CONSUMER STAPLES - Ambitreports.ambitcapital.com/reports/Ambit_Consumer_Thematic_DBTOport... · and admin cost Case study on how ... Colgate and Dabur are likely to be the biggest

AFTER

CONSUMER STAPLES

Analysts:

Rakshit Ranjan, [email protected]: +91 22 3043 3201

November 2015

DBT: Oportunidades India

KIRANA SHOP

Para

chute

Colgate

Wheel

Govt of India BEFORE

Middle Man

BEFORE

AFTER

DBT

Ritesh Vaidya, [email protected]: +91 22 3043 3246

Consumer Staples

November 03, 2015 Ambit Capital Pvt. Ltd. Page 2

CONTENTS DBT: Oportunidades India ……………………………………………………………3

Executive summary…………………………………………………………………….4

Direct Benefit Transfer – A background ……………………………………………7

Structure of Government’s food subsidy programme (PDS) …………………….9 implemented so far

DBT of food subsidy – Savings through reduced leakages …………………….13 and admin cost

Case study on how conditional and non-conditional …………………………..17 cash transfers helped spur overall consumption

Computing the proportion of incremental disposable ………………………….20 household income spent on FMCG

DBT of Food subsidy is only the tip of the iceberg ..…………………………….22

HUL, Colgate and Dabur are likely to be the biggest…………………………..25 beneficiaries of cash transfers

Valuation - Upgrade HUL and Marico to buy; …………………………………..27 maintain SELL on others

Annexure 1:Takeaways from rural visit ..………………………………………110

COMPANIES Hindustan Unilever (BUY): The King of rural India ……………………………..31

Marico (BUY): Relentless deepening of “moats”…………………………………43

Colgate Palmolive (SELL): Rural secure, urban a challenge……………………55

Godrej Consumer (SELL): More risk than reward ……………………………….67

Britannia (SELL): Will lose rural upside to Parle………………………………….77

Dabur (SELL): Misaligned to drive premiumsation ………………………………89

Nestle (SELL): Rome is being rebuilt……………………………………………….97

GSK Consumer (SELL): Running out of steam ………………………………….105

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

THEMATIC November 03, 2015

DBT: Oportunidades India

The Government’s clear intent of rolling out food subsidies on a direct benefit transfer (DBT) platform from FY17 onwards is likely to result in a `455bn annual rise in disposable income for the targeted households. Based on our analysis, we estimate that 15-40% of incremental household income is likely to be spent on staples products. HUL, Colgate and Dabur are likely to be the biggest beneficiaries, given the size and shape of their rural product portfolios. We change our stance on HUL/Marico to BUY, as their strong competitive advantages are not fully factored into their current valuations of 33x/28x FY17E P/E. We retain SELL on other staples companies (ex-ITC). `455bn annual rise in household income due to food subsidy DBT Since September 2015, the Government has rolled out DBT of food subsidy through a pilot programme in three Union Territories. The pan-India rollout is intended to begin in 2016. Given the nature and quantum of leakages under the current Public Distribution System (PDS), and the admin cost savings under DBT, we estimate that the disposable income of targeted households will increase by at least `455bn each year (`482/month/household). Almost 15-40% of incremental household income to be spent on staples Based on current spending habits, we assume that, of the incremental income, households ‘below poverty line’ will spend ~15% on branded staples, whilst those ‘above poverty line’ will spend ~40% on branded staples. This will result in a 16% increase in rural staples spends upon full DBT implementation. We upgrade revenues by 5-14%, earnings by 6-20% in 4 years Based on a phased rollout of DBT across India over four years (from FY17), we have upgraded our forecasts for all staples companies over FY17-20. Given the strength, structure and size of their rural franchises, we expect HUL, Colgate and Dabur to be the biggest beneficiaries of DBT; we upgrade our EBIT estimates by 20% for HUL, 13% for Colgate, and 13% for Dabur by FY20. Change stance to BUY for HUL and Marico; retain SELL on others (ex-ITC) We have changed our stance from SELL to BUY for HUL (new TP `925; implied FY17E P/E of 38x) and Marico (new TP `435; implied FY17E P/E of 31x), as their share prices have corrected by 9% over the past three months and do not fully factor in the strengths of these businesses around: (a) the width and depth of HUL’s distribution and product portfolio which allows it to capitalise on new growth opportunities arising in India’s consumer staples sector; and (b) Marico’s ability to leverage on the strengths of its brands (Parachute, Saffola and Nihar) to expand its product portfolio organically whilst ensuring a rise in RoCEs to ~40% (currently 29%) and earnings CAGR of ~23% over FY15-20E. We retain SELL on the other staples companies (excluding ITC).

Consumer StaplesPOSITIVE

Key Recommendations

Hindustan Unilever BUY

Target Price: ̀ 925 Upside 15%

Marico BUY

Target Price: ̀ 435 Upside: 13%

ITC BUY

Target Price: ̀ 405 Upside: 21%

Godrej Consumer SELL

Target Price: ̀ 920 Downside: 27%

Dabur SELL


Colgate SELL


Britannia SELL

Target Price: ̀ 2,300 Downside: 29%

GSK Consumer SELL


Nestle SELL


Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA

+91 22 3043 3246 [email protected]

Intern: Saisha Panjabi

HUL, Colgate and Dabur to be biggest beneficiaries of DBT; upgrade HUL and Marico to BUY

Company DBT Benefit

Competitive positioning

Longevity of growth Stance Up/

Down FY17E

P/E Implied

FY17E P/E

HUL

BUY 15% 33.1 38.2

Colgate

SELL -9% 36.1 32.9

Dabur

SELL -3% 32.0 30.9

GSK CH

SELL -4% 32.3 31.0

Marico

BUY 13% 27.0 30.5

Britannia

SELL -29% 39.7 28.2

Nestle

SELL -15% 47.2 40.1

GCPL

SELL -27% 33.5 24.4

Source: Company, Ambit Capital research

Note: - Strong; - Relatively Strong; - Average; - Relatively weak - Weak.

mailto:[email protected]


Consumer Staples


Executive summary Implementation timelines – Three pilot projects launched; pan-India rollout from 2016 onwards In September 2015, the Government launched a pilot run of the direct cash transfer programme in the three Union Territories of Chandigarh, Puducherry and Dadra and Nagar Haveli. Eligible households receive direct cash transfer of `500-700/household/month for kerosene and grains such as rice and wheat. Pan-India implementation of DBT for food subsidy is likely to begin in 2016 in larger cities and grain surplus states, followed by expansion of the programme on a pan-India scale over the next four years.

DBT of food subsidy will result in `126bn of incremental spends in the FMCG industry We expect household incomes for the targeted population to increase by `455bn per annum on full implementation of food subsidy DBT, due to:

Incremental cash transfers under DBT vs food grains under PDS: Based on the statement of the Ministry of Consumer Affairs, Food and Public Distribution in August 2015 (http://tinyurl.com/p5twn6h), cash transfer against food subsidy payable to an eligible household amounts to `482 per month. This equates to a total payout of `946bn as compared to only `585bn worth of food grains received by the targeted households under PDS (i.e., `361bn of incremental household income). This is mainly due to the high amount of leakages under PDS, which we expect to reduce by 90% under DBT.

Household income generated from reinvestment of Government’s savings: Once cash transfers replace physical distribution of grains, we expect the Government to outsource a large part of procurement, storage and distribution of food grains to the private sector. This is likely to save ~80% of the current admin costs spent by the Government under PDS (i.e. a saving of 250bn for the Government). Assuming 75% of these savings are re-invested by the Government in infrastructure spending, we expect `94bn worth of household income to be generated through incremental wages and creation of local economy.

Exhibit 1: Out of the government’s total annual food subsidy bill of `1.3trn, `250bn will be saved by transferring food subsidy on to the DBT platform

Source: Ambit Capital research

Based on our analysis of consumer spending habits, we expect ~15%/40% of incremental household income to be spent by BPL/APL households on FMCG categories. This is equivalent to `126bn of incremental FMCG spends i.e., ~14% of the current rural FMCG industry size.

Leakages (` bn), 390

Leakages (` bn), 39

Admin cost (` bn), 325


Food grains received (` bn),

585

Cash Transfer (`bn), 946

Savings for GOI

-

200

400

600

800

1,000

1,200

1,400

Food subsidy under PDS Food subsidy under DBT

Leakages (Rs bn) Admin cost (Rs bn) Food grains received (Rs bn) Savings for GOI

GOI Savings ̀ 250bn

http://tinyurl.com/p5twn6h),

Consumer Staples


Exhibit 2: We expect incremental household income of `455bn to result in `126bn of FMCG spends in rural areas (i.e., 14% of current rural FMCG market)


HUL, Colgate and Dabur to be the biggest beneficiaries of increased rural spends due to DBT Based on the size, structure and strengths of rural portfolios, we expect HUL, Colgate and Dabur to be the biggest beneficiaries of the incremental FMCG spends generated from the implementation of DBT of food subsidy by the Government.

Exhibit 3: HUL, Colgate and Dabur best placed to benefit from increased rural spends

Company Rural

distribution outreach

Brand Equity

Mass/mid-mass brand

position

Width of product portfolio

Rural as % of total sales

Overall Driver of rural sales growth

HUL

40-45%

Best placed in soaps, detergents, shampoos, skin creams

Colgate

28-30%

To benefit most from higher spends on toothpaste

Dabur

30-33%

Strong presence in hair oil, shampoo, toothpaste and skin care

GSK CH

25-30%

Should benefit from higher spends on MFD category

Marico

23-25%

Market leadership in coconut oil, VAHO; presence limited only to hair oil

Britannia

30-35%

Whilst category may grow, Britannia impacted by lack of strong value brands

GCPL

15-20%

Presence in soaps and household insecticides; benefit limited by only 50% sales from India

Nestle

25-30%

Limited benefit as Nestle has no brands with mas and mid-mass positioning

Source: Company, Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak - Weak.

Staggered implementation of DBT over FY17-20 to result in back-ended upgrades We expect DBT implementation to be carried out evenly across four years i.e., 25%/50%/75%/100% implementation in FY17/18/19/20. Consequently, we have upgraded our sales and EBIT forecasts for all covered companies, as shown in the exhibit below.

Exhibit 4: HUL and Colgate to benefit the most; GCPL and Nestle to benefit the least

Company % sales upgrade % EBIT upgrade

FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20 HUL 5% 8% 11% 14% 6% 8% 12% 20% Colgate 2% 5% 7% 10% 3% 5% 8% 13% Dabur 2% 5% 7% 10% 3% 6% 8% 13% GSK CH 3% 5% 7% 8% 6% 9% 11% 14% Britannia 2% 4% 5% 7% 2% 4% 7% 11% Marico 1% 3% 4% 6% 2% 3% 4% 10% Nestle 1% 2% 3% 4% 2% 3% 4% 7% GCPL 1% 1% 2% 2% 1% 2% 2% 4%


Consumer Staples


Upgrade HUL and Marico to BUY from SELL The exhibit below highlights our relative rating of staples companies on the basis of the strength and sustainability of revenue growth rates, earnings and RoCEs.

Exhibit 5: Relative valuation table for our staples coverage universe

Company CMP Mcap Stance Target Price

Up/ Down

P/E EV/EBITDA ROCE Implied P/E Div.

Yield (%)

EPS Growth

Rev growth

Longevity score

(`) ($mn) FY16E FY17E FY16E FY17E FY17E FY16E FY17E FY16E FY15-20 FY15-20 HUL 801 26,682 BUY 925 15% 40.9 33.1 29.1 24.2 105.6% 47.3 38.2 1.9% 20% 14%

Nestle 6,174 9,346 SELL 5,250 -15% 57.7 47.2 33.3 27.2 35.2% 49.0 40.1 1.0% 12% 8%

Dabur 271 7,076 SELL 262 -3% 37.6 32.0 30.7 25.5 29.4% 36.3 30.9 0.9% 18% 16%

Colgate 955 1,964 SELL 870 -9% 43.6 36.1 28.4 23.3 69.8% 39.7 32.9 1.4% 18% 14%

Godrej Consumer

1,262 6,546 SELL 920 -27% 40.8 33.5 27.6 22.8 19.7% 29.7 24.4 0.5% 16% 13%

GSK Consumer 5,988 3,901 SELL 5,745 -4% 37.7 32.3 33.4 27.0 30.1% 36.1 31.0 1.0% 17% 15%

Marico 385 3,779 BUY 435 13% 33.5 27.0 22.5 18.4 36.3% 37.8 30.5 1.0% 24% 17%

ITC 334 44,127 BUY 405 21% 25.3 22.1 16.2 14.1 31.7% 30.7 26.8 2.3% 14% 14%

Britannia 3,232 5,973 SELL 2,300 -29% 47.7 39.7 18.6 15.5 42.4% 33.9 28.2 1.6% 25% 16%

Median -6% 40.8 33.1 28.4 23.3 35% 36.3 30.9 1.0% 18% 14% Source: Company, Ambit Capital research *Note: FY16/17 for Nestle implies CY15/16

Multiplier effect of 1.5-3.0x: NOT yet factored into our assumptions for increase in household income Several research papers suggest that the marginal propensity of consumption (MPC) of cash transfer beneficiaries is between 20% and 80%, depending on the nature and size of the cash transfer. The remainder of the income transfer is invested in productive assets.

Our forecasts for incremental household income from DBT currently do not factor in the multiplier effects that such cash transfers can create. Depending on the returns generated from these investments, they result in an income multiplier effect of 1.5-3.0x and hence increase household consumption by more than 20% over a five-year period. These multiplier effects can be due to one or more of the following factors:

Nutrients or livestock purchased for farms: For agriculture-related households, the purchase of nutrients for farms or livestock, which improves productivity and hence has a multiplier effect on household income.

Productive utilization of human capital: The availability of working capital for the agriculture business, which frees up human capital that was previously deployed in labour markets to generate liquidity.

Creation of local economy: As household consumption moves towards areas such as milk, eggs, pulses, packaged foods, personal care, healthcare or education, there will be an increase in demand and hence investment towards infrastructure to produce (like manufacturing units/ schools/ dispensaries) and/or trade (supply chain and distribution setup etc).This will result in creation of local economy towards such segments of consumption.

Therefore, we see the possibility of an upgrade to our estimates of increase in household income levels following the implementation of DBT of food subsidy.

We do not factor in higher HH income due to multiplier effect as HHs invest part of cash transfer into productive assets

Consumer Staples


Direct Benefit Transfer – A background In his State of the Union Address before Congress on January 4, 1935, President Roosevelt declared, "the time has come for action by the national Government" to provide "security against the major hazards and vicissitudes [uncertainties] of life. A few months later, Roosevelt signed the Social Security Act along with several other schemes, changing the face of social security forever. A social welfare scheme as comprehensive as that of Roosevelt was put forward by Lester Frank Ward, first president of the American Sociological Association, stating that for the success of a democratic Government, a universal system of education was necessary. Soon after, in 1938, the UK implemented its own social welfare scheme, with the rest of Europe gradually following.

Today, we see India heading in a similar direction, improving its financial inclusion, financial security and social security through various schemes. One such scheme is the Direct Benefit Transfer (DBT) programme, an attempt by the Government of India to change the mechanism of subsidy transfers. By ensuring that benefits go to an individual’s bank accounts electronically, the DBT scheme aims to minimise the tiers involved in fund flow, thereby reducing delays in payment and ensuring accurate targeting of the beneficiary and curbing pilferage and duplication. As of April 2014, 25 schemes were implemented for the Direct Benefit Transfer, and by July 2015, 130mn people had been reached through DBT.

The Government of India’s plans to effectively implement DBT through the JAM trinity (Jan Dhan + Aadhaar + Mobile) are explained in detail in the following sections.

Pradhan Mantri Jan Dhan Yojana (PMJDY)

The PMJDY is a national mission for financial inclusion to ensure that low income groups have access to financial services such as basic savings account, need-based credit cards, remittance facilities, insurance and pension. This initiative was announced by Prime Minister Narendra Modi on August 15, 2014 and was launched the very same month, on August 28, 2014. Run by the Department of Financial Services (which sits inside the Finance Ministry), PMJDY has opened about 171 million bank accounts in various banks, including public, private and regional banks in both rural and urban locations as of July 2015.

Exhibit 6: There are a total of 19 participating banks, with 10 from the public sector and 9 from the private sector Public Sector Private Sector Banks

Bank of Baroda Indian Bank Axis Bank ING Vysya Bank

Bank of India Punjab National Bank Federal Bank Karnataka Bank

Canara Bank Union Bank of India HDFC Bank Kotak Mahindra Bank

Corporation Bank State Bank of India & Affiliates IndusInd Bank YES Bank

IDBI Bank Oriental Bank of Commerce Dhanlaxmi Bank

Source: PMJDY Website, Ambit Capital Research

How does it work?

Under the PMJDY scheme, account holders: 1. are provided with zero-balance bank accounts with RuPay debit cards; 2. are provided with an accidental insurance (Pradhan Mantri Suraksha Bima Yojana)

cover of ₹0.1mn; 3. registered before January 26, 2015 will be given an additional life insurance

(Pradhan Mantri Jeevan Jyoti Bima Yojana) cover of ₹ 30 000; 4. may avail ₹5,000 overdraft from the bank, after six months from opening of the

account; 5. may transfer funds and check balances through both smart-phones and non-

smart-phones; and 6. will have access to mobile banking through the National Unified USSD Platform

(NUUP)

The DBT programme is an attempt by the Government of India (GOI) to change the mechanism of subsidy transfers

Consumer Staples


Exhibit 7: The PMJDY scheme has seen considerable successful (approx. 190m accounts opened) with PSU banks leading the way in opening new accounts

Number Of Accounts (mn)

Number Of RuPay Debit

Cards (mn)

Balance In Accounts

(̀ . Mn)

% of Zero Balance Accounts Rural Urban Total

Public Sector Bank 82 66 148 132 201,952 38.3 Rural Regional Bank 29 5 34 24 43,793 38.9

Private Banks 4 3 7 6 11,191 41.7

Total 115 74 189 163 256,935 38.5

Source: PMJDY Website, Ambit Capital research. These numbers are update as of 21Oct15

Aadhaar Aadhaar is a 12-digit unique identification (UID) number given to each Indian resident by the Unique Identification Authority of India (UIDAI). This number is linked to an Indian resident’s basic biometric and demographic information such as photographs, fingerprints and iris scans. The Central Government agency that headed the Aadhaar movement, UIDAI, was established on 28 January 2009 and issued the first UID in September 2010. The Aadhaar project, which is considered the world’s largest national identification number project had the mission to eliminated duplicate and fake identities, and verify and authenticate residents in an easy and cost-effective manner, digitally. In December 2010, a letter issued by the UIDAI received the recognition of being a document formally accepted by the Government of India. As of October 24, 2015, over 927 million Aadhaar card numbers have been issued, allowing the benefits of the UID to be accessed by ~72% of the country’s population. Only seven states (Meghalaya, Mizoram, Nagaland, Manipur, Jammu Kashmir, Arunachal Pradesh and Assam) – have a sub-50% enrollment rate for Aadhaar.

Applications

The Aadhaar card has extended its applications to the following efforts:

Direct Benefit Transfer;

Aadhaar-enabled biometric attendance systems in all central government offices located in Delhi; and

Expedited passport issuance

LPG subsidy implementation under DBT will be followed by food subsidy in 2016 In August 2014, the NDA Government, moved the LPG cylinder subsidy on to DBT wherein rather than receiving a subsidised cylinder, subsidy claimants had to give their bank account number and then receive the subsidy directly in their bank accounts. As per the Government, this shift to DBT has saved the Exchequer `147bn (US$2.3 bn; 0.1% of GDP) or 30% of the original subsidy outlay on LPG cylinders. The success of shifting the LPG subsidy to DBT is seen to have enhanced the political credibility of the DBT platform (see http://tinyurl.com/oethp8k)

In March 2015, the Food Ministry decided to roll out DBT in a Public Distribution System (PDS) on a pilot basis in certain Union Territories. Under DBT, instead of subsided food grains, cash was decided to be transferred to accounts of the identified beneficiaries, thereby allowing them to purchase grains from any shop rather than being restricted to specific PDS stores (see http://tinyurl.com/qaue7pp)

Currently 72% of India’s population has been issued an Aadhaar card

Transfer of LPG onto DBT has saved the government `147bn

http://tinyurl.com/oethp8k)

http://tinyurl.com/qaue7pp)

Consumer Staples


Structure of Government’s food subsidy programme (PDS) implemented so far Over the past decade, the Government’s food subsidy bill has expanded at a CAGR of 15%, with FY08-15 generating a CAGR of over 20%. The food subsidy amount for FY16 stands at `1.3 trillion ($20bn; 0.9% of FY15 GDP).

Exhibit 8: India’s food subsidy bill has expanded at a 15% CAGR over FY05-16

Source: Budget documents, Ambit Capital research

Targeted PDS (1997-2012) – Limited only to the BPL households The Government introduced the Targeted Public Distribution System in June 1997, aimed at supplying subsidised food grains (20kg of grains per household) to about 65mn households (~30% of population) who were categorised as ‘below poverty line’ (BPL). Whilst the Central Government had the responsibility of procuring and supplying the necessary quantity of grain for every state, State Governments were responsible for identifying the beneficiary households, distributing food grains to these families through the Fair Price Shops (FPS) and determining the quantum and price at which the food grain was to be given.

National Food Security Act (NFSA), 2013 – Covers 67% of the population Whilst TPDS was meant only for BPL households, the Government promulgated the National Food Security Act in 2013 which planned to supply subsidised grain to 67% of the population. The changes brought about by NFSA as a result included:

Increased coverage of households: The NFSA is targeted to supply subsidised food grain to 75% of rural and 50% of urban households. This would mean an overall coverage of 67% of the population vs ~30% under TPDS.

Larger subsidy on food grains: Under the NFSA, every covered individual is supplied 3kg of wheat and 2kg of rice at a subsidised price of `2/kg and `3/kg respectively. This issue price is lower than `4.15/kg and `5.65/kg set for BPL under TPDS. The implementation of the NFSA will lead to a supply of 61MMT of food grains to households.

NFSA has been only partially implemented so far across 11 states. The Government targets to achieve complete implementation across all states by the end of FY16. This expanded coverage and higher subsidy is likely to result in a food subsidy bill of `1.3trn (0.8 % of FY15 GDP) in FY16 vs `315bn in FY08 (0.6% of FY08 GDP).

0.5%

0.6%

0.7%

0.8%

0.9%

1.0%

- 200 400 600 800

1,000 1,200 1,400

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

BE

Food subsidy bill (Rs.bn) Food subsidy as % of GDP

Under TPDS, 30% of population was given 20kgs of food grains at subsidised prices

NFSA targets to provide 67% of the population with subsidised food grains

Consumer Staples


Leakages under the current PDS (30% of Govt’s food subsidy bill) As highlighted in the exhibit below, based on estimates from various Government bodies, 40-50% of the total grains allocated under PDS did NOT reach the intended beneficiaries.

Exhibit 9: 40-50% of total allocated food grains do not reach intended beneficiaries

Source: Ambit Capital research based on industry research papers – “Leakages from PDS and the way forward – Gulati and Saini (2015)”, “Report of the High Level Committee on FCI (2015), “Performance Evaluation of TPDS (2005”

Exhibit 10: Various academic papers on leakages from the Public Distribution System (PDS) suggest that only 50% of the subsidised grains reaches its target group

Paper Key Relevance Source

Leakages from Public Distribution System (PDS) and the Way Forward

“Calculations show that in 2011-12, 25.9 MMTs or 46.7 per cent of the off-taken grain leaked from the PDS.” (http://tinyurl.com/nw3h75z)

Indian Council For Research On International Economic Relations

How Can Food Subsidies Work Better? Answers from India and the Philippines

“A study by the Indian Statistical Institute researchers using NSS data for 1993-4 along with other data for Andhra Pradesh and Maharashtra estimated both the extent of leakage as well as the economic inefficiency of the public food procurement system relative to the open market. The study shows that only 56 per cent to 58.5 per cent of the total food subsidy (i.e. Centre and State) reaches the PDS consumers.” (http://tinyurl.com/q2arxtb)

Asian Development Bank

India’s Hunger Problem: A Comparative Analysis of the Performances of Food Distribution at the National level and in the State of Tamil Nadu

"Pilferage and leakages at both Central and local levels have been huge concerns in proper delivering of food grain. In 1999-2000, around 10 per cent of rice and almost 49 per cent of wheat allotted for the PDS have been diverted. Between 1999 and 2005, the leakages from the PDS at the all India level increased from 24 per cent to 54 per cent. In 2007-08, the overall diversion of the PDS grains was 44 per cent." (http://tinyurl.com/o6d7w5z)

Uppsala University

Functioning of the Public Distribution System

“However, CACP noted that only 25.3 million tonnes were actually consumed, implying a leakage of 40.4 percent of food grains from the TPDS network. Leakage also decreased from 54.1 per cent in 2004-05 to 40 per cent in 2009-10.“ (http://tinyurl.com/nqg89q6)

PRS Legislative Research, (2013)

Performance Evaluation of Targeted Public Distribution System (TPDS)

“Leakages and diversions of subsidized grains are large and only about 42% of subsidized grains issued from the Central Pool reaches the target group.” (http://tinyurl.com/ptknc7l)

Programme Evaluation Organisation Planning Commission (March 2005)


The nature of these leakages can be broadly categorised into:

Ghost ration cards: Our recent visits to rural India suggest that a large proportion of PDS grains are allocated to ghost ration cards and subsequently sold in the open market at a discount to the Minimum Support Price (MSP).

Absence of ration cards with households: This is mainly due to lack of proper documentation, loss of ration card or change of address. Grains intended to be delivered to them are sold in the open market at a discount to MSP.

Beneficiaries ignoring PDS and purchasing superior-quality grains: Some above poverty line (APL) households prefer to procure superior-quality grains on their own expense rather than those provided by the Government under PDS. Grains allotted to such households are also routed to the open market.

Unintended beneficiaries possessing ration cards and claiming PDS: Based on NSSO surveys conducted in Jan’13, one-third of the richest 25% of rural households and one-tenth of the richest 25% of urban households currently purchase subsidised rice and wheat under PDS. These households are NOT entitled to receive the subsidy even under the expanded NFSA.

Loss in transit: These are genuine losses which occur in storage and transportation of grains from one part of the country to another.

0%

10%

20%

30%

40%

50%

60%

FY99 FY02 FY05 FY07 FY08 FY10 FY12 FY14

% Food grain leakage

http://tinyurl.com/nw3h75z)

http://tinyurl.com/q2arxtb)

http://tinyurl.com/o6d7w5z)

http://tinyurl.com/nqg89q6)

http://tinyurl.com/ptknc7l)

Consumer Staples


As a result, we estimate that as much as `390bn ($6.0bn; 0.3% of GDP) of the `1.3 trillion food subsidy bill spent by the Government is lost through leakage of grains under the PDS system.

Admin costs incurred under the current PDS (25% of Govt’s food subsidy bill) Admin costs incurred by the Government to distribute ~60MMT of grains under PDS include: (a) procurement operations done through the Food Corporation of India and its designated state agencies; (b) storing and moving the procured grain from surplus regions to deficit ones in a timely manner through railways and other truck transporters; and (c) distribution of these grains to beneficiary households through a network of ~500,000 fair price shops spread across the country.

Based on the estimates provided by the Indian Council of Research on International Economic Relations, we estimate that the total admin costs incurred under the current PDS for food subsidy is ~`325bn ($5.0bn; 0.3% of GDP). Note that this cost is over and above the `390bn of costs incurred due to leakage of grains under the PDS system.

What do the households receive eventually? Due to the various inefficiencies in the current PDS, the receipt of grains by the households can be summarised as follows:

Only ~78% of the entitled Below Poverty Line (BPL) card holders and only ~15% of the entitled Above Poverty Line (APL) card holders currently receive grains through PDS. Note that we do NOT have an estimate of what proportion of entitled households form ration card holders (not all the entitled households are ration card holders).

Within the households that receive grains through PDS, on average a household receives only ~15kgs of rice and wheat as against a total entitlement of 20kgs i.e., 75% of the entitled amount.

Of the `975bn worth of grains disbursed by the Government, targeted households receive only around `585bn worth of grains under the current PDS (see the exhibits below).

Exhibit 11: Split of Government’s food subsidy bill into leakages, admin costs involved, and receipts by targeted households


Admin costs, 25%

Leakage, 30%

Receipts by targeted

households, 45%

Eventually only 45% of food subsidy is received as food grains

Consumer Staples


Exhibit 12: Break-up of Government’s current food subsidy bill into various components BPL Non-BPL Total

households No. of households currently receiving food subsidy (mn) 80 83 163

Food subsidy `/month ` mn/yr `/month ` mn/yr Total in ̀ mn/yr Comments

PDS (current structure) Admin costs involved in food subsidy disbursal (A) 166 160,009 166 164,858 324,867 ~25% of subsidy amount is spent on

admin costs

Leakages in food subsidy disbursal (B) 199 192,011 199 197,829 389,840 Assume ~40% of ex-admin subsidy is lost in leakages

Food subsidy received by households (in the form or grains) (C) 298 288,016 298 296,744 584,760

Due to leakages, every household effectively receives only ~75% of good quality grains out of its total eligible quota

Food subsidy related spends by the government (D) = (A) + (B) + (C) 663 640,036 663 659,431 1,299,467 ~`1.3tn of food subsidy spent on

162mn households Source: Ambit Capital research

Consumer Staples


DBT of food subsidy – Savings through reduced leakages and admin cost Under the new DBT route for food subsidy, we expect the Government to gradually introduce ‘unconditional’ cash transfers into the bank accounts of eligible households (definition of eligible households being same as that adopted under the National Food Security Act 2013). These cash transfers under DBT are likely to be given in the name of the woman of the house and routed through the Prime Minister’s Jan Dhan Yojna (PMJDY), which will thereby link these cash transfers to Aadhaar cards/unique identification numbers.

In July 2015, the Government announced that beginning Sept’15, around 0.6mn beneficiaries in the three Union Territories of Chandigarh, Puducherry and Dadra and Nagar Haveli would receive direct cash for kerosene and grains such as rice and wheat in addition to 10kg of free rice and 5kg of wheat. At 2015-16 prices, an eligible family will receive `500-700/month in cash transfers into their bank account. These pilots were subsequently launched as scheduled in Sept’15.

Pan-India implementation of DBT for food subsidy is likely to begin in 2016 with larger cities and grain surplus states. There is a possibility that grain-deficit states will be given an option to choose between cash transfer and physical grain distribution.

Subsidy received per household under DBT to be ~60% higher than that under current PDS system Based on the statement of the Ministry of Consumer Affairs, Food and Public Distribution in August 2015 (http://tinyurl.com/p5twn6h), the food subsidy payable to an eligible household shall be computed by multiplying the entitled quantity of food grains with the difference between 1.25x Minimum Support Price (MSP) and the Central Issue Prices (CIP). Every person in the household will be eligible for 3kg of wheat and 2kg of rice per month. Assuming a household of 5 individuals, the subsidy works out to `482 of cash transfer per household per month as food subsidy under the DBT scheme (see exhibit below).

Under the current PDS system, due to ~40% leakages, households receive only ~75% of good quality grains out of its total eligible quota amounting to food grains equivalent to `298/month/household.

Exhibit 13: Every household can receive `482/month as food subsidy under the DBT scheme Minimum Support Price (MSP) (̀ /kg)

Paddy Common 14.1

Grade A 14.5

Rice (Paddy to Rice is assumed to have ~67% conversion ratio)

Common 21.0

Grade A 21.6

Wheat 14.5

Central Issue Price (̀ /kg)

Rice (Grade A) 3

Wheat 2

Subsidy (MSP*1.25-CIP) (̀ /kg)

Rice (Grade A) 24.1

Wheat 16.1

Subsidy per person (3kg wheat, 2kg rice, in `/month) 96

Subsidy per household (5 pax per HH, in ̀ /month) 482

Source: Ambit Capital research, using the framework laid out by the Ministry of Consumer Affairs, Food and Public Distribution

Cash transfers are to be given in the name of the woman of the house into the PMJDY A/C

Pilot tests of cash transfer for food are being conducted in Puducherry and Chandigarh

Under DBT, every household will receive food subsidy of `482 vs `298 currently, 60% higher

http://tinyurl.com/p5twn6h),

Consumer Staples


Lower admin costs and leakages under DBT We have assumed that administrative costs under DBT will be only 20% of those under the PDS structure currently. This is because we now expect the private sector to manage a large part of procurement, storage and distribution of food grains under DBT. (In August 2015, Rajasthan kicked-started the first such outsourcing scheme with the Future Group: http://tinyurl.com/njs7qld). A calculation by a high-level committee on restructuring the Food Corporation of India estimated that if this pilot scheme were to rolled out on a nationwide basis, the potential savings arising from eliminating costs associated with procurement, distribution and storage of food grains could be more than `300bn ($4.6bn or 0.2% of GDP) annually or 25% of the total food subsidy.

