; MRCO.BO



Company Update SELL

Current price RsTarget price RsUpside/(downside) % (31) Earning estimate Revised

Market dataMkt capitalisation Rs bn 117.5Average daily vol '000 111.152-week H/L Rs 189 / 134.1Shares O/S mn 644.5Free float mn 240.3Promotor holding % 62.7Foreign holding % 25.6Face value Rs 1.0


Nifty (abs) 4.7 1.2 9.4 (6.3)Stock (abs) 6.9 6.8 20.8 10.6Relative to Index 2.2 5.6 11.3 16.8

Performance

182 125

(20)

(15)

(10)

(5)

0

5

120

140

160

180

200


Marico BSE FMCG

(%)(Rs)




Investment Rationale

Broad summary of the acquisition Marico acquired the personal care business carved out of Paras Pharma, which was acquired by Reckitt Benckiser in 2010 for 8x sales value (CY10 sales was roughly Rs 4bn) at Rs32.4bn.

Paras Pharma had two business segments – personal care products and OTC healthcare products with attractive and strong brands in both categories. Marico acquired only the personal care segment and has bought the rights to market Set Wet (gels and deos), Zatak (deos) and Livon (leave-on hair conditioner) at roughly 5x sales value of Rs 1.5bn (F12e by company management). All the products are into fast growing categories with low penetration levels in India and are spurred with rising disposable income in the hands of the consumer and with increasing awareness/inclination towards personal grooming. Of all the three categories, Marico is most upbeat about Set wet since it’s a strong brand that straddles across 2-3 categories.

Most of the acquisitions in the sector are expensive We feel that quite a few companies (GCPL , Dabur, Marico, Reckitt Benckiser etc) in the sector have made expensive domestic and international acquisitions in past (CY08 -CY12). We believe that FMCG sector is still seen as a defensive sector and hence the valuations have sky-rocketed due to jittery global and domestic market conditions. Valuations of target companies in India have gone past 3-4x sales value, which make these smaller companies way more expensive than the stalwarts of the sector like HUL and ITC. We believe Marico- Paras deal is an expensive one (roughly 5x sales of Rs 1.5 bn) especially because the size of the business acquired is very small. All the products belong to very small and immature albeit fast growing categories.

To fund the acquisition, Marico has raised Rs 5bn by selling 4.56% stake to Baring India Pte (Rs1.25bn) and Indivest India (Rs3.75bn) at Rs 170/share.

Snapshot of brands acquired from Paras

Brand name Category Market Share (%)

Sales (Rs mn)

Market Size(Rs mn)

Category growth rates(%) Comments

Set wet Hair

gels/creams/deos

24 480 2000 Gel-25%, deos -35-40%

Biggest hair gel brand in the market, pipped GCPL's Brylcreem. MRCO already has a brand called 'Aftershower' in the post wash category, in which they have 11% market share.

Zatak Deodorants 6 660 11000-12000 35-40%

HUL with Axe probably has 17-18% market share. Second player has 7% share : McNroe Chemicals with Wild Stone brand. The rest is all unorganised market. There is a big gray market for imported deo's in India. The three big players make 30% while the rest 70% is made up of small players which has 1-2% share only. Axe is a well-established and widely distributed brand, and is heavily supported by advertisements in India.

Livon Leave-on conditioners 68 578 850 20%

Marico has a brand called Silk-n-Shine which is extension of Hair and Care. They already have 23% market share in that category.

Dr Lips Lip balm 560 Very marginal sales- roughly 1%

RecovaAnti-ageing cream for women

Roughly Rs 3000-4000.

Very marginal sales- roughly 1%. Very big players like HUL (Pond's anti-ageing cream, Gold radiance) and P&G(Olay). Anti ageing is a fast growing sub-segment in creams and lotions category which is 10% of the total skin care market. Olay has 36.7%, Garnier has 18.9%, Ponds has 16.5% as per Nielsen - Nov 2010 figures. Total skin care market is Rs 3500 cr currently. HUL has 50% market share with mass brands like Ponds/Fair & Lovely and Vaseline.

