154
June 04, 2013 Consumer Staples SECTOR INITIATION 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 consider this report as only a single factor in making their investment decision. Please refer to disclaimer section on the last page for further important disclaimer. Summary valuation table Company Comptt. Mapping Rating CMP (Rs) Mcap (US$bn) Target Price (Rs) Upside/ Downside P/E (FY14E) P/E (FY15E) Implied P/E (FY14) EPS CAGR (FY08-13) EPS CAGR (FY13-15) ROE (FY13) GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35% Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70% Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107% Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23% HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103% Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40% GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23% Median 37.2 32.8 31.6 18% 15% Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15 Analyst contacts Rakshit Ranjan, CFA Tel: +91 22 3043 3201 [email protected] Shariq Merchant Tel .: +91 22 3043 3246 [email protected] Trade off between defensiveness v/s valuations for discretionary and staples 0% 10% 20% 30% 40% 20 30 40 EPS CAGR (FY13-15) P/E FY14 BATA TTKPT APNT GCPL TTAN MRCO DABUR BRGR PIDI HUVR CLGT JUBI SKB NEST ITC Source: Bloomberg, Ambit Capital research Note: Bubble size indicates level of defensiveness; Our competitive advantage framework (see page 12) I – Capital deployment (a) Returns on deployment initiatives followed over the past decade; (b) Deployment strategy for future II – Product portfolio positioning (a) Width and depth of portfolio; (b) Category growth for the portfolio; (c) Competition displacement capability (in terms of market share in relevant product categories) III – Near term raw material cost benefits The ’party‘ is over The current valuations of FMCG stocks—37.2x one-year forward P/E, at ~35% premium to their historical three-year averages—do not reflect the likely moderation in earnings growth in the near term (to 15% EPS CAGR over FY13-15E from 18% EPS CAGR over FY08-13). Whilst we do not doubt the secular growth trend of the Indian consumption story, the rising competitive intensity and saturating penetration in few product categories would adversely affect the earnings growth and valuations of FMCG firms. Lack of further softening in raw material costs is a near- term negative catalyst for these companies. We advise investors to SELL the frontline FMCG stocks (excl ITC, NOT RATED) and invest in discretionary consumer stories (such as TTK and Asian Paints) owing to the latter’s relatively higher EPS growth and cheaper valuations. Deflating growth rates for staples companies: Penetration levels (at 80- 90%) are approaching saturation levels in product categories such as oral care, soaps, detergents, skin creams and hair oils. Furthermore, competitive intensity is rising quickly (owing to new entrants and promotion-led push from incumbents) in categories such as oral care, chocolates, noodles, premium edible oils and cosmetics. Thus, revenue growth could moderate (to 15% over FY13-15 vs 19% over FY08-13) and EBITDA margins could contract, thereby pulling down the EPS CAGR (by 500bps over FY13-15 vs FY08-13) for the frontline FMCG stocks covered in this note (HUL, Nestle, Colgate, Marico, GCPL, Dabur, and GSK Consumer). HUL and Nestle better placed than the rest: HUL and Nestle are the best placed in the FMCG sector, given HUL’s ability to leverage on its size to ride a wave of consumption evolution across most product categories and Nestle’s dominant presence in less-penetrated, rapidly-growing and entry-level aspirational categories. HUL’s and Nestle’s consistent strategy of dividend payouts/share buybacks alongside consistent reinvestment into the core business give them a further edge over competition. Colgate, Marico, GCPL, Dabur and GSK Consumer are intermediately placed. No more support for punchy valuations: Given punchy valuations, we initiate coverage with a SELL stance on each of these stocks. Our DCF-based valuation implies a 10-30% downside for most (as we model near-term earnings estimates factoring in lower growth and more importantly no more softening in raw material costs). We believe investors should move their consumption-focused investments to discretionary consumption stocks in paints, light electricals and apparel, as the rising disposable incomes in India would increase the depth and breadth of consumption to newer categories. We recommend investors to switch into high-quality discretionary names like Asian Paints, TTK Prestige and Bata.

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Page 1: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

June 04, 2013

Consumer Staples SECTOR INITIATION

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 consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Summary valuation table

Company Comptt.

Mapping Rating

CMP (Rs)

Mcap (US$bn)

Target Price (Rs)

Upside/ Downside

P/E (FY14E)

P/E (FY15E)

Implied P/E (FY14)

EPS CAGR (FY08-13)

EPS CAGR (FY13-15)

ROE (FY13)

GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%

Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%

Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%

Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%

HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%

Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%

GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%

Median 37.2 32.8 31.6 18% 15%

Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15

Analyst contacts

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

Shariq Merchant Tel .: +91 22 3043 3246 [email protected]

Trade off between defensiveness v/s valuations for discretionary and staples

0%

10%

20%

30%

40%

20 30 40

EPS

CA

GR

(FY1

3-1

5)

P/E FY14

BATA

TTKPTAPNT

GCPL

TTAN

MRCO

DABUR

BRGR

PIDI

HUVR

CLGT

JUBI

SKB

NEST

ITC

Source: Bloomberg, Ambit Capital research Note: Bubble size indicates level of defensiveness; Our competitive advantage framework (see page 12)

I – Capital deployment

(a) Returns on deployment initiatives followed over the past decade;

(b) Deployment strategy for future

II – Product portfolio positioning

(a) Width and depth of portfolio;

(b) Category growth for the portfolio;

(c) Competition displacement capability (in terms of market share in relevant product categories)

III – Near term raw material cost benefits

The ’party‘ is over The current valuations of FMCG stocks—37.2x one-year forward P/E, at ~35% premium to their historical three-year averages—do not reflect the likely moderation in earnings growth in the near term (to 15% EPS CAGR over FY13-15E from 18% EPS CAGR over FY08-13). Whilst we do not doubt the secular growth trend of the Indian consumption story, the rising competitive intensity and saturating penetration in few product categories would adversely affect the earnings growth and valuations of FMCG firms. Lack of further softening in raw material costs is a near-term negative catalyst for these companies. We advise investors to SELL the frontline FMCG stocks (excl ITC, NOT RATED) and invest in discretionary consumer stories (such as TTK and Asian Paints) owing to the latter’s relatively higher EPS growth and cheaper valuations. Deflating growth rates for staples companies: Penetration levels (at 80-90%) are approaching saturation levels in product categories such as oral care, soaps, detergents, skin creams and hair oils. Furthermore, competitive intensity is rising quickly (owing to new entrants and promotion-led push from incumbents) in categories such as oral care, chocolates, noodles, premium edible oils and cosmetics. Thus, revenue growth could moderate (to 15% over FY13-15 vs 19% over FY08-13) and EBITDA margins could contract, thereby pulling down the EPS CAGR (by 500bps over FY13-15 vs FY08-13) for the frontline FMCG stocks covered in this note (HUL, Nestle, Colgate, Marico, GCPL, Dabur, and GSK Consumer). HUL and Nestle better placed than the rest: HUL and Nestle are the best placed in the FMCG sector, given HUL’s ability to leverage on its size to ride a wave of consumption evolution across most product categories and Nestle’s dominant presence in less-penetrated, rapidly-growing and entry-level aspirational categories. HUL’s and Nestle’s consistent strategy of dividend payouts/share buybacks alongside consistent reinvestment into the core business give them a further edge over competition. Colgate, Marico, GCPL, Dabur and GSK Consumer are intermediately placed.

No more support for punchy valuations: Given punchy valuations, we initiate coverage with a SELL stance on each of these stocks. Our DCF-based valuation implies a 10-30% downside for most (as we model near-term earnings estimates factoring in lower growth and more importantly no more softening in raw material costs). We believe investors should move their consumption-focused investments to discretionary consumption stocks in paints, light electricals and apparel, as the rising disposable incomes in India would increase the depth and breadth of consumption to newer categories. We recommend investors to switch into high-quality discretionary names like Asian Paints, TTK Prestige and Bata.

Page 2: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Consumer Staples

Ambit Capital Pvt Ltd 2

CONTENTS

SECTOR Investment thesis 3 Industry overview 7 Competitive advantage framework 13 - Capital utilisation strategies 13 - Portfolio positioning across segments 19 - Recent raw material trends 26 Valuations set to decline 31

COMPANIES Hindustan Unilever (SELL) 39 Nestlé (SELL) 58 Godrej Consumer (SELL) 73 Dabur (SELL) 89 GSK Consumer (SELL) 105 Colgate Palmolive (SELL) 120 Marico (SELL) 134

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Consumer Staples

Ambit Capital Pvt Ltd 3

Investment thesis India’s consumption story is structurally sustainable

India’s consumption story is on a robust structural trend owing to: (a) the influence of working women on disposable income levels and spending patterns; (b) traditionally backward regions, such as Bihar, Chhattisgarh, Madhya Pradesh and Orissa, driving the next leg of growth; and (c) high Government spending over the next 2-3 years. (refer pages 8-12)

HUL and Nestle are best placed amongst the seven FMCG plays

Exhibit 1: Competitiveness framework and the relative standing of peers - HUL and Nestle are ahead of the pack

HUL Colgate Dabur Marico Nestle GSK Consumer GCPL

Portfolio positioning (diversification and category growth)

Ability to displace competition

Capital allocation and corporate strategy

Near-term raw material cost benefits

Overall rating

Source: Ambit Capital research; Note: indicates superior positioning relative to peers; indicates intermediate positioning relative to peers; indicates inferior positioning relative to peers

Portfolio positioning: Under this parameter, we rate companies based on:

(a) pace of growth of the relevant categories driven by an increase in penetration of consumption, increase in frequency of consumption, and the rate of premiumisation within the relevant categories; and

(b) spread of the product portfolio across premium/economy brands and across various product categories.

Nestle (market leader in fast-growing categories) and Dabur (diverse portfolio in moderately growing categories) are best placed on this parameter. Colgate, GSK Consumer and Marico are poorly placed on this parameter given their predominant presence in one or two categories, with weak-to-moderate category growth rates. HUL (diverse portfolio and predominantly weak growth rate of categories) and GCPL (moderate diversification and category growth) are placed at the intermediate level. (refer pages 18-25)

Ability to displace competition: The rating on this parameter is based on our expectations of market share gains/losses for the respective companies.

Marico (hair oils and premium edible oils) is the best placed on this parameter due to its strong potential to gain market share. Dabur is poorly placed on this parameter due to the likelihood of market share losses in categories such as hair care and oral care. GCPL, GSK Consumer, Colgate, HUL and Nestle are intermediately placed due to a combination of market share gains in a few categories (such as soaps and shampoos for HUL, coffee for Nestle, home insecticides for GCPL and auxiliary income from Sensodyne for GSK) and market share losses in others (such as oral care for Colagte, oral care and skin creams for HUL, chocolates for Nestle and MFD for GSK).

Capital allocation and corporate strategy: Given the cash-generative nature of the companies in this sector, capital allocation is a key component of corporate strategy. We rate HUL, Nestle and Colgate Palmolive as firms which have historically been the best allocators of surplus capital, with dividend payouts and capex related to core operations forming over 80% of cash generated by these companies. GCPL and Marico, on the other hand, have underperformed vis-à-vis their peers on this metric because they have

India’s consumption story is on a robust structural trend

Nestle and Dabur have the best portfolio positioning

Marico (domestic portfolio) is best placed to displace competition

HUL, Nestle and Colgate have the best capital allocation strategy

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Consumer Staples

Ambit Capital Pvt Ltd 4

invested a large proportion of their capital generated towards a combination of M&A and international business expansion which have NOT been value accretive for shareholders over the past five years. (GCPL has invested 125% of its cash generated over FY03-12 vs 52% for Marico.) GSK Consumer and Dabur are intermediately placed because: (a) GSK Consumer has accumulated cash on the balance sheet and no effective means of capital deployment; and (b) Dabur has made a value-destructive M&A of Namaste in the US and Africa despite highly value-accretive expansion of its Middle Eastern business. (refer pages 13-18)

Near-term raw material cost benefits: Input costs for Tea, Milk Food Drinks (wheat) and HDPE (key ingredient used for packaging of most products) have significantly increased in YTD CY13 over the previous year. Also, input costs for soaps (palm oil), rice bran oil and coffee have declined in YTD CY13 over the previous year. Consequently, in 1HCY13, we expect HUL, GCPL and Marico to be the key beneficiaries of these trends; whilst GSK Consumer is likely to be at a disadvantage as compared to its peers. (refer pages 25-30)

However, a derating of the seven stocks under our coverage is warranted

The table below shows that the FMCG sector (i.e. the seven stocks covered in this note) has been rerated by 61% over FY09-13. The rerating from FY09 to FY11 was justified by increase in the growth momentum of India’s consumption story over this period (volume growth increased by 200bps YoY over FY09-11). However, the rerating over the past 24 months to current levels of 37.3x one-year forward P/E multiples is not justified by any fundamental acceleration in volume or earnings growth prospects of the relevant stocks. Instead, volume growth has moderated by 520bps over the past 24 months (FY11-13) for the sector.