Exhibit 14: Future Group to manage 5,000 PDS stores in Rajasthan

Future Group will manage 5,000 PDS shops in Rajasthan rebranding them as Annapurna Bhandar

Along with the usual rice, wheat and kerosene sold at PDS outlets, they will sell Future Group's private label food grains and a gamut of FMCG products

All these products will be sold at a subsidised price pre-decided by the State Government

Source: Ambit Capital research, Press articles (http://tinyurl.com/njs7qld)

We have also assumed that leakages under DBT are only 10% of our assumed leakages under the PDS structure, as highlighted previously in this note.

Computing Government’s total savings under DBT of food subsidy As highlighted in the exhibit below, switching from PDS to DBT for food subsidy is likely to result in a `250bn saving for the Government annually.

Exhibit 15: DBT for food subsidy could result in ~`250bn (US$3.8bn; 0.2% of GDP) of savings for the Government

BPL Non-BPL

Food subsidy `/month ` mn/yr `/month ` mn/yr Total in ̀

mn/yr Comments

Food subsidy related spends by the Government (as computed in exhibit 7) (A)

663 640,036 663 659,431 1,299,467 `1,300bn of food subsidy spent on 162mn households

DBT (new structure) Admin costs involved in food subsidy disbursal (B) 33 32,002 33 32,972 64,973

Assumed to be 20% of admin costs under PDS

Leakages in food subsidy disbursal (C) 20 19,201 20 19,783 38,984 Leakages are assumed to be ~10% of what they were under PDS

Food subsidy received by households (in the form of cash) (D) 482 465,921 482 480,039 945,960

Based on the statement of Ministry of Consumer Affairs, Food and Public Distribution (see Exhibit 7)

Food subsidy released by the government (E) = (B) + (C) + (D) 535 517,124 535 532,794 1,049,917 Total savings for the government under food subsidy (F) = (E) – (A)

127 122,913 127 126,637 249,550 DBT should result in ~`250bn of savings for the government


Exhibit 16: Out of the government’s total annual food subsidy bill of `1.3trn, `250bn will be saved by transferring food subsidy on to the DBT platform


Leakages (` bn), 390

Leakages (` bn), 39



Food grains received (` bn),

585

Cash Transfer (`bn), 946

Savings for GOI

-

200

400

600

800

1,000

1,200

1,400

Food subsidy under PDS Food subsidy under DBT

Leakages (Rs bn) Admin cost (Rs bn) Food grains received (Rs bn) Savings for GOI

GOI Savings ̀ 250bn

We assume admin costs under DBT to be only 20% of that under PDS

Leakages under DBT are expected to be 10% of that under PDS

http://tinyurl.com/njs7qld

http://tinyurl.com/njs7qld)

Consumer Staples


Computing the impact of DBT of food subsidy on disposable household incomes As highlighted in the table below, we expect ~`455bn of incremental surplus money available in the bank accounts of entitled households across the country. This computation is based on the following assumptions: Higher food subsidy per household under DBT vs PDS (`361bn increase in

household income): As explained earlier, under PDS every household was allocated subsidized food grains equivalent to a subsidy of `298/month. Thus, with cash transfers of `482/month to every household, the effective surplus subsidy transferred to BPL and non-BPL households is `184/month (`361bn of surplus income for all households in all). This increase in surplus subsidy is predominantly on account of reduction in leakages.

Reinvestment of Government’s savings as capex (`94bn increase in household income): Of the ~`250bn savings for the Government as computed in Exhibit 10 above, we assume that at least 75% will be reinvested back as capex and the balance will contribute towards reduction in the Central Government’s fiscal deficit. Of the ~`187bn incremental capex assumed through this route, we assume that `94bn will contribute incrementally to household incomes due to creation of wages and local economy through the Government’s capex.

Exhibit 17: Expect incremental surplus money of ~`455bn generated in rural areas

Impact of Food DBT on consumption BPL household Non-BPL household

Comments

`/month ` mn/yr `/month ` mn/yr Total in mn/yr

Food subsidy received by HHs under DBT (A) 482 465,921 482 480,039 945,960 Computed based on Government recommended guidelines (see Exhibit 13)

Amount of food subsidy received under the older PDS system (B)

298 288,016 298 296,744 584,760 As explained in Exhibit 12

Surplus left for consumption (C) = (A) - (B) 184 177,904 184 183,295 361,200 Total savings for the government under food subsidy (D) 127 122,913 127 126,637 249,550 As explained in Exhibit 15

Government's savings reinvested in rural capex to drive investment cycle (E) = (D) * 75%

95 92,184 95 94,978 187,162 Expect 75% of government savings of `250bn to be reinvested on rural welfare programmes

Re-investment of govt savings adding to HH income (F) = (E) * 50% 48 46,092 48 47,489 93,581

Expect 50% of the above re-investment to add to HH income through wages and creation of local economy

Admin costs involved in food subsidy disbursal un PDS (G) 166 160,009 166 164,858 324,867 As explained in Exhibit 12

Total discretionary money available per household thru food DBT (I) = (C) + (F) + (H) 232 223,997 232 230,784 454,781

Expect total incremental disposable household income of ~`455bn per annum due to above factors


Multiplier effect of 1.5-3.0x: NOT yet factored into our assumptions for increase in household income “Our analysis shows that for each peso transferred, beneficiary households consume 74 cents directly and invest the rest.” – Gertler, Martinez, Rubio-Codina (2012) (http://tinyurl.com/plkuulm) Several research papers suggest that the marginal propensity of consumption (MPC) of cash transfer beneficiaries is between 20% and 80%, depending on the nature and size of the cash transfer. In the case of cash transfers that are ~20% of household expenditure and permanent in nature, the MPC is 75-80%. However, MPC is low (~20%) in case of short-term non-recurring transfers. The remainder of the income transfer is invested in productive assets.

Empirical evidence from cash transfer programmes around the globe suggest that assurance of a regular income stream due to the cash transfer results in an increase in the risk-taking ability of rural households and encourages them to start micro enterprises. As a result, based on the marginal propensity to invest (MPI), households invest a portion of their income into productive assets such as farm equipment and livestock.

DBT will result `184/month of higher food subsidy per household

Re-investment of government savings into capex is likely to generate `94bn of incremental household income

We do not factor in higher HH income due to multiplier effect as HHs invest part of cash transfer into productive assets

http://tinyurl.com/plkuulm)

Consumer Staples


Our forecasts for incremental household income from DBT currently do not factor in the multiplier effects that such cash transfers can create. Depending on the returns generated from these investments, they result in an income multiplier effect of 1.5-3.0x and hence increase household consumption by more than 20% over a five-year period. These multiplier effects can be due to one or more of the following factors:

Nutrients or livestock purchased for farms: For agriculture-related households, the purchase of nutrients for farms or livestock, which improves productivity and hence has a multiplier effect on household income.

Productive utilization of human capital: The availability of working capital for the agriculture business, which frees up human capital that was previously deployed in labour markets to generate liquidity.

Creation of local economy: As household consumption moves towards areas such as milk, eggs, pulses, packaged foods, personal care, healthcare or education, there will be an increase in demand and hence investment towards infrastructure to produce (like manufacturing units/ schools/ dispensaries) and/or trade (supply chain and distribution setup etc).This will result in creation of local economy towards such segments of consumption.

Therefore, we see the possibility of an upgrade to our estimates of increase in household income levels following the implementation of DBT of food subsidy.

Consumer Staples


Case study on how conditional and non-conditional cash transfers helped spur overall consumption Direct cash transfer programmes have been implemented by several countries in LatAm, Africa and South East Asia, with programmes in Brazil (called Bolsa Familia) and Mexico (called Progresa) being the biggest of these programmes. In both these programmes, the cash was transferred to the bank account of the female head of the family. We highlight below the key takeaways from these programmes which are also relevant for India.

Brazil’s Bolsa Familia (conditional transfer) – 24mn households lifted above poverty line The Bolsa Familia Program, launched in 2003, was the centerpiece of Brazil’s social safety net, which integrated four cash transfer programmes to huge success. The programme seeks to reduce current poverty and inequality, by providing a minimum level of income for extremely poor families, and break the inter-generational transmission of poverty by conditioning these transfers on beneficiary compliance with human capital requirements (school attendance, vaccines, pre-natal visits). The programme was declared by the World Bank as the largest conditional cash transfer programme in the developing world in 2007.

In order to receive the cash transfers, each household had to ensure: (a) kids in the households attended school for minimum 85% of the days in a year; and (b) household members, particularly pregnant women, underwent regular health checks ups. As of 2013, the programme covered 14.1mn households with a total cost of BRL 22.4mn (0.5% of Brazil’s GDP for the year). Here are the achievements of this programme:

Short-term benefit - Reduction in poverty: In the short term, the cash transfers ensured a regular income for all households and helped take ~24mn out of poverty.

Long-term benefit – Improving human capital: Due to the criteria of maintaining minimum school attendance and doing regular health check-ups, the programme improved the human capital among the poor households. Gini index, which is a measure of income inequality contracted from 59.3 in 2002 to 52.7 in 2013 indicating reducing income inequality in the country.

GDP multiplier effect of 1.8x: The most important impact was the multiplier effect on GDP. Secondary research (Neri, Vaz and Souza 2013, http://tinyurl.com/plkuulm) suggests that the Bolsa Familia programme had a 1.8x multiplier effect i.e., GDP would increase by BRL1.8 for each BRL1 transferred through the Bolsa Familia program with a substantial increase in GDP for the poorer section of the society.

Mexico’s Progresa (conditional transfer) – Improved GDP growth, education, health and nutrition In order to tackle the rising level of poverty in Mexico (14% in 1994 rising to 19% in 1998) and in order to counter the failure of food subsidies, Mexico launched a conditional cash transfer programme in 1996, targeting rural households below the poverty line. In order to get the cash transfers, households had to ensure certain minimum school attendance for the kids in the household and regular health check-ups by all members of the household. During the first half of the last decade, the programme was expanded to include the urban poor as well and it currently covers 5mn households (25% of the population) at a total expenditure of ~0.4% of GDP. This programme has had the following benefits:

Short-term benefit - Reduction in poverty: Poverty headcount has reduced from 19% of population in 1998 to 6% in 2010.

“Supporters of the program [Bolsa Familia] claim that it was responsible for the emergence of a new class of consumers in the first decade of the 21st century, and also contributed to the fast growth of the Brazilian economy during the same period.“ – Kamakura, Mazzon (2014)

http://tinyurl.com/plkuulm)

Consumer Staples


Long-term benefit – Increase in consumption, school enrolment and overall health: Following the implementation of the programme, households increased their consumption expenditure by ~15% with an increase in per capita food consumption. Enrolment in schools increased both at the primary and secondary level by 2-11%. Health visits increased particularly for children. There was a decrease in inequality, denoted by a contraction in the Gini index from 54.7% in 1996 to 47.5% in 2010.

GDP growth boost for the lower section of society: Although Mexico grew at an average GDP growth of 1% YoY over 2000-05, the lower section of society which benefited the most from the cash transfer programme grew at more than double the rate.

Exhibit 18: Bolsa Familia and Progresa have accelerated growth of lower sections of society

Program Country Launched in year

Program size (% of

GDP) Targeted towards Methodology Purpose Impact

Bolsa Familia Brazil 2003 0.50%

Below poverty line population living mainly in North-Eastern part of the country

Cash transfers conditional on school attendance and health check-ups by households To reduce poverty in

short term and avoid inter-generation transmission of poverty over the longer term

- Reduced income inequality, - 24mn households lifted above poverty line - 1.8x GDP multiplier effect

Progresa Mexico 1996 0.40% Poor households in urban and rural

Cash transfers conditional on school attendance and health check-ups by households

- Reduced households below poverty line from 19% of population in 1998 to 6% in 2010, - Increased enrolment in primary and secondary schools - >2x GDP multiplier effect


Case study: Unconditional cash transfer pilot in Delhi Unconditional direct cash transfers are largely still in the planning and experimental stage around the world. A study conducted in 2013 focused on a randomly controlled trial in Delhi and provided unconditional cash transfer to 500 self-selected households as a replacement for food security (refer to http://tinyurl.com/ohcs798). Whilst a major concern expressed was that households might prioritize wasteful expenses rather than ensure food security, results showed that food security was not compromised. Instead, the results showed that cash transfers provided opportunities for households to shift to nutritious options in the non-cereal segment. Overall, cash transfers neither compromised food security nor priority in the subset that was tested.

Change in the nature of household expenditure - Incremental income is spent in a rational manner Incremental income is not wasted on alcohol and tobacco

Several research papers which have analysed the spending pattern of households pre and post the cash transfer have concluded that consumer spending on alcohol and tobacco have not increased (refer to http://tinyurl.com/ptbxduu).

“Our experiment suggests that unconditional cash transfers do not lead to an increase in the consumption of alcohol.” – Gangopadhyay, Lensink, Yadav: Cash or Food Security through PDS? Evidence from a Randomized Controlled Trial in Delhi, India (2013)

Unconditional cash transfers do not result in wasteful consumer expenditure

http://tinyurl.com/ohcs798

http://tinyurl.com/ptbxduu

Consumer Staples


Incremental income diverted towards food, health and hygiene products

According to secondary research (Kamakura, Mazzon (2014); Angelucci, Attanasio, Maro (2011), http://tinyurl.com/pmct9ua) analysis of expenditure of households receiving cash transfers in other geographies suggests that:

Majority (~60%) of the incremental income from cash transfers is diverted towards purchase of food products. Consumers shift their consumption from cereals to non-cereals such as pulses, milk, egg, fish and meat, and fruits and vegetables, which helps them increase their protein intake.

After food, consumers divert a majority of their income towards health & hygiene and personal care products such as soaps, oral care, detergents, shampoo and skin care products.

Case study – Multiplier effect from direct cash transfer in Zimbabwe An organisation called Concern Worldwide conducted a study in 2010 in Zimbabwe. The study was aimed at quantifying the differences in impact on local markets of two forms of aid assistance, cash transfers and food aid conducted by calculating a multiplier for each of the two scenarios.

The multiplier is intended to measure the stimulus to the local economy, and their models have shown that these knock-on effects are happening. It was found that whilst the multiplier figure for cash transfers to poor households was 2.59x, the multiplier for providing food aid hovered around 1.5x. This is likely to be because the cash is not just spent once but re‐spent again. At every stage, cash is ‘leaking’ out of the area, but enough is being spent locally to generate a significant multiplier for cash. Overall, given the situation that existed in Gokwe North (Midlands province of Zimbabwe) in late-2009, the injection of cash to very poor households had a much more significant positive impact on the market than distribution of food rations.

Multiplier figure for cash transfers to poor households was ~2.6x, the multiplier for providing food aid was ~1.5x

http://tinyurl.com/pmct9ua)

Consumer Staples


Computing the proportion of incremental disposable household income spent on FMCG Most of the cash transfers globally have been targeted on the below poverty line (BPL) population, amounting to ~20-25% of the respective country’s total population. However, India’s food subsidy programme under the National Food Security Act 2013 (NFSA) covers ~67% of the total population. Note that 50% of this targeted population under NFSA is from the BPL category whilst the remainder is above poverty line (APL).

How meaningful are these cash transfers compared to the monthly per capita expenditure of targeted households?

As shown in the exhibit below, incremental household (HH) income of `232/household/month (`455bn/annum) would represent ~10% of the total monthly per household expenditure (MPHHE) for the bottom 30% (BPL) of the households.

Exhibit 19: Cash transfers would amount to ~10% of monthly per capita expenditure for the bottom 30% of the population

Source: NSSO survey 2011-12, Ambit Capital research

We expect BPL/APL households to spend 15%/40% of the cash transfers on branded FMCG products

As a result, we expect cash transfers under DBT, replacing the current food subsidy structure, to be spent by households in the following manner:

Based on the spending patterns observed in Brazil and Mexico (Kamakura, Mazzon (2014); Angelucci, Attanasio, Maro (2011), http://tinyurl.com/pmct9ua), we expect the BPL population in India to spend their incremental income from the cash transfer in a similar i.e., ~60% will be spent on food, ~15% will be spent on FMCG products and the remainder will be invested into various avenues, in particular agriculture.

Given the decreasing marginal propensity of consumption on food items with a rise in household income, the APL population in India is likely to spend most of their incremental income from cash transfers on FMCG purchases (~40%) and the majority of the remainder is likely to be invested in productive assets such as farm equipment and livestock.

3%

5%

7%

9%

11%

2,000

3,000

4,000

5,000

6,000

7,000

0-5% 5-10% 10-20% 20-30% 30-40% 40-50% 60-70%

Consumption quintile

Total MPHHE (Rs.) Incremental HH income as % MPHHE, (RHS)

We expect APL/BPL households to spend 40%/15% of incremental income on FMCG purchases

http://tinyurl.com/pmct9ua),

Consumer Staples


Expect the total incremental income from DBT to be equivalent to ~14% of the current rural FMCG market

Exhibit 20: We expect the incremental income from DBT to be equivalent to ~16% of the current rural FMCG market size

BPL household

(̀ /month, ̀ mn/year) Non-BPL household (̀ /month, ̀ mn/year) Total (̀ mn)

Total discretionary money available per household thru food DBT 232 223,997 232 230,784 454,781

% of above spent on FMCG 15% 40% 29%

Incremental amount spent on FMCG 35 33,599 93 92,314 125,913

Total FMCG market size 2,500,000

Proportion of rural FMCG market in total FMCG market 35%

As % of current rural FMCG market 14%


As shown in the exhibit above, we expect the total incremental income from DBT to be equivalent to ~14% of the current rural FMCG market. We have currently assumed three factors – incremental income from subsidy transfer through DBT, higher government spending on rural welfare and new economy created due to operation of food supply chain by private players - contribute towards a rise in FMCG expenditure in India following DBT implementation. However, multiplier effects from the proportion of DBT receipts invested in productive assets can result in a further rise in household income and hence in FMCG expenditure for beneficiary households. Please note that such “second round” impacts have NOT been factored into our assumptions or estimates for the sector or for specific companies.

Exhibit 21: We expect incremental household income of `455bn to result in `126bn of FMCG spends in rural areas


Consumer Staples


DBT of food subsidy is only the tip of the iceberg “DBT is not a programme which addresses expenditure concerns or a department's efficiency concerns. It is about putting an overarching architecture in place which can be a game changer.” – National Committee on Direct Cash Transfers, (2012)

“Prime Minister Narendra Modi has called for accelerating the delivery of benefits, and expanding the applications of the Aadhaar (UID) platform” – PMO office in Jun’15

As highlighted in our March 2015 note, the transfer of subsidy schemes on to the DBT architecture will be one of the three resets to be initiated by the Modi-administration. Following the implementation of DBT for LPG subsidy (already completed) and food subsidy (implementation likely to start from 1QFY17), the complete potential of the DBT architecture will be realised when all the various subsidies (fertilisers, scholarships, pension, income support, wage payment, etc) are consolidated and put on DBT. The Government is likely to keep some of these cash transfers conditional on children maintaining minimum attendance in school and BPL households undertaking regular health checkups, thereby improving the human capital beyond just the reduction of poverty in the country.

Transfer of Food subsidy onto the DBT reduces the food subsidy bill by 20% i.e. `250bn. Assuming similar savings of 20% for other subsidies, implementation of DBT for Petroleum and Fertiliser subsidy as well by FY20 could result in savings of `667bn i.e. `0.3% of GDP. If delivered through DBT, these subsidies could amount to `1,360/household/month, equivalent to ~40% of monthly household expenditure for BPL households.

Exhibit 22: Implementation of DBT for subsidies by FY20 could result in savings of `667bn

Year Nominal

GDP (̀ bn)

Subsidy (̀ bn) Subsidy as % of GDP Potential savings through DBT

Food Fertiliser Petroleum Total Food Fertiliser Petroleum Total ` bn % of GDP FY17E 149,777 1,348 899 135 2,381 0.9% 0.6% 0.1% 1.6% 476 0.3% FY18E 168,649 1,518 1,012 135 2,665 0.9% 0.6% 0.1% 1.6% 533 0.3% FY19E 189,899 1,709 1,139 133 2,981 0.9% 0.6% 0.1% 1.6% 596 0.3% FY20E 213,826 1,924 1,283 128 3,336 0.9% 0.6% 0.1% 1.6% 667 0.3%


Exhibit 23: List of various scholarship schemes run by the various Government bodies, which can eventually be put under DBT Ministry/ Department

Number of Schemes Name of Schemes

M/o Social Justice & Empowerment

6

Post Matric Scholarship for SC Students, S Pre-Matric Scholarship for SC Students, Pre-Matric Scholarship for Children of those engaged in unclean occupations, Upgradation of merit of SC Students., Post Matric Scholarship for OBCs, Top Class Education Scheme

M/o Human Resources Development, D/o Higher Education

3 Scholarship to Universities/College Students, S Fellowship Schemes of UGC, Fellowship Schemes of AICTE

M/o Human Resources Development, D/o School Education & Literacy

2 National Means cum Merit Scholarship, National Scheme for Incentive for the girl child for secondary education

M/o Tribal Affairs 3 Post-Matric Scholarship Scheme for ST Students, Top Class Education System, Rajiv Gandhi National Fellowship

M/o Minority Affairs 3 Matric Scholarship Scheme, Maulana Azad National Fellowship, Merit cum Means Scholarship Scheme

M/o Women and Child Development 2 Indira Gandhi Matritva Sahyog Yojana (IGMSY), Dhanalakshmi Scheme

M/o Health & Family Welfare 1 Janani Suraksha Yojana

M/o Labour and Employment 5

Scholarship to the Children of beedi workers, Housing subsidy to beedi workers, Stipend to children in the special schools under the Child Labour Project, Stipend to trainees under the Scheme of Welfare of SC/ST job seekers through Coaching, Guidance and Vocational Training, Payment of stipend to trainees under the Scheme of Skill Development in 34 Districts affected by Left Wing Extremism (LWE)


Transfer of all subsidies on to DBT could result in cash transfer of `1,360/month/household

http://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_Resetbutton_23Mar2015.pdf

Consumer Staples


The potential short-term benefits from shifting subsidies to DBT are:

Multiplier effects from improved productivity/liquidity: Replacement of the current PDS system by the DBT system will give households the flexibility to modify their approach towards areas such as: (a) types of food grain production/ procurement; (b) consumption of various types of fertilizers/ nutrients for agriculture; and (c) ready availability of working capital would allow family members to work on their own farms instead of seeking labour elsewhere to generate working capital. This flexibility can create significant multiplier effects with regards to household income generation over time.

Efficient identification of targeted beneficiaries: The creation of Aadhar-linked biometric database has helped eliminate several ghost ration cards as well as issue new ration cards with updated income status. (Refer http://tinyurl.com/od7kzf8)

Reduced corruption: As explained in our February 2015 rural thematic, the current subsidy system in India is tantamount to dropping cash from a helicopter on rural India and expecting the poor to get some of the subsidy. In reality, what happens is that anywhere between 40% and 80% of the subsidy is pilfered by the political middleman. DBT should be able to reduce the quantum of pilferage.

Elimination of wastage: There is significant wastage of food grains when the Government tries to transport food grains from one part of the country to another as part of the PDS programme (see http://tinyurl.com/nw3h75z). Wastages such as these would be eliminated.

Local economies grow over the longer term due to cash transfers

Over the longer term when all subsidies are consolidated and passed on through the cash transfer mechanism, the quantum of transfer could amount to ~40% of the total monthly expenditure by a BPL household. Due to the decreasing marginal utility of food with the increase in household income, households invest incremental income into non-food products such as farm equipment and livestock. These products are either produced locally or purchased from outside. In both the cases, the increase in consumption stimulates the local economy.

Hence, transfer of subsidies on to the DBT architecture will drive growth of local economies mainly in rural areas.

DBT-led growth to benefit more rural households than helicopter-drop-driven rural growth The rural consumption boom over CY07-11 (average of 15% growth per annum in rural consumption spend vs 13% per annum over this period) was driven by a 20% CAGR in the Government’s rural development spend over FY05-13 on schemes such as MGNREGA (a rural employment scheme), Indira Awas Yojna (rural housing scheme) and the Pradhan Mantri Gram Sadak Yojana and Central Road Fund (road development schemes).

However, due to less-than-ideal transmission of these subsidies, they were akin to a helicopter drop where only the top-earning households, having significant authority in village administration, benefited disproportionately from the subsidies. (February 2015 note: Rural India: at a crossroads) We believe that the DBT mechanism should result in effective transmission of subsidies to the targeted households. As more lower-income households would benefit from DBT, we believe a rural consumption boom would be led by more spending on small-ticket items such as FMCG products.

DBT would lead to better targeting of subsidies, reduce corruption and multiplier effect in local economy

MGNREGA benefited the middle men while DBT will cut out the middle men

http://tinyurl.com/od7kzf8

http://tinyurl.com/nw3h75z

http://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_RuralIndia_24Feb2015.pdf

Consumer Staples


Hurdles likely to be faced during DBT implementation Banking infrastructure and systems will have to be put in place in rural India.

It is not enough to ensure that everyone has a Jan Dhan account, as smooth payment of the subsidy into these accounts has to be also ensured. Delays in payments will be a challenge that the Government will need to overcome.

The Government will have to ensure that the bank branch network is more diverse than the current network of ration shops. For instance, Puducherry had attempted a pilot in October 2014. It involved direct cash transfer of `300/month into bank accounts of targeted families, instead of 10kg of free rice. But the programme had to be called off in February this year due to operational problems, mainly related to banks – there were only 100 bank branches available in a Union Territory with 400 ration shops.

A key argument against cash transfers is that they will not protect the beneficiaries against market volatilities and supply shocks and that the cash reimbursement may not be inflation-proof. Indexing the cash payout to the MSP could address this problem. So any increase in MSP will mean a 1.25x increase in cash reimbursement. However the challenge can be difficult to address if retail prices rise even higher and supply shocks are prevalent in geographically remote areas.

Key success factors of DBT for food subsidy Whilst we have discussed the success factors of the DBT architecture earlier, the success of food subsidies through the DBT route will hinge on the following factors:

Ability of private players to replace government’s food supply chain: Under the current PDS system, the Food Corporation of India (FCI) ensures the availability of food grains by procuring food grains from surplus states and transferring them to deficit states. Thus, the supply chain will now have to be operated by private players in a manner similar to what the Future Group is doing in Rajasthan. They will have to ensure procurement of food grains at competitive prices whilst also ensuring their own profitability. In order to avoid a situation of food shortage, the Ministry of Consumer Affairs (MCA) which has formulated the rules for Cash Transfer for Food Subsidy has set a pre-condition that the State Government has to ensure adequate availability of food grains in the open market before implementing the cash transfer scheme.

Adequate and timely cash transfers to ensure food security: The quantum of cash transfers needs to be adequate, with the quantum being adjusted appropriately to factor in any price shocks. Also, the cash transfers will need to be done in a timely manner every month to avoid cash shortage for food purchase especially for BPL households who are leading hand-to-mouth lives.

Increasing production of non-cereals: As households tend to substitute consumption of food grains with non-cereals when they get cash transfers instead of subsidised food, it will be necessary to increase the production of non-cereals in order to avoid inflation of their prices. However, the assured procurement of paddy and wheat by the Food Corporation of India (FCI) at attractive MSP prices has led to farmers producing more of rice and wheat instead of cereals. As a result, it is not clear whether India’s agri economy will be able to respond to the challenge of stepping up non-cereal production.

Inadequate banking infrastructure and volatility of food prices could impact DBT implementation

Ability of private sector to undertake the food supply chain, timely cash transfer to beneficiary A/c’s and increasing production of non-cereals are key success factors of DBT

Consumer Staples


HUL, Colgate and Dabur are likely to be the biggest beneficiaries of cash transfers As mentioned earlier, we expect cash transfers for food to result in incremental spends of `156bn on FMCG products, which amounts to ~16% of current rural FMCG spends. We believe this amount will be prioritised on the personal hygiene, health, packaged foods and personal care categories. The specific product categories benefiting from an increase in rural consumption and the companies benefiting in each category in decreasing priority order are detailed below.

Exhibit 24: Packaged foods, hygiene and personal care products to benefit the most

Categories Beneficiary companies Drivers of growth

Soaps HUL, GCPL Incremental spends will be on rising frequency of consumption and even on premiumisation

Toothpaste Colgate, Dabur, HUL Growth will come from increase in penetration and increased per capita consumption of toothpaste

Biscuits Parle, Britannia Growth will be driven by increased penetration and conversion from unbranded to branded biscuits

MFD GSK CH Increase in penetration and frequency of consumption will drive growth

Household Insecticides GCPL Increase in penetration will be the key driver of growth in this category

Shampoo HUL, Dabur Whilst penetration is high, growth will be driven by increase in frequency of consumption and premiumisation

Detergents HUL Growth will be driven by increased frequency of consumption and premiumisation

Hair Oil Marico, Dabur Shift from unbranded to branded hair oils will drive growth in this category

Skin Cream HUL Growth will be driven by an increase in penetration

Tea HUL Growth will be driven by shift from loose to branded tea powder


We believe the key attributes for a company to benefit disproportionally from increased FMCG spends by rural households are: (a) Distribution outreach in rural areas; (b) Brand equity; (c) Mass and mid-mass positioned brands in the above-mentioned product categories; (d) Presence across the above product categories; and (e) Percentage of total sales derived from rural areas. Based on these criteria, we expect HUL, Dabur and Colgate to benefit the most from increased rural household spends.

Exhibit 25: HUL, Colgate and Dabur best placed to benefit from increased rural spends

Company Rural

distribution outreach

Brand Equity

Mass/mid-mass brand

position

Width of product portfolio

Rural as % of total sales

Overall Driver of rural sales growth

HUL

40-45%

Best placed in soaps, detergents, shampoos, skin creams

Colgate

28-30%

To benefit most from higher spends on toothpaste

Dabur

30-33%

Strong presence in hair oil, shampoo, toothpaste and skin care

GSK CH

25-30%

Should benefit from higher spends on MFD category

Marico

23-25%

Market leadership in coconut oil, VAHO; presence limited only to hair oil

Britannia

30-35%

Whilst category may grow, Britannia impacted by lack of strong value brands

GCPL

15-20%

Presence in soaps and household insecticides; benefit limited by only 50% sales from India

Nestle

25-30%

Limited benefit as Nestle has no brands with mas and mid-mass positioning


Note: - Strong; - Relatively Strong; - Average; - Relatively weak - Weak.

As we expect the implementation of the DBT programme to happen in a staggered manner over FY17-20, companies will see increasing benefit of higher rural spends over FY17-20. We expect this to result in:

Sales upgrades, ranging from 2% to 14% across companies.

EBIT upgrades, ranging from 2% to 20%, higher than sales upgrades. As incremental sales are due to incremental income for consumers, we expect operating leverage to result in EBIT upgrades ahead of sales upgrades.

Consumer Staples


The table below summarises the upgrade in our sales and EBIT estimates for our coverage companies over FY17-20.

Exhibit 26: HUL and Colgate to benefit the most; GCPL and Nestle to benefit the least

Company % sales upgrade % EBIT upgrade

FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20

HUL 5% 8% 11% 14% 6% 8% 12% 20%

Colgate 2% 5% 7% 10% 3% 5% 8% 13%

Dabur 2% 5% 7% 10% 3% 6% 8% 13%

GSK CH 3% 5% 7% 8% 6% 9% 11% 14%

Britannia 2% 4% 5% 7% 2% 4% 7% 11%

Marico 1% 3% 4% 6% 2% 3% 4% 10%

Nestle 1% 2% 3% 4% 2% 3% 4% 7%

GCPL 1% 1% 2% 2% 1% 2% 2% 4%


HUL – Widest rural distribution and market leadership in S&D

HUL has increased its direct distribution by 3x over the last 4 years to >3mn outlets with major focus being on increasing rural outreach. The company derives ~40% of its sales from rural areas. HUL is also the market leader in soaps, detergents, shampoo, skin cream and packaged tea category. It has marquee mass and mid-mass positioned brands in these categories which should help the company benefit disproportionately from an increase in rural consumption. As a result, we upgrade HUL’s sales and EBIT by 5-20% over FY17-20E.

