Building platform for strong long-term growth
Near-term prospects look challenging due to high wholesale dependence
Key takeaways from Emami’s (HMN) FY17 annual report:
* Innovation remained the key focus area in FY17
* Took much-needed efforts to boost direct reach via Project Race/Project Dhanush
* Continued to emphasize on growing the Kesh King franchise
* Healthy operating cash flow growth, led by reduction in other assets
Right portfolio, low penetration, focused spending brighten growth potential
* 80% of the portfolio comprises high-demand problem-solving products, and the remaining 20% is discretionary products. This insulates the company from volumes risk in an adverse consumer environment.
* Penetration is low in many categories. We note that HMN is the dominant player in its leading categories, which puts it at the forefront to drive category growth.
* Brands like Fair & Handsome (now with a wide men’s personal care portfolio) are available in only 1.4m out of the 4.3m outlets that HMN reaches across the country. Balms is another category, where penetration is low at 36% (Zandu balm reaches only 1.6m outlets, and Mentho Plus only 1.2m outlets).
* While Zandu is already strong with its balms and Chyawanprash products, it can also emerge as a strong Ayurvedic products brand. Management believes that the company’s strength lies in its ability to validate product efficacy on the basis of data derived from systematic scientific research at NABL and Ministry of AYUSH accredited laboratories.
* HMN spends more on R&D than most FMCG companies in India; it incurred INR231m (0.99% of sales) in FY17.
* Despite demonetization, absolute A&P spend grew from INR4.3b in FY16 to INR4.43b in FY17. In terms of A&P as a percentage of sales, HMN stands among the top in the FMCG space.
New launch momentum stays robust
* Over the past five years, the company has introduced more than 25 products, variants and extensions.
* Some of the prominent new launches in FY17 were Boroplus Perfect Touch Cream, Navratna Almond Cool Oil, Navratna i-Cool Talc, Fair & Handsome 100% Oil Clear Instant Fairness Face Wash, He Respect deodorant, He Range of perfumes and deodorants, Kesh King Ayurvedic Medicinal Oil with blend of coconut oil, and He ‘On-the-Go’ Waterless Face Wash.
Targeting to significantly increase direct, rural reach
* The company increased its direct reach to 0.73m outlets from 0.64m in FY16, with a target to reach 0.8m in FY18. However, for a company with a pan-India reach of 4.3m outlets at end-FY17, the direct reach is well below that of peers and also weak in terms of proportion of total outlets.
* HMN initiated ‘Project Race’ in FY17 to expand its direct reach in urban towns. The company has engaged AC Nielsen to conduct a study in the top 30 towns to understand the best way to take the expansion plan forward.
* During the year, the company also initiated ‘Project Dhanush’ to enhance its rural direct reach via van operations (which were introduced in ~1,500 routes covering 6,000 towns with a population of below 5,000). The target is to double its rural reach in two years.
Kesh King expected to be strong revenue/profitability driver
* Kesh King was able to become cash EPS-accretive within the first year of operations, creating the foundation for rapid repayment of debt raised for its acquisition.
* Kesh King’s reach was 0.54m outlets prior to the acquisition (MAT March 2015), which has been increased to 0.75m (MAT December 2016). The brand now has 32.1% market share v/s 30% at the time of acquisition.
* Operating leverage potential is huge as the product reaches only 3% of households in India.
* Apart from increasing distribution, management is planning targeted communication, leading to product trials.
* The company launched sachet SKUs in the shampoo category. Sachets are a strong driver in the shampoo category, accounting for 65% of overall category sales. We believe that while growth of Kesh King is likely to be muted in 1Q/2QFY18 due to its high wholesale dependence (70% of sales), the brand will be a source of strong revenue and profitability growth (gross margins of over 70%) in the medium-to-long term.
Financial highlights – FY17 was a story of two halves
* Strong summer and abundant rainfall enabled 15% YoY domestic business sales growth in 1HFY17, along with 29% EBITDA growth. However, 2HFY17 was impacted by demonetization, and thus, sales declined 2% YoY with flattish EBITDA. n While profit growth was unimpressive, net operating cash flows increased to INR7.3b in FY17 from INR5.6b in FY16, led by lower other assets.
* Debentures of INR 3b are scheduled to be redeemed in three tranches in FY18 (INR1.5b on 22 May, INR750m on 22 August and INR750m on 22 November).
n Management reiterated its target to become debt-free by end-FY18.
Valuation and view
* Despite significant near-term challenges due to likely higher sales disruption following GST implementation (as it has high wholesale channel dependence v/s peers), we believe that HMN remains a credible long-term play due to (a) expected healthy growth in the existing product categories, where it has dominant market share, (b) demonstrated ability to leverage on its innovative ability, customer understanding and distribution reach to turnaround acquisitions, (c) best-of-breed R&D and A&P spend, innovative products and ability to back-up innovation with strong marketing and (d) efforts toward improving its direct distribution reach.
* Valuations at 31.6x FY19E EPS are inexpensive relative to peers. We like the company’s healthy long-term earnings growth prospects and return ratios in the mid-30s. We thus maintain our Buy rating with a target price of INR1,265, implying 18% upside to CMP
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