Exhibit 2: Rerating in the FMCG sector vis-à-vis volume and EPS growth trends

FY09 FY10 FY11 FY12 FY13 Current

Sector P/E average (1-yr fwd) 18.5 21.9 26.7 27.4 29.7 37.2

Volume Growth 12% 13% 14% 10% 8% NA

EPS Growth 17% 27% 16% 15% 20% NA

Source: Company, Ambit Capital research; P/E multiples are simple averages of daily P/E multiples for each year using Bloomberg consensus forecasts

Over FY13-15, we forecast an EPS CAGR of 15% for the sector, 500bps lower than that of FY12-13, and around 300bps lower than the EPS CAGR of FY08-13.

Exhibit 3: Rerating in the FMCG sector given declining volume growth trends

15

18

21

24

27

30

33

FY09 FY10 FY11 FY12 FY13

6%

8%

10%

12%

14%

16%

18%

20%

Average P/E (LHS) Average Volume Growth

Penetration FY07 Advt spends FY07Skin creams 25% GSK Cons. 12.9%

Biscuits 68% HUL 10.2%

Detergents 88% Marico 12.5%Penetration FY12 Advt spends FY13Skin creams 62% GSK Cons. 16.3%

Biscuits 89% HUL 12.5%

Detergents 98% Marico 13.6%

Source: Bloomberg, Company, Ambit Capital Research; Average volume growth represents simple average of the annual volume growth reported by the FMCG companies (excluding GCPL) covered in this note

HUL, GCPL and Marico are beneficiaries of near term commodity price movements

Sector has been re-rated to 37x FY14 P/E despite 600bps moderation in YoY volume growth over FY11-13

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Consumer Staples

Ambit Capital Pvt Ltd 5

This moderation in EPS CAGR for the sector can be broadly attributed to the following factors:

High penetration levels of several product categories: The penetration of categories such as oral care, hair oils, milk/milk products, soaps and detergents have substantially increased over the past five years. With the current penetration levels exceeding 80% in these categories, growth rates are likely to moderate going forward as compared to those achieved in the past.

Exhibit 4: High-price and low-utility items have low penetration (percentages in bubbles and size of bubbles indicate penetration levels)

5%

11%

25%

17%

15%

15%

5%

47%

40%

90%

74%

88%

83%

90%

99%

-2

7

0 10

P R

I C

E

U T I L I T YLow utility High utility

Baby foods

Premium edible oils

Milk food drinks

InsecticidesOral care

Soaps and detergents

Coffee

Noodles

Milk/milk products

Skin care

Fruit juices

Shampoos

Biscuits

Tea

Hair oils

Hig

h P

rice

Low

Pri

ce

Source: Industry, Ambit Capital research; Size of the bubble = penetration level of the respective category

Increased competitive intensity: Categories such as noodles, premium biscuits, premium edible oils, oral care and cosmetics, previously had only one or two large players controlling the market; however, these categories have seen an influx of new entrants with large balance sheets, such as HUL and ITC in noodles, ITC in biscuits, P&G and GSK Consumer in toothpastes, and Adani Wilmar in premium edible oils. This has led to a rise in competitive intensity, which is also visible in increased advertising spend to sales ratio for these players over the past five years.

Tailwinds related to raw material cost benefits are fleeting: Over the past 12 months, although the volume growth of discretionary consumer categories has moderated, most players in the FMCG sector have been able to stimulate consumer spending through accelerated promotions. Also, the companies that have gained market shares from competitors have been well supported by their ability to increase investment in advertising. This has been made possible by weak raw material prices, a tailwind which is likely to be fleeting. Gross margins are not likely to expand as substantially as they did over the past 12 months, thereby cushioning EBITDA margins from the impact of rising competitive intensity and saturating the penetration level in FY13.

Penetration levels are approaching saturation in several high utility product categories

Competitive intensity has increased substantially for several product categories over FY08-13

Tailwinds related to raw material cost benefits are fleeting

Page 6: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Consumer Staples

Ambit Capital Pvt Ltd 6

Exhibit 5: Gross margin expansion vs EBITDA margin expansion for FY13 (bps)

430

240170 160

80 80150 120

-10

-220

60 40

-70-50

-250

-150

-50

50

150

250

350

450

550

Mar

ico

Nes

tle

Dab

ur

GC

PL

HU

L

Gross Margin Expansion EBITDA Margin expansion

GC

PL

GSK

C

onsu

mer

Col

gate

Source: Company, Ambit Capital research

Consequently, based on our DCF valuations on these companies, our implied fair multiple for the frontline FMCG stocks is ~15% lower than the current multiples and hence warrants a sector-wide derating over the next 12 months.

Exhibit 6: Summary valuation table

Company Comptt

Mapping Rating

CMP (Rs)

Mcap (US$ mn)

Target Price (Rs)

Upside/ Downside

P/E (FY14E)

P/E (FY15E)

Implied P/E (FY14)

EPS CAGR (FY08-13)

EPS CAGR (FY13-15)

ROE (FY13)

GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%

Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%

Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%

Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%

HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%

Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%

GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%

Median 37.2 32.8 31.6 18% 15%

Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15

Whilst we retain our SELL stance on the FMCG sector, we believe discretionary consumption stocks like Asian Paints (MCap US$7.9bn, 6% upside) and TTK Prestige (MCap US$694mn, 23% upside) offer a significantly stronger growth profile and are available at more attractive valuations.

Level of defensiveness in consumer stocks highlighting valuations and EPS growth

0%

10%

20%

30%

40%

20 25 30 35 40 45

EPS

CA

GR

(FY1

3-15

)

P/E FY14

BataTTK Prestige

Asian Paints

GCPL

Titan

Marico

Dabur

Berger Paints

Pidilite

HUL

Colgate

Jubilant Foodworks

GSK Consumer

Nestle

ITC

Source: Bloomberg, Ambit Capital research; Note: Size of the bubble highlights the level of defensiveness determined by the coefficient of variation of revenues over the past 24 quarters.

Discretionary consumption stocks offer a significantly stronger growth profile and more attractive valuations

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Summary Sheet

Ambit Capital Pvt Ltd 7

Exhibit 7: Summary of our investment hypothesis

Rating CMP Mcap

(US$ bn) Target

Price Downside

P/E FY14

P/E FY15

Implied FY14 P/E

Comments on hypothesis

Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 Benefit = Oral care leadership; Negative = a) lack of portfolio diversification; b) competitive intensity rising (Oral-B, GSK); and c) drivers of GM benefits are over

Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8 Benefit = Juices & home care; Negative = a) 45% revs in mass market positioning, penetrated and intense competition (oral, hair, skin); b) 23% in niche which doesn't offer premiumisation

GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6 Benefit = Strong and efficient domestic portfolio; Negative = 60% capital generated deployed towards intl M&A: a) volatile margins; b) low returns so far; c) economic/infra uncertainties

GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 Benefit = Franchise in S&E + aux revs; Negative = a) mkt sh loss to Complan; b) comptt intensity in premium MFD; c) capital allocation risks; and d) new aux launch won't offset EPS growth moderation

HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6 Benefit = size/width helps ride consumption waves + efficient capital deployment; Negative = subdued vol growth:: a) 60% revs from penetrated cat.; b) mkt sh loss and rising A:S in oral, skin, and bevs; and c) rising royalty rates and tax rates

Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8 Benefit = Strong cat growth of vaule added hair oils; Negative = a) reliance on commodity prices for Parachute & Suffola; b) capital allocation risks - EM MNC target; and c) comptt from Fortune

Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 Benefit = Leadership in strong growth cat.; Negative = comptt intensity rising in chocolates (Fererro & Cadbury's), premium coffee (HUL), noodles (ITC & HUL) and risk of Danone's and Mead Johnson's expansion in baby foods

Median 37.2 32.8 31.6

Source: Company, Ambit Capital research

Exhibit 8: Summary of our forecasts

Competitive mapping FY08-13 FY13-15

Portfolio position-

ing

Ability to displace competi-

tion

Capital allocation

strategy

Near term RM benefits

Overall Sales CAGR

EPS CAGR

Sales CAGR

Gross Margin change

(bps)

EBITDA Margin change

(bps)

EPS CAGR

ROE FY13

Comments on forecasts

Colgate 16% 16% 15% 40 (77) 8% 107% Rising A:S given comptt intensity, rising tax rates (150bps each year)

Dabur 21% 18% 14% 20 14 15% 40% Penetration and comptt will constrain revs and margins respectively

GCPL 42% 21% 19% 60 211 28% 23% Margin expansion on low base of FY13; organic growth

GSK CH 19% 22% 15% 50 88 18% 35% 23% CAGR of Aux income, mkt sh loss in MFD portfolio

HUL 13% 13% 13% 110 (27) 9% 103% Rising royalty & A:S given comptt from GCPL, L'Oreal, P&G, Nestle

Marico 19% 17% 10% (10) 150 *24% 23% 14% underlying EBITDA CAGR ex-Kaya; commodity play

Nestle 19% 21% 15% 475 (18) 14% 70% Vol growth moderation even once discretionary spends revive

Median 19% 18% 15% 50 14 15% 40%

Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; inferior positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15

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Consumer Staples

Ambit Capital Pvt Ltd 8

Industry overview Revenues in the Rs1,807bn Indian FMCG market have increased by ~15% YoY in FY12, with rural revenues accounting for 34% of the overall sector. Whilst until CY06, urban growth rates were higher than rural growth rates (refer to the exhibit below), rural growth has outpaced urban growth by ~200bps over CY07-11 (average of 15% growth per annum in rural vs 13% per annum in urban over this period). The rural and urban markets increased by ~15% YoY in FY12.

Exhibit 9: FMCG industry split across rural and urban

1,566

1,040

526

1,807

1,201

606

-200400600800

1,0001,2001,4001,6001,8002,000

FMCG Industrysize

Urban Rural

FY11 FY12

Source: Industry, Ambit Capital research

Exhibit 10: Rural growth picked up pace after CY05

(10)

(5)

-

5

10

15

20

CY03 CY05 CY07 CY09 CY11

Urban(%)

Rural(%)

OverallFMCG(%)

Source: Industry, Ambit Capital research

Revenue growth in rural markets has outpaced those in the urban markets due to a combination of the following factors:

1. Growth led by traditionally backward regions

The traditionally backward Indian states are now leading the charge in terms of economic growth rates. Besides this pick up in income growth in traditionally backward regions, the phenomenal proliferation of three drivers of aspirational consumption over the past decade is likely to propel this story forward, namely,

Improved penetration of electricity access over the past decade which in turn will facilitate consumption of electricity-based durables;

Improved levels of household sanitation which are likely to drive the consumption of personal and home care products; and

Revolution in general awareness levels driven by the jump in penetration of mobile phones and rising penetration of the internet.

The traditionally backward Indian states are now leading the charge in terms of economic growth rates

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Ambit Capital Pvt Ltd 9

Exhibit 11: The traditionally backward states in the late-1990s…

6.5%5.4%

4.9%4.3%

3.7% 3.4%

0%

1%

2%

3%4%

5%

6%

7%

Indi

a

MP

Biha

r

Oris

sa

Utt

aran

chal

Cha

ttis

garh

Avg GDP growth over FY95-99 (YoY, in %)

Source: CSO, Industry, Ambit Capital research

Exhibit 12: …are now leading the charge in terms of economic growth rates

13.7%

11.1%

9.4%8.4% 8.2% 7.9%

4%

6%

8%

10%

12%

14%

16%

Utt

aran

chal

Biha

r

MP

Cha

ttis

garh

Oris

sa

Indi

a

Avg GDP growth over FY07-12 (YoY, in %)

Source: CSO, Industry, Ambit Capital research

2. Rise in Government’s welfare spends

Rural development spends by the Government have recorded a CAGR of 33% over FY05-11 and 20% over FY05-13 (see the exhibit below). This has been achieved through Government schemes such as MGNREGA (a rural employment scheme which is likely to spend Rs294bn in FY13), Indira Awas Yojana (a rural housing scheme with an estimated spend of Rs81bn in FY13), and the Pradhan Mantri Gram Sadak Yojana and Central Road Fund (road development schemes with an FY13 estimated spend of Rs91bn).

Exhibit 13: Rural development spends have recorded a CAGR of 33% over FY05-11

0100200300400500600700800900

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E

-40%

-20%

0%

20%

40%

60%

80%

100%

Rural Spends (Rs bn) % Growth

Source: Industry, Ambit Capital research

The long-term prospects of structural growth in consumption remain intact Besides the benefits related to a high economic growth rate, we expect the following factors to drive growth of consumption over the longer term in India:

1. Influence of women on disposable income levels

Improving economic opportunities for women, which have been a function of rising female literacy levels, have helped in the economic empowerment of women. More women are increasingly employed in the non-farm sector, which is characterised by higher income levels vis-à-vis the farm sector. Furthermore,

Rural development spends by the Government - 20% CAGR over FY05-13

Household incomes will continue to rise in India driven by increased employment of women in the non-farm sector

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Ambit Capital Pvt Ltd 10

international experience suggests that as a country develops economically (as measured by per capita income), the non-farm sector employs most of the women. For instance, only 35% of India’s working women are currently employed in the non-farm sector at a point where India’s per capita income is US$3,400 (in PPP terms). At the other end of the spectrum is the US where 99% of working women are employed in the non-farm sector, as its per capita income is at US$46,900 (in PPP terms). Therefore, we expect household incomes to continue to rise in India driven by increased employment of women in the non-farm sector.