Exhibit 27: HUL is a market leader in several FMCG categories Brand Position Category Brand Size (̀ . Bn) Market position

Lifebuoy Mass Soap `20bn+ #1

Lux Mid-mass Soap `10bn+ #2

Wheel Mass Detergent `20bn+ #1

Rin Mid-mass Detergent `20bn+ #2

Brooke Bond Mid-mass Packaged Tea `20bn+ #1

Fair & Lovely Mass Skin care `20bn+ #1

Clinic Plus Mass Shampoo `10bn+ #1


Colgate – Market leadership and strong brand equity

Colgate is the widest distributed oral care brand in rural India with a total outreach of 4.8mn outlets as of 2014. The company currently derives ~30% of its sales from rural areas. Colgate has ~65% volume share in rural areas and consumer-connect programmes such as ‘Oral Health Month’ have resulted in strong brand equity for Colgate. Toothpaste per capita consumption in rural areas is only 85gm vs ~280gm in urban India, indicating significant headroom for growth in rural areas. Given Colgate’s wide distribution reach and strong brand equity of brands such as Cibaca and Colgate Dental Cream we believe Colgate should benefit disproportionately from higher rural FMCG spends. We have upgraded Colgate’s sales and EBIT by 2-13% over FY17-20E.

Dabur - Increased rural distribution and presence across product categories

Following the implementation of Project Double, Dabur increased its rural outreach from 14,000 villages in FY11 to ~50,000 villages in FY15. The company currently derives ~50% of its India sales from rural areas. However, with 33% of sales from overseas business, rural contribution to total sales is only 33%. Given Dabur’s presence in hair oil, shampoo and toothpaste with strong brands such as Dabur Amla, Vatika, Dabur Red and Babool, we expect Dabur to benefit from increased FMCG spends by rural households. We have upgraded Dabur’s sales and EBIT by 2-13% over FY17-20E.

Consumer Staples


Valuation - Upgrade HUL and Marico to buy; retain SELL on others We adopt a DCF-based valuation methodology for valuing FMCG companies due to: (a) high cash generation ability of the businesses; and (b) ability of the method to capture the varying nature of the longer-term business prospects of the different companies. We break-up the DCF model into three stages to capture the different phases of growth:

Phase I - Explicit forecast (until FY20): As we believe that the complete implementation of DBT would be completed by FY20, we have created explicit forecasts for all companies until FY20.

Phase II - Fade period: We differentiate between the longevity of growth of different companies by factoring in different fade periods. The determinants of longevity of growth are described in the following section.

Phase III - Perpetual growth: After the fade period, we assume the same perpetual growth of 5% for every company. We estimate 5% perpetual by assuming 3% real GDP growth and 2% longer term inflation.

We assume a cost of equity (Ke) of 13% for all companies. The assumptions for the same are summarised in the exhibit alongside.

Framework for comparing longevity of growth rates In order to determine the longevity of growth of different companies, we evaluate them on the following factors: Longevity of category growth rates given potential to increase penetration,

frequency of consumption and premiumisation; Positioning of the company on its competitive advantage framework, and

hence ability to sustain trends of market share gains/retention/losses; Key man risk, thereby factoring in the probability of material changes to growth

prospects of a company with changes to its senior management team; New category entry potential, and hence the ability of a firm to leverage on its

existing strengths around brand and distribution to add new revenue growth drivers and hence increase the longevity of its medium-term growth period;

Diversification of the product portfolio, and hence factoring in the exposure of a company’s growth trajectory to changes in the growth dynamics of a specific product category;

Capital allocation, and hence the ability of companies to prudently allocate to deliver consistent growth with improvement in RoCE.

The table below shows the performance of staples companies against each of the above parameters.

Exhibit 28: Nestle and HUL have the best longevity of growth followed by Dabur and Colgate

Company Category Growth

Competitive positioning

Diversification of product portfolio

Key man risk

New category possibility

Capital allocation Overall

HUL

Nestle Colgate Dabur Marico Britannia GSK CH

GCPL

Source: Ambit Capital research Note: - Strong; - Relatively Strong; - Average; - Relatively weak - Weak.

Cost of equity assumptions

Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.5

Equity risk premium (%) 9.0

Cost of equity (%) 13.0


Consumer Staples


HUL and Nestle are best positioned on our framework from long-term growth perspective

We give the highest implied P/E rating to Nestle followed by HUL on our valuation framework due to the following factors: Nestle benefits from the following moats vs other staples companies:

Baby foods (~30% of revenues, ~50% of EBIT): Strong category growth led preference of using packaged baby foods due to factors like rising working women population of the country and changing preferences around feeding a baby. Nestle current market share of 80%+ is unlikely to be challenged by new entrants especially because of a ban on advertising for these products.

Brand recall for Maggi (25% of revenues, ~20% of EBIT in a normal year): Whilst we expect Nestle to report market share losses and weak earnings over the next 18-24 months given the recent Maggi fiasco, over a longer term Maggi is likely to benefit from brand investments and made over the past several decades.

Presence in underpenetrated categories: Nestle’s entire portfolio of products includes underpenetrated categories like noodles, baby foods, chocolates, coffee, ketchups and soups. As a result, as long as the firm demonstrates ability to capitalize well on the macro potential, it will NOT face headwinds around saturation of macro potential.

Despite having the highest implied P/E multiple (30% premium to sector average), we have a SELL recommendation on Nestle mainly on valuation grounds as the current valuations do not adequately factor in the drag on earnings from market share loss and forthcoming investments likely behind the Maggi brand over the next 2 years.

HUL benefits from the following moats vs other staples companies:

Quality of talent in its middle management team: HUL has maintained a strong focus on hiring and retaining best quality talent right from the level of management trainees. Hence, with a high-quality management team, HUL demonstrates superior execution of initiatives around strengthening distribution, marketing, sales, and operating efficiencies.

Width and strength of its product portfolio: HUL benefits from strong brand equity and presence from economy to premium products across all categories including personal care, home care and packaged foods. This enables the firm to better capitalise on various trends around consumption evolution consistently.

Distribution capabilities: HUL’s direct distribution increased by 3x over the last 4 years to >3mn outlets. The quality of its distribution improved with the number of outlets billing higher than its internal benchmark of ‘throughput-per-store’ being ~80% in FY15 vs. ~57% in FY14. Its latest market place execution strategy - WIMI (Winning In Many India’s) has allowed faster execution of region-specific product development and consumer promotions.

GCPL is the worst positioned vs peers on our framework because of:

Lack of premium portfolio in categories like soaps (17% of revenues): GCPL doesn’t have a strong premium offering in the soaps segment which is likely to limit sales growth given high category penetration and hence premiumisation being the key growth driver (FY15-20 10% sales CAGR for GCPL’s soaps portfolio).

Integration challenges and fewer moats in Africa/ LatAm/ UK (30% of consolidated revenues): As GCPL pursues its target sales CAGR of 26% (over FY11-21), we expect substantial capital allocation towards M&A in emerging markets. However, with the international portfolio’s RoCEs declining from 16% in FY08 to 8% in FY15, we see a risk of a sustained drag on return ratios, due to challenges around management bandwidth, integration expertise, and focus/incentive to consolidate the existing portfolio before further acquisitions are pursued.

Consumer Staples


Relative valuation The exhibit below highlights our relative rating of staples companies on the basis of the strength and sustainability of revenue growth rates, earnings and ROCEs.

Exhibit 29: Relative valuation table for our staples coverage universe

Company CMP Mcap Stance Target Price

Up/ Down

P/E EV/EBITDA ROCE Implied P/E Div.

Yield (%)

EPS Growth

Rev growth

Longevity score

(`) ($mn) FY16E FY17E FY16E FY17E FY17E FY16E FY17E FY16E FY15-20 FY15-20 HUL 801 26,682 BUY 925 15% 40.9 33.1 29.1 24.2 105.6% 47.3 38.2 1.9% 20% 14%

Nestle 6,174 9,346 SELL 5,250 -15% 57.7 47.2 33.3 27.2 35.2% 49.0 40.1 1.0% 12% 8%

Dabur 271 7,076 SELL 262 -3% 37.6 32.0 30.7 25.5 29.4% 36.3 30.9 0.9% 18% 16%

Colgate 955 1,964 SELL 870 -9% 43.6 36.1 28.4 23.3 69.8% 39.7 32.9 1.4% 18% 14%

Godrej Consumer

1,262 6,546 SELL 920 -27% 40.8 33.5 27.6 22.8 19.7% 29.7 24.4 0.5% 16% 13%

GSK Consumer 5,988 3,901 SELL 5,745 -4% 37.7 32.3 33.4 27.0 30.1% 36.1 31.0 1.0% 17% 15%

Marico 385 3,779 BUY 435 13% 33.5 27.0 22.5 18.4 36.3% 37.8 30.5 1.0% 24% 17%

ITC 334 44,127 BUY 405 21% 25.3 22.1 16.2 14.1 31.7% 30.7 26.8 2.3% 14% 14%

Britannia 3,232 5,973 SELL 2,300 -29% 47.7 39.7 18.6 15.5 42.4% 33.9 28.2 1.6% 25% 16%

Median -6% 40.8 33.1 28.4 23.3 35% 36.3 30.9 1.0% 18% 14% Source: Company, Ambit Capital research *Note: FY16/17 for Nestle implies CY15/16

Normalisation of P/E multiple ratings vs sector average by FY20, as DBT rollout is expected to be fully implemented by then

We expect FY17/18/19/20 to report 25%/50%/75%/100% of transition of food subsidy onto the DBT platform. Due to such staggered implementation over four years, our DCF-implied P/E multiples for biggest beneficiaries like HUL/ Colgate/ Dabur are likely to be artificially inflated in FY17/18 relative to the peer group average. This is because whilst their DCF valuations factor in the longer term benefits from food-subsidy DBT rollout, their expected earnings for FY17/18 do not yet factor in these benefits meaningfully.

As a result, the divergence from sector median, of P/E multiples for firms like HUL/Colgate, will normalise over FY17-20, as highlighted in the exhibit below.

Exhibit 30: HUL’s and Colgate’s premium to the sector multiple reduces, as they have sector-leading EPS growth

Company Implied P/E Premium/(Discount) to sector median multiple

FY16E FY17E FY18E FY19E FY20E FY16E FY17E FY18E FY19E FY20E

HUL 47.3 38.2 31.3 25.6 21.2 28% 25% 19% 15% 14%

Colgate 39.7 32.9 27.3 22.4 18.7 7% 7% 4% 1% 1%

Dabur 36.3 30.9 26.1 22.1 18.5 -2% 1% -1% -1% -1%

GSK CH 35.4 30.5 26.6 22.7 19.3 -4% -1% 1% 2% 3%

Britannia 34.0 28.3 23.8 20.0 17.0 -8% -8% -10% -10% -9%

Marico 37.8 30.5 25.1 20.5 16.8 2% -1% -5% -8% -10%

Nestle 49.0 40.1 32.6 27.7 24.0 32% 31% 24% 25% 29%

GCPL 29.7 24.4 21.3 18.9 16.3 -20% -20% -19% -15% -12%

Median 37.1 30.7 26.3 22.3 18.6 Source: Company, Ambit Capital research

Consumer Staples


This page have been intentionally left blank


COMPANY INSIGHT HUVR IN EQUITY November 03, 2015

The King of rural India

HUL is best positioned to capitalise on the benefits of the DBT rollout over FY17-20E due to: (i) its highest proportion of rural sales, (ii) high exposure to the most-functional staples categories (like soaps, detergents, shampoos, and oral care), and (iii) the increase in the width and depth of its distribution network over the past 3-4 years. The recent rise in price-led competitive intensity is likely to moderate in FY17E. Based on our upgraded EPS estimates of 12-16% over FY17-20E, the stock is trading at 33x FY17E P/E. We change our stance to BUY (TP of `925, implied FY17E P/E of 38x) and expect positive catalysts around macro revival and DBT benefits from 1QFY17E onwards.

Competitive position: STRONG Changes to this position: POSITIVE HUL’s product portfolio is best placed to benefit from DBT rollout More than 80% of HUL’s revenues are derived from categories which will be the biggest beneficiaries of DBT-induced incremental spends, such as soaps, detergents, shampoos, packaged tea, skin care and oral care. Moreover, HUL is the market leader in all these categories except for oral care, which is the #2 player. Also, >50% of HUL’s revenue from these categories is derived from rural India, and thus, it has the highest exposure to segments that will benefit the most from the DBT rollout of subsidies. HUL has improved its depth and quality of distribution over FY13-16 HUL’s direct distribution increased by 3x over the last 4 years to >3mn outlets. The quality of its distribution improved, with the number of outlets billing higher than its internal benchmark of ‘throughput-per-store’ being ~80% in FY15 vs ~57% in FY14. Its latest marketplace execution strategy, WIMI (Winning In Many India’s), has allowed faster execution of region-specific product development and consumer promotions. Thus, HUL is best placed to expand in an improved macro environment over the next 2-3 years. Near-term headwinds affecting earnings growth will fade away in FY17 Through consistent investments behind its brands and distribution over the past 12 months, HUL has focused on protecting its market share despite disruptive price-led competition from players like P&G. We expect moderation in competitive intensity in FY17 given the base effect of input cost tailwinds. Turn BUYers with TP of `925; expect 20% EPS CAGR over FY15-20 We have revised our FY17-20 sales/EBIT estimates upwards by 12-16% and our target price upwards by 21% to `925/share (15% upside), implied FY17E P/E of 38x vs 31x for the sector. These premium valuations vs sector average are justified, as: (a) HUL is best positioned to benefit from a rural macro demand recovery over the next 3-5 years, with our FY17 EPS factoring in only 25% of the benefits of DBT implementation; (b) HUL’s practice of talent hiring and retention allows it to execute expansion efficiently and sustainably over longer time periods vs peers. We expect sector-leading sales/EPS growth of 14%/20% over FY15-20 with >100% RoCE. We turn BUYers.

Hindustan UnileverBUY

Consumer Staples

Recommendation Mcap (bn): `1,718/US$26.5 6M ADV (mn): `1,373/US$21.2 CMP: `801 TP (12 mths): `925 Upside (%): 15

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: RED

Catalysts

Uptick in rural demand during FY17E due to DBT

Urban macro demand revival in 1HFY17E

Moderation in competitive intensity from 4QFY16E onwards

Performance (%)

Source: Bloomberg, Ambit Capital research

90 100 110 120 130 140

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex HUL

Key financials Year to March FY14 FY15 FY16E FY17E FY18E

Operating income (` mn) 280,191 308,056 331,603 382,966 441,354

EBITDA (` mn) 44,753 52,082 58,719 70,495 84,995

EBITDA Margin (%) 16.0% 16.9% 17.7% 18.4% 19.3%

Adjusted PAT (` mn) 34,027 37,611 42,342 52,348 64,005

Adjusted EPS (`) 16.5 17.2 19.6 24.2 29.6

RoE (%) 117.0% 105.2% 103.1% 105.3% 104.1%

P/E (x) 48.7 46.5 41.0 33.1 27.1


Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA




Hindustan Unilever


HUL to benefit the most from DBT-induced rural growth Product portfolio ideally positioned to benefit from DBT Relevant category exposure: As shown in the exhibit below, over 60% of HUL’s

revenues are derived from categories which will be the biggest beneficiaries of DBT-induced incremental spends.

Leadership in relevant categories: HUL is the market leader in all these DBT-affected categories except for oral care, where it is the #2 player.

Rural exposure in relevant categories: >50% of HUL’s revenue from these categories is derived from rural India.

Exhibit 1: HUL is a market leader in most of the DBT beneficiary FMCG categories

Brand Position Category HUL’s revenue Size (`. Bn)

Market position % of HUL sales

Lifebuoy Mass Soap `20bn+ #1 ~20% of sales

Lux Mid-mass Soap `10bn+ #2

Wheel Mass Detergent `20bn+ #1 ~20% of sales

Rin Mid-mass Detergent `20bn+ #2

Brooke Bond Mid-mass Packaged Tea `20bn+ #1 ~8% of sales

Fair & Lovely Mass Skin care `20bn+ #1 ~10% of sales

Clinic Plus Mass Shampoo `10bn+ #1 ~5% of sales


Distribution initiatives implemented over the past few years will help improve execution of rural expansion Increase in direct reach: HUL has increased its direct out-reach in rural areas

by more than 3x over FY09-13, and currently stands at over 3mn outlets, the highest as compared to any other staples company in India. Some of the initiatives underway to further improve this include examples such as the low-cost distribution model of using tele-calling to take orders from marginal retailers in rural markets.

Increase in throughput per store: Throughput per store has been enhanced (see chart on the right below) by leveraging on IT and the Perfect Store concept, which drives assortment at the store. HUL has created awareness of the various product categories among the rural population through its Perfect Village where the company visits villages and runs awareness campaigns highlighting the benefit of new FMCG products categories like face washes, hair conditioners, fabric conditioners etc.

Exhibit 2: HUL has not only multiplied its direct coverage but also increased throughput per store

Source: Company presentation – Analyst Day Jun’15

Hindustan Unilever


Decentralised approach towards product development, marketing and distribution Exhibit 3: The country has been divided into 14 clusters reporting into 5 branches

Source: Company presentation – Analyst Day Jun’15

Under the WIMI approach, HUL has divided the country in to 14 clusters reporting in to 5 branches instead of the earlier approach of having 4 zones. A new 5th branch focused on the Hindi belt of Bihar, Uttar Pradesh, Madhya Pradesh, Rajasthan and Chattisgarh has been created. It has also further empowered the front end teams in every cluster allowing them to take faster cluster specific decisions. Some of such initiatives have been:

To capture coastal Andhra consumers up-trading from loose tea to branded tea, a new TVC, in-store advertising and trade sampling initiatives were launched,

Pepsodent clove and salt was launched in South India to cater to the South Indian traditional habit of using clove oil and salt for teeth cleansing,

To convince consumer in UP to switch from Ghari to Rin, HUL introduced region specific smaller SKUs at lower prices.

As a result, given HUL’s strength in its product portfolio and distribution, we expect HUL to be one of the biggest beneficiaries of DBT-induced incremental rural consumption growth and hence deliver sales/EBIT CAGR of 14%/20% over FY15-20 vs. our earlier expectations of 11%/16% sales/EBIT over the same period but without the DBT benefit.

Impact of DBT on our DCF projections We expect FY17/18/19/20 to see 25%/50%/75%/100% implementation of DBT for food subsidy at a pan-India level respectively. Due to the cumulative nature of these benefits, upgrades to our forecasts are higher in FY19 and FY20 vs those over the next 2 years, as shown in the exhibit below.

Hindustan Unilever


Exhibit 4: The impact of DBT on our free cash flow forecasts


Change in estimates As highlighted in the table below, our revenue and earnings forecasts for HUL have changed to reflect the following:

Upgrade to revenue forecasts to include an evenly staggered implementation of DBT for food subsidy over a four year period from 25% implementation in FY17 to 100% in FY20.

Operating leverage gains predominantly from scale efficiencies related to A&P and investments already made to expand rural distribution and marketing.

Exhibit 5: Change in estimates for HUL (` mn)

New Old Ch%

FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E

TP 925 751 23%

Sales 331,603 382,966 441,354 327,403 365,176 409,375 1.3% 4.9% 7.8%

EBITDA 58,719 70,495 84,995 56,994 65,943 78,018 3.0% 6.9% 8.9%

EBITDA margin (%) 17.7% 18.4% 19.3% 17.4% 18.1% 19.1% 30 35 20

PBT 61,012 75,642 92,583 59,000 71,206 85,352 3.4% 6.2% 8.5%

PAT 41,549 51,436 62,956 40,179 48,420 58,040 3.4% 6.2% 8.5%

EPS 19.2 23.8 29.1 18.6 22.4 26.8 3.4% 6.2% 8.5%


0%

5%

10%

15%

20%

25%

40,000

54,000

68,000

82,000

96,000

110,000

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

Old DCF (Rs. Mn) DCF factoring in DBT benefit (Rs. Mn) % increase (RHS)

Hindustan Unilever


HUL: A machine in perpetual motion ‘Cash cow’ brands allow significant investments in new products/categories

We believe HUL’s dominant position in the detergent, soaps and skin care segment is secure given its strong brand equity, well-penetrated distribution (highest indirect reach of >8.5mn outlets among FMCG companies), parent Unilever’s R&D capabilities and presence across price points in a category. Also, due to the high profitability of these brands (EBIT margin of Personal Products >25% and Soaps & Detergents is 12-14%) and best in-class working capital management, they generate >80% of the company’s annual FCF (FCF for FY15 was ~`37bn). The security of these cash cow brands gives HUL the firepower to: Invest in new product categories thus creating potential future growth drivers. For

e.g. the company has been investing in the packaged foods category in order to grow brands such as Knorr and Kissan. Packaged Foods contributed 6.2% of sales in FY15 vs. 5.1% in FY09.

Invest heavily in creating brands to counter competition. For e.g. the rapid success of Nirma detergent in the late 1980s resulted in HUL launching an indigenous brand Wheel and invested heavily in growing this brand which is now the #1 detergent brand in the country.

Invest aggressively to recoup lost market share as in the case of Axe deodorants where the company has been aggressive with its A&P spends to regain market share through Axe signature.

Ability to attract and retain the best-quality talent

Along with ITC and Asian Paints, HUL is one of the few FMCG companies to attract and retain the best quality talent from premium institutes such as IIT/IIMs. HUL also has one of the best-in-class management trainee programmes where every new manager undergoes a sales stint particularly in rural areas, irrespective of the function they are hired for. The opportunity to head some of the marquee brands in Indian FMCG industry and also the prospects of working at an overseas subsidiary of Unilever helps HUL retain its talent. Decades of hiring and retaining the best quality talent has helped HUL create a very strong talent pool in the middle management.

This high-quality talent has helped HUL create brands such as Wheel, Fair & Lovely and come up with innovative consumer connect programs such as Kan Khajura Teshan (KKT). KKT helped HUL reach out to ~5mn rural consumers through an innovative free mobile radio service in an otherwise media-dark region of Bihar.

Leverage technology to create systems and processes

Along with Marico, HUL has been at the forefront of using technology to create systems and processes which could track primary and secondary sales data and supplier inventory. This has helped HUL to forecast demand with higher accuracy, drive assortment selling and also plan production in order to have one of the best in-class working capital management. Also, these systems have enough checks and balances in place thus preventing managers from committing errors which could lead to stock outs and thus lost sales.

These checks and balances and strong talent also reduce the key man risk for HUL unlike its domestic FMCG peers.

Not ceded market share despite high competitive intensity

Unlike in 2010, this time HUL has been pro-active in taking timely price cuts and passed on the benefits of lower commodity costs on to consumers through stepped consumer promotion spends. Although this has impacted sales growth and also resulted in only single-digit PAT growth despite significant margin benefit, it has ensured that HUL has maintained its market share in its key categories of soaps and detergents despite the intense competitive action.

Hindustan Unilever


Exhibit 6: HUL’s volume growth has been sustained despite weak consumer demand through higher A&P spends


Valuations premium to sector is justified given longevity of growth We expect HUL to deliver 14%/20% sales/EBIT CAGR over FY15-20 vs. category growth of 14%/18% over the same period. However, given the competitive strengths of existing brands, diverse portfolio, capability to enter new categories, process oriented operations, and superior capital allocation (>100% RoCE for FY15), HUL has higher longevity of growth than most of its peers. This complemented by the potential upside from higher rural spends, we believe HUL deserves to trade at a premium to the sector. Our DCF-based TP of `925 (15% upside) implies FY17E P/E of 38x vs sector average of 31x (premium of 24%).

As explained in Exhibit 4, due to the staggered implementation of DBT over four years, our DCF-implied P/E multiples for firms like HUL are artificially inflated in FY17/18 relative to the peer group average. This is because whilst our DCF valuation on the firm factors in the longer term benefits from food-subsidy DBT rollout, its expected earnings for FY17/18 do not yet factor in these benefits meaningfully.

As a result, the divergence from sector median, of P/E multiple for HUL normalizes over FY17-20 from a 24% premium to sector average in FY17 to only 14% by FY20.

Our WACC assumptions for the DCF-model are summarized in the exhibit alongside. The cash flow and return profiles generated our model are shown in the exhibits below.

2.5%

3.5%

4.5%

5.5%

6.5%

11.5%

12.5%

13.5%

14.5%

1QFY

13

2QFY

13

3QFY

13

4QFY

13

1QFY

14

2QFY

14

3QFY

14

4QFY

14

1QFY

15

2QFY

15

3QFY

15

4QFY

15

1QFY

16

A&P spends as % of sales Volume growth YoY (%), RHS

WACC assumptions Item Value





Cost of debt (%) 12.0

Debt/Equity ratio (%) 0%

Tax rate (%) 28.0

WACC (%) 13.0

Terminal growth rate (%) 5.0


Hindustan Unilever


Exhibit 7: Cash flow profiles for HUL (` mn)


Exhibit 8: Return profiles for HUL (%)


Exhibit 9: One-year forward P/E bands for HUL


Exhibit 10: One-year forward EV/EBITDA bands for HUL


19,000

39,000

59,000

79,000

99,000

119,000FY

11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

CFO (Rs mn) Free cash flow (Rs mn)

0%

5%

10%

15%

20%

25%

30%

70%

80%

90%

100%

110%

120%

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

ROE (%) EBITDA margin (%), RHSEPS growth (%), RHS Sales growth (%), RHS

22

26

30

34

38

42

46

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

HUL 1-yr fwd P/E 5-yr avg

+1 s.d. -1 s.d.

17

20

23

26

29

32

35

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

HUL 1-yr fwd EV/EBITDA 5-yr avg

+1 s.d. -1 s.d.

Hindustan Unilever


Summary of our key assumptions and estimates Exhibit 11: Key segmental growth assumptions Segment FY15 FY16E FY17E FY18E FY19E FY20E Comments

Soaps Industry Value Growth 6.0% 2.0% 11.5% 11.0% 11.0% 11.0% We expect HUL to grow ahead of the market by

gaining market share through brands such as Lifebuoy and Lux HUL Soaps growth 7.8% 3.1% 15.7% 15.0% 14.9% 14.7%

Detergents Industry Value Growth 9% 2% 12% 11% 11% 11%

Growth to be led by share gain and mix change HUL Detergent growth 9.7% 3.3% 15.3% 14.7% 14.5% 14.4%

HUL Soaps and Detergent growth 8.7% 3.4% 15.4% 14.8% 14.7% 14.6% Oral care Industry Value Growth 10.0% 11.0% 12.0% 12.0% 12.0% 12.0%

Market share loss to Colgate HUL Oral Care growth 7.7% 9.1% 11.0% 11.0% 11.0% 11.0% Skin care Industry Value Growth 11% 13% 16% 16% 16% 16% Growth to be led by share gain driven by new

product launches HUL Skin Care growth 12.0% 13.9% 18.2% 18.1% 18.1% 18.0% Hair care

Industry Value Growth 9% 10% 13% 13% 13% 13%

HUL will grow ahead of market by gaining share through wider distribution outreach

HUL Hair Care growth 12.2% 13.1% 17.3% 17.2% 17.2% 17.1%

Total PP growth (%) 10.9% 12.0% 14.9% 15.0% 15.1% 15.2%

Tea

Industry Value Growth 10% 10% 12% 12% 12% 12% Red Label will drive market share gains

HUL Tea growth 9.1% 12.4% 17.1% 16.9% 16.6% 16.4%

Coffee

Industry Value Growth 10% 11% 13% 13% 13% 13% Will gain market share on the back of success of Bru Gold HUL Coffee growth 11.7% 10.0% 14.0% 14.0% 14.0% 14.0%

HUL Beverages growth 9.7% 11.9% 16.4% 16.2% 16.1% 15.9% Ice Creams Industry Value Growth 15% 11% 15% 15% 15% 15% New product launches such as Magnum will drive

share gains HUL Ice Cream growth 21.2% 20.0% 27.1% 26.0% 25.1% 24.3% Branded Staples Industry Value Growth 7.0% 5.0% 9.0% 9.0% 9.0% 9.0% Forecast moderate penetration-led growth in

branded staples of 9% HUL Branded Staples growth 7.0% 5.0% 9.0% 9.0% 9.0% 9.0% Culinary Products 8,752 9,715 11,464 13,527 15,962 18,835 Industry Value Growth 18.0% 11.0% 18.0% 18.0% 18.0% 18.0% Expect the culinary foods portfolio to deliver 18%

CAGR over FY17-20 led by strong growth in the sauces and soups segment HUL Culinary Products growth 15.4% 11.0% 18.0% 18.0% 18.0% 18.0%

HUL Packaged Foods growth 14.8% 12.1% 18.8% 18.8% 18.8% 18.8% Source: Company, Ambit Capital research

Exhibit 12: Key assumptions and estimates – others (in ̀ mn)

FY15 FY16E FY17E FY18E FY19E FY20E Comments

Profit and loss Net sales 308,056 331,603 382,966 441,354 508,508 585,745

Expect HUL to deliver 14% sales CAGR over FY15-20 Growth (%) 9.9% 7.6% 15.5% 15.2% 15.2% 15.2%

Gross Profit 151,821 168,812 197,832 231,304 270,312 315,762 Premiumisation to drive gross margin gains for HUL

Gross margin (%) 49.3% 50.9% 51.7% 52.4% 53.2% 53.9%

Employee cost (% of sale) 5.1% 5.0% 5.0% 5.0% 5.0% 5.0% Expect employee costs to remain stable

Advertising (% of sale) 12.6% 13.5% 13.2% 13.2% 13.1% 13.1% Expect A&P spends to normalise FY17 onwards

EBITDA 52,082 58,719 70,495 84,995 102,758 122,759 Expect EBITDA margins to expand given above assumptions

EBITDA Margin 16.9% 17.7% 18.4% 19.3% 20.2% 21.0% Consol PAT 37,299 42,342 52,348 64,005 78,299 94,523

Expect PAT to grow at 20% CAGR over FY15-20 Growth (%) 5.8% 12.8% 23.8% 22.4% 22.5% 20.8%

Balance Sheet

Capex 2,785 3,000 3,000 3,000 3,000 3,000 No material capex requirements expect over FY15-20

Working Capital days (62) (62) (62) (62) (62) (62) Expect working capital days to remain stable

Cash flows (` mn)

Operating cash flows 42,162 48,261 62,896 75,637 91,289 109,068 Expect free cash flows to grow strongly given low capex requirements and negative working capital Free cash flows 37,348 45,261 59,896 72,637 88,289 106,068


Hindustan Unilever


Risks to our BUY stance Delay in implementation of the DBT scheme: Delay in implementation of DBT would fail to spur an increase in rural spends and hence lead to lower-than-expected sales and profit growth.

Lower-than-expected household spends on FMCG from DBT income: Lesser-than-expected spends on FMCG products from DBT income by rural households would lead to lower sales for rural areas.

Catalysts Uptick in rural consumer spends over FY17 and urban demand by 1HFY17: With ~40% of HUL’s income being derived from rural areas, an uptick in rural consumer spending in FY17 is the key catalyst for HUL. An uptick in urban demand by 1HFY17 should also be a positive catalyst for the stock.

Decrease in competitive intensity from 4QFY16: As the benefit of lower input costs reduces from 4QFY16, a decrease in competitive intensity would be a positive catalyst.

Timely and proper rollout of DBT scheme: Rolling out of the DBT scheme from FY17 onwards in a correct manner where the beneficiary household actually receives the allocated quantum of money in a timely manner will be the key catalyst for rural demand which will drive HUL’s sales growth.

Ambit vs consensus Exhibit 13: Our FY16/17/18 estimates factor in an increase in A&P spends to support new launches (in ̀ mn)

Ambit Consensus Divergence from consensus Comments

FY16E

Net Sales (` mn) 324,934 329,982 -2% In line with consensus

EBITDA (` mn) 58,719 59,167 -1% In line with consensus

EPS (`/share) 19.2 20.3 -5% Consensus yet to factor in higher tax rate for FY16

FY17E

Net Sales (` mn) 375,897 369,657 2% Slightly ahead as DBT benefits start accruing

EBITDA (` mn) 70,495 67,414 5% Expect DBT led sales growth to lead to margin expansion

EPS (`/share) 23.8 23.1 3% EBITDA growth flows through to EPS

FY18E

Net Sales (` mn) 433,861 414,303 5% Ahead of consensus due to benefits of DBT implementation

EBITDA (` mn) 84,995 77,196 10% Expect DBT-led sales growth to lead to margin expansion

EPS (`/share) 29.1 26.4 10% EBITDA growth flows through to EPS


Explanation of our forensic accounting scores Exhibit 14: Explanation for our forensic accounting scores

Segment Score Comments

Accounting GREEN In the past, HUL has reported excellent cash conversion, efficient management of working capital, and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability AMBER Whilst HUL’s revenue growth has been fairly stable, the company’s bottom-line has seen some volatility due to recent input cost volatility.

Earnings momentum RED In the past six months, consensus estimates have been downgraded by >6% for FY16-17.


