Bajaj Consumer (BaCo), Emami and Jyothy Labs (JYL) - the trio - trades at a considerable discount to FMCG peers (ITC as well, but that’s a different story). All three (four) seemingly appear great value picks, however, it's been value traps over last 3 years (16-31% underperformance versus Nifty) due to reasons ranging from, (1) ESG (for ITC), (2) execution, (3) difficulty in navigating economic headwinds and operational dislocations (demonetisation, GST), (4) managerial change, and (5) technical issues like promoter pledge. The trio appear to be in varying stages of solving (or having solved) their issues and are also relatively better placed ("this time it’s different"?) to endure the ongoing slowdown. Emami, in our opinion, is a likely outperformer in the longterm, driven by superior direct reach, higher share of value-for-money products and potential to benefit from faster growth in new age channels (execution is key). Our five metric scorecard for the three stocks suggests Emami as a winner with JYL a close second (see figure 1). There are triggers/drivers for others as well – a high dividend payout policy for BaCo and 85% essential portfolio for JYL.
* Emami scores a tad above over JYL and BaCo: We evaluate the three stocks based on five metrics that we believe are important in the medium-term – (1) direct distribution reach, (2) wholesale contribution, (3) contribution of essential products, (4) proportion of portfolio with strong value-for-money positioning, (5) share of modern trade and e-commerce . Our assertion - Emami is relatively better placed with superior direct reach, higher share of value-for-money and greater contribution from MT and E-commerce. JYL is a close second. However, we do note that a potential announcement of dividend policy can be an upside trigger for BaCo stock in the near-term.
* Widening valuation gap within Staples: BaCo, Emami and JYL have been clear underperformers within India staples over 10Y/5Y/ 3Y/ 2Y/ 1Y periods (see figures 5- 8 for a comparison). We believe that this underperformance has been driven by (1) hiccups in execution (slow in focusing on digital marketing, Modern Trade and Ecommerce and/or evolving product innovation) and (2) relatively greater reliance on wholesale (impacted from both demonetisation and GST implementation).
* There are other factors too: There were technical factors at play as well – high promoter pledge being one of them. We believe that the companies are in different stages of resolving this though. Bajaj Consumer promoter sold 22% stake in Oct’19 (bringing promoter stake down to 38%) and thereby removing all promoter pledge (as of Mar’20). Emami on the other hand, is yet to resolve this issue fully, with 89% promoter pledge (as of Mar’20). The promoter group has however announced potential sale of its cement business to Nuvoco group (for a consideration of Rs 33 bn net of debt) which, as per management, should reduce the promoter pledge (comment as of Feb’20).
* Triggers to narrow the valuation gap: We believe that the companies with better direct distribution reach should benefit in the current environment as we expect the wholesale channel to remain under pressure. We note that after the twin shocks of demonetisation and GST, all the three companies have reduced their contribution from wholesale and have been building their direct reach. Another potential trigger, in our opinion, is improvement in contribution of modern trade and e-commerce – contribution for the three companies is ~10% versus much higher for peers (see figure 4).
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