Exhibit 14: Female literacy levels are rising faster than male literacy levels in India

10%

20%

30%

40%

50%

60%

70%

80%

90%

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

Yout

h Li

tera

cy R

atio

s (in

%)

Males Females Gap

Source: CEIC, IMF, Ambit Capital research

Exhibit 15: The rising employment of women in the higher-paying non-farm sector

25% 26%

29%

35%

20%

22%

24%

26%

28%

30%

32%

34%

36%

CY94 CY00 CY05 CY10Shar

e of

Indi

an w

omen

em

ploy

ed in

the

no

n-fa

rm s

ecto

r (in

%)

Source: World Bank, Ambit Capital research

2. Revival of discretionary spends by the Government

Whilst discretionary spending increased by only 12% in FY13, we expect a 19% increase in FY14 in these spends based on the Government’s FY14 budget. These benefits given out before the elections are likely to help rural consumers over the next 12-18 months.

Exhibit 16: Allocation to NREGA by the Government has declined since FY11

113 120

300

391 401 400

330

-50

100150200

250300350400450

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

2012-13

NREGA Allocation (Rs Bn)

Source: Budget transcripts, Ambit Capital research

Exhibit 17: Discretionary spends by the Government pick up in the two years before the general elections

3%6%

12%

22%25%

19%

0%

5%

10%

15%

20%

25%

30%

Gen Election2004

Gen Election2009

Gen Election2014

Year 1,2 and 3 Year 4 and 5

Source: Ambit Capital research

We expect 19% YoY increase in discretionary spending by the Government in FY14

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Ambit Capital Pvt Ltd 11

3. Evolution of consumption patterns

The factors highlighted above will have a structurally positive impact on household incomes across most segments of the Indian population and hence will lead to a large proportion households shifting from illiterate daily wage manual labourers towards educated salaried/small business controllers.

Exhibit 18: Shift in proportion of Indian consumers across various categories based on household income and segregation into rural vs urban

50%

24%

6% 6%8%

2%4%

28%30%

6%

13%10%

5%8%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Stru

ggle

rs

Smal

l tow

nne

xt b

illio

n

Larg

e to

wn

next

bill

ion

Rura

lA

spire

rs

Urb

anA

spire

rs

Trad

ition

alA

fflu

ent

Prof

essi

onal

Aff

luen

t

2010 2020

Source: ‘The Tiger Roars’ - Boston Consulting Group & CII; Ambit Capital research

This shift in household profiles is likely to lead to a change in consumption patterns for various categories of consumption due to:

Spending patterns of the next generation: When consumers who are currently in the age group of 15-25 years become decision-makers for consumption, they would significantly change the consumption patterns in their respective households. They would have observed wealth creation and the influx of foreign brands first hand. Thus, they are likely to spend significantly more on consumer products as compared to the previous generations. Consequently, the definition of ‘fashion’/’luxury’/’leisure’ will evolve over the next decade.

Migration from rural to urban areas: Urban dwellers have better access to goods and are exposed to more consumerism. Therefore, a migration to larger cities tends to increase a household’s spending on various categories. This is likely to add more depth to consumption in India and widen the range of SKUs consumed in a typical household.

Nuclear families: Anecdotal data suggests that nuclear families spend 20-50% more per capita as compared to traditional joint families in the same household income group. These higher spends are mostly related to discretionary consumption categories rather than staples.

This is likely to lead to the evolution of consumption spends across all product segments along the following lines:

Several product categories within the staples segment as well as others including light electricals, brown goods, white goods, auto and luxury spending categories are currently under-penetrated in India. Penetration in these categories is likely to increase either for the overall product segment or from a shift from the unorganised product segment into the organised segment.

Professional Affluent

Income over US$18,500. Educated, professionals

Traditional Affluent

Income over US$18,500. Less educated, self-employed, value conscious

Urban Aspirers

Income between US$7,400-18,500. High aspirations, live in urban cities

Rural Aspirers

Income between US$7,400-18,500. less aspirational, live in rural areas

Large Town Next Billion

Income between US$3,300-7,400. Live in large towns. Basic education/lifestyle.

Small Town Next Billion

Income between US$3,300-7,400.Live in small towns. Basic education/ lifestyle.

Strugglers Income less than US$3,300. Illiterate, daily wage earners

Penetration of several categories (relatively more discretionary in nature) is likely to increase going forward

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Ambit Capital Pvt Ltd 12

The chart below maps FMCG product categories across a price vs utility matrix, with categories being more discretionary in nature at the top-left of the chart and the ones that are more staple in nature at the bottom-right of the chart. Alongside the price and utility, we map category penetration and find categories such as baby foods and milk food drinks are the least penetrated across the country whilst those such as soaps, detergents, biscuits and tea are almost completely penetrated given their higher utility and smaller ticket size.

Exhibit 19: High-price and low-utility items have low penetration (percentages in bubbles and size of bubbles indicate penetration levels)

5%

11%

25%

17%

15%

15%

5%

47%

40%

90%

74%

88%

83%

90%

99%

-2

7

0 10

P R

I C

E

U T I L I T YLow utility High utility

Baby foods

Premium edible oils

Milk food drinks

InsecticidesOral care

Soaps and detergents

Coffee

Noodles

Milk/milk products

Skin care

Fruit juices

Shampoos

Biscuits

Tea

Hair oils

Hig

h P

rice

Low

Pri

ce

Source: Industry, Ambit Capital research; Size of the bubble indicates penetration level of the respective category

Premiumisation is likely to be a strong driver of growth in well-penetrated categories such as soaps, detergents and biscuits, as higher disposable household incomes will be spent towards lifestyle upgrades for existing consumers of these products. Also, the frequency of consumption of categories such as noodles, fruit juices, deodorants and cosmetics are also likely to propel consumption going forward.

Staples growth in well penetrated categories will be driven by premiumisation and frequency of consumption

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Ambit Capital Pvt Ltd 13

Competitive advantage framework Our framework analyses the following competitive advantages of the seven companies covered in this report:

1. Capital utilisation strategies: Given the high cash generation in this sector, this section compares the efficiency of capital utilisation strategies adopted by the respective companies over the past decade and the intended strategy for the next 3-5 years.

2. Portfolio positioning: This section analyses the drivers of growth of key product categories in the FMCG universe and identifies the winners and losers within each of these product categories for FY13-15.

3. Raw material cost benefits: This section looks at the short-term gains or losses that are likely at a gross margin level for various companies from the changes in commodity prices over the past three months.

I - Capital utilisation strategies in a sector with strong cash generation As shown in the table below, cash generation in the FMCG sector has remained strong for most companies over the past decade.

Exhibit 20: High asset turns and pre-tax CFO/EBITDA indicate strong cash conversion

Average Asset

Turnover Average PAT

Margin Average

ROCE Average Pre-tax

CFO/EBITDA

Colgate 5.8 14.4% 84% 126%

Nestle 6.4 12.3% 82% 118%

HUL 5.3 12.8% 66% 114%

GCPL 3.9 14.0% 62% 96%

Dabur 2.6 11.5% 34% 100%

ITC 1.1 23.2% 27% 114%

Marico 3.2 7.7% 24% 75%

GSK Consumer 2 11.5% 23% 137%

Source: Company, Ambit Capital research; Note: Average =ten-year period over FY03-12

In this section we analyse the various modes of capital deployment adopted by large listed FMCG companies over the past decade, the consequent impact felt on their return ratios, and the corporate strategy over the next 3-5 years.

Capital deployed over the past ten years

Modes of surplus capital deployment have varied across the sector and can be classified into the following categories (see the exhibit below):

Dividend paid to shareholders through a combination of normal dividend, special dividend and buybacks;

Core investments to expand the core product portfolio i.e. manufacturing capacity, R&D facilities and distribution network;

Investments in non-core activities i.e. expanding presence in geographies outside India or M&A around product categories which are not directly related to the core business;

Surplus capital accumulation in the absence of appropriate avenues for capital deployment;

Strong cash generation in the FMCG sector over the past decade…

…calls for a need to choose from amongst various capital deployment initiatives

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Ambit Capital Pvt Ltd 14

Accumulation of unutilised cash which neither has been returned to shareholders nor has been invested in core/non-core activities.

Exhibit 21: Avenues of capital deployment for various companies over FY03-12

-20%

0%

20%

40%

60%

80%

100%

HU

L

Nes

tle

Col

gate

GSK

Con

sum

er

Dab

ur

Mar

ico

GC

PL

Investment in core Dividend Paid Non core Inv./Intl. M&A Change in cash Others

Source: Company, Ambit Capital research; Note: height of the bar for each company refers to the sum of operating cash flows, new equity raised and increase in gross debt.

Segregation of companies into three buckets

HUL, Nestle and Colgate – repatriation to shareholders: These companies are best placed with over 80% of the cash generated deployed towards either investments in the core business or share buybacks/dividend payouts to shareholders. Moreover, across these ten years, the payout ratio has reduced for these firms only during years where deployment opportunities in the core business have been exploited (e.g. Nestle’s payout below 70% only over the past three years due to the capex towards doubling manufacturing capacities in its core business). As a result, these three companies have consistently had high RoEs and RoCEs over the past ten years.

GSK Consumer – attempted to expand core business, but has ended up accumulating unutilised cash: Whilst GSK Consumer’s working capital management and cash generation is amongst the best in the sector, the company’s dividend payout ratio has been between 35% and 50% over the past ten years, leaving ~50% of the cash generated over the past ten years (after capex) unutilised. Attempts to leverage on the Horlicks brand to enter into categories like biscuits, noodles, energy drinks and health bars have not been successful. Consequently, GSK Consumer’s RoEs have been consistently at 20-30% over the past ten years, several notches below that of its peers.

Dabur, Marico and GCPL – substantial non-core investments/ International M&A: These firms have ventured into new geographies/product categories through M&A which has been funded by a combination of reduction in the dividend payout ratio (see chart below) and new capital raised in the form of equity and debt. An analysis on the returns generated through these ‘non-core’ capital deployment initiatives (provided in the next section of this note) suggests that the incremental returns generated on these ’non-core investments/International M&A‘ have been either at or below par as compared to the cost of equity of the corresponding capital employed.

Capital deployment strategies have varied substantially across the sector

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Ambit Capital Pvt Ltd 15

Exhibit 22: Dividend payout trends over the past decade

0%

20%

40%

60%

80%

100%

120%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

GCPL

Marico

Dabur

Colgate

HUL

GSKConsumer

Nestle

Source: Company, Ambit Capital research

Exhibit 23: Acquisitions made by FMCG companies since FY08

CY GCPL Marico Dabur

2007 NA Enaleni Pharma (South Africa)

NA

2008 Kinky NA NA

2009 NA NA NA

2010 Tura, Megasari, Issue, Argencos

Code 10 (Malaysia) Namaste Labs, Hobi Kozmetik

2011 Darling (On going) International Consumer Products (Vietnam)

30 Plus

2012 Cosmetica Nacional Paras (Personal Care) NA

Total increase in Debt over FY08-12 (Rs mn)

10,925 552 6,033

Total dividend retained over FY08-12 (Rs mn)

11,500 9,553 14,212

Total equity diluted over FY08-12 (Rs mn)

18,263 NA NA

Source: Company, Ambit Capital research

Analysis of investments in non-core M&A by Dabur, Marico and GCPL

Whilst the RoAs (see chart below) have significantly declined for all three companies, an RoA-based analysis is not the best way to compare capital deployment of these companies because: (1) Goodwill paid for acquisitions is a drag on the RoA; and (2) since FMCG businesses are capital-light in nature, any small reduction in the dividend payout ratio leads to a significant increase in the asset base, irrespective of the capital deployment initiative (eg: cash held on the books of HUL is higher than its equity).

International M&A has NOT generated substantial shareholder returns so far

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Ambit Capital Pvt Ltd 16

Exhibit 24: RoA trends as reported

-10%

10%

30%

50%

70%

90%

110%

130%

150%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Dabur

Marico

GCPL

Source: Company, Ambit Capital research

Exhibit 25: RoA trends after adjusting for goodwill

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Dabur

Marico

GCPL

Source: Company, Ambit Capital research

To analyse the returns generated on capital deployed, we have compared the incremental EPS generated by the three firms on incremental capital deployed towards M&A or international growth.

The underlying assumptions for this approach are: (a) the current gap between the standalone and consolidated accounts almost fully reflects growth of international entities over FY08-12; and (b) capital deployed towards non-core acquisitions relates to a combination of retained earnings (which otherwise would have been paid out as dividends to shareholders) and new equity/debt issuance. Also, we have assumed a 13% cost of equity on this capital deployed over this period. The conclusions from our analysis are:

Exhibit 26: Analysis of value created by the M&A strategy of Indian FMCG companies

Sum of standalone

EPS (FY08-12)

Retained earnings/ share

(FY08-12)

Equity diluted/share

13% Cost of Equity

Standalone EPS + Return on Equity

Sum of consolidated EPS

(FY8-12) % Gain

Dabur 11.85 8.16 0 1.06 12.91 14.06 9%

Marico 19.17 15.54 0 2.02 21.19 19.52 -8%

GCPL 53.40 33.79 53.67 11.69 65.09 63.66 -2%

Source: Company, Ambit Capital research; Note: EPS is bonus adjusted and retained earnings/share is based on shares outstanding as on 31 March 2012.