Hindustan Unilever


Balance Sheet (` mn)

Year to March FY14 FY15 FY16E FY17E FY18E

Shareholders' equity 2,163 2,164 2,164 2,164 2,164

Reserves & surpluses 30,608 35,084 41,201 52,139 64,466

Total networth 32,771 37,248 43,364 54,302 66,629

Minority Interest - - - - -

Debt - - - - -

Deferred tax liability (1,617) (1,960) (1,960) (1,960) (1,960)

Total liabilities 31,153 35,288 41,405 52,343 64,670

Gross block 44,429 47,214 50,214 53,214 56,214

Net block 24,221 24,575 24,856 25,105 25,324

CWIP 3,198 4,790 4,790 4,790 4,790

Investments 30,941 32,779 42,779 54,779 69,779

Cash & equivalents 22,210 25,376 25,204 32,602 39,610

Debtors 8,164 7,829 8,428 9,733 11,217

Inventory 27,475 26,027 28,016 32,356 37,289

Loans & advances 11,432 12,407 13,356 15,424 17,776

Other current assets 726 597 643 742 856

Total current assets 70,007 72,236 75,646 90,857 106,747

Current liabilities 69,257 63,671 68,537 79,153 91,221

Provisions 27,957 35,422 38,130 44,036 50,750

Total current liabilities 97,214 99,093 106,667 123,189 141,971

Net current assets (27,206) (26,857) (31,021) (32,332) (35,224)

Total assets 31,153 35,288 41,405 52,343 64,670


Income statement (` mn)


Operating income 280,191 308,056 331,603 382,966 441,354

% growth 8.6% 9.9% 7.6% 15.5% 15.2%

Operating expenditure 235,439 255,974 272,884 312,470 356,359

EBITDA 44,753 52,082 58,719 70,495 84,995

% growth 11.8% 16.4% 12.7% 20.1% 20.6%

Depreciation 2,606 2,867 2,719 2,751 2,781

EBIT 42,147 49,216 56,000 67,744 82,214

Interest expenditure 360 168 120 210 210

Non-operating income 6,210 6,184 5,132 8,107 10,579

Adjusted PBT 47,997 55,231 61,012 75,642 92,583

Tax 13,180 18,410 19,463 24,205 29,626

Adjusted PAT/ Net profit 34,817 36,821 41,549 51,436 62,956

% growth 9.7% 5.8% 12.8% 23.8% 22.4%

Extraordinaries 1,571 (312) - - -

Reported PAT / Net profit 33,247 37,133 41,549 51,436 62,956


Share of associates 781 478 793 912 1,048 Adjusted Consolidated net profit 34,027 37,611 42,342 52,348 64,005


Hindustan Unilever


Cash Flow statement (` mn)


EBIT 48,357 55,399 61,132 75,852 92,793

Depreciation 2,606 2,867 2,719 2,751 2,781

Others 70 (511) (120) (210) (210)

Tax (13,180) (18,410) (19,463) (24,205) (29,626) (Incr) / decr in net working capital 8,638 2,816 3,992 8,709 9,900

Cash flow from operations 46,491 42,162 48,261 62,896 75,637

Capex (4,939) (4,814) (3,000) (3,000) (3,000)

(Incr) / decr in investments (7,635) (1,838) (10,000) (12,000) (15,000)

Others - - - - - Cash flow from investments (12,573) (6,652) (13,000) (15,000) (18,000)

Net borrowings - - - - -

Issuance of equity - - - - -

Interest paid (360) (168) (120) (210) (210)

Dividend paid (32,730) (37,991) (37,991) (43,057) (53,188)

Others 4,303 5,815 2,678 2,768 2,768

Cash flow from financing (28,787) (32,344) (35,433) (40,498) (50,629)

Net change in cash 5,131 3,166 (172) 7,398 7,008

Closing cash balance 22,210 25,376 25,204 32,602 39,610

Free cash flow 41,552 37,348 45,261 59,896 72,637


Ratio Analysis


Gross margin (%) 48.8% 49.3% 50.9% 51.7% 52.4%

EBITDA margin (%) 16.0% 16.9% 17.7% 18.4% 19.3%

EBIT margin (%) 17.3% 18.0% 18.4% 19.8% 21.0%

Net profit margin (%) 12.7% 12.1% 12.8% 13.7% 14.5%

Dividend payout ratio (%) 84.6% 88.0% 91.4% 83.7% 84.5%

Net debt: equity (x) (1.4) (1.4) (1.4) (1.5) (1.5)

Working capital turnover (x) (5.7) (5.9) (5.9) (5.9) (5.9)

Gross block turnover (x) 6.3 6.5 6.6 7.2 7.9

RoCE (%) 117.9% 105.5% 103.3% 105.6% 104.4%

RoE (%) 117.0% 105.2% 103.1% 105.3% 104.1%


Valuation Parameter


EPS (`) 16.5 17.2 19.6 24.2 29.6

Diluted EPS (`) 16.5 17.2 19.6 24.2 29.6

Book value per share (`) 15.2 17.2 20.1 25.1 30.8

Dividend per share (`) 13.0 15.0 15.0 17.0 21.0

P/E (x) 48.7 46.5 41.0 33.1 27.1

P/BV (x) 52.9 46.6 40.0 31.9 26.0

EV/EBITDA (x) 38.3 32.8 29.1 24.2 19.9

Price/Sales (x) 6.2 5.6 5.2 4.5 3.9


Hindustan Unilever




COMPANY INSIGHT MRCO IN EQUITY November 03, 2015

Relentless deepening of “moats”

Marico continues to evolve around its five key thrust areas: (1) product innovation in the non-Saffola/Parachute coconut oil portfolio; (2) direct distribution expansion; (3) hire and retain high-quality talent; (4) use of IT and data analytics; and (5) cost management. With a strong focus on organic growth and capital efficiency, these initiatives are likely to help the firm deliver FY15-20E sales/EPS CAGR of 17%/23%, with RoCE improving to 39% by FY20 (vs 18% in FY15). Hence, Marico deserves to trade in-line with our sector implied FY17E P/E of 31x and at a premium to our implied multiple for peers like Dabur and GCPL. With its share price having fallen by 9% over the past three months and currently trading at a 16% discount to the staples sector average, we change our stance to BUY (TP of `435; 13% upside).

Competitive position: STRONG Changes to this position: POSITIVE Moderate beneficiary of DBT rollout through coconut oil (34% of sales) We do not expect either premium edible oils or value-added hair oils (VAHO) to see any meaningful benefit from the DBT rollout given the discretionary nature of consumer spends on such products. However, we expect higher propensity of consumers to spend incrementally on branded hair oil instead of loose oil (which still accounts for 34% of coconut oil users). Parachute & Nihar coconut oil (34% of Marico’s consolidated sales) will benefit from this switch. VAHO and Saffola to lead future business growth Over FY15-20, we expect domestic revenue CAGR of 17% for Marico, led by its focus on VAHO (~21% of sales) through increased value share and Saffola (~17% of sales) through increased penetration, with 13% CAGR for coconut oil. Focus on non-coconut oil growth in Bangladesh and organic growth in the rest of international business should drive 16% CAGR in FY15-20E in the overseas business as well. As a result, we expect the firm to deliver 17%/23% FY15-20E sales/EPS CAGR. Changes implemented to drive the next leg of growth Over the next five years, the firm aims to consolidate its current product portfolio and leverage on it to innovate and develop new growth drivers. To support this initiative, changes have been made around: (a) shift in control from the promoter-led management team to professionals; (b) management incentive structures giving a greater weightage to long-term growth drivers; and (c) capital deployment focus on organic growth and dividend payouts. Deserves in-line P/E vs sector; turn BUYers (TP of `435; 13% upside) Execution of the next phase of growth should help improve RoCE from 18% in FY15 to 39% in FY20 due to prudent capital allocation towards growing the organic business and increased dividend payout. Our DCF-based TP of `435 (13% upside) implies 31x FY17E P/E, in line with the sector average. We turn BUYers (the share price has declined by 9% over the past three months).

MaricoBUY

Consumer Staples

Recommendation Mcap (bn): `253/US$3.9 6M ADV (mn): `375/US$5.8 CMP: `385 TP (12 mths): `435 Upside (%): 13

Flags Accounting: AMBER Predictability: AMBER Earnings Momentum: RED

Catalysts

Uptick in macro demand across categories in FY17

Market share gains in VAHO and premium edible oils in 2HFY16

Performance (%)


85

100

115

130

145

160

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex Marico



EBITDA (` mn) 7,480 8,701 10,913 13,103 15,790

EBITDA Margin (%) 16.0% 15.2% 16.5% 16.9% 17.4%

Adjusted PAT (` mn) 4,854 5,735 7,419 9,194 11,193

Adjusted EPS (`) 7.5 8.9 11.5 14.3 17.4

RoCE (%) 21.5% 28.7% 32.9% 36.3% 37.5%

P/E (x) 51.2 43.3 33.5 27.0 22.2


Analyst Details

Rakshit Ranjan, CFA +91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA

+91 22 3043 3246

[email protected]



Marico


Domestic FMCG with MNC attributes Whilst understanding the sales or earnings growth potential of a company’s product categories, it is essential to analyse key attributes such as management quality, ability to hire and retain high quality talent, focus on capital allocation and use of technology in the business, as these factors decide the ability of a firm to grow over long periods of time whilst sustaining (or increasing) its ROCE. We believe Marico scores the highest amongst its domestic FMCG peers on all these attributes as discussed below.

Attracts the best talent in the sector Marico has fostered a competitive, professional culture amongst employees that is focused on performance. These practices place Marico at par with its MNC FMCG competitors like HUL and Nestle, making it an employer of choice amongst its domestic FMCG peers.

We spoke to a recruitment consultant about how job-seekers perceived Marico as a place to work for and the response was:

“Amongst the domestic FMCG companies, Marico and Asian Paints are considered in the top tier, whilst Dabur and GCPL are a notch below.”

“Marico has been able to create substantial brand equity, making it the employer of choice among the domestic FMCG peers.”

“Employees of MNC FMCG companies like Mondelez and HUL seek opportunities with domestic companies like Marico, as the company is in a higher growth trajectory which allows its staff to grow at a faster rate as well. This has allowed Marico to attract some of the best talent in the market.”

This, we believe, is one of the biggest intangible assets that helps Marico create and maintain a high-quality middle management team, which is the key ingredient needed across various business functions for the successful evolution of a firm through the different phases of its business cycle.

Incentive structure aligned to long term goals Since 2014, Marico has changed the incentive structure for its top-100 managers. The incentive structure focuses on the longer-term goals of creating capability ahead of growth:

Only 50% of the variable pay is linked to goals like annual sales/ profit targets,

50% of the incentive is linked to long-term value-added objectives such as preparing the product pipeline for the next 2-3 years for a manager in the R&D department, or increasing the number of junior managers groomed to take up leadership roles (HR department).

Capital allocation to increasingly focus on RoCE “Acquisitions had become an escape button for not growing the domestic portfolio. We are changing that. We need to grow organically.” - Mr. Saugata Gupta, MD and CEO, Marico

After a series of large acquisitions like Paras in India and a slew of overseas acquisitions, Marico’s RoCEs halved to 17% in FY13 from 41% in FY08. Over the last 12 months, the management has been communicating their focus on increasing RoCE. This it plans to achieve through the following steps:

50% of the incentive is linked to long-term value-added objectives

Marico


Large-scale M&A transactions unlikely over the next couple of years: The management team has also indicated that Marico does not intend to pursue more big-ticket acquisitions over the next 2-3 years as it would first focus on improving the profitability and realising more synergy benefits from its recent acquisitions. It plans to leverage the existing overseas businesses to enter the neighbouring geographies in an organic manner. Entering into new product categories through the inorganic route would not be the company’s focus area.

Higher dividend payout ratio: As the company does not plan to resort to any big-ticket acquisitions, it plans to increase its dividend payout ratio from current levels of ~30%. Marico’s Chairman, Mr. Harsh Mariwala, acknowledged this in an interview to Forbes India: “There are some other issues like dividend payout which, in our case, was lower than some other FMCG companies as a percentage of profit. We have taken one jump and, maybe, over a period of time, we will take one more.” (Source: http://tinyurl.com/o78t6r5)

As a result of these strategic initiatives, we forecast an increase in ROCE for Marico from 18% in FY15 to 39% in FY20.

Leveraging IT to drive higher sales and improve distributor’s ease of business Marico continues to be at the forefront of using technology to improve ease of business for its distributors. It was one of the first companies to give hand held terminal to its sales representatives in early 2000s. Almost a decade ago the company started tracking secondary sales making it one of the first ones in the industry to do so. Recently the company implemented the completely automated distributor ordering system which has increased the ease of business for its distributors and improved their RoI through increased reduced inventory and higher turns. It has also increased the bandwidth of its sales force to pursue secondary sales instead of primary sales.

Based on anecdotal evidence and our discussions with Dabur and GCPL distributors, Dabur has not been successful in using automated primary ordering at its distributors whilst GCPL is still at the stage of equipping its salesforce with handheld terminals.

As a result, we believe that Marico’s distribution infrastructure is best placed amongst its Indian FMCG peers in scaling up the business and helping it grow ahead of competition.

http://tinyurl.com/o78t6r5)

Marico


Value-added products to drive 17% sales CAGR We expect hair oil to be one of the beneficiary categories due to DBT-induced higher rural spends as rural consumers are expected to shift from loose to branded hair oil. Marico is expected to benefit from an uptick in sales of coconut oil, as: (a) 35-40% of the coconut oil market is still dominated by loose unbranded oil purchases, and (b) Marico is the market leader in coconut oil with ~57% volume share through brands Parachute and Nihar.

Overall, we expect Marico to deliver 17% consolidated sales CAGR over FY15-20E led by 17% CAGR in its domestic portfolio and 16% CAGR in its international business. Growth in the domestic portfolio will be led by Value Added Hair Oils (VAHO) which is likely to record 21% sales CAGR over FY15-20E and Saffola edible oil is likely to record 17% CAGR over the same period. Coconut oil (Parachute + Nihar) is expected to report 13% CAGR over FY15-20E led by 7-8% volume growth.

International business growth is likely to be more organic in nature and will be led by 16%/17%/17% CAGR in the Bangladesh/MENA/Vietnam business over FY15-20E. Entry into new geographies like Nepal, Pakistan, Cambodia, Myanmar, Sri Lanka and North Africa will be through the organic route and is likely to contribute >`1bn sales by FY17E (1.5% of the firm’s overall revenues).

Exhibit 1: Marico’s sales growth across categories over FY15-20

Category FY15-20 sales CAGR

Market share growth Growth drivers

Coconut oil (34% of FY16E consolidated sales)

~13% value growth comprising 7-8% volume growth

~410bps market share increase over FY15-20

Conversion of users from loose coconut oil to branded coconut oil, which happens only as long as branded oil is priced lower than the 150% premium to loose oil. As a result, Marico has to take price corrections when prices of copra correct.

Increasing rural penetration

Strong brand equity of Parachute should help it grow ahead of the market

Value Added Hair Oil (VAHO, 19% of FY16E consolidated sales)


~400bps market share increase over FY15-20

Drive value share ahead of volume share by launching new premium hair oils (using modern ingredients like Moroccan and Argan oil) Focus on 'consumer need based' positioning instead of an 'ingredient-based positioning Capture attrition of coconut oil users to VAHO by using Parachute Jasmine as the main brand in South India

Saffola edible oils (~15% of FY16E consolidated sales)


~500bps market share gain over FY15-20

Increasing penetration in SEC A/B households Unique positioning as a healthy lifestyle brand focused on preventive heart care has enabled it to gain market share despite stiff competition

Youth portfolio (~3% of FY16E consolidated sales)

~20% value growth

~100bps market share gain in Hair Gels/Creams and Serums; Flat market share in Deos over FY15-19

Focus on increasing leadership in the Hair Gels/Creams and Serums categories Looking to only sustain market share in deodorants

Increasing penetration and focus on the chemist/cosmetics channel is likely to drive sales in this category

Bangladesh (~10% of consolidated sales) ~16% value growth

Focus on deriving ~80% of growth through the non-coconut oil portfolio by introducing new products from the Indian portfolio Increase consumption of coconut oil users to drive modest growth in this category Use Bangladesh as a hub to expand into adjacent countries such as Nepal, Pakistan, Myanmar and Sri Lanka

Middle East and Egypt (~4% of consolidated sales)

~17% value growth

Grow the hair creams/gels market and establish the VAHO portfolio

Gain lost market share in the Middle East

Use MENA as a base to enter adjacent countries in the North Africa region

Vietnam (~6% of consolidated sales) ~17% value growth

Grow market in male shampoos/shower gels by increasing penetration

Gain share in male deos

Extend into other South East Asian countries New geographies (Nepal, Pakistan, Cambodia, Myanmar, Sri Lanka, North Africa) These countries are likely to contribute >`1bn sales by FY17


Marico


Marico is not a commodity play Marico has been taking steps to increase the growth of its value-added products through brand creation and new category addition through the following measures:

Over the last 15 years Marico has created four `2.0bn+ brands in the VAHO segment – Nihar Shanti Amla, Parachute Advansed Jasmine, Nihar Naturals and Hair & Care through the organic and inorganic route.

Having attained the highest volume share in Value Added Hair Oil (VAHO), Marico now plans to increase value share gains ahead of volume share by upgrading its portfolio through premium launches (such as the recently launched prototypes - Parachute Aromatherapy, Parachute Advansed Aloe Vera Enriched Coconut Hair Oil) and new region-specific launches such as the recently launched Nihar Naturals Sarson Kesh Tel.

Organic growth in Bangladesh: From FY16 onwards, the company plans to achieve more than 80% growth at Marico Bangladesh through the non-coconut oil portfolio.

It plans to expand the youth portfolio by focusing on the high-margin categories of hair gels and serums. It re-launched hair gels in 4QFY15 and innovating in serums through premium launches such as the new Livon Moroccan Silk Serum.

As a result of these measures, we expect the firm’s product mix to shift more towards value added product segments, as shown in the chart below.

Exhibit 2: Proportion of non-coconut oil products should increase over the longer term


36.1% 35.4% 34.2% 33.0% 31.9% 30.8%

17.9% 18.7% 19.6% 20.4% 21.2% 21.9%

15.0% 14.6% 14.8% 15.1% 15.3% 15.5%

31.0% 31.3% 31.4% 31.5% 31.7% 31.8%

0%

25%

50%

75%

100%

FY15 FY16E FY17E FY18E FY19E FY20E

Others

Premiumedible oil

VAHO

Coconut oil

Marico is driving innovation to reduce dependence on the coconut oil portfolio

Marico


DBT to result in 6-10% earnings upgrade over FY17-20 We upgrade our FY17-20 sales/EBIT estimates by 6-10% in order to factor in higher rural spends due to the DBT-induced rural income boost. We expect FY17/18/19/20 to see 25%/50%/75%/100% of transition of food subsidy onto the DBT platform. Due to the cumulative nature of these benefits, the estimate upgrades are higher over FY18-20 vs the earlier years, as shown in the exhibit below.

Exhibit 3: The impact of DBT on our free cash flow forecasts


Change in estimates Exhibit 4: Change in estimates for Marico over FY16-18 ( ̀ mn)

New Old Ch%


TP 435 385 13.0%

Sales 66,046 77,426 90,627 66,046 76,484 88,229 0.0% 1.2% 2.7%

EBITDA 10,913 13,103 15,790 10,913 12,867 15,284 0.0% 1.8% 3.3%

EBITDA margin (%) 16.5% 16.9% 17.4% 16.5% 16.8% 17.3% 0 10 10

PBT 10,610 13,111 16,153 10,610 12,897 15,720 0.0% 1.7% 2.8%

PAT 7,419 9,194 11,193 7,419 9,042 10,889 0.0% 1.7% 2.8%

EPS 11.5 14.3 17.4 11.5 14.0 16.9 0.0% 1.7% 2.8%


0%

1%

2%

3%

4%

7,500

9,500

11,500

13,500

15,500

FY16E FY17E FY18E FY19E FY20E

Old DCF (Rs. Mn) DCF factoring in DBT benefit (Rs. Mn) % increase (RHS)

Marico


Deserves to trade in line with sector; turn BUYers Following the recent price correction of 9% over the last 3 months, Marico trades at a 20-25% discount to sector valuations. The stock has traditionally also traded at a ~20% discount to sector valuations due to investor concerns about the company’s fortunes being largely dictated by movement in copra prices. However, the company has been focusing on growing its non-coconut oil portfolio which is expected to result in coconut oil sales proportion decreasing from 35% of total sales in FY15 to 31% by FY20. Also, the company has been focusing on: (a) Hiring and retaining best-quality talent, (b) Aligning employee incentive pay to long-term goals, (c) RoCE during capital deployment, and (d) Leveraging technology to drive higher sales. As a result, we believe the company deserves to trade in line with the sector instead of the current 20% discount. Our DCF-based TP of `435 (13% upside) implies FY17E P/E of 31x, in line with the sector average of 31x.

Our WACC assumptions for the DCF-model are summarised in the exhibit alongside. The cash flow and return profiles generated our model are shown in the exhibits below.

Exhibit 5: Cash flow profiles for Marico (` mn)

Source: Ambit Capital research; Note: FCF and CFO for FY14 are distorted due to the demerger of Kaya Ltd.

Exhibit 6: Return profiles for Marico (%)

Source: Ambit Capital research; Note: Sales and EPS growth for FY14 is distorted due to the demerger of Kaya Ltd.

Exhibit 7: One-year forward P/E bands for Marico


Exhibit 8: One-year forward EV/EBITDA bands for Marico


(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

CFO (Rs mn) Free Cash Flow (Rs mn)

-5%

0%

5%

10%

15%

20%

25%

30%

35%

20%

25%

30%

35%

40%

45%

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

ROE (LHS) EBITDA Margin (RHS)

EPS Growth (RHS) YoY Growth in sales (RHS)

20

25

30

35

40

45

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

MRCO 1-yr fwd P/E 5-yr avg+1 s.d. -1 s.d.

14

17

20

23

26

29

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

MRCO 1-yr fwd EV/EBITDA 5-yr avg+1 s.d. -1 s.d.








Tax rate (%) 28.0

WACC (%) 13.0



Marico


Summary of our key assumptions and estimates Exhibit 9: Key estimates and assumptions (` mn)


Profit and loss Domestic revenues 45,006 51,346 60,345 70,786 82,994 97,290 Expect growth to be driven by VAHO, Saffola and youth

portfolio Growth (%) 28.5% 14.1% 17.5% 17.3% 17.2% 17.2%

International revenues 12,840 14,701 17,081 19,841 23,006 26,688 Growth would be driven by Bangladesh, Egypt and Vietnam Growth (%) 9.9% 14.5% 16.2% 16.2% 16.0% 16.0%

Total revenues 57,330 66,046 77,426 90,627 105,999 123,978 Growth (%) 22.3% 15.2% 17.2% 17.0% 17.0% 17.0%

Gross Profit 26,139 32,029 37,857 44,674 52,676 62,106 Higher proportion of value added products such as VAHO and personal products should drive margin expansion Gross margin (%) 45.6% 48.5% 48.9% 49.3% 49.7% 50.1%

Employee cost (% of sale) 5.7% 5.7% 5.7% 5.7% 5.7% 5.7% Expect employee expenses to remain stable

Advertising (% of sale) 11.3% 12.2% 12.0% 12.0% 12.0% 12.0% Do not expect material savings in A&P spends as the company would focus on new product launches

Carriage & freight (% of sale) 3.8% 3.8% 3.8% 3.8% 3.8% 3.8% Expect carriage and freight expenses to remain stable

Other expenses (% of sale) 9.6% 10.3% 10.5% 10.4% 10.4% 10.4% Expect other expenses to remain stable

EBITDA 8,701 10,913 13,103 15,790 18,893 22,593 Expect improvement in EBITDA margins led by the above changes EBITDA Margin 15.2% 16.5% 16.9% 17.4% 17.8% 18.2%

PAT 5,735 7,419 9,194 11,193 13,697 16,682 Expect PAT CAGR of 24% over FY15-20

Growth (%) 10.0% 11.2% 11.9% 12.4% 12.9% 13.5%

Balance Sheet Capex 364 1,000 1,100 1,100 1,100 1,100 No material capex requirements over FY15-19

Working Capital days 39 30 30 30 30 30 Expect working capital days to remain stable

Cash flows (̀ mn) Operating cash flows 3,441 9,037 9,207 11,087 13,437 16,228 Strong growth in free cash flows as capex requirements

are low Free cash flows 3,077 8,037 8,107 9,987 12,337 15,128


Risks to our BUY stance Weaker-than-expected rural demand uptick: A delayed or lesser-than-

expected uptick in rural demand is one of the key risks to our stance.

Continued tepid volume growth in Saffola and international portfolio: If Saffola continues to deliver <5% YoY volume growth over the next 12 months and international business also fails to recover during this period, then this could be a negative catalyst for the stock.

Catalysts Strength in its VAHO and Saffola portfolio: Marico’s performance in its key

product segments, VAHO and Saffola, will be keenly followed. Also, a sharper-than-expected deceleration in Coconut oil would be detrimental to the growth prospects.

Turnaround in its international portfolio: Better predictability of topline and stability of margins at its international business (~20% of total sales) are likely in the longer term.

Further increase in dividend payout ratio: Marico is focused on improving its RoCEs and it could increase its dividend payout ratio. A meaningfully high dividend payout ratio could lead to further re-rating for the stock.

Marico


Ambit vs consensus Exhibit 10: Marico - Ambit vs Consensus (` mn)

Ambit Consensus Diff%


Sales 66,046 77,426 90,627 64,528 74,343 84,564 2.4% 4.1% 7.2%

EBITDA 10,913 13,103 15,790 10,666 12,478 14,382 2.3% 5.0% 9.8%

EBITDA margin (%) 16.5% 16.9% 17.4% 16.5% 16.8% 17.0% (1) 14 42

PBT 10,610 13,111 16,153 10,313 12,265 14,366 2.9% 6.9% 12.4%

PAT 7,419 9,194 11,193 7,149 8,499 9,994 3.8% 8.2% 12.0%


Explanation of our forensic accounting scores Exhibit 11: Explanation for our forensic accounting scores on the first page


Accounting AMBER In the past, Marico has reported strong cash conversion, effective management of working capital and low levels of loans and advances, but it still ranks lower than the overall FMCG average and runs the risk of contingent liabilities not working in its favour.

Predictability AMBER Marico is strongly influenced by commodity price volatility. Whilst the company has historically reported strong volume growth, certain segments like Saffola and its international portfolio have seen erratic growth trends in recent quarters.

Earnings momentum RED In the last six months, there have been significant downgrades in consensus FY16/17 earnings estimates.


Marico




Shareholders' equity 645 645 645 645 645


Total networth 13,606 18,248 22,157 26,581 32,071

Minority Interest 358 137 251 365 479

Debt 5,259 3,342 1,342 - -

Deferred tax liability 96 79 79 79 79


Gross block 9,634 9,841 10,841 11,941 13,041

Net block 6,334 5,868 6,063 6,328 6,564

CWIP 44 30 30 30 30

Goodwill 2,543 4,892 4,892 4,892 4,892

Investments 3,105 2,838 2,838 2,838 2,838


Debtors 2,232 1,768 3,257 3,818 4,469

Inventory 7,962 9,947 10,857 12,728 14,898

Loans & advances 1,474 2,298 2,171 2,546 2,980

Other current assets 1,892 1,564 2,714 3,182 3,724



Provisions 857 1,040 1,809 2,121 2,483


Net current assets 7,294 8,177 10,006 12,936 18,306

Total assets 19,319 21,805 23,828 27,025 32,630





% growth 2.0% 22.3% 15.2% 17.2% 17.0%


EBITDA 7,480 8,701 10,913 13,103 15,790

% growth 19.5% 16.3% 25.4% 20.1% 20.5%

Depreciation 769 843 805 834 865

EBIT 6,711 7,857 10,108 12,269 14,926

Interest expenditure 345 230 125 36 -

Non-operating income 579 589 627 877 1,228

Adjusted PBT 6,946 8,217 10,610 13,111 16,153

Tax 1,905 2,368 3,077 3,802 4,846


% growth 35.3% 16.0% 28.8% 23.6% 21.5%

Extra-ordinary income - - - - -



Share of associates - - - - -

Adjusted Consolidated net profit 4,854 5,735 7,419 9,194 11,193


Marico




EBIT 7,290 8,446 10,735 13,146 16,153

Depreciation 769 843 805 834 865

Others (487) (583) (125) (36) -

Tax (1,905) (2,368) (3,077) (3,802) (4,846)

(Incr) / decr in net working capital 2,538 (2,898) 699 (935) (1,085)


Capex 7,078 (364) (1,000) (1,100) (1,100)

(Incr) / decr in investments (176) (2,082) - - -

Others - - - - -

Cash flow from investments 6,902 (2,446) (1,000) (1,100) (1,100)

Net borrowings (2,648) (1,917) (2,000) (1,342) -

Interest paid (345) (230) (125) (36) -

Dividend paid (2,632) (1,750) (3,028) (4,288) (5,220)

Others (43) 886 (357) (446) (482)


Net change in cash 9,440 (2,015) 2,528 1,996 4,284


Free cash flow 15,284 3,077 8,037 8,107 9,987


Ratio Analysis


Gross margin (%) 48.8% 45.6% 48.5% 48.9% 49.3%

EBITDA margin (%) 16.0% 15.2% 16.5% 16.9% 17.4%

EBIT margin (%) 15.6% 14.7% 16.3% 17.0% 17.8%



Net debt: equity (x) 0.1 0.1 (0.1) (0.2) (0.3)

Working capital turnover (x) 14.5 9.4 12.2 12.2 12.2


RoCE (%) 21.5% 28.7% 32.9% 36.3% 37.5%

RoE (%) 29.0% 36.0% 36.7% 37.7% 38.2%


Valuation Parameter


EPS (`) 7.5 8.9 11.5 14.3 17.4

Diluted EPS (`) 7.5 8.9 11.5 14.3 17.4



P/E (x) 51.2 43.3 33.5 27.0 22.2

P/BV (x) 17.4 13.0 10.7 8.9 7.4

EV/EBITDA (x) 33.4 28.7 22.5 18.4 15.0

Price/Sales (x) 5.3 4.3 3.8 3.2 2.7


Marico




COMPANY INSIGHT CLGT IN EQUITY November 03, 2015

Rural secure, urban a challenge

Colgate is likely to report 15% revenue CAGR over FY15-20E, as it is likely to be one of the biggest beneficiaries of DBT. Whilst we expect market share gain of 450bps in its rural portfolio over FY15-18E, we expect market share loss in its urban portfolio due to: (a) weak presence in the chemist channel, leading to loss of share to GSK’s Sensodyne; and (b) consumer preference for need-based toothpastes, resulting in loss of share to Dabur/Patanjali. Weak category premiumisation trends will add to the moderation in urban volume growth from penetration saturation. Our DCF-based valuation implies FY17E P/E of 33x. We reiterate SELL.

Competitive position: STRONG Changes to this position: POSITIVE Colgate best placed to benefit from increased rural spends on oral care Oral care is one of the highest utility categories in staples and hence it will be one of the biggest beneficiaries of DBT. Colgate is best placed to capitalise on this opportunity because: (a) rural toothpaste penetration is only 74%, with per capita consumption of only 85gms (vs 285gms in urban); (b) it has the widest distribution and strong brand equity due to initiatives like mobile van distribution in rural areas and awareness programmes involving doctors and school children; and (c) competitive intensity is weak for its entry-level toothpaste, Colgate Dental Cream. Macro headwinds in urban around premiumisation and penetration With 92% urban penetration and per-capita consumption of 280gms (~10% higher than the average for China and the Philippines), we expect only 4% volume CAGR for the urban toothpaste industry over FY15-20E. Toothpaste premiumisation in India will be a weak growth driver vs other personal care categories. Unlike the aspiration/celebrity-driven trends in other categories, premiumisation in oral care has largely been driven by utility, like herbal (Dabur Red, Meswak, Patanjali), habit-based (Active Salt), freshness-based (Maxfresh) or therapeutic products (Sensitive). Hence, we expect Colgate Total’s historical failure to drive premiumisation will continue in the future. Colgate will continue to lose market share in urban areas We expect Colgate to lose market share in urban areas to: (a) GSK’s Sensodyne (given its stronger presence in the chemist channel, which accounts for over 50% of the overall sensitive segment’s sales); and (b) Dabur’s herbal offerings like Dabur Red and Meswak (given Dabur’s strong herbal brand equity). Colgate cannot replicate these strengths over a short period of time. Headwinds from increased competition; SELL (~10% downside) We expect 15% sales CAGR over FY15-20E. However, increased competitive intensity from Dabur and HUL and risk of renewed aggression/price cuts from P&G (similar to shampoos) will result in elevated A&P spends for Colgate. Hence, this will limit EPS CAGR over FY15-20E to 18%. With the stock trading at a ~10% premium to peers like HUL on FY17 P/E, we reiterate SELL.