Total Sales 1,718 Source: Company, SSL



Synergies between Marico and Paras

Products are in fast growing and youth centric categories:The categories in which the brands operate are all fast growing (35-40% p.a.) categories although they are very small in size currently. They have low penetration currently and are currently at the bottom of the s-curve in the adoption cycle. In terms of the compounded annual growth rates over the past two-three years, the deo category is growing at around 40%, the styling gels around 20-25% and leave –on conditioners at 22%.

Dependence on Parachute and coconut hair oil in general is reduced: Reduces the dependence that Marico has on its core coconut hair oil business which is the cash cow of the whole company. It is very competitive and is facing high raw material cost pressures as well. Gross margin for MRCO was down by 200bps in F12 to 47.6% even after raising prices by 30% only on account of volatile copra prices.

Can make in-roads into the styling segment with Paras: Marico has ,with its international acquisitions like ICP – Vietnam, tried to enter into post wash hair care. There are two categories in post wash hair care - nourishment and styling. The brand equity of Parachute Advansed can definitely play in the nourishment area but not in the styling segment. Hence it made a strategic sense to acquire brands like Set Wet which were popular brands in hair styling.

The products have higher gross margin since they are new categories: The personal care business is estimated to have sales of Rs 1.5bn in F12. Gross margin of this segment is relatively higher than Marico’s base business; hence it should contribute towards margin expansion. Brands like Set Wet which are into 2-3 categories at the same time provide A&P efficiencies. Hence we expect that the operating margins of the new business will also be higher than the base business in sometime. Set Wet has 6% share in the deodorants space, however it’s a fast growing category and Marico believes that it will be able to make to the top 3-4 players; the company also has a ready –made portfolio from the international business which it plans to launch in India under the Set Wet brand name. Since the products will be of similar structure we expect some scale benefits coming from the fixed cost base of the business.



Negatives about the deal

Deal was done at a very expensive valuation: We believe that the valuation of 5x sales value is an expensive deal for a company of the size of Paras – sales of Rs 1.5bn. Currently, all FMCG companies in India, which are on the block, command meteoric valuations for being the most favored sector in the market. Historically, Marico has not proven its mettle when it comes to acquisitions. It acquired Nihar in 2006 (hair oil business focused in East India) which continues to face strong competition from regional players. Marico was also unsuccessful in turning around Nihar. Secondly, Marico has yet to show any results from Kaya Skin Clinics. The business model is bringing down margins at the consolidated level and also weighing heavily on the asset base.

Heavy overlap in distribution network; no benefit from cross-selling products: There is about 80% overlap between the erstwhile Paras reach and that of Marico, so there won’t be benefits in terms of complementary distribution networks. Marico has a reach of 3.3mn while Paras has a reach of 0.7mn.

Presence of Paras is currently limited to small and nascent categories: Products are into very small categories and it will be some time before they contribute significantly to the bottom line. Assuming a blue–sky scenario of 10-15% bottom line margin for Paras’s business, it will contribute only 5.6% to the bottom line.

Paras will be in an investment mode which will keep the return ratios depressed: In the next 3-4 years, the ROCE of the business will not be able to match that of Marico’s base business which is around 26% and has been declining sequentially due to depletion in operating margin mainly on account of high copra prices (up by 20% YoY); gross margin down by 200bps to 47.6%. We believe that the company will spend more on ad-spends and distribution costs for Paras to do justice to the acquisition and carve out synergies. Hence, we believe that the return ratios will be depressed for next 4-5 years.