Marico as well as GCPL have generated incremental earnings from non-core businesses, lower than the cost of equity deployed over FY08-12. Dabur, on the other hand, has generated incremental value for shareholders higher than the cost of equity.

GCPL and Marico both had a debt:equity of 0.67x in FY12. Since this does not form a part of the deployed capital considered in our analysis above, the total return on incremental capital deployed is further dragged down beyond what is highlighted in the analysis above.

Dabur appears to be unleveraged, with an FY12 net debt of only Rs730mn on a consolidated basis. However, the company holds Rs10.7bn of gross debt, largely in foreign currency at a subsidiary level, and holds Rs10bn of cash on the standalone balance sheet in FY12. This is driven by the company’s strategy of NOT deploying capital from the parent’s balance sheet to fund expansion of the subsidiary entity. Therefore, note the incremental debt capital is used to fund the return generated from non-core investments.

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FY13 acquisitions NOT taken into account: Our analysis does NOT take into account either Marico’s acquisition of Paras or the phase-2 integration of GCPL’s Darling business in Africa. These two transactions were executed in FY13, the annual report for which is not yet available to us. Whilst our analysis on GCPL’s historical capital allocation is unlikely to change after the integration of the Darling Group’s phase-2 acquisition, we expect further deterioration of Marico’s performance relative to its peers once the Paras acquisition is factored into our analysis. The acquired portfolio of Paras will bring revenues of ~Rs1.5bn, and for this, the consideration paid by Marico was Rs7.4bn. Consequently, even if the acquired entity generates PAT margins of 10%, the corresponding annual return on capital deployed towards the acquisition is only ~2-3%.

Future growth prospects of businesses acquired in the past: Our analysis above is based on historical data. With each of these three businesses planning to become an ’emerging market MNC‘, there is a possibility of deriving growth from the acquired entities which has not been part of the historical performance. However, whilst there have been examples of successful integration over the past five years, such as GCPL’s Megasari acquisition in Indonesia and Dabur’s Middle East business, there have also been examples of headwinds related to political/economic turmoil, business disruptions due to labour strikes/transporters’ strikes, and execution-related issues in a new geography.

Capital deployment strategy going forward

HUL, Colgate and Nestle: Based on their historical approach towards capital allocation, we see limited risk of these companies deploying their surplus capital towards value-destructive non-core investments.

GSK Consumer: Over the past three years, the company has highlighted prospective M&A as a mode of surplus capital deployment. Moreover, over the past four years, GSK Consumer has tried to leverage on the brand recall of Horlicks and Boost to enter into new product categories including biscuits, cookies, and nutribars and has also tried to launch new brands/products including Foodles (noodles). Most of these initiatives are yet to gather momentum materially for GSK Consumer. At the same time, the company has seen a consistent moderation in volume growth of its Milk Food Drinks categories over the past four quarters, which is on account of increased competition from Complan in non-south geographies and high penetration of Horlicks in south India. Based on a combination of these factors/initiatives/comments made by the company, we believe that: (a) GSK Consumer is NOT likely to repatriate/distribute a significant proportion of surplus capital; and (b) the risk of making a non-core acquisition remains high in the future and until then surplus capital will remain a drag on return ratios.

Godrej Consumer: Our recent discussions with GCPL’s management team suggest that the company is likely to focus on subsequent phases of integration of the Darling acquisition in Africa rather than seeking new M&A opportunities over the next 12-18 months. The surplus cash generated from its existing businesses in the near future is likely to be used for consolidation of Darling in Africa, debt repayment, and growth of the acquired businesses.

Dabur: Based on our discussions with Dabur’s management team, although the company is holding a large amount of cash on the standalone balance sheet, this will not be used to repay debt on the subsidiary balance sheets. Instead, the company is looking at M&A opportunities within India for standalone surplus capital deployment going forward. Until such M&A opportunity is explored, the management is comfortable with the treasury income being generated on the balance sheet surplus capital. Consequently, we see Dabur also running the risk of diversifying into non-core areas - both domestic as well as international.

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Ambit Capital Pvt Ltd 18

Marico: Our discussion with Marico’s management team suggests that the immediate goal of the company is to bring its core operations in India to a consistent double-digit YoY volume growth rate. Once this goal is achieved, the company intends to explore M&A opportunities in Indonesia and Africa, with the intention of evolving into an ’emerging market MNC firm‘. However, with an unattractive track record of capital deployment through M&A over the past five years, we consider this strategy to be a key risk to shareholder returns.

Overall conclusion on capital deployment

We rate HUL, Nestle and Colgate Palmolive as the best allocators of surplus capital, with dividend payouts and capex related to core operations likely to continue forming over 80% of cash generated by these companies. GCPL and Marico, on the other hand, have underperformed vis-à-vis their peers on this metric with their capital deployment initiatives NOT been value accretive for shareholders over the past five years. GSK Consumer and Dabur are intermediately placed.

Exhibit 27: Summary of ratings around capital deployment

Company Historical capital

deployment Deployment

strategy in future Overall rating

Comments

HUL High dividend payout ratio historically (ten-year average of 92%); high RoEs (103%); strategy unlikely to change going forward

Nestle High (ten-year average of 80%) dividend payout ratio historically; high RoEs (70%); strategy unlikely to change going forward

Colgate Around Rs4.5bn cash on books; going by historical trends, surplus likely to be repatriated through special dividends

GSK Consumer

Average ten-year dividend payout ratio of 46% in the past; no additional capital deployment initiatives followed so far; management highlights M&A as a likely option in the future

Dabur

M&A has been value accretive in the past; acquisition of entities like Namaste have not been successful; management intends to deploy over Rs10bn of surplus towards M&A in India

Marico M&A historically has NOT been value accretive; strategy going forward focuses on acquisitions in Indonesia and Africa

GCPL

M&A historically has NOT been value accretive for shareholders; strategy going forward includes integration of Darling’s businesses in Africa and debt repayment

Source: Company, Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning

HUL, Nestle and Colgate Palmolive are the best allocators of surplus capital

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Ambit Capital Pvt Ltd 19

II - Portfolio positioning across segments We have categorised the growth drivers of each product segment into Penetration, Premiumisation, and Frequency of consumption, which is our PPF framework, which have been defined as follows:

Rate of increase in penetration: This relates to an increase in the number of consumers within the relevant population size for that product category.

Premiumisation: This relates to an up-trading of consumers towards more premium products and hence leads to a growth in realisation rates per product for the FMCG players.

Frequency of consumption: This relates to an increase in the frequency of the consumption of products within the penetrated population of consumers.

We have divided the FMCG universe into four broad categories: Packaged Foods, Personal Products, Beverages and Home care. These four categories are further divided into 25 product-based sub-categories. The framework then analyses, for each sub-category, the following:

Sustainability of the three PPF growth drivers;

Extent of and the change in competitive intensity for each of the product categories based on both the aggression from existing players as well as from the aggressive entry of new players; and

Market share gainers and losers amongst key players prevalent in the respective product category.

The outcome of this portfolio analysis for each category as well as for each company is used in our company specific forecasts highlighted later in this note.

Overall conclusion: Nestle has the best portfolio positioning

Whilst each of the seven companies mentioned in the table below are market leaders in at least one of the product categories, we rate the companies on the basis of overall diversification, macro growth in the categories of presence and ability to win market share from competitors. On this basis, we find Nestle to be the best placed whilst GSK Consumer is the worst placed vs peers.

Exhibit 28: Overall rating of companies on portfolio positioning

Diversification

of portfolio Category growth

Competition displacement

ability

Overall portfolio

positioning Comments

HUL Diverse portfolio (presence in over 12 categories) + market share gains in soaps & shampoos; losses in oral, skin care.

Nestle Present in four categories, market leader in three; competitive intensity and focus on margins will restrict share gains

Colgate Present in only oral care; strong brand and dentist tie-ups. Competition from GSK and P&G.

Marico Own the strongest brands in the hair and edible oils; innovation and marketing to drive gains in hair oils

Dabur Diversified portfolio; present in few growth categories like juices; share gains restricted due to mass focus

GCPL Hair colours, insecticides and soaps only; gains likely in domestic business; modest positioning in Africa and LatAm

GSKCH Over 90% = MFD portfolio; Will face challenges from more premium positioned competitors

Source: Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning

Nestle has the best portfolio positioning across the sector

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Ambit Capital Pvt Ltd 20

Packaged foods: Penetration-led 15-20% CAGR; moderate but rising competitive intensity

Exhibit 29: Packaged foods market – key players and growth drivers Key players (mkt share) Key segment growth drivers Comments

Product category

Market Size (Rs bn)(+) Rank 1 Rank 2 Rank 3

Expected segment FY13-15 CAGR#

Freq. of consumption

Penetr-ation

Premium-isation

Biscuits 140 Parle

(34%) Britannia

(32%) ITC

(8%) 12%

Fully penetrated (90%); Premiumisation - glucose to creams/cookies

Chocolates 55 Cadbury

(67%) Nestle (21%)

Ferrero (6%)

15%

Increased frequency, penetration increasing in urban and rural (urban - 5% in ‘07 to 16% in ‘12)

Noodles (excl pastas)

20 Nestle (75%)

ITC (10%) HUL (3%)

20%

Penetration (19% urban, 3% rural), migration to healthier variants (premium of 20-50%)

Ice Cream 18 Amul (41%)

HUL (18%)

Vadilal (18%)

15%

Distribution growth - investment in cold chains, shift from unbranded to branded

Baby Foods

15 Nestle (88%)

Farex (7%)

15-20% Penetration increasing in urban population

Premium Edible Oils

10 Marico (58%)

Agro Tech

(42%) 15%

Rising spends on health based products, shift from base to premium edible oils

Sauces 8 Nestle (29%)

HUL (25%)

GD Foods (15%)

26%

Penetration (15% in urban; negligible in rural), shift from unorganised to branded

Overall 266 15-20%

Source: Company, Ambit Capital research; Note: #Based on Ambit’s estimates; / / indicates strong/moderate/weak driver of growth respectively

Exhibit 30: Packaged foods market – competitive positioning of various players

Market share changes Product category

Competitive intensity

Comments Gainers Losers

No Change

Comments

Biscuits Medium and flat

New players: Cadbury's; 80bps increase in A:S for BRIT over FY09-12

Britannia, ITC

Parle

Britannia = wide portfolio, first mover in health biscuits; ITC = advertising muscle, strong balance sheet; Parle = portfolio offers limited premiumisation

Chocolates Medium and rising

New entrants: Ferrero and Kraft

Cadbury’s, Ferrero

Nestle

Cadbury’s = wide portfolio, A&P up 300bps over five years, strong brand recall; Ferrero = strong premium offering; Nestle = focus on margins, price increases

Noodles (excl pastas)

Medium and rising

New entrants: GSKCH, Ching's; Increased aggression from HUL

ITC Nestle HUL,

GSKCH ITC = marketing, distribution, differentiated offering; Nestle= low media spends

Ice Cream Medium and rising

HUL Vadilal Amul HUL = strong distribution, advertising, new launches; Amul = strong distribution, brand recall, leadership in economy segment

Baby Foods Low and flat

Restrictions around adverts curb competitive intensity

Nestle, Farex

Nestle = strong brand recall, good quality; high entry barriers for competition

Prem. Edible Oils

Medium and rising

New entrant: Adani Wilmar Marico Agro Tech Foods

New entrants, disruptive adverts; Marico = stronger brand recall for Saffola vs Sundrop, higher A&P

Sauces Medium and flat

Media spends and price discounting frequent

Nestle HUL Nestle = strong brand recall for Maggi, superior product quality

Overall Medium & rising

Mainly aggression from new entrants

Source: Ambit Capital research, Company

Overall summary: The Packaged foods market in India is akin to an aspirational consumption segment with the following key characteristics:

Biscuits, the largest product category within packaged foods, has seen saturation in penetration rates, with penetration level of ~65% in 2007 rising to ~90% in 2012. Consequently, as shown in the table below, premiumisation is the largest driver of growth for biscuits.

Packaged foods market in India is akin to an aspirational consumption segment

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Ambit Capital Pvt Ltd 21

Exhibit 31: Biscuits face premiumisation from glucose to cookies/creams (share of category within biscuits in percentage)

Apr-Sep 2012 Apr-Sep 2011 Apr-Sep 2010 % Change (FY10-12)

Glucose 19.3 21.8 26.7 -28%

Sweet/cookies 26.2 26.9 23.8 10%

Cream 22.2 18.7 16.6 34%

Marie 10.7 10.9 11.1 -4%

Non-salt cracker 9.3 9.7 9.7 -4%

Salt cracker 6.0 6.2 6.5 -8%

Milk 4.3 4.1 4.1 5%

Arrowroot 0.8 0.6 0.6 33%

Wafer cream 0.9 0.8 0.5 80%

Other biscuits 0.1 - 0.1 0%

Assorted biscuits 0.2 0.2 0.2 0%

Cereal bars - - 0.1 -100%

Source: Industry, Ambit Capital research

Excluding biscuits, most other product categories are small in size, with strong revenue growth rates (15-25% CAGR over FY13-15).