Colgate PalmoliveSELL

Consumer Staples

Recommendation Mcap (bn): `260/US$4.0 6M ADV (mn): `430/US$6.6 CMP: `955 TP (12 mths): `870 Downside (%): 9

Flags Accounting: GREEN Predictability: RED Earnings Momentum: RED

Catalysts

Market share loss in urban market to Dabur and Patanjali over the next few quarters

Weak earnings growth in 4QFY16 due to the base effect of input cost tailwinds

Performance (%)


85

95

105 115

125 135

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex Colgate



EBITDA (` mn) 6,640 8,222 9,010 10,869 12,942

EBITDA Margin (%) 18.6% 20.6% 21.4% 22.3% 22.9%

Adjusted PAT (` mn) 4,111 5,590 5,964 7,191 8,664

Adjusted EPS (`) 17.5 20.6 21.9 26.4 31.9

RoE (%) 87.3% 81.6% 69.9% 70.0% 70.7%

P/E (x) 54.6 46.5 43.6 36.1 30.0


Analyst Details

Rakshit Ranjan, CFA +91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA

+91 22 3043 3246

[email protected]



Colgate Palmolive


Best placed to benefit from macro demand revival in rural areas Toothpaste sales contribute to ~90% of Colgate’s total sales, with rural contributing to ~32%/28% volume/value to the toothpaste portfolio. Colgate Dental Cream (CDC) and Cibaca are the two key brands for the company in rural areas, with a total volume share of ~65% in the rural toothpaste market. As a result, we expect Colgate to be one of the key beneficiaries of DBT-induced higher rural spends.

Rural opportunity from increase in frequency of toothpaste consumption

Although rural toothpaste penetration has almost doubled in the last ten years from 38% in 2005 to 74% in 2014, rural per capita toothpaste consumption in India is only ~85 gms vs urban India’s per capita consumption of ~280 gms and ~30% of China’s per capita consumption.

Exhibit 1: Rural toothpaste penetration has almost doubled in the last decade….


Exhibit 2: …but per capita consumption still has room to grow


As highlighted in the table below, driven by rising per capita consumption (frequency of consumption) and a gradual increase in penetration, we expect rural toothpaste volumes to expand at ~8% CAGR over FY15-20.

Exhibit 3: Rural toothpaste volumes are likely to report 8% CAGR over FY15-20

FY15 FY16E FY17E FY18E FY19E FY20E

Rural population (mn) 875 888 901 915 929 943

% YoY 1.5% 1.5% 1.5% 1.5% 1.5%

Rural toothpaste penetration (%) 74% 76% 79% 81% 84% 86%

ch% 2.0% 2.5% 2.5% 2.5% 2.5%

Rural toothpaste users (mn) 648 675 708 741 775 811

YoY% 4.2% 4.8% 4.7% 4.6% 4.5%

per capita consumption (gms) 85 88 91 94 97 100

YoY% 3.0% 3.5% 3.5% 3.5% 3.5%

Toothpaste consumed (tons) 55,038 59,094 64,122 69,507 75,272 81,443

YoY% 7.4% 8.5% 8.4% 8.3% 8.2%


3846

61 63

73 747580

90 91 91 92

30

40

50

60

70

80

90

100

2005 2008 2011 2012 2013 2014

Rural (%) Urban (%)

259 264

85

50

100

150

200

250

300

Philipines China India - rural

Per capita consumption (gms)

Colgate Palmolive


Colgate will gain share in rural markets through superior distribution and brand equity Based on our estimates, Colgate currently has ~65% volume share in the rural toothpaste market. We believe that Colgate (led by CDC and not Cibaca) can continue to gain share and grow ahead of the market due to the following reasons:

Widest oral care rural distribution: Colgate has a total distribution outreach of ~4.8mn outlets, which represents ~99% of the possible outreach.

Exhibit 4: Colgate’s rural distribution efforts have increased substantially since 2012


Strong brand equity driven by various oral care awareness initiatives: Colgate conducts various oral care awareness initiatives such as ‘Bright Smiles, Bright Futures’ targeted towards making children aware of oral hygiene. Every October and November, the company has been conducting ‘Oral Health Month’. As part of this initiative, the company reaches out to different towns and conducts free dental check-ups for people across different age groups. Below-the-line activities help Colgate increase its recall.

Exhibit 5: Towns covered and dentist participation has been increasing in the Oral Health Month


Based on a combination of 11% volume growth per annum and ~750bps market share gain by Colgate over FY15-20, we expect the company to increase its rural revenues at ~18% CAGR over the same period.

340

801

951

300

400

500

600

700

800

900

1000

2012 2013 2014

Number of mobile vans in rural areas

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

0

200

400

600

800

1000

1200

1400

2005 2007 2010 2012 2013 2014

Towns Covered (LHS) Dentist participation (RHS)

Colgate has the widest distribution, covering ~99% of the possible oral care outreach

Colgate Palmolive


Likely to lag behind its competitors in premiumisation trends Urban India’s toothpaste penetration is already at 92%, with per capita toothpaste consumption at ~280 gms, similar to the average for other emerging markets like China (264 gms) and the Philippines (259 gms). As a result, we believe that the urban toothpaste industry’s revenue growth in the future is likely to be driven mainly by premiumisation, rather than by an increase in either penetration or frequency of consumption.

Premiumisation in toothpaste is unlike other personal care categories

However, in toothpastes, premiumisation trends in India have largely been driven by the utility or functional aspect of upgrade to a premium product. Few observations which can be made from historical trends on this subject include:

With the launch of Colgate Total in 1993, Colgate was one of the first oral care companies to introduce a multi-benefit toothpaste. Over the years, the company has tried to premiumise consumers from the CDC (`42/100gm), a basic dental cream, to Colgate Total (̀ 81/100gm). However, even after two decades since its launch, Colgate Total contributes to <5% of total sales for Colgate.

Pepsodent (HUL) has also faced difficulty in premiumising the base variant (Germi Check) to multi-benefit variant Pepsodent Expert over the past two decades.

Lower-priced need-based toothpastes such as Freshness toothpastes (~`60/100gm), Ayurveda toothpastes (~`40/100gm) have done well.

Premium need-based toothpastes such as Whitening toothpastes (~`90/100gm) and Sensitive toothpastes (`125/100gm) have also done well.

Successful marketing initiatives of need-based toothpastes in India have included adverts which create consumer awareness about specialist needs such as sensitivity, whitening, freshness, natural and gum problems, rather than adverts around celebrities or superior packaging.

Colgate Sensitive unlikely to beat GSK’s Sensodyne in the sensitive segment GSK launched Sensodyne in 2011, by focusing on the specific need of curing the problem of sensitive teeth. By 2013, Sensodyne became a `1bn brand and is currently estimated to be a `3bn brand, i.e. >60% market share in the overall sensitive category. This rapid and successful growth has been driven by the following factors:

GSK made significant A&P spends to increase consumer awareness about tooth and gum sensitivity and focused on increasing doctor advocacy for Sensodyne by reaching out to >15K dentists.

GSK focused on the chemist channel: Being a premium, specific need-based toothpaste with high dentist advocacy, the chemist is an important distribution channel (~50% of sensitive toothpaste sales happen through this channel) for the Sensitive toothpaste category.

Until the launch of GSK Sensodyne, Colgate was trying to drive premiumisation by trying to move a CDC user to Colgate Total. Based on the initial success of GSK Sensodyne, Colgate Sensitive Pro-Relief (CSPR) was launched in July 2013. However, CSPR has grown slower than Sensodyne due to Sensodyne’s strong presence in the chemist channel and GSK’s superior pharma imagery. Since these are initiatives which CANNOT be implemented in a short space of time, we expect Colgate to continue to lose market share in this segment for at least three years.

Toothpaste premiumisation has not followed the trend in other personal care categories

Pharma imagery and strong presence in chemist channel are GSK’s sustainable competitive advantages vs Colgate

Colgate Palmolive


Colgate losing share to Dabur and Patanjali in Ayurveda-based toothpastes Whilst Colgate has had a herbal variant since 2000 (called Colgate Herbal), the company never focused on driving sales of this variant. Unlike Dabur’s and Patanjali’s Ayurveda positioning, Colgate’s MNC brand image acts as a major impediment in driving sales of its herbal toothpaste. Whilst we believe the herbal segment will continue to deliver 12-14% CAGR in value terms (implying 6-7% volume CAGR) over the next three years, Colgate’s structural issue with its brand positioning should result in the company underperforming its peers in the herbal segment. We also see a possibility of the herbal segment taking share away from basic dental creams, resulting in market share loss for CDC in urban areas.

MaxFresh, Active Salt and Visible White are the only bright spots in Colgate’s premium portfolio Specific need-based toothpastes such as Colgate Maxfresh, Colgate Active Salt and Colgate Visible White have done well for Colgate. We expect these variants to continue to do well for Colgate due to:

Colgate MaxFresh has grown on the back of Low Unit Packs (LUPs) over the last year. Whilst the focus on LUPs is margin-dilutive, it should help Colgate to continue to gain market share in the gel-toothpaste segment.

Success of Colgate Active Salt driven by launch of new variants such as Active Salt with Neem. Due to its unique offering coupled with successful product innovations, we believe Colgate Active Salt will continue to grow ahead of the market.

Colgate due to its first-mover advantage and strong brand equity vs the failure of HUL’s Close Up Diamond Attraction, should allow Visible White to grow ahead of the category growth rate.

Based on a combination of volume growth of 4.5%, marginal market share loss and ~6% price/mix-led growth, we expect Colgate to increase its urban sales at ~11% CAGR over FY15-20E.

Increasing user demand for natural products leading to market share loss for Colgate vs Dabur and Patanjali

Colgate MaxFresh, Active Salt and Visible White are likely to grow ahead of the market, leading to market share gains

Colgate Palmolive


High competitive intensity to keep margins under check Colgate will retain high A&P spends in an attempt to defend its overall market share From our discussions with the company, we understand that Colgate has not entered into other product category in India because the firm wants to conserve enough resources to focus on retaining its leadership in the oral care category. As a result, the company has always steadfastly protected its overall market share whenever competitive intensity has increased. For instance:

During the 2003 price war in toothpastes, Colgate reacted by taking ~20% price cuts across its portfolio. Colgate focused on growing the sales of its economy brand, Cibaca. Whilst the price cut resulted in flat revenue growth for Colgate in FY04, the company was able to retain its market share in the toothpaste category.

In 2013, Colgate stepped up its A&P spends from ~15% of sales in FY13 to ~19% in FY14, as it was expecting the launch of Oral B. Whilst such high levels of A&P spend led to a 4% YoY decline in PAT for Colgate, the company retained its market share despite the Oral B launch.

Post Oral-B challenge in FY15: Contrary to consensus expectations of a marked moderation in A&P spends following Colgate’s marketing blitz in 2013 to thwart the Oral B challenge, Colgate retained high levels of A&P spends as a percentage of sales even in 2HFY15 (see the exhibit below). Our channel checks suggest that this is due to aggressive consumer promotions from Dabur and HUL over the past 12 months.

Exhibit 6: Colgate has retained high levels of A&P spends, driving sales growth


We factor in an increase in A&P spends as a percentage of sales to be maintained at ~18% in FY16. This should result in EBITDA margin expansion of ~80bps YoY despite an estimated expansion of 100bps YoY in gross margin for FY16.

Threat of a price-war/re-launch of Oral B grows stronger; downside risk to our margin estimates As highlighted in our note dated 19thAugust (click here) (Is this the beginning of another price war), the probability of P&G resorting to a price war has increased in the detergents category. Similarly, given the failed launch of Oral B in 2013 and the recent management changes, we believe there is an increased probability of a price-war and/or a re-launch of Oral B. During the launch of Oral B in 2013, Colgate increased its A&P spends to ~19% of sales. A similar level of spending could wipe out all the gross margin benefit due to the lower commodity costs and could result in 5-6% YoY PAT growth for Colgate for FY16.

9%11%13%15%17%19%21%23%

5%7%9%

11%13%15%17%19%

Q2

FY13

Q3

FY13

Q4

FY13

Q1

FY14

Q2

FY14

Q3

FY14

Q4

FY14

Q1

FY15

Q2

FY15

Q3

FY15

Q4

FY15

Q1

FY16

Q2

FY16

Sales Growth YoY A&P as % of Sales, RHS

High A&P spends will continue due to increased competitive intensity, thus moderating Colgate’s margin expansion despite gross margin gains

http://reports.ambitcapital.com/reports/Ambit_HindustanUnilever_Isthisthebeginning_19Aug2015.pdf

Colgate Palmolive


Due to the factors highlighted earlier, we expect Colgate to deliver 15%/17%/18% gross sales/EBITDA/PAT CAGR over FY15-20E.

Deserves to trade only in line with sector average Whilst Colgate has a dominant market share in the toothpaste category, efficient working capital management and high RoCE vs peers, there are risks around:

Limited growth potential for the toothpaste category due to ~85% penetration and slower than expected premiumisation and higher usage led growth driver for the category,

Also, the company has not diversified beyond the toothpaste category, limiting future growth potential, and

Risk around market share loss in urban areas due to increased competitive intensity from GSK Pharma, Dabur, Patanjali and potential threat from Oral B.

As a result, the company deserves to trade almost in line with sector valuations unlike the premium valuations ascribed to HUL and Nestle.

Our DCF-based TP of `870/share (7% downside) implies FY17E P/E of 33x, a 9% premium to sector implied FY17E P/E of 31x.

Our WACC assumptions for the DCF-model are summarised in the exhibit alongside. The cash flow and return profiles generated from our model are shown in the exhibits below.

Exhibit 7: Cash flow profiles for Colgate (` mn)

Source: Ambit Capital research;

Exhibit 8: Return profiles for Colgate (%)


Exhibit 9: One-year forward P/E bands for Colgate


Exhibit 10: One-year forward EV/EBITDA bands for Colgate


2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E


0%

40%

80%

120%

160%

0%

10%

20%

30%

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

ROE (%), RHS EPS Growth (YoY)EBIT Margin (%) YoY growth in sales

22

26

30

34

38

42

46

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

CLGT 1-yr fwd P/E 5-yr avg

+1 s.d. -1 s.d.

17

22

27

32

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

CLGT 1-yr fwd EV/EBITDA 5-yr avg

+1 s.d. -1 s.d.








Tax rate (%) 28.0

WACC (%) 13.0



Colgate Palmolive


Summary of our key assumptions and estimates Exhibit 11: We expect Colgate to deliver 15%/18% sales and PAT CAGR over FY15-20

(in ` mn) FY15 FY16E FY17E FY18E FY19E FY20E Comments

Profit and loss Toothpaste revenues (incl mouthwash and toothpowder) 35,920 38,930 44,899 51,763 59,653 68,718 We expect Colgate's toothpaste growth to be led by

uptick in rural demand from FY17 onwards with market share gains for Colgate Dental Cream Growth (%) 10.5% 8.4% 15.3% 15.3% 15.2% 15.2%

Toothbrush revenues 6,171 7,405 8,886 10,485 12,373 14,600 We expect the company to maintain its market share in Toothpaste backed by product innovations Growth (%) 12.0% 20.0% 20.0% 18.0% 18.0% 18.0%

Total revenues 39,819 42,023 48,762 56,417 65,257 75,467 Expect 15% gross sales CAGR over FY15-20 driven by 8-9% volume growth Growth (%) 11.3% 5.5% 16.0% 15.7% 15.7% 15.6%

Gross Profit 25,142 26,954 31,374 36,412 42,248 49,009 Expect only marginal GM expansion due to limited premiumisation of portfolio Gross margin (%) 63.1% 64.1% 64.3% 64.5% 64.7% 64.9%

Employee cost (% of sale) 6.5% 6.6% 6.5% 6.5% 6.5% 6.5% Expect employee costs to remain flat

Advertising (% of sale) 17.9% 18.1% 17.7% 17.2% 16.8% 16.3% Expect A&P spends to be elevated in FY16 due to heightened competitive intensity from Dabur and HUL; expect gradual moderation YoY over FY17-20

Royalty (% of sale) 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% Expect royalty payment rate to remain stable

Other expenses (% of sale) 12.5% 12.4% 12.3% 12.3% 12.3% 12.3% Expect other expenses to remain flat

EBITDA 8,222 9,010 10,869 12,942 15,395 18,294 Above changes to lead to 360bps margins improvement in EBITDA margins over FY15-20 EBITDA Margin 20.6% 21.4% 22.3% 22.9% 23.6% 24.2%

Tax rate 28.4% 30.5% 32.0% 33.0% 33.0% 33.0% Tax rate is expected to increase towards 33% due to end of tax benefits at its Baddi plant


Growth (%) 17.6% 6.7% 20.6% 20.5% 21.8% 19.7%

Balance Sheet Capex 2,902 1,500 1,500 1,500 1,500 1,500 Capex intensity is expected to moderate as the AP and

Gujarat facilities are now commissioned

Working Capital days (40) (41) (41) (41) (41) (41) Do not expect material changes in working capital days

Cash flows (̀ mn) Operating cash flows 6,564 7,068 8,810 10,383 12,401 14,632 We expect Colgate to continue to report strong FCF

driven by stable WC and capex Free cash flows 3,560 5,979 7,310 8,883 10,901 13,132


Risks to our SELL stance Lower competitive intensity in the segment: Any reduction in competitive intensity in the oral care segment will ease the pressure on A&P spends and positively impact margins.

Higher-than-expected uptick in rural demand: Whilst we expect Colgate to be one of the key beneficiaries of the uptick in rural spends, higher-than-expected uptick in demand will lead to higher sales growth for Colgate.

Negative catalysts for the stock Weakness in rural demand: Continued weakness in rural demand for the next 6-9 months would lead significant volume growth moderation for Colgate.

Price cuts/increased competitive intensity from Oral B, Dabur, HUL and Patanjali: A price war similar to the one in 2003 or a re-launch of Oral B with increased promotional intensity would lead to price cuts/higher A&P spends from Colgate as well, impacting its sales and PAT growth.

Colgate Palmolive


Change in estimates Exhibit 12: Change in estimates for Colgate (` mn)

New Old Ch%


TP (`.) 870 735 18%

Sales 42,023 48,762 56,417 42,023 47,582 53,751 0.0% 2.5% 5.0%

EBITDA 9,010 10,869 12,942 9,010 10,583 12,331 0.0% 2.7% 5.0%

EBITDA margin (%) 21.4% 22.3% 22.9% 21.4% 22.2% 22.9% 0.0 5.0 0.0

PBT 8,582 10,575 12,931 8,582 10,288 12,320 0.0% 2.8% 5.0%

PAT 5,964 7,191 8,664 5,964 6,996 8,254 0.0% 2.8% 5.0%

EPS 21.9 26.4 31.9 21.9 25.7 30.3 0.0% 2.8% 5.0%


Ambit vs consensus Exhibit 13: Our estimates beyond FY17 are ahead of consensus as we factor in benefit from DBT increasing rural growth (` mn)



Sales 42,023 48,762 56,417 43,047 49,153 55,761 -2.4% -0.8% 1.2%

EBITDA 9,010 10,869 12,942 9,283 11,071 12,974 -2.9% -1.8% -0.2%

EBITDA margin (%) 21.4% 22.3% 22.9% 21.6% 22.5% 23.3% -12.4 -23.3 -32.6

PBT 8,582 10,575 12,931 8,823 10,691 12,541 -2.7% -1.1% 3.1%

PAT 5,964 7,191 8,664 6,157 7,216 8,518 -3.1% -0.3% 1.7%

EPS 21.9 26.4 31.9 22.3 26.0 30.4 -1.7% 1.5% 4.8%


Explanation of our forensic accounting scores Exhibit 14: Explanation for our forensic accounting scores on the first page


Accounting GREEN In the past, Colgate has reported excellent cash conversion, efficient management of working capital, and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability RED Colgate has a volatile earnings trajectory, as its margins are strongly influenced by the timing of its advertising and marketing campaigns which tend to be erratic.

Earnings momentum RED In the past six months, consensus estimates have been revised downwards by >5% due to weaker-than-expected demand and end of fiscal benefits.


Colgate Palmolive






Total networth 5,999 7,703 9,373 11,171 13,337


Preference share capital - - - - -

Debt - - - - -

Deferred tax liability (178) 26 26 26 26


Gross block 9,927 12,829 14,329 15,829 17,329

Net block 5,559 7,816 8,501 9,136 9,773

CWIP 1,415 1,412 1,000 1,000 1,000

Investments 371 371 371 371 371


Debtors 547 696 691 802 927

Inventory 2,257 2,522 2,662 3,089 3,574

Loans & advances 1,653 1,585 1,673 1,941 2,246




Provisions 952 1,272 1,342 1,557 1,802


Net current assets (1,525) (1,870) (473) 690 2,218

Miscellaneous - - - - -

Total assets 5,821 7,729 9,399 11,197 13,363





% growth 13.1% 11.3% 5.5% 16.0% 15.7%


EBITDA 6,640 8,222 9,010 10,869 12,942

% growth 1.1% 23.8% 9.6% 20.6% 19.1%

Depreciation 508 750 815 865 862

EBIT 6,133 7,472 8,195 10,004 12,080

Interest expenditure - - - - -

Non-operating income 503 332 387 571 851

Adjusted PBT 6,636 7,804 8,582 10,575 12,931

Tax 1,881 2,214 2,617 3,384 4,267 Adjusted PAT/ Net profit 4,755 5,590 5,964 7,191 8,664

% growth -4.3% 17.6% 6.7% 20.6% 20.5%

Extra-ordinary income 644 - - - -



Share of associates - - - - - Adjusted Consolidated net profit 4,111 5,590 5,964 7,191 8,664


Colgate Palmolive




EBIT 6,636 7,804 8,582 10,575 12,931

Depreciation 508 750 815 865 862

Others 47 204 - - 0

Tax (1,881) (2,214) (2,617) (3,384) (4,267) (Incr) / decr in net working capital 480 20 288 754 857


Capex (3,655) (3,004) (1,088) (1,500) (1,500) (Incr) / decr in investments 100 - - - -




Interest paid - - - - -

Dividend paid (4,296) (3,819) (4,294) (5,393) (6,498)

Others 644 (67) 0 - - Cash flow from financing (3,652) (3,885) (4,294) (5,393) (6,498)

Net change in cash (1,418) (325) 1,685 1,917 2,385


Free cash flow 2,134 3,560 5,979 7,310 8,883

Source: Company, Ambit Capital research,

Ratio Analysis


Gross margin (%) 60.8% 63.1% 64.1% 64.3% 64.5%

EBITDA margin (%) 18.6% 20.6% 21.4% 22.3% 22.9%

EBIT margin (%) 18.5% 19.6% 20.4% 21.7% 22.9%



Net debt: equity (x) (0.5) (0.3) (0.5) (0.6) (0.6) Working capital turnover (x) (8.1) (9.0) (8.9) (8.9) (8.9)


RoCE (%) 90.6% 82.5% 69.6% 69.8% 70.6%

RoE (%) 87.3% 81.6% 69.9% 70.0% 70.7%


Valuation Parameter


EPS (`) 17.5 20.6 21.9 26.4 31.9

Diluted EPS (`) 17.5 20.6 21.9 26.4 31.9



P/E (x) 54.6 46.5 43.6 36.1 30.0

P/BV (x) 43.3 33.7 27.7 23.3 19.5

EV/EBITDA (x) 38.7 31.3 28.4 23.3 19.4

Price/Sales (x) 7.3 6.5 6.2 5.3 4.6


Colgate Palmolive




COMPANY INSIGHT GCPL IN EQUITY November 03, 2015

More risk than reward

Godrej Consumer (GCPL) aims to achieve 18% organic sales CAGR and 26% total sales CAGR over FY10-20. As it derives less than 15% of its overall revenues from rural India, it is one of the weakest beneficiaries of rural welfare initiatives. Moreover, it faces headwinds around market share losses in soaps, high competitive intensity in LatAm and domestic hair care, and challenges around integration/macro issues in Africa. With its international portfolio’s RoCE at 5-8% over FY11-15, we expect the drag on return ratios from M&As to continue. We forecast 13% sales CAGR and RoCE of 20% over FY15-20. Our DCF-based fair value is `920 (29% downside; implied FY17E P/E of 24.4x).

Competitive position: MODERATE Changes to this position: NONE Least exposed to rural India sales (only 15% of consolidated revenues)

GCPL’s household Insecticides segment particularly the ‘Good Knight Fast Card’ and Godrej No.1 soaps should benefit from increased rural consumer spends. However, domestic sales contribute to only 50% of total sales (rest being international regions), with only ~30% of domestic sales from rural areas. Hence, we upgrade our sales estimates by only ~3% over FY17-20E, with total sales FY15-20E CAGR of 13% vs 19% over FY12-15. Domestic headwinds and overhang from Africa and LatAm business In the domestic business, hair colour (7% of sales) faces increasing competition, as MNC peers replicate GCPL’s low-cost crème format (15% sales CAGR in FY15-20E). In soaps (17% of sales), GCPL does not have a premium offering which will limit sales growth given high penetration and premiumisation being the key growth driver (10% sales CAGR in FY15-20E). The international business faces challenges around supply chain infrastructure in Africa (15% of sales; 15% sales CAGR in FY15-20E), resulting in delayed business integration and MNC competition in LatAm (7% of sales; 10% sales CAGR in FY15-20E). 10x10 target presents more risks than rewards around M&A prospects As GCPL pursues its target sales CAGR of 26% (over FY11-21), we expect substantial capital allocation towards M&As in emerging markets. However, the international portfolio’s RoCEs declined from 16% in FY08 to 8% in FY15; thus, we see a risk of a sustained drag on return ratios, due to challenges around management bandwidth, integration expertise, and focus/incentive to consolidate the existing portfolio before further acquisitions are pursued. Valuations do NOT adequately factor in its growth limitation vs peers We build in FY15-20E sales/EPS CAGR of 13%/16% and arrive at a DCF-based TP of `920 (29% downside), implying FY17E P/E of 24.4x. As a result, current valuations of 35x FY17E P/E seem expensive given expectations of growth and risk of capital misallocation. We retain SELL.

Godrej ConsumerSELL

Consumer Staples

Recommendation Mcap (bn): `430/US$6.6 6M ADV (mn): `278/US$4.3 CMP: `1,262 TP (12 mths): `920 Downside (%): 27

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: AMBER

Catalysts

Delay in integration of acquired businesses

Increased competitive intensity in domestic business

Weak YoY earnings growth in 4QFY16 once input cost benefits are in the base

Performance (%)


85 100 115 130 145 160

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex GCPL



EBITDA (` mn) 11,503 13,653 15,633 18,479 21,461

EBITDA Margin (%) 15.1% 16.5% 17.2% 17.9% 18.3%

Adjusted EPS (`) 22.2 27.1 31.0 37.7 43.2

RoCE (%) 16.1% 17.4% 17.8% 19.7% 20.2%

P/E (x) 57.0 46.5 40.8 33.5 29.2


Analyst Details

Rakshit Ranjan, CFA


Ritesh Vaidya, CFA +91 22 3043 3246

[email protected]



Godrej Consumer


Focus on M&A increases capital misallocation risk The core businesses of most Indian FMCG companies do not need incremental capital to grow due to their highly cash-generative nature. However, one of the important factors of longevity of growth is the company’s ability to continually pursue new organic or inorganic growth opportunities. Capital is the fuel which is needed to pursue these opportunities. These new opportunities in turn need to generate RoCE equivalent to at least the cost of capital to provide capital for the next opportunity and hence ensure the longevity of growth.

However, an analysis of RoCE of GCPL’s international (non-standalone) business which has mostly been built inorganically indicates that it has failed to generate >8% RoCE in the last 5 years. Given this poor track record with acquisitions, GCPL’s ambitions of achieving 10x growth in 10 years by using inorganic growth, as a key enabler raises further risk of capital misallocation and hence risks its longevity of growth.

Exhibit 1: International sales contributed to ~46% of the total in FY15


Exhibit 2: Profitability for the international business is significantly lower than the standalone business


As highlighted in the exhibit below, the firm’s consolidated RoCEs have reduced materially due to a combination of:

Reduction in the dividend payout ratio and fresh capital raise by the standalone business, which has been used to fund the acquisitions.

Weak cash generation and declining EBITDA margins (from ~18% in FY12 to ~12% in FY13) of the international portfolio.

Exhibit 3: GCPL’s International business (non-standalone) RoCEs have been sub-10% over the last 5 years


15%

20%

25%

30%

35%

40%

45%

50%

0

9,000

18,000

27,000

36,000

45,000

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Intl. sales (Rs mn) % of total sales (RHS)

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

Stndl. EBITDA margin (%) Intl. EBITDA margin (%)

14%16%

6%

21%6%

6% 7% 7% 8%

0%

5%

10%

15%

20%

25%

0%

10%

20%

30%

40%

50%

60%

70%

80%

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Div. payout ratio (%) Standalone RoCE (%)

Consol RoCE (%) non-standalone RoCE (%), RHS

Godrej Consumer


Employee incentive structure has low RoCE benchmark for pursuing inorganic growth The incentive structures for the middle and senior management team are largely driven by the YoY increase in the Economic Value Added (EVA), based on which, a multiplier is applied to the salary structure of every employee. Each country manager and his/her subordinates are evaluated on the growth in EVA for their respective country. The key drivers for EVA are: (a) growth in operating profits; and (b) assumption of Weighted Average Cost of Capital (WACC). However, in such an incentive structure, there remains a possibility that: (a) the WACC-based approach sets a low benchmark for outperformance as compared to RoCEs of at least 30-40% generated by efficient consumer firms in India; and (b) in FY11, despite acquisition of new businesses in higher risk geographies such as Africa, the WACC assumed for EVA calculation was lowered to 10% as shown in the exhibit below.

Exhibit 4: WACC came down in FY11 to only 10% after a few acquisitions in that year


Acquisitions straining management bandwidth Acquisitions in emerging markets face issues such as: (a) lack of well-established systems and processes in acquired business; and (b) macro-related issues including weak infrastructure, political uncertainty and weak consumerism in certain emerging markets. Hence, efficient integration and synergies generated from such acquired businesses require high quality of integration expertise and bandwidth for the senior management team, thus straining the management bandwidth at existing businesses.

Due to these above-mentioned reasons, we believe GCPL’s inorganic growth ambitions pose risks which jeopardise the longevity of growth of the business.

9%10%10%11%11%12%12%13%13%14%

50

100

150

200

250

300

FY05 FY06 FY07 FY08 FY09 FY10 FY11

EVA (Rs. Mn) WACC (%, RHS)

Godrej Consumer


Expect only 13% sales CAGR over FY15-20E GCPL is likely to be benefit the least from the DBT-induced higher rural spends due to ~50% of its sales coming from the international business and only ~30% of domestic sales coming from rural areas. We expect GCPL’s domestic business to deliver only 14% sales CAGR over FY15-20 due to:

Slowing growth (16% CAGR over FY15-20E vs 17% over FY11-15) in the Household Insecticides segment (~26% of consolidated sales), as GCPL’s market share at ~56% saturates due to renewed competitive intensity from Jyothy Labs, SC Johnson and Reckitt Benckiser which have also launched their version of Good Knight Fast Cards.

Slowing growth (10% CAGR over FY15-20E vs 13% over FY12-15) in the soaps segment (~18% of consolidated sales), as the market has reached ~100% penetration and GCPL does not have a well-known premium offering to drive premiumisation-led growth.

Increasing competitive intensity from MNC peers such as L’Oreal which also have a premium offering in hair colours is likely to result in only 15% sales CAGR over FY15-20E vs 19% over FY12-15 in the hair colours segment (~7% of consolidated sales).

Exhibit 5: We expect GCPL to deliver 14%/12% domestic and international sales CAGR voer

Contribution to revenues

(FY15) FY15 FY16E FY17E FY18E FY19E FY20E Comments

Domestic business Soaps sales (`. Mn) 17.6% 14,546 14,976 16,779 18,623 20,662 22,918 Expect to grow only slightly ahead of the

category led by limited share gains in Godrej No.1 and Cinthol Growth YoY (%) 8.5% 3.0% 12.0% 11.0% 11.0% 10.9%

Hair colour sales (`. Mn) 6.8% 5,564 6,288 7,235 8,350 9,667 11,228 Growth to moderate vs 30% in FY14 as competition in the Crème format increases Growth YoY (%) 12.6% 13.0% 15.1% 15.4% 15.8% 16.1%

Insecticide sales (`. Mn) 25.2% 20,748 23,652 27,679 32,346 37,755 44,021 Growth to be driven by: 1) frequent innovation and 2) strong brand equity Growth YoY (%) 9.4% 14.0% 17.0% 16.9% 16.7% 16.6%

Total domestic sales (`. Mn) 43,693 48,034 55,123 63,092 72,235 82,732 Growth YoY (%) 8.6% 9.9% 14.8% 14.5% 14.5% 14.5% International business

Indonesia 17.5% 5.7% 8.0% 13.5% 13.5% 13.5% 13.5%

Expect the Indonesian business to deliver growth through: 1) frequent innovations; 2) marketing investments in the Stella and Mitu brands; and 3) distribution expansion

Africa 14.4% 18.6% 15.6% 14.6% 14.6% 14.6% 14.6% Revenue growth to continue at a lower trajectory due to the delays and issues in Darling acquisition

Latin America 7.5% 2.3% 6.0% 10.5% 10.5% 10.5% 10.5% High competitive intensity from MNCs to result in only 10% sales CAGR over FY15-20

Europe 6.1% 4.6% 5.0% 7.0% 7.0% 7.0% 7.0% Expect growth in Europe to remain modest given muted market growth rate

Total international growth 8.4% 9.7% 12.5% 12.5% 12.6% 12.6% Overall growth 8.7% 9.8% 13.7% 13.6% 13.6% 13.7% Source: Company, Ambit Capital research

Godrej Consumer


Valuations – Deserves to trade at a discount to peers; retain SELL (TP `920, 29% downside) We expect GCPL to deliver sales/EPS CAGR of 13%/16% over FY15-20, lower than the sector average of 14%/18%. GCPL’s poor track record of capital allocation increases risks of potential capital misallocation as the company pursues its target of ‘10 times’ growth in ’10 years’ assisted by acquisitions. Given the poor visibility on longevity of growth, we believe GCPL should trade at a discount to the sector average valuations. Our DCF-based TP of `920 (30% downside) implies FY17E P/E of 24x vs the sector average of 31x (discount of ~20%).