Valuation and Outlook

At the CMP of Rs 182, Marico is trading at 28.7x and 22.8x EPS estimate of Rs 4.9/6.5 per share for F12/F13. It is one of the most expensive companies in the sector (apart from Colgate and Nestle) and it is trading at 50% premium to its historical 1-yr forward P/E multiple. We believe the recent run-up because of the Paras deal and also the high single digit volume growth that it has shown in its base business despite steep price increase of 30% (wtd average) is over-rated and is well priced in. We understand that Marico has once again proven to be an inflation cover by not losing volumes to small local players in situations of high inflation; however we feel that these fundamentals are priced in completely. We maintain our SELL rating on the company with a target price of Rs 125/share.

Key Concerns

• Sharp correction in Copra prices will spring back the gross margins to normal levels and could pose a downside risk to our thesis.

• The company might raise prices due to high input costs, leading to improvement in margins.

• MRCO might execute the integration process very efficiently using its distribution network leading to positive surprises.



Financials Income Statement (Y/E March ) Cash Flow Statement (Y/E March)Y/E March (Rs mn) F 11 F 12 F13e F14e Y/E March (Rs mn) F 11 F 12 F13e F14eTotal Revenues 32,102 40,082 48,958 58,404 PBT after exceptionals 4,583 4,003 5,244 5,159 Growth rate (%) 20.6 24.9 22.1 19.3 Depreciation/Amortisation 708 725 710 815 COGS 16,179 20,987 25,429 30,093 Interest expense 231 424 497 493 Gross Profit 15,923 19,095 23,529 28,311 Receivables (373) 64 (465) (440) Employee Costs 2,304 3,073 3,770 4,497 Inventories (1,563) (1,191) (1,374) (1,588) Share of Net Sales(%) 7.2 7.7 7.7 7.7 Loans and advances 143 186 (399) (479) Ad-spends 3,460 4,490 5,875 7,008 Payables 676 (386) 820 815 Share of Net Sales(%) 10.8 11.2 12.0 12.0 Cash tax 783 782 1,154 1,455 Other manufacturing costs 5,243 6,677 7,679 8,831 CFO 3,165 2,649 3,879 3,145 Share of Net Sales(%) 16.3 16.7 15.7 15.1 Capex (1,841) (847) (2,800) (1,000) EBITDA 4,917 4,855 6,205 7,975 Purchase of investments (59) (2,067) - - EBITDA Margin(%) 15.3 12.1 12.7 13.7 Sale/(Purchase) of fixed assets 32 - (7,400) 1,552 Growth rate(%) 31.1 (1.3) 27.8 28.5 CFI (4,774) (2,914) (10,200) 805 Depreciation 708.0 725.0 710.4 990.4 Interest Paid (393) (424) (497) (493) Interest Expense 393.3 423.8 496.7 492.8 Dividend Paid (475) (500) (646) (815) Other income 279.0 314.0 245.5 122.8 Inc/(Repayment) of loans 3,281 1,908 (150) - PBT 4,094.4 4,020.3 5,243.5 6,614.2 Inc in share capital 286 1 5,000 - Tax 849.5 782.4 1,153.6 1,455.1 CFF 2,757 985 3,707 (1,308) Tax Rate (%) 20.7 19.5 22.0 22.0 Net change in cash 1,057 720 (2,614) 2,642 PAT 3,244.9 3,237.9 4,090.0 5,159.1 Minority Interest 50.1 49.2 - - Net Profit 3,195 3,189 4,090 5,159 Net profit margin(%) 10.0 8.0 8.4 8.8 Growth rate (%) 33.3 (0.2) 26.3 26.1 EPS (Rs) 5.2 5.2 6.3 8.0

Balance sheet Key ratios Y/E March (Rs mn) F 11 F 12 F13e F14e Y/E March F 11 F 12 F13e F14eShare Capital 614 615 646 646 RoCE(%) 36.3 28.0 26.3 25.7 Reserves 8,542 10,815 19,228 23,572 Inventory Days 101.7 103.2 100.0 100.0 Total shareholder's Equity 9,156 11,430 19,874 24,218 Receivables Days 21.4 16.5 17.0 17.0 Minority interests 219 249 249 249 Loans and Advances Days 49.2 34.7 34.4 34.8 Debt 7,718 9,626 9,476 9,476 Payable Days 52.1 51.3 51.3 51.3 Deferred tax liability - - - - Provision Days 12.2 11.0 11.0 11.0 Total liabilities 17,094 21,306 29,599 33,943 Cash Conversion Cycle (Days) 107.9 92.1 89.0 89.5