Excluding biscuits, revenue growth is predominantly led by increased penetration, with average current penetration levels of 15-20% for most product categories.

Competitive intensity is medium and rising in most categories due to: (a) entry of new players like Cadburys in biscuits, Adani Wilmar in edible oils, Ferrero in chocolates and Ching’s in noodles; and (b) increased competitive intensity through advertising spends by incumbents like Britannia (80bps increase in advertising spends to sales ratio over FY09-12) and Cadbury’s (250bps increase in A:S over FY05-11 – see the table below).

Exhibit 32: Cadbury - financial summary (Rs mn)

CY05 CY06 CY07 CY08 CY09 CY10 CY11

Net Sales 8,798 10,582 12,935 15,886 19,344 25,032 33,595

YoY Sales Growth (%) NA 20.3% 22.2% 22.8% 21.8% 29.4% 34.2%

EBITDA Margin (%) 13.3% 14.0% 13.9% 15.3% 14.5% 12.5% 13.4%

PAT Margin (%) 5.2% 6.5% 9.1% 10.4% 9.8% 8.3% 8.8%

Adv/Net Sales (%) 10.9% 11.5% 12.2% 11.8% 12.3% 13.3% 13.4%

Source: Ambit Capital research

Packaged foods = Penetration led 15-20% CAGR; medium but rising competitive intensity

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Ambit Capital Pvt Ltd 22

Beverages: ~15% revenue CAGR over FY13-15; high and rising competitive intensity

Exhibit 33: Beverages market – key players and growth drivers Key players (market

shares) Key segment growth drivers Comments

Product category

Market Size (Rs bn)(+) Rank 1 Rank 2 Rank 3

Expected segment FY13-15

CAGR Freq. of

consumption Penetr-ation

Premium-isation

Milk/Milk Products

250+ Amul Nestle NA

Shift to branded and value-added products; organised penetration only 15%

Tea 79

Tata Tea

(22%)

HUL (22%)

Wagh Bakri (8%)

10% Slow rate of premiumisation; shift from loose to packaged tea; volume growth of 1-3%

Milk Food Drinks

40 GSKCH

(63%) Heinz (20%)

Cadbury (13%)

15%

Penetration especially in rural areas; premiumisation to value-added variants

Coffee 25

HUL (50%)*

Nestle (49%) 10-12%

Shift from loose to branded; premiumisation to 100% coffee; changing tastes

Fruit Juices 15

Dabur (52%)

PepsiCo (38%)

15-20%

Penetration; increasing consumption with meals, shift from nectar to 100% juice

Overall 409 15%

Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively

Exhibit 34: Beverages market – competitive positioning of various players

Market share changes Product category

Competitive intensity

Comments Gainers Losers

No Change

Comments

Milk/Milk Products

Low and rising

Private Equity backed new entrants Nestle Amul

Nestle = Aggressive marketing; brand strength and premium positioning

Tea Medium and flat Tata Tea

Wagh Bakri HUL

Playing out of benefits from Tata Global's 'Jaago re' marketing campaign

Milk Food Drinks High and flat

MNC fight for market share to keep A&P elevated Heinz GSKCH Cadbury

Heinz to benefit from presence in lower-penetrated north and west markets and premium positioning

Coffee Medium and rising

Nestle’s increased aggression recently Nestle HUL

Nestle to gain from stronger brand especially in the 100% coffee segment

Fruit Juices

Medium and rising

High growth category attracting new entrants

New entrants Pepsico Dabur

Dabur to gain from strong brand and frequent innovation; new entrants include Del monte, Parle, Godrej , Cavin care, KDD

Overall Medium and rising

Select high-growth segments facing aggression from MNCs

Source: Ambit Capital research, Company

Overall summary: The market for beverages in India can be divided into two segments: (a) tea and coffee; and (b) milk, milk food drinks and fruit juices. The characteristics of these two segments are exactly opposite to each other.

Whilst ‘tea and coffee’ are highly-penetrated slow-growing categories (~10% CAGR over FY13-15) driven predominantly by premiumisation, other beverage categories have low penetration rates with relatively higher revenue growth of over 15% YoY.

Competitive intensity is either high or rising across all beverages categories. This includes a strong distribution and advertising push from Heinz (27% sales CAGR and 30% EPS CAGR over CY06-11) for Complan in north and west India, and a large number of new entrants in packaged milk and milk products (Danone) and fruit juices (Parle, Coca Cola and KDD).

Beverages = ~15% revenue CAGR over FY13-15; high and rising competitive intensity

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Ambit Capital Pvt Ltd 23

Personal products: Saturating penetration; premiumisation-led growth; high and rising competitive intensity

Exhibit 35: Personal products market – key players and growth drivers Key players (market

shares) Key segment growth drivers Comments

Product category

Mkt Size

(Rs bn) Rank 1 Rank

2 Rank

3

Expected segment FY13-15

CAGR Freq. of

consumption Penetr-ation

Premium-isation

Soaps 100

HUL (45%)

GCPL (12%)

Reckitt Benck.

(9%) 8-10% Premiumisation only driver;

fully penetrated segment

Tooth paste

52 Colgate

(53%) HUL

(29%) Dabur (12%)

12-13% Overall penetration 83%; conversion from toothpowder to toothpaste; premiumisation

Tooth brushes

14 Colgate

(39%) Oral B (20%)

15%

Conversion from toothpowder to toothpaste; premiumisation; lower replacement cycles of toothbrushes

Tooth powder

6 Colgate

(42%) Dabur (32%)

-5% Declining market due to the shift to toothpaste

Shampoos 40

HUL (43%)

P&G (29%)

CavinCare (9%)

16% Penetration (urban 57%, rural 37%) and frequency drivers; strong premiumisation trends

Skin creams

40 HUL

(58%) L'Oreal

(13%) P&G

(10%) 15%

Premiumisation led; Penetration up substantially over five years (fairness creams fully penetrated)

Hair Oils 40

Marico (43%)

Dabur (14%)

Bajaj (12%)

10-15% Shift to value-added hair oils; 75-80% current penetration;

Cosmetics 11

HUL (29%)

L'Oreal (13%)

Revlon (18%)

20% Low penetration; premiumisation; entry of several new global players

Deodorants

6 HUL

(42%)

McNROE

(16%)

Marico

(15%) 25-30%

Currently low penetration; shift from grey market to organised; increasing frequency

Overall 305 15%

Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively

Exhibit 36: Personal products market – competitive positioning of various players

Market share changes Product category

Competitive intensity

Comments Gainers Losers

No Change

Comments

Soaps High and rising

Low commodity prices providing additional surplus for A&P

HUL, GCPL, Reckitt

Wipro, ITC

HUL = strong portfolio, weak premium portfolio from competitors; GCPL = gains from the rejuvenated Cinthol portfolio

Tooth paste High and flat

MNCs control 80% share, fighting for share

GSK HUL, Dabur

Colgate Colgate = better association with dentists; HUL = weaker product portfolio

Tooth brushes

Medium and rising

Commoditised, fight for portfolio premiumisation

Colgate, P&G

Local organised

HUL Colgate: Launch of new variants, brand, wider range, strong distribution

Tooth powder

Low and declining

Declining segment, lower focus

Regional players

Colgate Dabur Colgate: reducing focus on category

Shampoos High and rising

MNC fight for share in the premium space

HUL, L’Oreal

P&G, Cavin-Care, Dabur

HUL: strong portfolio across segments and innovation; L'Oreal: high spenders (A:S 35%); Dabur: lacks premium portfolio

Skin creams and lotions

High and rising

Besides premium, slowing mass-end segment witnessing push

L’Oreal HUL L’Oreal: significantly aggressive and strong innovation; HUL: overhang from Fair & Lovely

Hair Oils High and rising

Strong competition in inflexion point- value added segment

Marico Dabur, Bajaj

Emami Marico: strong brand, value-added portfolio; Dabur: slowest growing category (amla);

Cosmetics High and rising

New entrants in MNC- dominated category

L’Oreal Revlon Oriflame, HUL

Aggressive investments from L’Oreal; weaker innovation and marketing from Revlon

Deodorants Medium and rising

New entrants in fast-growing category

New entrants

HUL Marico New entrants - backed by heavy marketing spends; eats into HUL’s share

Overall High and rising

Innovation and fight for premium portfolio

Source: Ambit Capital research, Company

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Ambit Capital Pvt Ltd 24

The Personal products market has rapidly progressed towards high penetration over the past five years, with categories such as soaps, oral care, skin care and hair care having over 83% penetration currently.

Premiumisation is the biggest driver of growth in personal product categories.

Competitive intensity has remained exceptionally high and continues to rise further with: (a) entry of new players like Sensodyne in oral care, and others like Marico, Bodyshop and several international brands; and (b) significant investments behind advertising and new product launches by players such as P&G and L’Oreal, as highlighted below.

Aggression from P&G: P&G Home Products (with a presence in detergents, shampoos, skincare and diapers) has seen its A&P spends increase at a CAGR of 52% from 12.3% of sales in FY06 to 28.9% of sales in FY11. The parent company recently infused more equity (Rs15.4bn) into the company, adding to its advertising firepower. We expect the increasing competitive intensity to have the largest impact on HUL (whose A&P has increased from 8.8% of sales in CY05 to 14% in FY11). P&G Home Products has reported revenue CAGR of 28% over FY06-11.

Exhibit 37: P&G Home Products - financial summary (Rs mn)

FY07 FY08 FY09 FY10 FY11 FY12

Net Sales 9,937 13,037 16,991 21,042 28,329 39,304

Sales growth (%) 22.4% 31.2% 30.3% 23.8% 34.6% 38.7%

EBITDA Margin 9.9% 10.5% 1.5% 14.5% -9.2% -6.2%

PAT Margin 4.6% 6.0% -0.9% 9.1% -11.8% -9.0%

Adv/Net Sales 12.0% 13.5% 21.7% 21.3% 28.9% 16.5%

Source: Company

Increased aggression from L’Oreal (Not listed): L’Oreal has seen 26% revenue CAGR over CY06-11 and 31% CAGR over CY08-11, with advertising spends as a percentage of sales of around 35% (compared with 12-18% for most FMCG companies). With new launches at aggressive price points (especially shampoos), we do not expect any reduction in advertising spends and expect competitive intensity to remain high in the segment, putting pressure on market leaders like HUL. L’Oreal maintains EBITDA margins of around 6%. We expect L’Oreal’s strong brands and aggressive marketing to help it gain share in the cosmetics, haircare and skincare space.

Exhibit 38: L’Oreal - financial summary (Rs mn)

CY06 CY07 CY08 CY09 CY10 CY11

Gross Sales 4,590 6,190 6,383 9,112 12,033 14,396

Sales growth (%) NA 34.9% 3.1% 42.8% 32.1% 19.6%

EBITDA Margin 7.7% 8.8% -0.5% 5.5% 5.9% 6.4%

PAT Margin 4.9% 4.8% -5.6% 1.9% 3.6% 4.1%

Source: Company

Personal products = Saturated penetration; premiumisation-led growth; high and rising competitive intensity

L’Oreal and P&G have been substantially aggressive more recently

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Ambit Capital Pvt Ltd 25

Home care: 10-12% revenue CAGR; moderate but rising competitive intensity

Exhibit 39: Home care market – key players and growth drivers Key players (market

shares) Key segment growth drivers Comments Product category

Market Size (Rs bn)(+) Rank

1 Rank 2 Rank 3

Expected segment FY13-15

CAGR Freq. of

consumption Penetr- ation

Premium-isation

Detergents 130 HUL

(38%) Ghari (17%)

P&G (15%)

10% Fully penetrated segment; growth driven by premiumisation

Insecticides 30 GCPL (42%)

Reckitt Benckiser

(17%)

SC Johnson

(17%) 12-14%

Penetration (60% urban, 18% rural); rising incomes and focus on sanitation driving frequency

Dishwashing Products

10 HUL

(60%) Jyothy (20%)

20% Penetration and shift to organised segment

Surface Cleaners

3 Reckitt (74%)

HUL (13%) 30%

Penetration and shift to organised segment

Overall 173 12%

Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively

Exhibit 40: Home care products market – competitive positioning of various players

Market share changes Product category

Competitive intensity

Comments Gainers Losers No Change Comments

Detergents Medium and rising Only premium segment growing; MNC market share fight

Ghari P&G, Nirma

HUL Ghari: distribution expansion led gains; HUL: gains in premium to make up losses in the mass segment

Insecticides Medium and rising Increasing aggression from GCPL

GCPL Reckitt, SC Johnson

GCPL: frequent innovation, distribution expansion, marketing investments

Dishwashing Products

Medium and rising HUL Jyothy HUL: gain backed by strong brand and marketing

Surface Cleaners

Low and rising Reckitt, HUL No material changes expected

Overall Medium and rising

Source: Ambit Capital research, Company

‘Detergents’ form the bulk of the homecare market, with high penetration, weak volume growth and increasing competition for especially from players such as Rohit Surfactants (Ghadi) at the mass end and HUL at the premium end (highlighted below).