Exhibit 1: Cash flow profiles for GCPL (` mn)


Exhibit 2: Return profiles for GCPL (%)


Exhibit 3: One–year forward P/E band charts for GCPLxxxxx


Exhibit 4: One-year forward EV/EBITDA band charts for GCPL


(15,000) (10,000) (5,000) - 5,000 10,000 15,000 20,000 25,000

-

5,000

10,000

15,000

20,000

25,000

30,000

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

CFO (Rs mn) Free Cash Flow (Rs mn) (RHS)

0%

15%

30%

45%

60%

75%

90%

20%

25%

30%

35%

40%

45%

50%

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

ROE (LHS) EBITDA MarginEPS Growth YoY Growth in sales

15

20

25

30

35

40

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

GCPL 1-yr fwd P/E 5-yr avg+1 s.d. -1 s.d.

14

19

24

29

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

GCPL 1-yr fwd EV/EBITDA 5-yr avg+1 s.d. -1 s.d.








Tax rate (%) 28.0

WACC (%) 13.0



Godrej Consumer


Summary of key assumptions and estimates Exhibit 6: Key assumptions and estimates – others (` mn)

FY14 FY15 FY16E FY17E FY18E FY19E FY20E Comments

Profit and loss Domestic revenues 40,247 43,693 48,034 55,123 63,092 72,235 82,732 Expect hair colour and home insecticides to be the

drivers of domestic growth Growth (%) 14.3% 8.6% 9.9% 14.8% 14.5% 14.5% 14.5%

International revenues 35,950 38,970 42,744 48,070 54,086 60,885 68,572 Indonesia to lead growth; Africa and Latin America may drag down growth in the international business Growth (%) 18.5% 8.7% 9.8% 13.7% 13.6% 13.6% 13.7%

Total revenues 76,197 82,663 90,778 103,193 117,178 133,120 151,304 Expect 13% CAGR over FY15-20

Growth (%) 18.5% 8.9% 9.9% 13.7% 13.6% 13.6% 13.7%

Gross Profit 40,477 44,348 49,270 56,236 64,113 73,125 83,439 We see limited premiumisation led gross margin expansion driven mostly by insecticides Gross margin (%) 53.2% 53.6% 54.2% 54.4% 54.6% 54.8% 55.0%

Employee cost (% of sale) 9.9% 9.4% 9.4% 9.4% 9.4% 9.4% 9.4%

Expect costs to remain stable Advertising (% of sale) 14.6% 14.6% 14.6% 14.1% 13.9% 13.9% 13.9% Freight & forwarding (% of sale) 3.2% 3.1% 3.0% 3.0% 3.0% 3.0% 3.0%

Other expenses (% of sale) 10.5% 10.1% 10.0% 10.0% 10.0% 10.0% 10.0%

EBITDA 11,503 13,653 15,633 18,479 21,461 24,655 28,333 Above changes to lead to marginal EBITDA margin improvements EBITDA Margin 15.1% 16.5% 17.2% 17.9% 18.3% 18.5% 18.7%

PAT 8,134 9,936 11,373 13,821 15,916 18,044 20,893 Expect 16% PAT CAGR over FY15-20

Growth (%) 12.1% 22.1% 14.5% 21.5% 15.2% 13.4% 15.8%

Balance Sheet Capex 935 380 900 900 900 900 900 No material capex requirements in the near future

Working Capital days (20) (9) (10) (10) (10) (10) (10) Expect working capital days to remain stable

Cash flows (̀ mn) Operating cash flows 13,030 8,077 13,448 16,051 18,390 20,812 24,010 With no material capex requirements, free cash

flows to grow strongly over FY15-20 Free cash flows 12,136 7,214 12,548 15,151 17,490 19,912 23,110


Risks to our SELL stance Successful product innovation in the personal wash category: Successful

innovations in the personal wash category could lead to a higher-than-expected growth trajectory for this segment.

Stabilisation of African operations ahead of schedule: If GCPL is able to stabilise the African business with respect to the processes and set up basic infrastructure sooner than our expectations, then this could result in upsides to GCPL’s valuations.

Emerging market economic growth: A sudden rise of household income in the middle class population in emerging market economies can lead to strong growth for segments in which GCPL operates internationally.

New acquisitions at cheap multiples: With the management’s view of continued focus on M&As as one of the growth drivers over the longer term, the acquisition of an attractive asset at a low valuation can provide upside potential.

Godrej Consumer


Catalysts Increasing competitive intensity: With the company’s entry into the more

premium segment of both hair care and soaps, higher competitive intensity from incumbent MNCs with strong balance sheets in these premium categories is likely to lead to downward pressure on EBITDA margins through increased spends on advertising and promotions.

Integration of the African business: GCPL had originally planned to realise significant integration benefits at its African business. However, delays in the Darling acquisition have already postponed the realisation of some of these integration benefits. Further delays or change in the Darling acquisition plans could affect GCPL’s valuations over the longer term.

Weak topline and profit, growth from 4QFY16: Weak volume growth over 2HFY16 due to weak rural demand and muted profit growth starting 4QFY16 as lower input costs are in the base, which would act as negative catalysts for the stock.

Change in estimates Exhibit 7: Change in estimates for Godrej Consumer over FY16-18 (` mn)

New Old Ch%


TP 920 890 3.3%

Sales 90,931 103,404 117,457 90,931 102,764 116,009 0.0% 0.6% 1.2%

EBITDA 15,633 18,479 21,461 15,633 18,262 21,080 0.0% 1.2% 1.8%

EBITDA margin (%) 17.2% 17.9% 18.3% 17.2% 17.8% 18.2% 0 10 10

PBT 14,770 17,949 21,222 14,770 17,732 20,841 0.0% 1.2% 1.8%

PAT 11,373 13,821 15,916 11,373 13,654 15,631 0.0% 1.2% 1.8%

EPS 31.0 37.7 43.2 31.0 37.2 42.4 0.0% 1.3% 2.0%


Ambit vs consensus Exhibit 8: Godrej Consumer - Ambit vs Consensus (` mn)



Sales 90,931 103,404 117,457 93,930 108,520 124,991 -3.2% -4.7% -6.0%

EBITDA 15,633 18,479 21,461 16,801 19,715 22,857 -7.0% -6.3% -6.1%

EBITDA margin (%) 17.2% 17.9% 18.3% 17.9% 18.2% 18.3% (69) (30) (2)

PBT 14,770 17,949 21,222 15,605 18,693 22,159 -5.4% -4.0% -4.2%

PAT 11,373 13,821 15,916 11,523 13,855 16,499 -1.3% -0.2% -3.5%

EPS 31.0 37.7 43.2 33.9 40.7 48.6 -8.6% -7.6% -11.0%


Explanation of our forensic accounting scores Exhibit 9: Explanation for the flags on the cover page


Accounting GREEN In the past, Godrej Consumer has reported excellent cash conversion, efficient management of working capital in the domestic business, and reasonable levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability AMBER Whilst the company has seen strong performance in its domestic business, it is still investing in its African and Latin American businesses, which lead to volatility in its reported numbers at the EBITDA margin level.

Earnings momentum AMBER Consensus EPS estimates have been downgraded by less than 5% for FY16 in the last six months.


Godrej Consumer






Total networth 37,754 43,107 50,944 60,478 71,421

Minority Interest 2,251 1,620 2,452 3,450 4,648

Debt 17,023 21,697 16,197 12,697 9,197

Other long term liabilities 288 305 305 305 305

Deferred tax liability (203) (312) (312) (312) (312)


Gross block 22,511 22,890 23,790 24,690 25,590

Net block 15,689 15,069 15,079 15,089 15,098

CWIP 1,671 2,246 2,246 2,246 2,246

Goodwill 35,525 40,441 40,441 40,441 40,441

Investments 343 343 343 343 343


Debtors 7,321 8,046 8,719 9,915 11,263

Inventory 10,821 10,717 12,456 14,165 16,090

Loans & advances 3,561 3,758 4,484 5,099 5,792

Other current assets - - - - -



Provisions 559 977 747 850 965



Total assets 57,113 66,417 69,586 76,617 85,258





% growth 18.5% 8.9% 9.9% 13.7% 13.6%


EBITDA 11,503 13,653 15,633 18,479 21,461

% growth 16.0% 18.7% 14.5% 18.2% 16.1%

Depreciation 819 908 890 890 891

EBIT 10,685 12,745 14,744 17,589 20,570

Interest expenditure 1,074 1,002 980 747 566

Non-operating income 627 915 1,007 1,107 1,218

Adjusted PBT 10,238 12,659 14,770 17,949 21,222

Tax 2,104 2,723 3,397 4,128 5,305


% growth 13.2% 23.6% 16.7% 21.5% 18.2%

Extra-ordinary income 59 (172) - - -


Minority Interest (596) (693) (832) (998) (1,198)




Godrej Consumer




EBIT 11,312 13,660 15,750 18,697 21,788

Depreciation 819 908 890 890 891

Others (965) (1,725) (148) 251 631

Tax (2,104) (2,723) (3,397) (4,128) (5,305)

(Incr) / decr in net working capital 3,969 (2,044) 353 342 385


Capex (7,334) (5,779) (900) (900) (900)

(Incr) / decr in investments (343) (0) - - -

Others - - - - -

Cash flow from investments (7,676) (5,780) (900) (900) (900)

Net borrowings (2,463) 4,674 (5,500) (3,500) (3,500)

Interest paid (1,074) (1,002) (980) (747) (566)

Dividend paid (2,083) (2,183) (2,704) (3,289) (3,776)

Others (354) (1,398) 148 (251) (631)

Cash flow from financing (5,973) 91 (9,036) (7,787) (8,473)

Net change in cash (620) 2,388 3,512 7,364 9,016


Free cash flow 5,696 2,298 12,548 15,151 17,490


Ratio Analysis


Gross margin (%) 53.2% 53.6% 54.2% 54.4% 54.6%

EBITDA margin (%) 15.1% 16.5% 17.2% 17.9% 18.3%

EBIT margin (%) 14.9% 16.5% 17.3% 18.1% 18.5%



Net debt: equity (x) 0.2 0.3 0.0 (0.1) (0.3)

Working capital turnover (x) NA (38.7) (36.5) (36.5) (36.5)


RoCE (%) 16.1% 17.4% 17.8% 19.7% 20.2%

RoE (%) 23.0% 24.6% 24.2% 24.8% 24.1%


Valuation Parameter


EPS (`) 22.2 27.1 31.0 37.7 43.2

Diluted EPS (`) 22.2 27.1 31.0 37.7 43.2



P/E (x) 57.0 46.5 40.8 33.5 29.2

P/BV (x) 11.4 10.0 8.4 7.1 6.0

EV/EBITDA (x) 38.1 32.3 27.6 22.8 19.0

Price/Sales (x) 5.6 5.2 4.7 4.2 3.7


Godrej Consumer




COMPANY INSIGHT BRIT IN EQUITY November 03, 2015

Will lose rural upside to Parle

Britannia’s innovation-led premium product launches, leveraging on its strong brands, are steps in the right direction. Moreover, the firm has delivered significant operating efficiencies in its manufacturing and supply chain, with an improved focus on systems and processes in the channel. However, the threat from Parle in the mass market and from ITC and Mondelez in the premium category will limit market share gains to ~400bps (from 32% in FY15 to 36% in FY20). EBITDA margin gains in the future will be offset by higher A&P spends to support the new launches. We expect 16%/24% sales/EPS CAGR over FY15-20E. Our DCF-based TP of `2,300 implies 28x FY17E P/E.

Competitive position: STRONG Changes to this position: STABLE Huge opportunity but not best positioned to capitalise on it vs Parle Due to its small-ticket size/high utility, the biscuits category will be one of the key beneficiaries of incremental consumer spends on packaged foods. However, Britannia is unlikely to benefit disproportionately, as: (a) Britannia reaches out to only 67% of the total number of outlets that Parle reaches, due to Britannia’s weak presence in rural areas; (b) Britannia has a weak presence in the value segment (especially glucose) with its market share being one-fifth of Parle’s share; and (c) Its rural market share is only 67% of its urban share. Product innovation likely to result in market share gains Over the last 12 months, Britannia has launched biscuits in the super-premium cookies segment and has also re-launched some of its existing brands by focusing on: (a) technology-driven product differentiation, (b) superior packaging and (c) leveraging on the existing strong brands. We expect these innovations to result in market share gain of ~400bps from 32.5% in FY15 to 36.5% in FY20 led by share gain in the premium market. Resolution of distributors’ issues and operational efficiencies The company has improved the ease of business for distributors through: (a) use of IT platform; (b) new incentive structure; and (c) reduction of damaged goods in the supply chain which should drive market share gains. Operational efficiencies like use of energy-efficient ovens, large and technologically-superior factories and shorter distance traveled by end products should drive EBITDA margin gains of ~280bps over FY15-20E. However, our bullishness is capped by high competitive intensity Our bullishness around gains in market share and EBITDA margin is capped by: (a) the aggressive approach to product development by peers like ITC and Parle, and (b) heightened A&P spends for Britannia to support new launches. We have upgraded our sales/EBIT estimate by 6-10% and now we are building in 16%/24% sales/EPS CAGR over FY15-20. Our TP of `2,300 implies 28x FY17E P/E, a 25%/30% discount to the implied P/E for HUL and Nestle, which have demonstrated greater consistency of returns in the last two decades.

BritanniaSELL

Consumer Staples

Recommendation Mcap (bn): `388/US$5.9 6M ADV (mn): `664/US$10.2 CMP: `3,232 TP (12 mths): `2,300 Downside (%): 29

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: GREEN

Catalysts

Aggressive roll out of premium biscuit launches by Mondelez and ITC

New product launches and re-launches by Parle in the mass and mid-mass market

Lower gross margin expansion as lower input costs come in the base

Performance (%)


85 115 145 175 205 235 265

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex Britannia

Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA


Key financials



EBITDA (` mn) 6,272 8,639 12,179 14,191 16,555

Adjusted PAT (` mn) 3,954 3,965 8,132 9,777 11,632

Adjusted EPS (`) 33.0 45.2 67.8 81.5 97.0

RoE (%) 58.3% 53.1% 56.3% 51.8% 48.0%

P/E (x) 98.1 71.5 47.7 39.7 33.3

P/B (x) 48.4 31.0 23.5 18.1 14.2




Britannia


Product innovation back in focus Britannia has lagged its peers in product innovation in the last ten years, due to which the company saw a decline in its market share from ~35% in FY09 to 30% in FY14. 2HFY15 has marked the beginning of Britannia’s product innovation with the launch of Nutri Choice Heavens, Good Day Choco Chunkies and Pure Magic Chocolush. Over the next two years, product innovation will be in focus, as it tries to win back its lost market share particularly at the premium end of the market. We expect the firm to gain 420bps market share (from ~31% in FY14 to ~36% in FY20).

Whilst the company has a renewed focus on product innovation, it has tried to differentiate its product innovation through:

Targeting an unexplored area of demand: Through the launch of super-premium biscuits priced at `50/100gm, the company is targeting: (a) consumers of imported biscuits and (b) giving a premiumisation opportunity for consumers who currently buy premium products like Sunfeast Delishus Gourmet cookies and Dark Fantasy Chocofils; this market size is currently ~`2.4bn.

Leveraging on technology to deliver product differentiation: The technology used for manufacturing these products is imported and is one of the best-in-class.

Best-in-class packaging to highlight the super-premium positioning: Compared with the packaging of its existing premium range of biscuits, Britannia has used super premium packaging for Heavens, Choco Chunkies and Chocolush.

New launches to be a mix of innovation and renovation Britannia’s innovation will be a combination of uniqueness and

familiarity: On one hand, a very unique product may be a breakthrough innovation but could need several years of investment behind the brand until the consumers develop a taste for the product. On the other hand, a very familiar product allows easy replication by competitors, enabling them to launch a ‘me-too’ product. Britannia plans to have innovations which would be a combination of these two, giving product differentiation but with a breakeven period of 12-18 months.

Separate product development strategy for mid/mass vs premium segments of biscuits: As highlighted in the table below, besides launching new product variants of its existing brands (for instance, Nutrichoice Heavens and Good Day Choco Chunkies), the firm intends to: (a) refresh its existing products for the mid and mass end of the portfolio such as the recent re-launch of Good Day, Marie and Milk Bikis and (b) launch entirely new brands at the premium end of the product portfolio.

Exhibit 1: Product innovation strategy in biscuits for Britannia

Type of innovation Purpose of innovation

Refreshing existing product portfolio

Launching new variants of existing brands

Launching new brands

Biscuit category

Mass Protect market share

Mid Extend market leadership for core brands and enhance profitability

Premium Building presence in the premium category which currently is dominated by ITC


Product innovation at the premium end and renovation at the mass end will be the likely path of new product development going ahead…

Britannia


Rising satisfaction amongst distributors Britannia has increased the efficiency and morale of its distributors by setting up new systems and processes like:

New IT infrastructure for distributors to help improve transparency within the channel and better MIS for stock tracking for Britannia

Split salesman to improve the ability to push the entire product portfolio; and

More decision-making power with Britannia’s junior sales managers allowing resolution of some issues at their level itself.

Resolution of existing issues has also resulted in a more motivated sales channel that is ready to work harder to help Britannia grow ahead of the market. The company has resolved the issues by:

Improving supply chain efficiencies to reduce instances of damaged/near-expiry products being delivered to distributors,

Re-working modern trade margins to resolve the issue of retailers being incentivised to buy from modern trade rather than general trade, and

Re-calibrating incentive schemes to encourage distributors to achieve their sales targets.

“The new management seems more driven and intent on making a change for the betterment of the company. We also hope to benefit from the improving fortunes of the company.” - Britannia’s channel partner in north India

Britannia


Market share gains in mid and premium segment for Britannia Due to the positive changes implemented in its distribution channel and the company’s renewed focus on new product launches, we expect Britannia to deliver sales CAGR of 16% over FY15-20E, led by 420bps/270bps share gain in the premium/mass and mid-segment, leading to overall share gain of 420bps over FY15-20E. The strategy for Britannia’s entire portfolio is summarised in the exhibit below.

Exhibit 2: Britannia (BIL) – The strategy for its entire biscuit portfolio

Segment Description Key success factors in the segment

What is Britannia's current positioning in the segment?

What is Britannia doing?

Britannia’s positioning will – Improve / Stay Unchanged / Deteriorate

Mass Market Price <=`10/100gm 1. Product pricing - Low double-digit market share

- Launching new variants of Tiger cookies Stay Unchanged

Size: ~48% of the biscuit market

2. Rural and semi-urban distribution

- Immense competition from Parle’s wide & deep distribution

- Widening its rural distribution through the hub and spoke model

Key categories: Glucose (45-50%), Creams (21%), Cookies (16%), Milk cookies (9%)

- Threat from ITC’s low priced products and cigarette distribution

- Deepening its urban distribution by implementing split salesman model

Key players: Parle (~70% share), BIL and ITC (10-12%)

Mid-market `10<Price<=`17/100gm 1. Strong Brand Equity - Strong positioning

through 'Good Day' and 'Marie'

- Plans to refresh existing portfolio Stay Unchanged

Size: ~38% of the biscuit market 2. Product pricing

- Adequate brand investments strengthening its positioning

- Follow it up with launch of new variants of existing brands

Key categories: Cookies (26%), Marie (21%), Cream (18%), Non-salt cracker (17%)

3. Product Innovation

- Focus on its existing brands

Key players: BIL (~68%), ITC (18%), Parle (13%)

Premium `17<Price<=`25/100gm 1. Strong Brand Equity - Strong position due to 'Good Day'

- Plans to refresh existing portfolio especially in the creams category

Improve

Size: ~11% of the biscuit market 2. Product Innovation

- Innovative product launches from ITC and Parle weakened BIL’s positioning in this segment

- Launch new variants of existing brands

Key categories: Cookies (46%), Cream (36%)

- Launch new brands with differentiated offering

Key players: BIL (~53%), Parle (19%), Mondelez (18%), ITC (10%)

- Focus on its existing core brands and on any new brands launched

Super Premium Price>`25/100gm 1. Product Innovation

- Losing competitive edge to ITC which focuses on product innovation

- Differentiate through product innovation Improve

Size: ~3% of the biscuit market 2. Strong Brand Equity

- Only recently BIL has launched new products in this segment

- Possibly launch new premium brands

Key categories: Cookies (63%), Cream (32%)

Key players: BIL (~64%), ITC (32%), Parle (4%)


Britannia


EBITDA margins to sustain at current levels; unlikely to expand materially further Higher A&P spends to back new launches should limit EBITDA margin gains

Since Varun Berry joined Britannia in January 2013, its EBITDA margins have continuously expanded from 6.3% in 3QFY13 to 14.3% in 1QFY16 through several cost optimisation measures implemented over this period. Whilst we expect these benefits to continue in the future, we believe:

Gross margins which are currently at a peak of 42.6% have limited upside given the lower input costs will come in base from 4QFY16.

A&P spends will need to be increased to support the new product launches. We expect A&P spends to increase up to 8.5% of sales from 8% currently in order to support new launches. Hence, beyond the ~250bps of EBITDA margin seen in FY15, we expect EBITDA margin to remain flat at current level of ~13.5% over FY16-20. As a result, we expect 25% EPS CAGR over FY15-20E.

Exhibit 3: EBITDA margin likely to remain flat over FY16-20


DBT benefit higher for Parle due to Britannia weak mass market presence Due to its small-ticket size/high utility, the biscuits category will be one of the key beneficiaries of incremental consumer spends on packaged foods. However, Britannia is unlikely to benefit disproportionately, as: (a) Britannia reaches out to only 67% of the total number of outlets that Parle reaches, due to Britannia’s weak presence in rural areas; (b) Britannia has a weak presence in the value segment (especially glucose) with its market share being one-fifth of Parle’s share; and (c) Its rural market share is only 67% of its urban share. Also, given Parle’s strong hold in the mass market through Parle-G and Parle 20-20 cookies, we believe Parle will benefit more than Britannia from an uptick in rural spends. As a result, we build in only 2-7% sales upgrade over FY17-20 and slightly higher upgrade in EBIT of 4-11% over FY17-20 due to operating leverage.

Exhibit 4: Change in estimates for Britannia consolidated (` mn)

New Old Ch%


TP (̀ .) 2,300 2,020 13.9%

Sales 90,021 105,129 121,907 89,277 102,904 117,676 0.8% 2.2% 3.6%

EBITDA 12,179 14,191 16,555 12,075 14,021 16,143 0.9% 1.2% 2.6%

EBITDA margin (%) 13.5% 13.5% 13.6% 13.5% 13.6% 13.7% 0 (13) (14)

PBT 11,698 14,166 16,854 11,496 13,830 16,157 1.8% 2.4% 4.3%

PAT 8,132 9,777 11,632 7,992 9,545 11,151 1.8% 2.4% 4.3%

EPS 67.8 81.5 97.0 66.6 79.6 93.0 1.8% 2.4% 4.3%


6.5%

7.5%

8.5%

9.5%

10.5%

11.5%

12.5%

13.5%

14.5%

37.0%

38.0%

39.0%

40.0%

41.0%

42.0%

43.0%

44.0%

FY13 FY14 FY15 FY16E FY17E FY18E FY19E FY20E

Gross margin % EBITDA margin % (RHS) A&P spends as % of sales (RHS)

Britannia


Expensive MNC-like valuations given risks around longevity of growth vs MNC peers Change in strategy by the new management under Varun Berry has resulted in a re-rating for the stock from trading at a 20-25% discount to peers vs a ~15% premium to sector valuations. We believe such premium valuations are not warranted for Britannia given the risks around: (a) Lack of diversification of the company’s product portfolio and (b) Key man risk underlined by the change in fortunes the company has had after Varun Berry took over from Vinita Bali. Also, Britannia’s ambitions of reaching `200bn topline in 5 years through an entry in highly competitive product categories such as chocolates, snacks, breakfast adds to the risk, given that the company has no previous track record of entering new categories.

Our DCF-based valuation suggests a TP of `2,300/share, implying 28x FY17E P/E at a ~9% discount to our sector average implied FY17E P/E of 31x.

Our WACC assumptions for the DCF-model are summarised in the exhibit alongside (will insert later). The cash flow and return profiles generated our model are shown in the exhibits below.

Exhibit 5: Cash flow profiles for Britannia (` mn)


Exhibit 6: Return profiles for Britannia (%)


Exhibit 7: One-year forward P/E bands for Britannia


Exhibit 8: One-year forward EV/EBITDA bands for Britannia


0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

(5,000)

-

5,000

10,000

15,000

20,000

FY11

FY12

FY13

FY14

FY15

E

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

FCFF Rs mn (LHS) Revenue Growth (RHS)

PBIT Margin (RHS)

4%

8%

12%

16%

10%

20%

30%

40%

50%

60%

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

Revenue growth (%) EPS growth (%)

EBITDA margin (%) (RHS) PAT margin (%) (RHS)

20

25

30

35

40

45

50

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

BRIT 1-yr fwd P/E 5-yr avg+1 s.d. -1 s.d.

10

15

20

25

30

35

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

BRIT 1-yr fwd EV/EBITDA 5-yr avg+1 s.d. -1 s.d.

DCF assumptions Item Value







WACC (%) 13.0



Britannia


Summary of our key assumptions and estimates Exhibit 9: Key segmental growth assumptions

Segments Share of

revenues (FY15)


BIL biscuits segment growth (̀ mn) 76.2% 60,503 69,568 81,619 94,857 110,242 127,260

We expect the over-`17/100gm category to grow at a faster rate than the lower-priced category. Expect Britannia to gain market share in the higher-priced category through new product launches and in the sub-`17/100gm category through product re-launches.

Biscuit market growth 9.7% 11.7% 13.8% 13.8% 13.8% 13.0% BIL sub-`17/100gm growth 12.6% 13.5% 16.2% 15.1% 15.1% 14.0%

BIL over-`17/100gm growth 18.1% 20.9% 21.4% 20.3% 20.3% 20.2%

BIL biscuit segment growth (%) 13.6% 15.0% 17.3% 16.2% 16.2% 15.4%

Bread, toast and rusk growth 9.6% 12.7% 14.5% 14.5% 14.5% 14.5% 14.5%

Factor in normalisation of growth for the bread and rusk business to 14.5% from 26% CAGR delivered over FY04-13 due to the low base

Cake growth 5.1% 32.2% 13.4% 15.5% 15.5% 15.5% 15.5% Factor in normalisation of growth for the cake business to 15% from the 30% CAGR delivered over FY04-13 due to the low base

Dairy growth 4.1% 10.1% 15.0% 18.0% 18.0% 18.0% 18.0% Expect dairy to be one of the fastest-growing businesses for Britannia as the company increases its focus on non-biscuit segments

International business growth 4.4% 20.6% 10.0% 15.0% 15.0% 15.0% 15.0%

With no significant competitive advantages in the international business, we do not see this segment being a focus area for Britannia in the near term

Gross Sales growth 14.4% 14.6% 16.9% 16.0% 16.0% 15.4% Source: Company, Ambit Capital research

Exhibit 10: Key assumptions and estimates – others (in ̀ mn)

Consolidated FY15 FY16E FY17E FY18E FY19E FY20E Comments

Profit and loss Net Sales 78,584 90,021 105,129 121,907 141,372 163,111 Revenue growth to be led by the biscuits

segment growth of ~16% CAGR over FY15-20 Growth (%) 13.7% 14.6% 16.8% 16.0% 16.0% 15.4%

Gross Profit 31,666 38,581 45,137 52,439 60,928 70,465 Gross margin is likely to expand due to premiumisation benefits Gross margin (%) 40.3% 42.9% 42.9% 43.0% 43.1% 43.2%

Employee cost (% of sale) 3.6% 3.7% 3.7% 3.7% 3.7% 3.7% Employee cost is likely to remain stable

Advertising (% of sale) 8.3% 8.5% 8.5% 8.5% 8.5% 8.5% New product launches and re-launches would need higher spends

Freight (% of sale) 5.4% 5.4% 5.4% 5.4% 5.4% 5.4% Costs are likely to remain stable over FY15-20 Conversion charges (% of sale) 6.2% 5.9% 5.9% 5.9% 5.9% 5.9%

Other expenses (% of sale) 5.8% 5.8% 5.9% 5.9% 5.9% 5.9%

EBITDA 8,639 12,179 14,191 16,555 19,315 22,452 Gross margin gains are likely to be partially offset by higher A&P spends EBITDA Margin 11.0% 13.5% 13.5% 13.6% 13.7% 13.8%

PAT 5,426 8,132 9,777 11,632 13,837 16,256 Expect PAT CAGR of 25% over FY15-20 due to margin expansion PAT growth YoY (%) 37.2% 49.9% 20.2% 19.0% 19.0% 17.5%

Balance Sheet Capex 786 1,500 1,000 1,000 1,000 1,000 Expect capex to moderate over FY17-20 as

the new factories are commissioned Working Capital days -13 -9 -8 -8 -8 -8

Expect working capital to remain stable Debtor days 6 7 8 8 8 8

Current Liabilities days 65 60 60 60 60 60

Inventory days 19 23 23 23 23 23

Cash flows (̀ mn) Operating cash flows 6,231 9,301 11,298 13,516 15,859 18,407 FCF to grow materially from FY17 onwards

as we factor in slowing pace of capex Free cash flows 5,446 7,801 10,298 12,516 14,859 17,407


Britannia


Risks to our SELL stance Wadia exiting Britannia at a premium valuation: In the event Britannia is acquired, the acquisition could happen at a sharp premium to the current market price. As discussed earlier, an acquisition multiple of 2.5x EV/sales would imply an upside of more than 80% from current levels.

Efficiencies leading to EBITDA margin expansion: Varun Berry has initiated several cost-optimisation projects which have led to significant EBITDA margin expansion. Although we believe most of the optimisation benefits have already been realised, substantial optimisation gains from the current levels could lead to significant EBITDA margin expansion.

Higher-than-expected share gains due to new product launches and re-launches: Whilst we build in ~400bps market share gains over FY15-20, better-than-expected success of new product launches could result in higher share gains for Britannia.

Catalysts Increased competitive pressure from incumbents and MNCs: If incumbents such as Parle and ITC and MNC peers such as Unibic and Mondelez decide to increase competitive pressure through higher A&P spends and several new product launches, Britannia’s market share and EBITDA margin would be adversely affected.

Minimal margin expansion as benefit of lower input costs comes in base: Over the last 9 months, Britannia has benefited from lower inputs costs. However, over the next 6 months, as most of these lower input costs are in the base, there will be limited scope of margin expansion for Britannia.

Increased competitive pressure from ITC through a dedicated distribution channel for biscuits: ITC currently sells biscuits through the same distribution channel as that used for cigarettes. If ITC is to setup a dedicated distributor channel for its biscuit business, this could significantly step up the competitive pressure on Britannia.

Unsuccessful new product launches by Britannia without supporting A&P spends: A series of new launches particularly in the premium segment could lead to higher A&P spends from Britannia. An unsuccessful product launch could lead to further pressure on EBITDA margin.

Ambit vs consensus Exhibit 11: Our FY16/17/18 estimates factor in an increase in A&P spends to support new launches (in ̀ mn)

Ambit Consensus Divergence Comments

FY16E Net Sales 90,021 89,274 1% No material difference from consensus

EBITDA 12,179 12,088 1% No material difference from consensus

EPS 67.8 69.2 -2% No material difference from consensus


EBITDA 14,191 14,660 -3% Expect lower EBITDA margin gains due to higher A&P spends

EPS 81.5 84.8 -4% The lower margins flow through to EPS


EBITDA 16,555 17,613 -6% Expect lower EBITDA margin gains due to higher A&P spends

EPS 97.0 102.3 -5% The lower margins flow through to EPS


Britannia




Accounting GREEN Britannia has, in the past, reported high cash conversion and efficient management of working capital and it ranks in the top quartile of our forensic accounting checks for FMCG. Consequently, we give a high rating to the quality of its accounting.