Net block 8,227 8,972 18,462 18,471 Valuation RatiosCWIP 646 - - - P/E (x) 33.8 34.1 27.8 22.0 Investments 890 2,956 2,956 2,956 EV/Sales(x) 3.5 2.7 2.4 2.0 Current Assets 12,240 13,901 13,525 18,675 EV/EBITDA(x) 22.8 22.5 18.9 14.4 Inventories 6,011 7,202 8,577 10,165 P/BV(x) 11.8 9.5 5.7 4.7 Receivables 1,880 1,816 2,280 2,720 FCF yield (%) 0.9 1.3 0.5 1.5 Loans & advances 2,181 1,995 2,394 2,873 Dividend Yield(%) 0.4 0.5 0.6 0.7Cash 2,168 2,888 274 2,917 Current Liabilities 5,175 4,789 5,609 6,425 Du Pont Analysis - RoEPayables 4,098 3,584 4,403 5,219 NPM(%) 10.0 8.0 8.4 8.8Provisions 1,077 1,206 1,206 1,206 Leverage 1.8 1.8 1.5 1.4Deferred tax asset 265 265 265 265 Asset turnover 2.3 2.1 1.9 1.8Total Assets 17,094 21,306 29,599 33,943 RoE(%) 41.7 30.6 23.7 22.6Source: Company, SSLe

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INSTITUTIONAL DEALING Arundhati Parab Sr. Sales Trader 42273434 [email protected]

Vikas Nathani Sr. Sales Trader 42273433 [email protected]

Dhavan Parekh Sales Trader 42273431 [email protected]

INSTITUTIONAL RESEARCH Rabindranath Nayak Lead Analyst Power & Capital Goods 42273310 [email protected]

Alok Ramachandran Associate Power 42273478 [email protected]

Nirav Vasa Associate Capital Goods 42273460 [email protected]

Ravikant Bhat Analyst Banking 42273349 [email protected]

Divyanshi Dayanand Analyst Banking 42273385 [email protected]

Aayush Dureha Associate Banking 42273456 [email protected]

Manish Kumar Analyst Infra/Construction/Aviation/Port 42273388 [email protected]

Rohan Phadke Associate Infra/Construction/Aviation/Port 42273388 [email protected]

Vivek Kumar Analyst Pharma 42273312 [email protected]

Kunal Mishra Associate Pharma 42273459 [email protected]

Akshit Shah Analyst Realty/Hotel&Resort/ Consumer Durables 42273329 [email protected]

Sagarika Mukherjee Analyst FMCG 42273386 [email protected]

Vaishali Parkar Analyst Auto 42273364 [email protected]

Rahul Kundnani Analyst Media / Retail 42273387 [email protected]

Dipesh Mehta Analyst IT/Telecom 42273311 [email protected]

Ankit Pande Associate IT 42273458 [email protected]

Jatin Damania Analyst Metal, Mining & Pipes 42273361 [email protected]

Dikshit Mittal Analyst Oil & Gas 42273330 [email protected]

Gunjan Poddar Associate Oil & Gas 42273363 [email protected]

Milind Raginwar Analyst Cement/Logistics 42273362 [email protected]

Sanjay Bhansali Sr. Manager Production 42273313 [email protected]

Key to investment Ratings

Guide to the expected return over the next 12 months. 1=BUY (expected to give absolute returns of 20 or more percentage points); 2=ACCUMULATE/ADD (expected to give absolute returns between 10 to 20 percentage points); 3=REDUCE (expected to give absolute returns between 0 to 10 percentage points); 4=SELL (expected to give absolute negative returns)

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