‘Insecticides’ is the other decently sized, underpenetrated and fast-growth category in this market dominated by GCPL.

Ghadi’s aggression likely to accelerate further: Rohit Surfactant’s Ghadi detergent recently displaced HUL’s Wheel to become the largest detergent brand in India. The company targets only the mass end of the market, and recorded revenue CAGR of 21% over FY07-11 and has maintained an average EBITDA margin of 11% over the same period (broadly in line with HUL’s soaps and detergent margins). We expect Ghadi to continue its competitive intensity at the mass-end and gain further share as it expands its distribution across India.

Exhibit 41: Rohit Surfactants - financial summary (Rs mn)

Rohit Surfactants

FY07 FY08 FY09 FY10 FY11 FY12

Net Sales 9,169 10,846 14,158 18,003 19,366 25,588

Sales Growth (%) NA 18.3% 30.5% 27.2% 7.6% 32.1%

EBITDA Margin 6.5% 9.3% 16.4% 15.6% 9.3% 10.2%

PAT Margin 3.1% 4.5% 9.4% 9.9% 5.4% 6.7%

Adv/Net Sales 4.1% 4.4% 4.9% 4.7% 4.7% 3.4%

Source: Company

Reckitt looking for new growth avenues: With more than 50% of revenues coming from the highly penetrated soaps business, Reckitt has still managed to record revenue CAGR of 20% over CY06-11. With healthy EBITDA and PAT

Competitive intensity from Ghadi and Reckitt is likely to accelerate further going forward

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Ambit Capital Pvt Ltd 26

margins (averaging at least 200bps above industry average), the company still maintains aggression, with advertising spends averaging 15% of sales over CY06-11. Its recent acquisition of Paras Pharmaceuticals is indicative of the company’s aggression. We expect Reckitt to gain share in the soaps space, as it benefits from faster than market growth in the germicidal category. However, we expect it to lose share to GCPL in the insecticides space, as GCPL will benefit from its distribution expansion and aggressive promotions.

Exhibit 42: Reckitt Benckiser - financial summary (Rs mn)

Reckitt Benckiser CY06 CY07 CY08 CY09 CY10 FY12

Net Sales 11,019 13,131 15,296 17,901 21,658 27,947

Sales Growth (%) NA 19.2% 16.5% 17.0% 21.0% 29.0%

EBITDA Margin 18.6% 22.5% 21.8% 19.9% 20.6% 20.5%

PAT Margin 14.2% 19.2% 18.3% 16.3% 15.6% 15.4%

Adv/Net Sales 16.7% 15.8% 15.6% 16.6% 14.1% 10.9%

Source: Ambit Capital research. Note: FY12 figures are adjusted for a 12M year ending

III - Recent raw material trends CY13 YTD has seen the following key input cost trends:

Significant increase in input costs for tea, milk food drinks (wheat) and HDPE (key ingredient used for packaging of most products) over the previous year; and

Significant decline in input costs for soaps (palm oil), rice bran oil and coffee over the previous year.

However, the prices of tea, safflower oil and Palm Fatty Acid Distillate (PFAD) have declined by over 10% decline.

Manufacturing for most product segments (excluding tea, coffee, coconut hair oils and soaps) includes an average holding period of 30-40 days. Therefore, near-term gross margins for most FMCG categories will be driven by input cost trends over the past two months. Given that the raw material holding period for tea, coconut oils and soaps, on average, is 2-3 months, we expect soaps and coffee to report a continued gain in gross margins in early FY14 due to weak raw material costs (palm oil and coffee respectively) in 4QFY13. We see no major commodity price increases in 4QFY13.

The historical price trends of key raw materials used in manufacturing FMCG products by listed companies are highlighted on pages 28-30. Based on the contribution of each of these raw material inputs towards CoGS for various companies, the key trends affecting the FMCG companies are:

Gross margin benefit over in FY13: As highlighted in the exhibit below, gross margins for most companies in the sector have increased by a median of 160bps YoY in FY13. This gross margin gain has been predominantly led by raw material cost declines for these companies.

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Ambit Capital Pvt Ltd 27

Exhibit 43: Gross margin expansion YoY recorded in FY13 (bps)

430

240

170 160

80 80-50

-100

0

100

200

300

400

500

Mar

ico

Nes

tle

Dab

ur

GC

PL

HU

L

GSK

Con

sum

er

Col

gate

Source: Company, Ambit Capital research

Exhibit 44: Increase in advertisement to sales ratio in FY13 (bps)

180

145

120

95

60

20

0

40

80

120

160

200

Mar

ico

Col

gate

Dab

ur

GC

PL

HU

L

GSK

Con

sum

er

Source: Company, Ambit Capital research

A&P spends over the FY13: As highlighted in the exhibit above, the expansion in gross margins in FY13 so far has been ploughed back into advertising and promotions for most of the FMCG companies, thereby supporting category volume growth (through promotions) and market share gains (through investments in advertising).

Conclusions

Based on these observations, we expect the following sector-wide and stock specific implications:

Impact on the sector: Whilst most players have seen the benefit of low input costs over the past three quarters, the pace of gross margin expansion is likely to recede in the near term, as (1) some commodities (especially copra, tea, wheat and packaging materials) have displayed inflationary trends in 4QFY13; and (2) FY13 forms a high base for gross margins for the sector.

Impact on Marico: Whist Marico benefitted from lower copra prices through FY13, the past two quarters have seen a strong escalation in prices of copra (14% from October 2012 to March 2013), the key raw material for its coconut oil portfolio. With favourable copra prices seen throughout FY13, it will be difficult for Marico to sustain the pace of margin expansion in FY14, assuming no changes to commodity prices from current levels.

Impact on HUL and GCPL: A high inventory situation in Malaysia and strong soybean crop in the West has led to palm oil prices correcting by 20% from September 2012 to April 2013 (30% over the past one year). This is a key raw material for soaps, and the price correction is likely to positively impact HUL and GCPL, both of which derive ~20% of their consolidated revenues from their soaps business.

Impact on GSK Consumer: Given the price increase of ~25% YoY in wheat in 4QFY13, we expect GSK Consumer’s gross margin to contract as it enters FY14.

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Ambit Capital Pvt Ltd 28

Exhibit 45: Impact of recent raw material price trends on various players in the industry

Source: Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning

HUL Nestle Dabur Marico GCPL GSK

Cons Colgate Recent price trends

Recent raw material movements

Copra

Whilst copra prices sharply trended downwards until Oct’12, they saw a 25% increase over Oct’12-Jan’13. However, copra prices have eased 7% over February-April 2013.

Sugar

Whilst sugar prices have shown signs of moderation over the past quarter, they still remain higher by 10% YoY. Reduction in sugar prices augurs well for GSK and Nestle.

Milk

Milk prices have remained relatively stable on a QoQ basis, helping GSK and Nestle contain cost inflation.

Tea

HUL and Tata Global will see impact of tea prices inching up from 2HFY13 onwards due to production shortages (note that prices are currently 25% higher YoY)

Coffee

With coffee prices having eased by around 30% YoY until April 2013, Nestle and HUL will be key beneficiaries.

Wheat

GSK will be the most impacted by the 20-30% YoY increase in wheat prices, whilst HUL and Nestle will also see a small impact.

LAB (Linear Alkyl Benzene)

LAB prices have remained fairly stable with prices increasing by about 6% YoY in April.

Polyethylene (PE)

With a 10-15% YoY increase in 4QFY13, PE prices have led to packaging cost pressures but prices have moderated slightly in 1QFY14.

Safflower Oil

The sharp rise of around 50% in safflower oil prices in FY13 will negatively impact Marico. However, there has been a sharp correction in Safflower prices in March.

Rice Bran Oil

Prices of Rice bran oil, an input for the Saffola portfolio, has been on declining trend over Feb-April 2013, a 13% decline from January 2013 prices (April 2013 prices are down 21% YoY).

Liquid Paraffin Liquid paraffin prices have been fairly stable

this year and they are down 10% YoY.

HDPE

Prices of a key component of plastic packaging, HDPE, have risen around 14% YoY over the previous quarter.

Calcium Carbonate

Prices of a key raw material for toothpastes, Calcium Carbonate, have been flat YoY.

Palm Oil

Both palm oil and PFAD prices have seen a decline of 30-40% YoY, which will benefit all soap manufacturers.

Caustic Soda & Soda Ash

Caustic soda prices have risen around 10-15% YoY, with prices strengthening from September onwards.

Barley

Whilst October-January saw sharp increases in Barley prices (30% YoY), February-April saw sharp cooling in prices (down 13% YoY in April).

Net RM impact

Contributes more than 20% of Raw materials

Contributes up to 20% of Raw materials

Contributes up to 10% of Raw materials

Contributes 0% of Raw materials

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Consumer Staples

Ambit Capital Pvt Ltd 29

Exhibit 46: Copra (Rs/100Kg)

2,0003,0004,0005,0006,0007,0008,000

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research

Exhibit 47: Sugar M-grade (Rs/tn)

2,000

2,500

3,000

3,500

4,000

4,500

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: NCDEX, Ambit Capital research

Exhibit 48: Milk – WPI (Indexed)

120

140

160

180

200

220

Apr

-09

Sep-

09

Mar

-10

Aug

-10

Jan-

11

Jul-

11

Dec

-11

Jun-

12

Nov

-12

Apr

-13

Source: Bloomberg, Ambit Capital research

Exhibit 49: Tea (Rs/Kg)

60708090

100110120130140

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Tea Board, Ambit Capital research

Exhibit 50: Coffee (US$/lb)

100

150

200

250

300

Jan/

10

Jun/

10

Dec

/10

Jun/

11

Nov

/11

May

/12

Oct

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

Exhibit 51: Wheat – New Delhi (Rs/quintal)

1,0001,1001,2001,3001,4001,5001,600

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: NCDEX, Ambit Capital research

Exhibit 52: Coconut oil (Rs/100Kg)

3,0004,0005,0006,0007,0008,0009,000

10,00011,000

May

/09

Oct

/09

Mar

/10

Aug

/10

Feb/

11

Jul/

11

Dec

/11

May

/12

Oct

/12

Apr

/13

Source: Marico, Ambit Capital research

Exhibit 53: LAB (Rs/Kg)

60708090

100110120130

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Reliance Industries, Ambit Capital research

Exhibit 54: Polyethylene (Rs/Kg)

6065707580859095

100A

pr/0

9

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Reliance Industries, Ambit Capital research

Exhibit 55: Sunflower oil (Rs/10Kg)

300400500600700800900

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research

Exhibit 56: Kardi oil (Rs/10Kg)

400600800

1,0001,2001,4001,6001,800

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research

Exhibit 57: Rice bran oil (Rs/10Kg)

200

300

400

500

600

700

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research

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Ambit Capital Pvt Ltd 30

Exhibit 58: Liquid paraffin (Rs/lt)

20304050607080

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research

Exhibit 59: HDPE* (Rs/Kg)

6065707580859095

100

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Marico, Ambit Capital research. * stands for High density polyethylene

Exhibit 60: Calcium Carbonate (Indexed)

115120125130135140145

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

Exhibit 61: India RBD Palmolein (Rs/tonne)

600700800900

1,0001,1001,2001,3001,400

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

Exhibit 62: Caustic Soda/ Soda Ash (Indexed)

100

120

140

160

180

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

Exhibit 63: Palm Fatty Acid Distillate (Rs/tonne)

400500600700800900

1,0001,100

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

Exhibit 64: Barley India UP (Rs/quintal)

700800900

1,0001,1001,2001,3001,4001,500

Apr

/09

Sep/

09

Mar

/10

Aug

/10

Jan/

11

Jul/

11

Dec

/11

Jun/

12

Nov

/12

Apr

/13

Source: Bloomberg, Ambit Capital research

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Consumer Staples

Ambit Capital Pvt Ltd 31

Valuations set to decline We adopt a DCF-based approach to value the FMCG sector because it appropriately captures: (a) the varied capital reinvestment/allocation strategies likely to be adopted in the future; (b) earnings growth moderation attached to rising competitive intensity and penetration saturation; and (c) the relative defensive/ predictable nature of the respective businesses. Thus, we initiate coverage on the sector with a SELL stance on the seven stocks, as shown in the tables below.

On one-year forward P/E multiples, the sector has rerated by over 70% since FY08. Whilst two-thirds of this re-rating is backed by an improved fundamental performance of the respective stocks, the balance we believe is not justified given the moderation in volume growth related to an increase in competitive intensity and saturating penetration in several large product categories over the past five years.

Also, a comparison with other listed emerging market plays in countries, such as Indonesia, Brazil and China, suggests that the Indian FMCG sector currently trades at a 40% premium to these international peers despite having generated 300bps lower revenue CAGR and 500bps lower EPS CAGR over FY08-13 with 100bps lower revenue and 500bps lower EPS forecasts over the next 24 months.