Predictability AMBER Due to a combination of its presence across products, categories and SKUs, and predominant exposure to consumer-activity-led sector of the economy, revenues show stability. However, the current economic environment, volatility in raw material prices and company’s margin expansion initiatives can lead to some volatility in earnings.

Earnings Momentum GREEN Margin expansion has led to consensus upgrading its EPS forecast for Britannia by >5% for both FY16 and FY17 over the past six months.


Britannia






Total networth 7,981 12,451 16,424 21,301 27,199


Debt 1,482 1,402 - - -

Deferred tax liability 89 (234) (234) (234) (234)


Gross block 14,855 15,989 17,489 18,489 19,489

Net block 7,406 7,334 7,160 6,721 6,202

CWIP 1,071 484 484 484 484

Goodwill 1,070 1,107 1,107 1,107 1,107

Investments 350 771 771 771 771


Debtors 1,087 1,358 1,726 2,304 2,672

Inventory 4,203 4,040 5,673 6,625 7,682

Loans & advances 3,042 5,563 4,933 5,760 6,680




Provisions 3,321 4,228 2,960 3,456 4,008


Net current assets (322) 3,949 6,691 12,006 18,419

Total assets 9,576 13,644 16,213 21,087 26,982





% growth 11.8% 13.7% 14.6% 16.8% 16.0%


EBITDA 6,272 8,639 12,179 14,191 16,555

% growth 49.1% 37.7% 41.0% 16.5% 16.7%

Depreciation 832 1,445 1,674 1,439 1,519

EBIT 5,440 7,194 10,506 12,752 15,036

Interest expenditure 83 39 28 - -

Non-operating income 336 880 1,220 1,414 1,818

Adjusted PBT 5,693 8,035 11,698 14,166 16,854

Tax 1,736 2,611 3,568 4,391 5,225


% growth 52.4% 37.2% 49.9% 20.2% 19.0%

Extra ordinary income - 1,461 - - -


Minority Interest 4 (2) (2) (3) (3)



Britannia




EBIT 5,776 8,074 11,726 14,166 16,854

Depreciation 832 1,445 1,674 1,439 1,519

Others (42) (320) 0 0 0

Tax (1,736) (2,611) (3,568) (4,391) (5,225) (Incr) / decr in net working capital 1,231 (318) (503) 85 368


Capex (1,460) (786) (1,500) (1,000) (1,000)

(Incr) / decr in investments (75) (457) - - -


Net borrowings (1,932) (80) (1,402) - -


Interest paid (83) (39) (28) - -

Dividend paid (1,678) (2,238) (3,659) (4,400) (5,235)

Others 127 1,282 (500) (500) (500)


Net change in cash 878 3,914 2,211 5,399 6,781


Free cash flow 4,519 5,446 7,801 10,298 12,516


Ratio Analysis


Gross margin (%) 39.7% 40.3% 42.9% 42.9% 43.0%

EBITDA margin (%) 9.1% 11.0% 13.5% 13.5% 13.6%

EBIT margin (%) 8.4% 10.3% 13.0% 13.5% 13.8%



Net debt: equity (x) (0.2) (0.4) (0.5) (0.7) (0.8)

Working capital days (16) (13) (9) (8) (8)


RoCE (%) 42.9% 47.0% 54.6% 52.4% 48.4%

RoE (%) 58.3% 53.1% 56.3% 51.8% 48.0%


Valuation Parameter


EPS (`) 33.0 45.2 67.8 81.5 97.0

Diluted EPS (`) 33.0 45.2 67.8 81.5 97.0



P/E (x) 98.1 71.5 47.7 39.7 33.3

P/BV (x) 48.4 31.0 23.5 18.1 14.2

EV/EBITDA (x) 61.6 44.3 31.1 26.3 22.1

Price/Sales (x) 5.6 4.9 4.3 3.7 3.2


Britannia




Key financials Year to March FY14 FY15 FY16E FY17E FY18E Operating income (` mn) 70,944 78,271 87,117 101,869 119,420 EBITDA (` mn) 11,564 13,163 15,431 18,298 21,630 EBITDA Margin (%) 16.3% 16.8% 17.7% 18.0% 18.1% Adjusted PAT (` mn) 9,154 10,657 12,557 14,772 17,498 Adjusted EPS (`) 5.2 6.1 7.2 8.5 10.0 RoE (%) 38.3% 35.5% 33.6% 32.5% 31.9% P/E (x) 51.6 44.7 37.6 32.0 27.0


COMPANY INSIGHT DABUR IN EQUITY November 03, 2015

Misaligned to drive premiumsation

Dabur has successfully executed initiatives related to distribution/operating efficiency over the past 3-4 years; however, the company now faces headwinds around rising competitive intensity on most of its domestic urban portfolio (except in oral care) from Marico (hair oils), Patanjali (overall Ayurveda positioning) and ITC (fruit juices). Returns from Dabur’s international portfolio, albeit superior to GCPL/Marico, include only 12-14% RoCE given the difficulties faced by Namaste. Risks also remain around future capital misallocation given surplus cash balance of >`20bn. Current valuation of 32x FY17E P/E leaves limited upside. Reiterate SELL.

Competitive position: MODERATE Changes to this position: NEUTRAL Moderate beneficiary of DBT rollout given <40% sales from rural Dabur’s portfolio of oral care (Babool, Dabur Red), health supplements (Chyawanprash), hair oil (Dabur Amla) and shampoo (Dabur Vatika) is likely to benefit from the DBT-induced incremental consumer spends. These categories contribute ~35% of total sales, with ~50% of these sales coming from rural areas. Dabur has also continued to increase its rural coverage through Project Double, which currently reaches ~44,000 villages vs 14,000 in FY11. Hence, given the DBT tailwind, Dabur is likely to deliver 16% sales CAGR over FY15-20E vs 14% over FY12-15. Weak competitive positioning in domestic urban portfolio Dabur’s domestic revenues face headwinds from: (a) category saturation in ~50% of its urban portfolio, with an inability to premiumise customers in health supplements and digestives, (b) Dabur Amla hair oils (~13% of revenues) will continue losing share given price aggression from Marico’s Nihar Shanti Amla; (c) threat from ITC’s expansion in fruit juices; and (d) competition from Patanjali (which could crimp Dabur’s growth prospects in most of categories due to similar Ayurveda positioning at 15-20% lower price points). Risk from capital misallocation given rising cash balance Whilst overseas organic expansion (Middle East and Egypt) has done well for Dabur, inorganic initiatives like ‘Namaste’ have been disappointing due to distribution-led issues. Hence, Dabur’s overall international business generates only 12-14% RoCE. With current surplus capital of ~`20bn and Dabur’s inorganic growth ambitions, we see a risk of capital misallocation in the future. Positives factored in; limited upside from CMP; reiterate SELL Although Dabur’s current management team, led by Mr. Duggal, has successfully executed several initiatives related to distribution/operating efficiencies like Project Double, CORE and LEAD, company faces headwinds around its urban product portfolio, capital misallocation risks and risk of high competitive intensity from ITC and Patanjali. After upgrades to our sales/EBIT estimates by 10-13% over FY17-20 due to DBT-related tailwinds, we expect sales/EPS CAGR of 16%/18% over FY15-20E. We reiterate SELL with TP of `262 (3% downside; implied FY17E P/E of 31x).

DaburSELL

Consumer Staples

Recommendation Mcap (bn): `476/US$7.3 6M ADV (mn): `387/US$6.0 CMP: `271 TP (12 mths): `262 Downside (%): 3


Catalysts

Aggressive expansion by peers like Patanjali and ITC

Weak earnings growth in 4QFY16 once input costs tailwinds are in the base

Weak sales growth in 2HFY16 due to poor rural demand

Performance (%)


85

100

115

130

145O

ct-1

4

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex Dabur

Analyst Details

Rakshit Ranjan, CFA


Ritesh Vaidya, CFA +91 22 3043 3246

[email protected]



Dabur


Dabur domestic portfolio to benefit from DBT Dabur’s portfolio of oral care (Babool, Dabur Red), health supplements (Chyawanprash), hair oil (Dabur Amla), shampoo (Dabur Vatika) and skin care (Fem and Gulabari) is likely to benefit from the DBT-induced incremental consumer spends. As shown in the exhibit below, Dabur is among the top-3 brands in each of these categories. However, these categories contribute only ~35% of total sales, with ~50% of these sales coming from rural areas.

Exhibit 1: Dabur is among the top-3 brands in categories benefiting from higher rural spends

Brand Position Category Brand Size (̀ . Bn)

Market position

% of Dabur sales

Babool Mass

Oral Care

`1bn+ #3

~9% of sales Dabur Red Mid-market `1bn+

Dabur Laal Toothpowder Mass `1bn+ #2

Chyawanprash Mid-market Health tonic `1bn+ #1 7-8% of sales

Dabur Amla Mid-market Hair Oil `10bn+ #2 ~15% of sales

Dabur Vatika Mass Hair Shampoo `10bn+ #4

Fem & Gulabari Mass Skin Care `1bn+ #2 ~3% of sales


More than doubled rural coverage through Project Double: Dabur launched Project Double in FY13 to expand direct coverage in rural markets. This initiative has helped increase direct coverage from 14,000 villages in FY11 to 44,000 villages in FY15, with plans to expand it further to 60,000 villages by FY17.

Improving rural consumer connect: Also, Dabur has been always been at the forefront of increasing its rural presence through consumer connect programmes such as ‘Swasthya Chetna Abhiyan’ for Chyawanprash and conducting a rural beauty contest, ‘Dabur Gulabari Miss Fresh Face’.

As a result, we believe that Dabur’s domestic business will benefit from an uptick in rural spends. However, the benefit is dampened, as 31% of total sales for Dabur come from its international business. Hence, we upgrade Dabur’s sales estimates by 2-10% over FY17-20 to factor in the DBT impact. EBIT is upgraded by 3-13% ahead of sales due to operating leverage benefits.

Exhibit 2: Change in estimates for Dabur over FY16-18 (` mn)

New Old Ch%


TP (`) 262 217 20%

Sales 87,117 101,869 119,420 87,117 99,390 113,884 0.0% 2.5% 4.9%

EBITDA 15,431 18,298 21,630 15,431 17,754 20,513 0.0% 3.1% 5.4%

EBITDA margin (%) 17.7% 18.0% 18.1% 17.7% 17.9% 18.0% 0.0 10.0 10.0

PBT 15,696 18,699 22,433 15,407 18,090 21,245 1.9% 3.4% 5.6%

PAT 12,557 14,772 17,498 12,326 14,291 16,571 1.9% 3.4% 5.6%

EPS 7.2 8.5 10.0 7.1 8.2 9.5 1.9% 3.4% 5.6%


Dabur


Domestic portfolio facing competitive pressure Dabur’s domestic revenues face headwinds from:

Slowing growth for Dabur Amla hair oil (~13% of revenues): Dabur Amla has been losing market share to its lower-priced competitor, Nihar Shanti Amla, which has increased its volume share from 15% in Jun’11 to 34% in Jun’15.

Weak competitive positioning in domestic urban portfolio: In categories such as skin care, shampoo and air fresheners, the company faces competitive pressure from MNC peers who have better positioned products to capture the premiumisation trend in these categories.

Category in saturation in Chyawanprash and Digestives segment: Although the base variant of Chyawanprash has been facing saturating growth, it has not been able to premiumise consumers to the more premium variants. The company faces a similar situation in the digestives segment.

Competition from ITC in fruit juices: The launch of ‘B Natural’ fruit juices by ITC has increased the competitive intensity in the fruit juices category where Dabur has >50% market share. ITC with its widespread distribution and focus on growing volumes vs profits can threaten Dabur’s dominant position in the category. Also, with Dabur’s market share at 60%+, growth is expected to moderate to 10-15% instead of 15%+ growth earlier due to market share saturation.

Competition from Patanjali: Patanjali products also have a similar Ayurveda positioning as Dabur but Patanjali sells these products at a 15-20% discount to Dabur. As Patanjali increases its distribution, this could be a threat to Dabur’s growth prospects.








Tax rate (%) 28.0

WACC (%) 13.0



Dabur


Deserves to trade in line with sector valuations Although Dabur’s current management team, led by Mr. Duggal, has successfully executed several initiatives related to distribution/operating efficiencies like Project Double, CORE and LEAD, it continues to face headwinds around its urban product portfolio, capital misallocation risks and risk of high competitive intensity from ITC and Patanjali. After upgrades to our sales/EBIT estimates by 10-13% over FY17-20 due to DBT-related tailwinds, we expect sales/EPS CAGR of 16%/18% over FY15-20E. We see limited upside at CMP. Reiterate SELL with TP of `262 (3% downside; implied FY17E P/E of 31x).


Exhibit 3: Cash flow profiles for Dabur (` mn)


Exhibit 4: Return profiles for Dabur (%)


Exhibit 5: One-year forward P/E bands for Dabur


Exhibit 6: One-year forward EV/EBITDA bands for Dabur


(10,000)

(5,000)

-

5,000

10,000

15,000

20,000

25,000

-

5,000

10,000

15,000

20,000

25,000

30,000

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

CFO Free Cash Flow (RHS)

0%10%20%30%40%50%60%70%80%

0%

10%

20%

30%

40%

50%

60%

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

FY19

E

FY20

E

ROE (LHS) EBITDA MarginEPS Growth YoY Growth in sales

20

25

30

35

40

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

DABUR 1-yr fwd P/E 5-yr avg+1 s.d. -1 s.d.

15

20

25

30

35

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

DABUR 1-yr fwd EV/EBITDA 5-yr avg

+1 s.d. -1 s.d.








Tax rate (%) 28.0

WACC (%) 13.0



Dabur


Summary of our key assumptions and estimates Exhibit 7: Key segmental assumptions


Domestic business Health Supplements sales (`. Mn) 9,629 10,784 12,519 14,657 17,160 19,915 Expect growth to be led by increased penetration and

consumption of Chyawanprash in rural areas and also from Glucose Growth YoY (%) 11.5% 12.0% 16.1% 17.1% 17.1% 16.1%

Digestives sales (`. Mn) 3,210 3,387 3,873 4,427 5,061 5,765 Expect growth of ~14% over FY17-20 led by increased penetration in rural and premiumisation Growth YoY (%) 9.0% 5.5% 14.3% 14.3% 14.3% 13.9%

OTC & Ethicals sales (`. Mn) 4,814 5,214 5,986 6,991 8,166 9,537 Growth to be led by Dabur's increased focus on this

segment through projects such as LEAD Growth YoY (%) 5.7% 8.3% 14.8% 16.8% 16.8% 16.8%

Hair care sales (`. Mn) 12,303 13,893 16,366 19,248 22,603 26,504 Expect market share losses in hair care due to: 1) high competitive intensity, 2) mass positioning and 3) slower growth in the amla segment Growth YoY (%) 11.5% 12.9% 17.8% 17.6% 17.4% 17.3%

Home care sales (`. Mn) 3,210 3,723 4,393 5,272 6,326 7,591 Expect market-led growth in home care with air fresheners and surface cleaners driving growth for the category Growth YoY (%) 12.0% 16.0% 18.0% 20.0% 20.0% 20.0%

Oral Care sales (`. Mn) 7,489 8,451 10,128 12,090 14,400 17,104 Expect growth to be led by Dabur Red and Meswak through premiumisation and increased rural growth Growth YoY (%) 11.5% 12.8% 19.8% 19.4% 19.1% 18.8%

Skin Care sales (`. Mn) 2,675 2,942 3,419 3,973 4,616 5,364 Growth to be led by new product launches and increased penetration Growth YoY (%) 6.4% 10.0% 16.2% 16.2% 16.2% 16.2%

Foods sales (`. Mn) 9,571 11,197 13,640 16,473 19,890 24,011 Expect market-driven growth and share to be maintained despite new entrants in the space driven by the strong brand equity and frequent innovation Growth YoY (%) 19.7% 17.0% 21.8% 20.8% 20.7% 20.7%

Total Domestic sales (`. Mn) 55,158 62,190 73,414 86,903 102,822 121,405

Growth YoY (%) 11.8% 12.7% 18.0% 18.4% 18.3% 18.1%

International business Africa - sales (`.mn) 5,268 5,690 6,600 7,656 8,881 10,302 Expect normalised growth of ~16% as Namaste increases

presence in Africa Growth YoY (%) 17.2% 8.0% 16.0% 16.0% 16.0% 16.0% Middle East - sales (`.mn) 8,933 9,558 11,088 12,862 14,920 17,307 Under-penetration of the portfolio and potential demand

for ayurvedic oral and hair care products to drive growth in Middle East Growth YoY (%) 12.8% 7.0% 16.0% 16.0% 16.0% 16.0%

Asia - sales (`.mn) 3,894 4,283 4,979 5,789 6,729 7,823 Expect ~16% growth by increasing the distribution of its portfolio Growth YoY (%) 13.7% 10.0% 16.3% 16.3% 16.3% 16.3%

USA - sales (`.mn) 3,665 3,909 4,126 4,354 4,596 4,851 Expect only ~5% sales growth as Dabur is likely to increase focus on Africa and Asia than USA Growth YoY (%) -22.2% 6.7% 5.6% 5.6% 5.6% 5.6%

Total International sales (`. Mn) 22,906 24,700 28,204 32,241 36,896 42,265

Growth YoY (%) 7.0% 7.8% 14.2% 14.3% 14.4% 14.6%


Dabur


Risks to our SELL stance Strong rural recovery: A stronger and earlier than expected rural recovery over the next 12 months would lead to stronger sales growth for Dabur.

Significant market share gains on the back of Yoodle launch: Whilst we build in ~80bps market share gain every year over FY16-20 in fruit juices for Dabur, higher share gains due to the success of Yoodle would reduce our downside.

Catalysts Aggressive expansion by peers like Patanjali and ITC: Aggressive expansion by ITC in the fruit juices category and by Patanjali in the OTC, oral care category could hinder the growth prospects of Dabur.

Weak topline and profit growth from 4QFY16: Weak volume growth over 2HFY16 due to weak rural demand and muted profit growth starting 4QFY16 as lower input costs are in the base would act as negative catalysts for the stock.

Ambit vs consensus Exhibit 8: Dabur - Ambit vs Consensus (` mn)



Sales 87,117 101,869 119,420 88,264 101,580 116,921 -1.3% 0.3% 2.1%

EBITDA 15,431 18,298 21,630 16,024 18,758 21,613 -3.7% -2.5% -0.1%

EBITDA margin (%) 17.7% 18.0% 18.1% 18.2% 18.5% 18.5% -44 -50 -37

PBT 15,697 18,699 22,433 16,146 19,122 22,366 -2.8% -2.2% 0.3%

PAT 12,557 14,772 17,498 12,937 15,239 17,727 -2.9% -3.1% -1.3%




Accounting GREEN In the past, Dabur has reported strong cash conversion and working capital management, and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability AMBER Following the reduction in input costs, the predictability of Dabur’s profit margins has reduced.

Earnings Momentum AMBER Dabur’s estimates have been trimmed by less than 5% over the last six months.


Dabur




Shareholders' equity 1,744 1,757 1,757 1,757 1,757


Total networth 26,560 33,541 41,166 49,774 60,079


Preference share capital - - - - -

Debt 7,081 7,336 5,336 3,336 2,547

Deferred tax liability 448 587 587 587 587


Gross block 17,913 19,194 21,194 23,194 25,194

Net block 11,455 12,557 13,291 13,971 14,601

CWIP 217 503 503 503 503

Investments 10,765 18,134 18,134 18,134 18,134


Debtors 6,753 7,108 8,354 9,768 11,451

Inventory 9,723 9,733 10,833 12,667 14,849

Loans & advances 1,566 2,996 1,909 2,233 2,617

Other current assets 1,232 1,057 2,387 2,791 3,272



Provisions 3,110 3,022 4,296 5,024 5,889




Total assets 28,034 35,431 41,056 47,663 57,180





% growth 14.9% 10.3% 11.3% 16.9% 17.2%


EBITDA 11,564 13,163 15,431 18,298 21,630

% growth 12.3% 13.8% 17.2% 18.6% 18.2%

Depreciation 975 1,150 1,266 1,319 1,370

EBIT 10,589 12,013 14,165 16,979 20,260



Adjusted PBT 11,363 13,193 15,696 18,699 22,433

Tax 2,191 2,509 3,139 3,927 4,935


% growth 19.1% 16.5% 17.5% 17.6% 18.5%

Extraordinaries (7) - - - -


Minority Interest (25) (26) - - - Adjusted Consolidated net profit 9,154 10,657 12,557 14,772 17,498


Dabur




EBIT 11,904 13,594 15,982 18,845 22,439

Depreciation 975 1,150 1,266 1,319 1,370

Others (442) (266) (286) (146) (6)

Tax (2,191) (2,509) (3,139) (3,927) (4,935) (Incr) / decr in net working capital 4,644 (1,074) (763) (379) (451)


Capex (2,116) (2,538) (2,000) (2,000) (2,000)

(Incr) / decr in investments (4,446) (7,369) - - -

Others - - - - -

Cash flow from investments (6,562) (9,907) (2,000) (2,000) (2,000)

Net borrowings (4,432) 254 (2,000) (2,000) (789)


Interest paid (542) (401) (286) (146) (6)

Dividend paid (3,570) (4,110) (4,932) (6,165) (7,193)

Others (260) 435 - - -


Net change in cash (476) (2,835) 3,842 5,402 8,430


Free cash flow 12,774 8,357 11,060 13,712 16,417


Ratio Analysis


Gross margin (%) 52.1% 52.5% 53.7% 53.7% 53.7%

EBITDA margin (%) 16.3% 16.8% 17.7% 18.0% 18.1%

EBIT margin (%) 16.8% 17.4% 18.3% 18.5% 18.8%



Net debt: equity (x) 0.3 0.2 0.1 0.1 0.0

Working capital turnover (x) 175.7 53.0 38.9 38.9 38.9


RoCE (%) 28.4% 28.9% 28.8% 29.4% 29.8%

RoE (%) 38.3% 35.5% 33.6% 32.5% 31.9%


Valuation Parameter


EPS (`) 5.2 6.1 7.2 8.5 10.0

Diluted EPS (`) 5.2 6.1 7.2 8.5 10.0



P/E (x) 51.6 44.7 37.6 32.0 27.0

P/BV (x) 17.8 14.1 11.5 9.5 7.9

EV/EBITDA (x) 41.0 36.5 30.7 25.5 21.2

Price/Sales (x) 6.7 6.1 5.5 4.7 4.0



COMPANY INSIGHT NEST IN EQUITY November 03, 2015

Rome is being rebuilt

Nestle’s biggest strengths are leadership in under-penetrated categories and sustainability of competitive advantages in baby foods. However, over the past three years, Nestle has lost share in chocolates, coffee and noodles due to strategic errors and the recent Maggi crisis. The firm is yet to successfully implement steps towards revival, following a change in management; however, current valuations of 50x FY17E P/E do not adequately factor in the earnings drag likely over the next 18 months from fixed costs related to Maggi and a likely rise in A&P spends. Our DCF-based TP of `5,250 implies sector-leading CY16E P/E of 40x with weak earnings-related negative catalysts likely in 2HFY16.

Competitive position: STRONG Changes to this position: NONE Smallest beneficiary of DBT Nestle will be least benefitted by a DBT-induced uptick in rural demand, as: (a) ~70% of sales include premium-positioned products catering to only urban consumers; (b) rural sales (25% of overall revenues) include products like Maggi, Nescafe and Munch which are not utility-based/ functional products. Strong competitive advantages in baby foods, not so in other products Baby foods (>30% of revenues and ~50% of earnings) benefits immensely from: (a) strong nation-wide distribution; (b) connect with pediatricians; (c) WHO’s ban on advertising on baby foods; and (d) strong macro tailwinds given rising population of working women and rising affordability. Whilst the rest of its product portfolio has enjoyed strong brand equity (like Maggi, Nescafe), over the past three years, its non-baby foods portfolio has consistently lost share due to the firm’s focus on driving profitability rather than volumes amidst rising competitive intensity from players like Cadbury’s (chocolates), Ferrero (chocolates), HUL (coffee), and ITC (noodles). Hence, sales CAGR moderated from 22% over CY06-10 to 12% over CY10-14. Maggi revival + change in strategy under new MD = turnaround story? Whilst we expect Maggi Noodles sales to begin from Dec’15, we expect them to reach their CY14 monthly run rate only by 1QCY17. The newly appointed CEO Suresh Narayanan is likely to focus on driving volume growth in the future, with limited intervention from the parent. Whilst this could prove to be a turning point for Nestle, the impact is yet to be felt at the ground level. High-quality franchise but current valuations remain expensive Nestle remains a high-quality franchise due to: (a) Superior working capital management vs peers, (b) Lack of any capital misallocation risk vs domestic peers, and (c) dominant presence in the cash-generative baby foods segment. Hence, the company deserves sector-leading valuations. However, current valuations of 58x/47x CY15E/16E P/E do NOT adequately factor in the earnings related to fixed costs and upcoming brand investments related to Maggi. We estimate sales/EPS CAGR of 8%/12% over CY14-19E with a TP of `5,250, implying 49x/40x CY15/16E P/E.

NestleSELL

Consumer Staples


Flags Accounting: GREEN Predictability: RED Earnings Momentum: RED

Catalysts

Earnings drag from fixed costs related to Maggi during 2HFY16

Sustainably high levels of A&P spends to minimise share loss to ITC in noodles

Performance (%)

Source: Bloomberg, Ambit Capital Research

85

95

105

115

125

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex Nestle

Key financials Year to December CY13 CY14 CY15E CY16E CY17E


EBITDA (` mn) 19,084 19,832 17,621 21,204 25,746

EBITDA Margin (%) 21.1% 20.2% 19.8% 20.9% 22.4%

Adjusted PAT (` mn) 11,033 11,777 10,320 12,624 15,551

Adjusted EPS (`) 114.4 122.1 107.0 130.9 161.3

RoE (%) 53.0% 45.2% 34.4% 37.5% 40.7%

P/E (x) 54.0 50.5 57.7 47.2 38.3


Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA




Nestle


Earnings drag from high fixed costs in the near term Whilst the company reported an exceptional cost of `4.5bn in 2QCY15 relating to the recall of Maggi Noodles, as shown in the exhibit below, we estimate that this included a fixed cost of `1.2bn for the quarter related to Maggi Noodles. We estimate that Nestle would continue to incur this fixed cost for 2HCY15 despite the company being unable to sell Maggi Noodles.

Exhibit 1: We estimate Maggi Noodles has ~`1.2bn of quarterly fixed costs Total exceptional costs reported for 2QCY15 (̀ mn) (A) 4,517

Raw material inventory written off & other recall costs for 2QCY15 (` mn) (B) 1,650

Balance costs (fixed + variable cost of production, `.mn) (C = A-B) 2,867

Key Assumptions Maggi Noodles Gross Margin (%) 50%

Maggi noodles A&P Spends (%, pre-Maggi fiasco) 15%

License fee (%) 4%

Freight charges (%) 5%

Total Maggi Noodles variable costs (%) (D) 74%

Total variable operating costs for the inventory recalled in 2QCY15 (` mn) (E = D*C) 2,134

Fixed costs for sales reversed in 2QCY15 (` mn) (F = C-E) 733

Estimated monthly fixed costs for 3QCY15 (̀ mn) (G) 400

Estimated quarterly fixed costs for 3QCY15 (̀ mn) (H = G*3) 1,200


The drag from these fixed costs is likely to act as a negative catalyst for Nestle’s share price over the next 3-6 months until there is a resumption of sales run-rate of Maggi Noodles to a meaningful extent.

Expect Maggi Noodles to be back on shelves by Dec 2015; Non-Maggi portfolio to report flat sales YoY in CY15

Although the company has resumed production, we believe the company will take another 4 weeks until its gets approvals for these fresh samples from accredited labs. Hence, we assume sales to resume from December 2015. This will be followed by only a gradual increase in sales volume and we expect sales to normalise by 4QCY16, supported by extra A&P spends over the first 12-18 months of sales after the ban is lifted.

Based on the recent management commentary, we expect Nestle’s remaining portfolio to report flat sales growth for CY15 impacted by: (a) rub-off of negative publicity from the Maggi Noodles controversy on the rest of the Maggi brand portfolio and (b) Distraction at the management level as it tries to devote extra energy to revive Maggi Noodles growth.

Exhibit 2: Expect CY15/16 to report Maggi Noodles sales at only 33%/65% of CY14 level

CY14 CY15E CY16E

Total Consolidated Nestle Sales (`. Mn) 98,063 88,865 101,310

YoY Growth (%) 8.2% -9.4% 14.0% Estimated Maggi Sales as % of CY14 sales run-rate 100% 33% 65%

A&P as % of consolidated sales for Nestle 4.5% 6.5% 6.4%

Consolidated EBITDA for Nestle (`. Mn) 19,832 17,621 21,204

EBITDA margin 20.2% 19.8% 20.9%

PAT 11,777 10,320 12,624

YoY Growth (%) 6.7% -12.4% 22.3%


Nestle


Appointment of new CEO could turn things around Nestle’s focus on margins rather than volumes over CY12-13 resulted in a significant slowdown in revenue growth to 9-10% YoY during this period. Nestle has lost market share in coffee to HUL’s Bru Gold and in noodles to ITC’s Yippie Noodles. It also faces intense competitive pressure from Ferrero and Cadbury’s in the chocolates segment.

The newly appointed CEO Suresh Narayanan acknowledges the fact that even before the Maggi controversy, sales growth at Nestle had turned sluggish. Hence, a focus on driving volume growth instead of the margin focus could be expected in the medium term. This should help Nestle regain its lost share.

High-quality franchise but valuations are stretched; retain SELL Nestle is the least benefited from a DBT-induced uptick in rural growth, as most of the company’s portfolio is premium and urban focused. We believe Nestle deserves to trade at a premium to sector valuations due to qualities such as:

Longer-term growth potential due to low penetration levels for its categories and diversification across packaged food categories,

Market domination in cash cow category such as baby foods and nutrition where government regulation against advertising prevents high competitive intensity,

Potential to launch new products by leveraging parents product portfolio,

Efficient working capital management vs its peers, and

Lack of any significant capital misallocation risk unlike GSK Consumer or its domestic FMCG peers.

These qualities ensure longevity of growth for Nestle, thus warranting it premium valuations vs peers. However, at CMP of `6,174, the stock is trading at 47x CY16E P/E (a 44% premium to sector FY17E P/E of 33x), which even after factoring in the depressed earnings for Nestle due to the Maggi fiasco seems very expensive. Our DCF-based TP of `5,250/share (15% downside) implies CY16E P/E of 40x, a 30% premium to the sector-implied FY17E P/E of 31x. We would like to point out that any weakness during the forthcoming results due to high Maggi-related fixed costs could be a good entry point into the stock.

Our WACC assumptions for the DCF-model are summarised in the exhibit alongside (will insert later). The cash flow and return profiles generated our model are shown in the exhibits below.

Nestle


Exhibit 3: Cash flow profiles for Nestle (` mn)


Exhibit 4: Return profiles for Nestle (%)


Exhibit 5: One-year forward P/E bands for Nestle


Exhibit 6: One-year forward EV/EBITDA bands for Nestle


5,000

10,000

15,000

20,000

25,000

30,000C

Y10

CY

12

CY

13

CY

14

CY

15E

CY

16E

CY

17E

CY

18E

CY

19E


0%

20%

40%

60%

80%

100%

120%

0%

5%

10%

15%

20%

25%

30%

CY

10

CY

12

CY

13

CY

14

CY

15E

CY

16E

CY

17E

CY

18E

CY

19E

ROE (RHS) EPS Growth

Sales growth EBITDA Margin

27

32

37

42

47

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

NEST 1-yr fwd P/E 5-yr avg+1 s.d. -1 s.d.

16

19

22

25

28

Oct

-10

Apr

-11

Oct

-11

Apr

-12

Oct

-12

Apr

-13

Oct

-13

Apr

-14

Oct

-14

Apr

-15

Oct

-15

NEST 1-yr fwd EV/EBITDA 5-yr avg+1 s.d. -1 s.d.

Nestle


Summary of our key assumptions and estimates Exhibit 7: Key assumptions and estimates

Contribution to revenues

(CY14) CY14 CY15E CY16E CY17E CY18E CY19E Comments

Profit and loss Milk Products & Nutrition sales (`. Mn) 45.2% 45,752 48,497 54,487 61,799 70,092 79,499 Expect 13% CAGR in the milk products &

nutrition business over CY15-19 led equally by the baby foods and the milk products segments.

