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Working capital improvement may accelerate value creation; reiterate preferred pick status

While Indian FMCG’s value-creation story over 2010-2020 has been primarily driven by good earnings growth, we note instances (Emami and GSK Consumer) where accelerated value-creation was driven by working capital (WC) improvement (and hence higher OCF / FCF). In this report, we highlight the Marico story – it improved WC by 30 days to 17 days in FY21 driven by (1) SKU rationalisation, (2) new manufacturing footprint and automated systems, (3) lower receivables and (4) stricter credit control in general trade. We believe this improvement is largely sustainable and model WC days of 24 days and 23 days in FY22e and FY23e. BUY; TP Rs550.

* Case studies of balance sheet driven value creation: Emami and GSKConsumer (now acquired by HUL) are two FMCG companies where OCF / FCF improvement drove value creation in the past. During FY04-FY15, Emami’s profit, and market cap CAGR were 33% and 46% with a big jump in FCF. Similarly, GSK’s profit, FCF and market cap CAGR (over FY04-FY14) were 24%, 14% and 37%. See Figures 3-6. Furthermore, RoCE for both Emami and GSK improved to 44% and 50% from 7% and 15% during FY04-FY14. We note that GSK’s working capital improvement is credited to new policies under the stewardship of the then CFO, Ramakrishnan Subramanian (Subu).

* Marico value creation to be driven by both balance sheet improvement and P&L: We highlight balance sheet improvement at Marico driven by management’s focus on working capital efficiencies – inventory (reduced inventory days by 18 days to 51 days in FY21) focus driven by SKU rationalisation, new manufacturing footprint and automated systems, lower receivables (reduced receivables days by 9 days to 18 days in FY21) through order management system with zero manual intervention and stricter credit control in general trade. That said, some of the working capital reduction was driven by (1) lower share of modern trade and Canteen Stores Dept. (have higher receivables than general trade) and (2) lower raw material inventory (particularly copra) given the expectation of (some) input price correction.

* Leaner system to help drive NPD agenda. We believe a leaner distribution system (possibly improving distributor ROI as well) will give Marico the headroom to push its new products in GT. Some of the initial traction may be potentially seen in Healthy Foods (Honey, Chyawanprash and Soya Chunks). Marico has already ramped up (1) direct distribution in both rural and urban areas and (2) e-commerce share (8% contribution – amongst the highest in our coverage) to aid new product development and premiumisation.

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