Finally, we briefly compare the valuation gap between large-cap discretionary consumer stocks and the seven FMCG stocks covered in this report. We conclude that the seven FMCG stocks compare unfavourably against major FMCG companies such as ITC as well as discretionary names such as Asian Paints, Berger Paints, Titan and TTK Prestige

Our DCF-based valuation suggests ~15% derating of valuations

Exhibit 65: Summary valuation table

Company Comptt

Mapping Rating

CMP (Rs)

Mcap (US$ mn)

Target Price (Rs)

Upside/ Downside

P/E (FY14E)

P/E (FY15E)

Implied P/E (FY14)

EPS CAGR (FY08-13)

EPS CAGR (FY13-15)

ROE (FY13)

GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%

Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%

Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%

Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%

HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%

Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%

GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%

Median 37.2 32.8 31.6 18% 15%

Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15

We prefer DCF since it captures cash generation, utilisation and growth moderation Since the Indian consumer story is constantly evolving both in terms of the pace of growth (width and depth of consumption) as well as in terms of the competitive intensity, we prefer a DCF-based approach which factors in the implication of this evolution at a firm specific level. Also, our DCF captures: (a) the varied capital deployment strategies likely to be adopted by these companies through capex and working capital investments; and (b) the relative defensive (or lack thereof) nature of these businesses as compared to each other. Mentioned below is a summary of our assumptions around these factors:

Capital deployment: Given that working capital and capex are strong drivers of cash flows, the divergence in working capital efficiency is clearly visible in the chart

We adopt a DCF-based approach to value the FMCG sector

Comparison with listed emerging market plays suggests 40% premium rating of Indian FMCG sector

FMCG stocks compare unfavourably against ITC and discretionary consumer names

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Ambit Capital Pvt Ltd 32

below. MNCs operate on a negative working capital cycle whilst the Indian companies still have a long way to go to reach that level of efficiency.

Exhibit 66: Working capital as a percentage of sales for various FMCG companies over FY15-26E

-2.2%

-1.8% -1.8%-1.5%

0.0%

0.8%

1.3%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

GSK

Con

sum

er

HU

L

Nes

tle

Col

gate

GC

PL

Dab

ur

Mar

ico

Source: Company, Ambit Capital research; Note: Numbers based on our DCF forecasts over FY15-26

Exhibit 67: Capex as a percentage of sales for various FMCG companies over FY15-26E

0.5%0.8%

1.3% 1.4%1.5% 1.6% 1.7%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

HU

L

GC

PL

GSK

Con

sum

er

Nes

tle

Mar

ico

Dab

ur

Col

gate

Source: Company, Ambit Capital research; Note: Numbers based on our DCF forecasts over FY15-26

Factoring in the evolution of the consumption story: Whilst we believe in the sustainability of India’s consumption story for the next decade, our three-stage DCF model uses the following approach:

Stage 1 (first five years): Explicit forecasts for the next five years are based on the expectations of category growth rates and sustainability of competitive advantages of these companies.

Stage 2 (next eight years): Cash flow growth moderation from 15% on average in Stage 1 (FY14-FY18) to 10% average in Stage 2 (FY18-26) is based on the assumption that: (a) increase in competitive intensity and increase in penetration of categories will result in moderation in revenue growth after FY18 for all these companies; (b) EBITDA margins will be broadly steady in this stage as margin benefits from premiumisation of product portfolios will be fully offset by increased advertising spends to counter rising competitive intensity; and (c) it would be unfair to expect a mid- to high-teen growth rate for the companies even after 13 years given the need to evolve with the consumption trends through changes in long-term strategies of these companies.

Stage 3 (FY26 onwards): Terminal growth of 5% after 13 years.

Exhibit 68: Stage 1 and stage 2 free cash flow CAGR

0%5%

10%

15%

20%

25%30%

35%

HU

L

Nes

tle

GC

PL

Dab

ur

Mar

ico

GSK

Con

sum

er

Col

gate

Stage 1 (FY13-18) Stage 2 (FY18-26)

Source: Company, Ambit Capital research; For Marico, Stage 1 has been calculated from FY14-18 as our FY13 forecast suggest negative free cash flow to firm

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Consumer Staples

Ambit Capital Pvt Ltd 33

Cost of equity assumed: Based on an assumption of a risk-free rate of 8.5%, equity risk premium of 7% and a beta range of 0.5-0.55, our cost of equity assumed for the FMCG stocks ranges from 12% to 12.5%.

Sector P/E multiples rerating vs fundamentals: Disconnect has emerged over the past 24 months

Exhibit 69: Rerating in the FMCG sector given declining volume growth

15

18

21

24

27

30

33

FY09 FY10 FY11 FY12 FY13

6%

8%

10%

12%

14%

16%

18%

20%

Average P/E (LHS) Average Volume Growth

Penetration FY07 Advt spends FY07Skin creams 25% GSK Cons. 12.9%

Biscuits 68% HUL 10.2%

Detergents 88% Marico 12.5%Penetration FY12 Advt spends FY13Skin creams 62% GSK Cons. 16.3%

Biscuits 89% HUL 12.5%

Detergents 98% Marico 13.6%

Source: Bloomberg, Company

The 61% rerating of the sector on one-year forward P/E multiples (see the exhibit above) is partly justified by improved fundamentals and partly by the defensive nature of the sector in a weak economic environment. This rerating can be divided into two parts:

Rerating over FY08-11 - emergence of India’s consumption story: Due to a combination of macro-economic and demographic factors such as increased government spends, women empowerment, media penetration, urbanisation, and growth of economies which have been laggards in the past, fundamental volume growth of the FMCG companies accelerated over FY08-11. Since these structural drivers of improved fundamentals of India’s consumption story are here to stay over the next five years, we expect the rerating of the sector on P/E multiples from 18.5x in FY09 to 26.7x in FY11 to be sustainable going forward.

Rerating achieved over FY11-13 despite moderating volume growth: The 16% rerating over the past 24 months to current levels of 37.2x one-year forward P/E multiples is not justified by any fundamental improvements. Instead, volume growth of companies covered in this report moderated by 300-400bps over FY11-13 (except for Dabur where the portfolio of juices and home care has offset moderation in volume growth of other categories over this period).

Exhibit 70: Volume growth trends over the past 9 quarters (YoY)

4QFY11 1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13

HUL 13% 8% 10% 9% 10% 9% 7% 5% 6%

Dabur 10% 9% 5% 11% 12% 12% 9% 10% 12%

Marico 12% 14% 14% 13% 13% 14% 14% 11% 8%

Nestle 10% 8% 8% 5% 3% 3% -5% 1% 0%

Colgate 9% 12% 13% 15% 12% 11% 10% 7% 12%

GSK Consumer 4% 16% 10% 11% 7% 7% 6% 8% 8%

Source: Ambit Capital research;

FY08-11 re-rating reflects emergence of India’s consumption story

FY11-13 re-rating despite moderating volume growth

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Consumer Staples

Ambit Capital Pvt Ltd 34

Over FY13-15, we forecast an EPS CAGR of 17% for the sector, 300bps lower than the performance over FY12-13, and around 200bps lower than the EPS CAGR of 19% reported over FY08-13. This moderation in EPS CAGR for the sector can be broadly attributed to the following factors:

High penetration levels of several product categories: Penetration of categories such as oral care, hair oils, milk/milk products, soaps and detergents have substantially increased over the past five years. With the current penetration levels exceeding 80% in these categories, growth rates are likely to moderate going forward as compared to those achieved in the past.

Exhibit 71: Increase in penetration levels over 2007-2012 for a few categories

2012 2007

Rural Urban Rural Urban

Food & Beverages

Biscuits 83% 94% 55% 80%

Soaps 99% 100% 89% 97%

Toothpaste 67% 91% 38% 75%

Skin creams 57% 67% 18% 32%

Washing powder/liquid 97% 99% 84% 91%

Mosquito repellents 18% 59% 27% (avg)

Toilet/Bathroom cleaners 3% 30% 9% (avg)

Floor cleaners 4% 26% 2% 22%

Source: Industry, Ambit Capital research

Increased competitive intensity: Categories such as noodles, premium biscuits, premium edible oils and cosmetics, which were previously controlled by only one or two large players, have seen an influx of new entrants including MNCs with large balance sheets. This has led to a rise in competitive intensity in these categories. Consequently, we expect a combination of moderation in revenue growth potential and increased advertising spend to sales ratios for some of the incumbents in these categories.

Exhibit 72: Rise in new entrants indicates an increase in competitive intensity

Category Key players five years ago Formidable new entrants since then

Biscuits Britannia, Parle, ITC United Biscuits, Cadbury, Unibic

Chocolates Cadbury, Nestle Ferrero, Kraft

Noodles Maggi, ITC Smith and Jones, Ching’s Secret, GSK Consumer

Premium Edible Oils Agro Tech, Marico Adani Wilmar

Fruit juices Dabur, PepsiCo KDD, Parle, Coca Cola

Toothpaste Colgate, HUL, Dabur GSK Consumer, P&G (expected)

Skincare/Cosmetics HUL, L'Oreal, P&G, Revlon, Beiersdorf Marico, Bodyshop, Shiseido, Clinique, Faces

Source: Company, Ambit Capital research

Tailwinds related to raw material cost benefits are fleeting: Despite the volume growth moderation over FY11-13, PAT growth in the sector has remained robust over this period. This support to PAT growth is derived from a substantial gross margin expansion due to softening commodity prices (see the table below). Assuming that commodity prices remain unchanged from the current levels, we do not expect this margin support to continue for the sector, especially given the high price elasticity of demand currently and hence the less likelihood of substantial price increases going forward.

Moderation in earnings growth will continue over FY13-15

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Ambit Capital Pvt Ltd 35

Exhibit 73: Gross margin expansion vs EBITDA margin expansion for FY13

430

240170 160

80 80150 120

-10

-220

60 40

-70-50

-250

-150

-50

50

150

250

350

450

550

Mar

ico

Nes

tle

Dab

ur

GC

PL

HU

L

Gross Margin Expansion EBITDA Margin expansion

GC

PL

GSK

C

onsu

mer

Col

gate

Source: Company, Ambit Capital research

Moderation in revenues and EPS growth over FY13-15: Based on a bottom-up approach related to our category framework analysis, we forecast a median moderation of 600bps in revenue CAGR (15% CAGR over FY13-15 as against 21% CAGR over FY08-13) and 200bps in EPS CAGR (17% CAGR over FY13-15 as against 19% CAGR over FY08-12) for the stocks covered in this note (refer to the table below). This applies particularly to stocks such as Dabur, GSK Consumer, Marico and Nestle, where we expect the FY13-15 EPS CAGR to be lower than that achieved over FY08-13 (see the tables below).

Exhibit 74: Relative valuation multiples for the Indian FMCG sector

P/E EV/EBITDA EV/SALES Co Name

CMP (Rs)

Mcap ($mn)

Implied P/E (FY14) FY14E FY15E

PEG (FY14) FY14E FY15E

P/CFO (FY14) FY14E FY15E

Dividend yield (%)

(FY14)

Indian Consumer

GSK Consumer 5,515 4,112 32.5 45.5 38.0 1.4 38.4 32.3 36.4 6.0 5.2 1.1

Nestle 5,306 9,036 35.6 43.0 36.7 3.0 25.2 21.8 31.0 5.4 4.7 1.4

Colgate 1,451 3,492 32.2 38.1 33.8 4.5 27.0 23.1 33.5 5.3 4.6 2.1

HUL 592 22,660 31.6 37.2 32.8 3.7 28.5 25.0 32.3 4.3 3.8 1.9

Marico 234 2,647 27.8 33.0 27.1 1.0 21.0 17.9 25.1 3.2 2.7 0.5

Dabur 158 4,891 26.8 31.2 27.0 2.0 23.5 20.3 29.2 3.9 3.4 1.1

Godrej Consumer 873 5,263 29.6 32.6 27.2 1.2 22.5 18.7 27.6 3.8 3.3 0.9

Mean 30.9 37.2 31.8 2.4 26.6 22.7 30.7 4.6 4.0 1.3

Median 31.6 37.2 32.8 2.0 25.2 21.8 31.0 4.3 3.8 1.1

Source: Ambit Capital research, Bloomberg; All forward looking numbers are based on our forecasts

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Ambit Capital Pvt Ltd 36

Exhibit 75: Return profiles of the Indian FMCG sector

Company Name EPS CAGR

FY08-13 EPS CAGR

FY13-15 EBITDA CAGR

FY08-13 EBITDA CAGR

FY13-15 Sales CAGR

FY08-13 Sales CAGR

FY13-15 ROE

(FY13) ROCE

(FY13)

ITC 18% 19% 20% 19% 16% 17% 36% 36%

HUL 13% 10% 14% 12% 13% 13% 103% 104%

Dabur 18% 15% 20% 14% 21% 14% 40% 27%

Colgate 16% 8% 18% 13% 16% 15% 107% 112%

Godrej Consumer 21% 28% 34% 27% 42% 19% 23% 15%

Marico 17% 24% 20% 16% 19% 10% 23% 17%

Britannia 8% 15% 11% 13% 17% 15% 54% 30%

Emami 23% 21% 36% 8% 24% 18% 42% 37%

GSK Consumer 22% 18% 16% 19% 19% 15% 35% 36%

Nestle 21% 14% 21% 14% 19% 15% 70% 41%

Median 18% 17% 20% 14% 19% 15% 41% 36%

Source: Ambit Capital research, Company, Bloomberg; Forecasts for ITC, Emami and Britannia are based on Bloomberg consensus

MNC share buybacks – do they change the fundamentals?