Volume growth YoY (%) -2.3% 0.0% 5.0% 6.0% 6.0% 6.0%

Value growth YoY (%) 12.4% 6.0% 12.4% 13.4% 13.4% 13.4%

Beverages sales (`. Mn) 13.2% 13,398 14,068 15,657 17,591 19,764 22,204 Expect 12% CAGR sales as we expect Nescafe to only maintain market share Volume growth YoY (%) -11.0% 0.0% 6.0% 7.0% 7.0% 7.0%

Value growth YoY (%) 1.2% 5.0% 11.3% 12.4% 12.4% 12.4%

Packaged Foods sales (`. Mn) 29.2% 29,613 15,695 19,298 22,093 25,292 28,954 Expect recovery in sales growth over CY17-19 as sales of Maggi revive through CY17 Volume growth YoY (%) 3.7% -50.0% 16.0% 8.0% 8.0% 8.0%

Value growth YoY (%) 9.7% -47.0% 23.0% 14.5% 14.5% 14.5% Chocolate and Confectionery sales (`. Mn) 12.4% 12,532 13,535 15,207 17,087 19,198 21,570 Expect only modest volume growth of 5.5%

as the company is expected to maintain market share in the category

Volume growth YoY (%) -12.1% 0.0% 5.5% 5.5% 5.5% 5.5%

Value growth YoY (%) -2.6% 8.0% 12.4% 12.4% 12.4% 12.4%

Total Sales 101,295 91,795 104,650 118,569 134,346 152,227 Expect 8% sales CAGR over CY14-19E

Growth YoY (%) 8.0% -9.4% 14.0% 13.3% 13.3% 13.3%

Gross Profit 52,823 50,715 58,121 66,196 75,394 85,871 Expect modest gross margin improvement led by premiumisation Gross margin (%) 53.9% 57.1% 57.4% 57.7% 58.0% 58.0%

Employee cost (% of sale) 8.4% 9.4% 9.0% 9.0% 9.0% 9.0% Expect employee costs to remain stable

Advertising (% of sale) 4.5% 6.5% 6.4% 4.9% 4.6% 4.6% Expect advertising spends to be high for CY15-16 but normalise over CY17-19E

Carriage & freight (% of sale) 4.9% 4.6% 4.7% 4.8% 4.8% 4.8% Expect carriage and freight expenses to remain stable

Other expenses (% of sale) 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% Expect other expenses to remain stable

EBITDA 19,832 17,621 21,204 25,746 29,952 34,380 Expect gross margin gains to flow down to EBITDA margin EBITDA Margin 20.2% 19.8% 20.9% 22.4% 23.0% 23.3%

PAT 11,777 10,320 12,624 15,551 18,259 21,127 Expect 12% PAT CAGR over CY14-19E

Growth YoY (%) 6.7% -12.4% 22.3% 23.2% 17.4% 15.7%

Balance Sheet

Capex 1,058 1,000 750 750 750 750 No material capex planned post CY13

Capital Work in Progress 2,448 2,947 2,947 2,947 2,947 2,947

Working Capital days (60) (60) (60) (60) (60) (60) Expect working capital to remain stable

Cash flows (̀ mn)

Operating cash flows 16,313 12,646 18,754 22,259 25,711 29,408 Expect free cash flows to grow strongly as capex is also completed Free cash flows 15,364 11,146 18,004 21,509 24,961 28,658


Nestle


Risks to our SELL stance Strong urban recovery: A stronger than expected urban recovery over the next 6 months would lead to stronger sales growth for Nestle.

Earlier than expected revival on Maggi noodles sales: We expect Maggi sales to begin by end-CY15 with normalisation of sales by CY17. Earlier than expected and a stronger revival is a risk to our SELL stance.

Catalysts Earnings drag from Maggi related fixed costs: We believe Nestle incurs fixed costs of `1bn-1.2bn every quarter for Maggi. This cost will dent the bottomline over 2HCY15 until Maggi sales reach their 2014 monthly run rate.

Sustained high A&P spends by Nestle to counter threat from ITC: Whilst we expect Nestle to increase A&P spends following its re-launch over the next three months, we believe Nestle will have to continue with higher A&P spends for the next 12 months in order to take back market share lost to ITC during the ban period. This would impact EBITDA margins in CY16.

Change in estimates Exhibit 8: Change in estimates for Nestle over CY15-17

New Old %Change

CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E

Target Price (`.) 5,250 5,050 4%

Sales 88,865 101,310 114,786 97,426 110,522 124,116 -9% -8% -8%

Gross Margin % 57.1% 57.4% 57.7% 55.6% 56.2% 56.5% 150 120 120

EBITDA 17,621 21,204 25,746 18,560 24,260 27,369 -5% -13% -6%

PAT 10,320 12,624 15,551 10,949 14,672 16,638 -6% -14% -7%

EPS (`.) 107 131 161 107 129 157 0% 2% 3%


Ambit vs consensus Exhibit 9: Nestle - Ambit vs Consensus

Ambit Consensus %Var

CY15E CY16E CY17E CY15E CY16E CY17E CY15E CY16E CY17E

Sales 88,865 101,310 114,786 91,384 108,719 123,447 -3% -7% -7%

EBITDA 17,621 21,204 25,746 18,848 23,244 27,730 -7% -9% -7%

EBITDA margin (%) 19.8% 20.9% 22.4% 20.6% 21.4% 22.5% (80) (45) (3)

PAT 10,320 12,624 15,551 10,407 13,926 16,791 -1% -9% -7%

EPS (`.) 107 131 161 114 140 168 -6% -6% -4%




Accounting GREEN In the past, Nestlé has reported excellent cash conversion, efficient management of working capital, and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability RED Following the ban on Maggi noodles in Jun’15, Nestle’s financials have shown high volatility.

Earnings Momentum RED Due to the ban on Maggi noodles (~25% of sales) since Jun’15, estimates for Nestle have been cut by >5% over the last 6 months.


Nestle



Year to December CY13 CY14 CY15E CY16E CY17E



Total networth 23,688 28,372 31,586 35,749 40,583


Debt 11,895 196 - - -

Deferred tax liability 2,155 2,227 2,227 2,227 2,227


Gross block 49,032 50,090 51,090 51,840 52,590

Net block 33,693 31,766 29,053 25,719 21,977

CWIP 2,947 2,448 2,947 2,947 2,947

Goodwill - - - - -

Investments 8,511 8,118 8,118 8,118 8,118


Debtors 843 991 974 1,110 1,258

Inventory 7,359 8,441 7,547 8,604 9,749

Loans & advances 2,258 1,820 1,948 2,221 2,516

Other current assets 38 152 - - -



Provisions 14,073 16,017 13,391 15,266 17,296


Net current assets (7,414) (11,537) (6,306) 1,191 9,769

Total assets 37,737 30,795 33,813 37,976 42,810





% growth 9.1% 8.2% -9.4% 14.0% 13.3%


EBITDA 19,084 19,832 17,621 21,204 25,746

% growth 6.4% 3.9% -11.1% 20.3% 21.4%

Depreciation 3,300 3,375 3,713 4,084 4,493

EBIT 15,785 16,457 13,909 17,119 21,253

Interest expenditure 365 142 30 - -


Adjusted PBT 16,642 17,674 15,403 18,841 23,211

Tax 5,609 5,897 5,083 6,218 7,659


% growth 3.3% 6.7% -12.4% 22.3% 23.2%

Extraordinaries 138 70 - - -






Nestle




EBIT 17,007 17,816 15,433 18,841 23,211

Depreciation 3,300 3,375 3,713 4,084 4,493

Others 169 (70) (30) - -

Tax (5,609) (5,897) (5,083) (6,218) (7,659)

(Incr) / decr in net working capital 3,513 1,088 (1,388) 2,046 2,215


Capex (4,456) (949) (1,499) (750) (750)

(Incr) / decr in investments (4,862) 393 - - -

Others - - - - -

Cash flow from investments (9,318) (557) (1,499) (750) (750)

Net borrowings 1,393 (11,699) (196) - -

Interest paid 365 142 30 - -

Dividend paid (5,471) (7,107) (7,107) (8,460) (10,717)

Others (224) (128) (30) - -


Net change in cash 5,124 (3,035) 3,844 9,543 10,792


Free cash flow 13,923 15,364 11,146 18,004 21,509


Ratio Analysis


Gross margin (%) 54.5% 53.9% 57.1% 57.4% 57.7%

EBITDA margin (%) 21.1% 20.2% 19.8% 20.9% 22.4%

EBIT margin (%) 18.8% 18.2% 17.4% 18.6% 20.2%



Net debt: equity (x) 0.2 (0.2) (0.3) (0.5) (0.7)



RoCE (%) 33.2% 34.6% 32.0% 35.2% 38.5%

RoE (%) 53.0% 45.2% 34.4% 37.5% 40.7%


Valuation Parameter


EPS (`) 114.4 122.1 107.0 130.9 161.3

Diluted EPS (`) 114.4 122.1 107.0 130.9 161.3



P/E (x) 54.0 50.5 57.7 47.2 38.3

P/BV (x) 25.1 21.0 18.8 16.7 14.7

EV/EBITDA (x) 31.4 29.8 33.3 27.2 22.0

Price/Sales (x) 6.6 6.1 6.7 5.9 5.2



COMPANY INSIGHT SKB IN EQUITY November 03, 2015

Running out of steam

GSK Consumer benefits from its strong foothold in milk food drinks (MFD) in south and east, widening rural distribution reach, and strength of Sensodyne in oral care through its chemist channel. However, the firm faces headwinds around: (a) market share saturation in south and east; (b) intense competition from peers like Abbott and Complan in north and west; and (c) ROCE dilution given capital misallocation risks (`23bn of surplus cash on the balance sheet). As a result, we forecast 15%/17% sales/EPS CAGR over FY15-20E and average RoCE of ~30% over this period with a DCF-based TP of `5,745 (4% downside; 31x implied FY17E P/E).

Competitive position: STRONG Changes to this position: POSITIVE Beneficiary of increased rural spends on packaged foods following DBT Although incremental rural spends on packaged foods will lag behind spends on packaged foods, we expect categories like biscuits and heath food drinks (HFD) to face a sizeable tailwind after the DBT implementation. GSK Consumer is likely to benefit the most in HFD due to: (a) dominant positioning with ~60% market share; (b) increasing rural distribution (current reach of 27,000 villages vs 16,000 in FY14); and (c) consumer connect programmes such as Horlicks Swasthya Abhiyan (HSA). As a result, we expect sales to accelerate to 15% CAGR over FY15-20E vs 10% over FY14-16E. Headwinds from growth saturation in S&E and competition in N&W GSK derives >80% of its sales from South & East India where it holds ~75% market share (vs ~30% in North & West India) in the Malt-based Food Drinks (MFD) category. GSK faces possible growth moderation due to: (a) market share saturation in MFD in S&E India, (b) Weak presence in premium MFD with rising competitive intensity from peers such as Abbott; and (c) GSK’s inability to counter Complan’s threat in brown powder MFD in North & West. Risks around capital misallocation given over `23bn surplus cash GSK has accumulated `23bn cash on its balance sheet by maintaining a low dividend payout ratio. Given the unsuccessful past attempts at diversifying beyond the MFD segment, the surplus cash would either remain unutilised or be deployed towards M&As and hence is likely to result in meaningful dilution in RoCE for the firm. Positives fully priced in; retain SELL with TP of `5,745 We have increased our sales/EBIT estimates over FY17-20 by 8-11% to factor in the impact of higher rural spends. Whilst we appreciate the sales growth potential from increased rural spends, given headwinds from growth moderation and possible RoCE dilution, we do not see significant upside from current valuations of 38x/32x FY16E/17E P/E. We factor in sales/EPS CAGR of 15%/17% over FY15-20E with a DCF-based TP of `5,745 (4% downside), implying FY16E/17E P/E of 36x/31x.

GSK ConsumerSELL

Consumer Staples



Catalyst

Lack of market share gains in north and west given high competitive intensity

Weak YoY earnings growth in 4QFY16 once input cost benefits are in the base

Performance (%)

Source: Bloomberg, Ambit Capital Research

85

95

105

115

125

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Sensex GSK CH

Key financials Year to March (̀ mn) FY14 FY15 FY16E FY17E FY18E


EBITDA (` mn) 6,871 5,589 6,780 8,196 9,684

EBITDA Margin (%) 14.7% 13.5% 14.8% 15.4% 15.6%

Adjusted PAT (` mn) 6,747 5,836 6,686 7,800 9,035

Adjusted EPS (`) 160.4 138.8 159.0 185.5 214.8

RoE (%) 42.5% 29.7% 29.1% 28.9% 28.6%

P/E (x) 37.3 43.2 37.7 32.3 27.9


Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201

[email protected]

Ritesh Vaidya, CFA




GSK Consumer


Summary of our key assumptions and estimates Exhibit 1: Key assumptions and estimates


Profit and loss Milk Food Drinks (Sales `. Mn) 41,258 45,772 53,550 62,621 73,197 85,523 Growth to be led by market share gains of

>100bps every year over FY16-20 Growth (%) 10.2% 10.9% 17.0% 16.9% 16.9% 16.8%

Biscuits and Oats 2,341 2,441 2,699 2,984 3,300 3,649 Expected to grow below category growth due to lack of competitive advantage for GSK Consumer Growth (%) 4.7% 6.7% 10.6% 10.6% 10.6% 10.6%

Gross revenues 43,599 48,213 56,249 65,605 76,497 89,173 Growth (%) 10.4% 10.6% 16.7% 16.6% 16.6% 16.6% Gross Profit 26,373 29,942 35,039 40,930 47,797 55,802 Minimal gross margin expansion due to very slow

premiumisation in MFD category Gross margin (%) 63.8% 65.5% 65.7% 65.8% 65.9% 66.0%

Employee cost (% of sale) 10.4% 10.4% 10.4% 10.4% 10.4% 10.4%

Expect costs to remain stable

Advertising (% of sale) 17.3% 17.3% 17.2% 17.2% 17.2% 17.2%

Carriage & Freight (% of sale) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%

Royalty (% of sale) 3.2% 3.4% 3.4% 3.4% 3.4% 3.4%

Other expenses (% of sale) 14.3% 14.5% 14.3% 14.2% 14.2% 14.2%

EBITDA 5,589 6,780 8,196 9,684 11,364 13,332 Gross margin gains flow into EBITDA

EBITDA Margin 13.5% 14.8% 15.4% 15.6% 15.7% 15.8%

Other Income 3,930 4,157 4,512 4,965 5,834 6,797 Other income growth to be led by a CAGR of 16% in auxiliary commissions, 7% in interest income and 6% in miscellaneous income over FY15-20 Growth (%) 0.1% 5.8% 8.5% 10.0% 17.5% 16.5%


Growth (%) 8.1% 14.6% 16.7% 15.8% 18.1% 18.3%

Balance Sheet Capex 2,047 1,800 1,500 1,000 1,000 1,000 No material capex planned over FY15-20

Working Capital days (73) (65) (65) (65) (65) (65) Expect working capital days to be stable

Cash flows (̀ mn) Operating cash flows 9,589 7,335 9,950 11,463 13,411 15,614 FCF to materially improve over FY15-20 due to no

material capex Free cash flows 7,411 5,535 8,450 10,463 12,411 14,614


Risks to our SELL stance Strong urban and rural recovery: A stronger and sooner than expected urban and rural recovery over the next 12 months would lead to stronger sales growth for GSK Consumer. Margin gains from premiumisation: If GSK is able to drive premiumisation in the MFD category then it would impact margins positively thus reducing our downside on the stock.

Catalysts Lack of market share gains in North and West India: GSK faces high competitive intensity from brown powder MFD drinks such as Complan in North & West India. Also, the company faces competition from Abbott at the premium end of MFD category. This we believe should limit market share gains for GSK in North & West India.

Weak topline and profit growth from 4QFY16: Weak volume growth over 2HFY16 due to weak rural demand and muted profit growth starting 4QFY16, as lower input costs are in the base, which would act as negative catalysts for the stock.

GSK Consumer


Change in estimates Exhibit 2: Change in estimates for GSK Consumer over FY16-18 (` mn)

New Old Ch%


TP 5,745 5,150 12%

Sales 45,742 53,366 62,243 45,742 51,886 59,190 0.0% 2.9% 5.2%

EBITDA 6,780 8,196 9,684 6,780 7,917 9,090 0.0% 3.5% 6.5%

EBITDA margin (%) 14.8% 15.4% 15.6% 14.8% 15.3% 15.4% 0 10 20

PBT 10,207 11,909 13,795 10,035 11,281 12,694 1.7% 5.6% 8.7%

PAT 6,686 7,800 9,035 6,573 7,389 8,314 1.7% 5.6% 8.7%

EPS 159.0 185.5 214.8 156.3 175.7 197.7 1.7% 5.6% 8.7%


Ambit vs consensus Exhibit 3: GSK Consumer - Ambit vs Consensus (` mn)



Sales 45,742 53,366 62,243 46,750 54,077 61,320 -2.2% -1.3% 1.5%

PBT 10,207 11,909 13,795 10,702 12,647 14,650 -4.6% -5.8% -5.8%

PAT 6,686 7,800 9,035 7,044 8,295 9,649 -5.1% -6.0% -6.4%

EPS 159.0 185.5 214.8 167.2 196.8 229.4 -4.9% -5.8% -6.3%




Accounting GREEN In the past, GSK has reported excellent cash conversion, efficient management of working capital, and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to its accounting quality.

Predictability AMBER Following the reduction in input costs, the predictability of GSK Consumer’s profit margins has reduced

Earnings Momentum AMBER GSK Consumer’s estimates have been trimmed by less than 5% over the last six months


GSK Consumer


Balance Sheet

Year to March (̀ mn) FY14 FY15 FY16E FY17E FY18E



Total networth 18,128 21,130 24,874 29,143 34,060


Debt - - - - -

Deferred tax liability (903) (1,043) (1,043) (1,043) (1,043)


Gross block 8,546 10,593 12,393 13,893 14,893

Net block 3,399 4,917 5,995 6,703 6,856

CWIP 385 423 423 423 423

Investments - - - - -


Debtors 2,993 3,134 1,629 1,901 2,217

Inventory 4,074 4,663 5,639 6,579 7,674

Loans & advances 2,643 1,610 1,629 1,901 2,217

Other current assets 1,329 1,440 627 731 853



Provisions 3,940 6,027 5,138 5,995 6,992




Total assets 17,225 20,087 23,830 28,100 33,016


Income statement



% growth 52.1% 10.4% 10.6% 16.7% 16.6%


EBITDA 6,871 5,589 6,780 8,196 9,684

% growth 47.7% -18.7% 21.3% 20.9% 18.2%

Depreciation 625 621 723 792 847

EBIT 6,246 4,968 6,057 7,404 8,837



Adjusted PBT 10,161 8,891 10,207 11,909 13,795

Tax 3,413 3,055 3,521 4,109 4,759


% growth 54.5% -13.5% 14.6% 16.7% 15.8%

Extraordinaries - - - - -





GSK Consumer


Cash Flow statement


EBIT 10,171 8,899 10,214 11,916 13,802

Depreciation 625 621 723 792 847

Others (297) (148) (7) (7) (7)

Tax (3,413) (3,055) (3,521) (4,109) (4,759) (Incr) / decr in net working capital (614) 3,273 (73) 1,358 1,581


Capex (498) (2,178) (1,800) (1,500) (1,000)

(Incr) / decr in investments - - - - -

Others - - - - -

Cash flow from investments (498) (2,178) (1,800) (1,500) (1,000)



Interest paid 11 7 7 7 7

Dividend paid (2,207) (2,697) (2,942) (3,531) (4,119)

Others (33) (145) (7) (7) (7)


Net change in cash 3,745 4,577 2,593 4,919 6,344


Free cash flow 5,974 7,411 5,535 8,450 10,463


Ratio Analysis


Gross margin (%) 62.9% 63.8% 65.5% 65.7% 65.8%

EBITDA margin (%) 14.7% 13.5% 14.8% 15.4% 15.6%

EBIT margin (%) 21.7% 21.5% 22.3% 22.3% 22.2%



Net debt: equity (x) (1.0) (1.1) (1.0) (1.0) (1.1)



RoCE (%) 44.7% 31.3% 30.5% 30.1% 29.6%

RoE (%) 42.5% 29.7% 29.1% 28.9% 28.6%


Valuation Parameter


EPS (`) 160.4 138.8 159.0 185.5 214.8

Diluted EPS (`) 160.4 138.8 159.0 185.5 214.8



P/E (x) 37.5 43.4 37.9 32.4 28.0

P/BV (x) 14.0 12.0 10.2 8.7 7.4

EV/EBITDA (x) 34.2 41.2 33.6 27.2 22.3

Price/Sales (x) 5.4 6.1 5.5 4.7 4.1


GSK Consumer


Annexure 1: Takeaways from our rural visit Earlier this year, we visited a small village in the interiors of Maharashtra (Sinchher-Vandana village, located in Satara district) in a bid to understand the staples consumption trends demographics of this part of the country.

Village: Sinchhre Vandana (~9km from Satara city centre)

Population: 3,500 (500-550 households)

Average income level: Rs45,000-50,000 per household

Primary occupation: Farming (average land holding is 1-1.5 acre) and Armed Forces

Evolution of the village (25 years ago) Irrigation facilities brings about prosperity for the village

The Krishna river is the main source of water from which canals were created in the late-80s. Almost 75-80% of the village farm lands are irrigated through these canals. Irrigation has been the key reason for prosperity of this village. As the region is a part of the sugarcane belt, sugarcane is the primary crop grown over here. Regular water supply allowed farmers to invest in fertilisers which increased the productivity of their land, thus further increasing their earnings.

Due to its proximity to an industrial area, villagers also sought employment in factories in the surrounding areas.

This village surely was not a normal village but seemed to be in the top 10% of Indian villages. Income levels were moderately high and everyone seemed to have basic education at least. This is how other villages would look 5-6 years in the future. (15-20 years ago) Educated younger generation supplementing household income

Education has been of utmost importance in this village and so with the increase in income levels, families started educating the younger generation. As the younger generation was educated, they pursued employment opportunities outside of agriculture and further supplemented the household income. (15 years ago) Consumerism sets in

The sustainable increase in income levels primarily due to the creation of irrigation facilities has led to increased consumerism. From just one TV across 6-7 households 15 years ago, TV penetration also increased and now every household has a television set. Whilst 15 years ago, ownership of a cycle was considered a big deal, now every household has a 2-wheeler. Several families have also purchased 4-wheelers for personal use and have also purchased commercial vehicles to supplement farm income. Our discussions clearly pointed to the fact that the rural consumer is a very cost-conscious user trying to derive the maximum bang for his buck. (Current situation) Children = Lux, Parents = Lifebuoy

TV advertising has largely influenced consumer behaviour in the village. Increasing income levels and exposure to TV adverts led to the adoption of bathing soaps. The germ-killing ability of Lifebuoy has led to blind adoption of this soap as a bathing soap particularly among farmers. However, the younger generation has shown a liking for Lux after watching its TV adverts. Possibly this generation is influenced by the use of film stars in Lux commercials and also the fragrance of this soap. The older generation recommends Lifebuoy as it lasts longer whilst Lux finishes faster. The per

Consumer Staples

GSK Consumer


capita use of soaps has increased over the last 5-6 years due to increased frequency and more liberal use of soap. Increasing use of shampoo – but using only sachets

Consumers are increasingly using shampoos, particularly amongst the younger generation. However, the frequency is low and they use only sachets. The logic of using sachets is it allows controlled use unlike bottles where over-use happens. Such is the craze to use shampoo among the current generation that some children use one sachet sparingly over 2-3 days. Sunsilk is the staple shampoo, with Dove being a very aspirational brand. Surprisingly, my single point of contaact in the village thought that Dove has only been recently launched, pointing to the gap in consumer awareness between rural and urban. Per capita use of shampoos is also increasing due to increased frequency of use. We know only Colgate!!

If we cannot convince the adults then let’s start with the children. By distributing free toothbrush and toothpaste to students in classes 1-7 and incentivising them to brush twice a day, Colgate has instilled the habit of brushing teeth among the villagers. Looking at their children brush regularly, even the parents have started brushing their teeth using toothpaste. Whilst five years ago a family would buy the smallest SKU of Colgate Dental Cream, they now buy the 100gm tube every month as all members are brushing even more regularly. Some college-goers reported using Close Up due to its freshness credentials. Detergents – Several brands battling it out

Detergents are being used by all households mostly in the bar format and to a lesser extent in the powder format. However, unlike in soaps where HUL has a clear leadership, detergents is hard-fought battleground with several brands in the fray – Rin, Wheel, Ghadi and Nirma. All brands seemed to have their set of loyal customers. Very few sachets of Tide were seen in Kirana stores. Fair & Lovely – Present in every household!!

This trip made us realise how big a brand FAL is. Every household was reporting the use of FAL, not only by the younger generation but also the older generation. Ponds Talcum powder is being used in several households. Hair oil was only Parachute coconut oil. Packaged foods – Usual suspects here

Consumers have been buying Red Label tea in case of packaged tea. Parle (20-20 cookies were a hit) mostly in case of biscuits, was popular and to a lesser extent Britannia. HUL – Part of the social fabric

With the bouquet of products that HUL offers, it virtually owns the branded FMCG products market in a village – soaps, detergents, shampoo, skin cream, powder and tea. Within each category it offers different brands straddling the price pyramid. It undertakes consumer awareness programmes under various brands, does wall painting and reaches out to school children to catch them young. Penetration done…frequency next driver…then it shall be premiumisation

Several FMCG products are now readily available and are being consumed by villagers, indicating that penetration is less of a driver of FMCG growth going ahead. As the younger generation start earning their own livelihood working, the frequency of use of several FMCG products will increase. Also due to their aspirations, there will be growing demand for premium products. This also has to be facilitated by continued strong macro growth particularly led by the rural areas.

Consumer Staples

GSK Consumer


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Abhishek Ranganathan, CFA Retail / Mid-caps (022) 30433085 [email protected]

Achint Bhagat, CFA Cement / Roads / Home Building (022) 30433178 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Kushank Poddar Technology (022) 30433203 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar, CFA Metals & Mining (022) 30433223 [email protected]

Prashant Mittal, CFA Derivatives (022) 30433218 [email protected]

Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected]

Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected]

Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

Singapore

Pramod Gubbi, CFA – Director Singapore +65 8606 6476 [email protected]

Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction











































GSK Consumer


Hindustan Unilever Ltd (HUVR IN, BUY)


Nestle India Ltd (NEST IN, SELL)


Dabur India Ltd (DABUR IN, SELL)


Godrej Consumer Products Ltd (GCPL IN, SELL)


0200400600800

1,0001,200

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

HINDUSTAN UNILEVER LTD

01,0002,0003,0004,0005,0006,0007,0008,000

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

NESTLE INDIA LTD

050

100150200250300350

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

DABUR INDIA LTD

0

500

1,000

1,500

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

GODREJ CONSUMER PRODUCTS LTD

GSK Consumer


Colgate Palmolive (India) (CLGT IN, SELL)


Marico Ltd (MRCO IN, BUY)


Britannia Industries Ltd (BRIT IN, SELL)


Glaxosmithkline Consumer (SKB IN, SELL)


0200400600800

1,0001,200

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

COLGATE PALMOLIVE (INDIA)

0

100

200

300

400

500

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

MARICO LTD

0

1,000

2,000

3,000

4,000

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

BRITANNIA INDUSTRIES LTD

01,0002,0003,0004,0005,0006,0007,000

Oct

-12

Dec

-12

Feb-

13

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

GLAXOSMITHKLINE CONSUMER HEA

GSK Consumer


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock Disclaimer

This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities is available on request.

Disclaimer

1. AMBIT Capital Private Limited (“AMBIT Capital”) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI

2. AMBIT Capital makes best endeavours to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes to be reliable. However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions, views expressed in this Research Report are those of the research analyst as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

3. This Research Report should be read and relied upon at the sole discretion and risk of the recipient. If you are dissatisfied with the contents of this complimentary Research Report or with the terms of this Disclaimer, your sole and exclusive remedy is to stop using this Research Report and AMBIT Capital or its affiliates shall not be responsible and/ or liable for any direct/consequential loss howsoever directly or indirectly, from any use of this Research Report.

4. If this Research Report is received by any client of AMBIT Capital or its affiliate, the relationship of AMBIT Capital/its affiliate with such client will continue to be governed by the terms and conditions in place between AMBIT Capital/ such affiliate and the client.

5. This Research Report is issued for information only and the 'Buy', 'Sell', or ‘Other Recommendation’ made in this Research Report such should not be construed as an investment advice to any recipient to acquire, subscribe, purchase, sell, dispose of, retain any securities and should not be intended or treated as a substitute for necessary review or validation or any professional advice. Recipients should consider this Research Report as only a single factor in making any investment decisions. This Research Report is not an offer to sell or the solicitation of an offer to purchase or subscribe for any investment or as an official endorsement of any investment.

6. This Research Report is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied in whole or in part, for any purpose. Neither this Research Report nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country including United States (to US Persons), Canada or Japan or to any resident thereof. The distribution of this Research Report in other jurisdictions may be strictly restricted and/ or prohibited by law or contract, and persons into whose possession this Research Report comes should inform themselves about such restriction and/ or prohibition, and observe any such restrictions and/ or prohibition.

7. Ambit Capital Private Limited is registered as a Research Entity under the SEBI (Research Analysts) Regulations, 2014.

Conflict of Interests

8. In the normal course of AMBIT Capital’s business circumstances may arise that could result in the interests of AMBIT Capital conflicting with the interests of clients or one client’s interests conflicting with the interest of another client. AMBIT Capital makes best efforts to ensure that conflicts are identified and managed and that clients’ interests are protected. AMBIT Capital has policies and procedures in place to control the flow and use of non-public, price sensitive information and employees’ personal account trading. Where appropriate and reasonably achievable, AMBIT Capital segregates the activities of staff working in areas where conflicts of interest may arise. However, clients/potential clients of AMBIT Capital should be aware of these possible conflicts of interests and should make informed decisions in relation to AMBIT Capital’s services.

9. AMBIT Capital and/or its affiliates may from time to time have or solicit investment banking, investment advisory and other business relationships with companies covered in this Research Report and may receive compensation for the same.

Additional Disclaimer for U.S. Persons

10. The research report is solely a product of AMBIT Capital 11. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 12. Any subsequent transactions in securities discussed in the research reports should be effected through Enclave Capital LLC. (“Enclave”). 13. Enclave does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports. 14. The research analyst(s) preparing the email / Research Report/ attachment is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that

therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

15. This report is prepared, approved, published and distributed by the Ambit Capital located outside of the United States (a non-US Group Company”). This report is distributed in the U.S.by Enclave Capital LLC, a U.S. registered broker dealer, on behalf of Ambit Capital only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through Enclave Capital LLC (19 West 44th Street, suite 1700, New York, NY 10036).

16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securities. 17. This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information

contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

Additional Disclaimer for Canadian Persons

18. AMBIT Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities and/or to provide advice with respect to securities. 19. AMBIT Capital's head office or principal place of business is located in India. 20. All or substantially all of AMBIT Capital's assets may be situated outside of Canada. 21. It may be difficult for enforcing legal rights against AMBIT Capital because of the above. 22. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2

Canada. 23. Name and address of AMBIT Capital's agent for service of process in the Province of Montréal is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada.

Additional Disclaimer for Singapore Persons 24. This Report is prepared and distributed by Ambit Capital Private Limited and distributed as per the approved arrangement under Paragraph 9 of Third Schedule of Securities and Futures Act (CAP

289) and Paragraph 11 of the First Schedule to the Financial Advisors Act (CAP 110) provided to Ambit Singapore Pte. Limited by Monetary Authority of Singapore. 25. This Report is only available to persons in Singapore who are institutional investors (as defined in section 4A of the Securities and Futures Act (Cap. 289) of Singapore (the “SFA”).” Accordingly, if a

Singapore Person is not or ceases to be such an institutional investor, such Singapore Person must immediately discontinue any use of this Report and inform Ambit Singapore Pte. Limited.

Disclosure 26. Ambit and/or its associates have financial interest in ITC.

Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

Ambit Capital Pvt. Ltd. Ambit House, 3rd Floor. 449, Senapati Bapat Marg, Lower Parel, Mumbai 400 013, India. Phone: +91-22-3043 3000 | Fax: +91-22-3043 3100 CIN: U74140MH1997PTC107598 www.ambitcapital.com

http://www.ambitcapital.com

Documents

CONSUMER STAPLES - Ambitreports.ambitcapital.com/reports/Ambit_Consumer_Thematic_DBTOport... · and admin cost Case study on how ... Colgate and Dabur are likely to be the biggest