One of the recent catalysts for share price re-rating (especially for players like HUL, GSK Consumer, Nestle and Colgate Palmolive) has been the buybacks announced by the parent companies of GSK Consumer and HUL to increase their stake in the listed entity through an open offer priced at 20-25% premium to the then prevailing share price. Whilst Unilever announced an increase in ownership in HUL from 52.5% to 75% through the open offer, GSK Consumer announced an increase from 43% to 75%.

The rationale behind the MNC parent’s decision to make these open offers can be one of the following: (a) Intention to help improve the Indian operations incrementally; or (b) Leveraging on low cost of capital to invest in high growth economy. Based on our analysis and discussions with market participants, we believe that the rationale behind these open offers is likely to be a reflection of the parent’s confidence in the Indian subsidiary’s long term leadership position in India’s fast growth consumption story and hence more of an investment opportunity given:

India’s consumption story: is one of the strongest and most sustainable in the parent’s portfolio of emerging markets, especially given weakening growth prospects in the developed world.

Cost of capital: for the MNC parent is substantially low in the current environment and hence deployment in growth profiles such as that offered by their subsidiaries in India is an attractive investment opportunity.

Limited prospects of new brand introductions from non-India portfolio: Unilever currently has 33 ‘brands in action’ globally, of which 22 are present in India. Of the rest, as highlighted in HUL’s stock specific section, only 3-4 brands currently have a good potential for a launch in India over the short to medium term. Also, for GSK Consumer, given a history of launches that have not met with success (Lucozade, Nutribars, Foodles, Aquafresh, Horlicks Chilled Doodh, etc), we believe it is pre-mature to expect a new launch to lead to a revenue growth that is as strong as that reported by Sensodyne over CY10-12.

Existing collaboration with the parent: The existing royalty structure takes into account the support provided by the parent to the Indian subsidiary on an ongoing basis.

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Consumer Staples

Ambit Capital Pvt Ltd 37

Comparison with other emerging market FMCG companies

Exhibit 76: Relative valuation multiples for global consumer companies

CY12

Revenues (US$ mn)

Mcap (USD bn)

CY07-12 Rev CAGR

CY07-12 EPS CAGR

FY14 P/E CY12-14

Rev CAGR CY12-14

EPS CAGR

Emerging market consumer companies

Unilever Indonesia TBK Pt 2,912 22.6 17% 20% 37.4 16% 11%

Unilever Nigeria Plc 350 1.6 10% 40% 54.9 15% 20%

Tingyi (Cayman Isln) (Taiwan) 9,212 14.5 23% 18% 35.6 16% 15%

BRF SA 14,656 20.3 34% 2% 22.3 11% 72%

M Dias Branco SA (Brazil) 1,822 5.0 19% 43% 18.2 9% 15%

Hengan Intl (China) 2,388 13.2 27% 25% 22.8 20% 18%

Mayora Indah Pt (Indonesia) 1,121 2.7 30% 39% 27.9 19% 21%

Want Want China Holdings Ltd 3,359 19.3 25% 25% 37.5 20% 20%

Nestle Nigeria Plc 735 5.0 22% 29% 6.9 20% 22%

Gudang Garam Tbk Pt (Indonesia) 5,229 10.4 12% 23% 18.5 11% 22%

Median 22% 25% 25.4 16% 20%

Source: Bloomberg, Ambit Capital research; Note: The non-India emerging market companies have been shortlisted based on their product portfolio

A quick comparison with large listed FMCG companies in countries like China, Indonesia and Brazil suggests that:

Indian companies have expanded at a lower rate: Indian players have reported 500bps lower EPS CAGR as compared to their international peers over CY07-12.

Indian companies are likely to expand slower: Indian players are likely to report 300bps lower EPS CAGR as compared to their international peers over CY12-14.

Indian companies are trading at a premium: Indian players currently trade at a ~20% premium as compared to their international counterparts on one-year forward P/E multiples.

This valuation disconnect, we believe, is not justified, because countries like China, Indonesia and Brazil broadly share similar long-term demographic and macro-economic growth drivers.

Aspirational consumer vs Staples consumer – trade-off between defensiveness and valuations Whilst we retain our SELL stance on the FMCG sector, we believe stocks like Asian Paints (MCap US$7.9bn, 6% upside) and TTK Prestige (MCap US$694mn, 23% upside) offer a significantly stronger growth profile and are available at more attractive valuations.

We have used the coefficient of variation of quarterly revenue growth over the past six years to determine the defensiveness of a stock. The matrix ranks Colgate as the most defensive stock and Berger as the least in the consumer space. Whilst there is a clear correlation between the level of defensiveness and the multiple at which the company is trading, the growth profiles of these companies vary significantly. We highlight the dichotomy between the growth profiles and valuations, with HUL, Colgate and Nestle (average EPS CAGR of 11% over FY13-15) enjoying premium multiples, and TTK and Bata (average EPS CAGR of 26% over FY13-15) trading at a 24% discount to the sector average.

Trade-off between FMCG’s defensiveness and discretionary plays’ growth and valuations

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Consumer Staples

Ambit Capital Pvt Ltd 38

Exhibit 77: Level of defensiveness in consumer stocks highlighting valuations and EPS growth

0%

10%

20%

30%

40%

20 25 30 35 40 45

EPS

CA

GR

(FY1

3-15

)

P/E FY14

BataTTK Prestige

Asian Paints

GCPL

Titan

Marico

Dabur

Berger Paints

Pidilite

HUL

Colgate

Jubilant Foodworks

GSK Consumer

Nestle

ITC

Source: Bloomberg, Ambit Capital research; Note: Size of the bubble highlights the level of defensiveness determined by the coefficient of variation of revenues over the past 24 quarters.

We haven’t included light electrical players such as Bajaj Electricals and Havells in the chart above since their ‘non-core’ businesses like E&P for Bajaj and Sylvania for Havells restrict a fair comparison on all parameters including consolidated EPS CAGR, P/E multiples as well as historical volatility in reported revenues. However, we believe strongly in the tailwinds for their product categories in the consumer vertical such as kitchen electrical appliances and other brown goods.

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Consumer Goods June 04, 2013

Hindustan Unilever Bloomberg: HUVR IN EQUITY Reuters: HLL.NS

Accounting: GREEN Predictability: AMBER Earnings momentum: RED

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income (` mn) 197,355 221,164 258,102 292,085 330,137 EBITDA(` mn) 26,784 32,913 40,038 44,509 50,307 EBITDA Margin (%) 13.6% 14.9% 15.5% 15.2% 15.2% Adjusted PAT(` mn) 20,953 26,565 32,206 34,437 39,080 Adjusted EPS (`) 9.7 12.3 14.9 15.9 18.1 RoE (%) 80.2% 83.1% 103.1% 108.2% 95.2% P/E (x) 61.1 48.0 39.7 37.2 32.8

Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `592

Target Price (Mar’14): `503

Previous TP: NA

Downside (%) 15%

EPS (FY14E): `15.9 Change from previous (%) NA

Variance from consensus (%) -5%

Stock Information

Mkt cap: `1,280bn/US$22.7bn

52-wk H/L: `598/400

3M ADV: `1,486mn/US$26.3mn

Beta: 0.53x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute 3 31 43 13

Rel. to Sensex 3 27 20 12

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Oct-12 Jan-13 M ay-13

400

500

600

Sensex Hind. Unilever

1-year forward P/E bancdchart

180

230

280

330

380

430

480

530

580

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

24x

27x

33x

30x

36x

Source: Bloomberg, Ambit Capital research

What goes up,… Hindustan Unilever’s (HUL) volume growth has gradually moderated from a steady run rate of 12-13% until FY11 to 6-8% over FY12-13. With a product portfolio that is skewed towards fully penetrated categories and with intense competition from MNC peers like Colgate, L’Oreal and Nestle, we expect an average volume growth of only 7% over FY13-15. Also, EBITDA margins are likely to decline by 50bps over FY13-15 due to rising competitive intensity, leading to increased advertising spends and an increase in royalty rates (as announced by the parent). With the stock currently trading at a 35% premium to its historical three-year and five-year P/E multiples, we initiate coverage with a SELL stance. Competitive position: STRONG Change to this position: STABLE

Due to the size and width of its product portfolio, HUL is able to ride the wave of evolving consumption in most product categories either by creating such a wave or by becoming the second entrant and yet a key beneficiary. However, we expect structural headwinds from the following:

Volume growth moderation: HUL’s overall volume growth could remain subdued at ~7% CAGR over FY13-15. HUL derives ~60% of its revenue from soaps & detergents (S&D) and tea—three fully penetrated categories with likely volume growth of only 2-5% per annum. Also, HUL is likely to lose market share in oral care (due to Colgate’s strong competitive advantages), skin care (high penetration in the mass market and intense competition from L’Oreal in the premium market) and beverages (weak brand recall of ‘100% coffee’, competition between HUL’s Bru Gold and Nescafe Classic).

EBITDA margin compression: Whilst we expect gross margin expansion of 40bps per annum over FY13-15 (related to portfolio premiumisation), we expect EBITDA margins to decline by 50bps over FY13-15, due to: (a) 50bps increase in advertising spend to sales ratio in response to strong competition from GCPL (S&D), L’Oreal (cosmetics, hair care and skin care), P&G (detergents, shampoos, skin care, oral care) and Nestle (beverages); and (b) a 140bps gradual increase in royalty rates over FY13-18 and a 4 percentage point increase in tax rates over the next two years.

Valuation: HUL’s one-year forward P/E multiple of 37.2x is at a ~35% premium to its three-year and five-year historical average of 27.0-28.0x. However, given the ongoing and forthcoming drag on EBITDA margins and volume growth, the extent of this premium rating is not justified. Unilever’s open offer indicates the parent company’s confidence in HUL’s long-term leadership positioning in India’s fast growth consumption story. However, we do not expect revenue and EPS CAGR to incrementally benefit from the parent’s increased ownership. Our DCF-based valuation generates a TP of `503/share (15% downside), an implied FY14 P/E multiple of 31.6x.

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Hindustan Unilever

Ambit Capital Pvt Ltd 40

Company Financial Snapshot

Profit and Loss (` mn) FY13 FY14E FY15E Net sales 258,102 292,085 330,137 Optg. Exp(Adj for OI.) 218,065 247,576 279,829 EBIDTA 40,038 44,509 50,307 Depreciation 2,360 2,318 2,339 Interest Expense 251 30 30 PBT 43,495 46,162 53,182 Tax 11,612 12,925 15,423 Adj. PAT 32,206 34,437 39,080 Profit and Loss Ratios EBIDTA Margin % 15.5% 15.2% 15.2% Adj Net Margin % 12.4% 11.4% 11.4% P/E (X) 39.7 37.2 32.8 EV/EBIDTA (X) 31.5 28.5 25.0 Dividend Yield (%) 3.1% 1.9% 2.0%

Company Background

HUL, a 52% subsidiary of Unilever, is India’s largest FMCG company, with a presence in Home and Personal Care Products and Food and Beverages.

The company has more than 35 brands spanning 20 categories such as soaps, detergents, shampoos, skin care, toothpastes, deodorants, cosmetics, tea, coffee, packagedfoods, ice cream, and water purifiers. Also, the company has more than 16,000 employees.

Its key brands include Lux, Lifebuoy, Surf Excel, Rin, Wheel,Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove, etc.

Balance Sheet (` mn)

FY13 FY14E FY15E

Total Assets 113,077 133,469 156,543 Net Fixed Assets 25,085 25,267 25,428 Current Assets 64,685 69,895 84,808 Other Assets 23,307 38,307 46,307 Total Liabilities 113,077 133,469 156,543 Networth 26,740 34,688 44,626 Debt - - - Current Liabilities 88,385 100,829 113,965 Deferred Tax (2,048) (2,048) (2,048) Balance Sheet Ratios ROE % 103.1% 108.2% 95.2% ROCE % 103.7% 108.3% 95.3% Net Debt/Equity (1.4) (1.5) (1.5) Equity/Total Assets 1.0 1.0 1.0 P/BV (X) 47.9 36.9 28.7

Cash Flow (` mn) FY13 FY14E FY15E PBT 43,495 46,162 53,182 Depreciation 2,360 2,318 2,339 Tax (11,612) (12,925) (15,423) Change in Wkg Cap 7,454 4,034 5,838 Others 95 (0) 0 CF from Operations 41,792 39,589 45,936 Capex (3,816) (2,500) (2,500) Investments 1,076 (15,000) (8,000) CF from Investing (2,741) (17,500) (10,500) Change in Equity - - - Debt - - - Dividends (46,834) (27,847) (30,379) Others 6,562 2,558 2,558 CF from Financing (40,272) (25,289) (27,821) Change in Cash (1,222) (3,200) 7,615

Best-in-class distribution (mn outlets) HUL’s working capital cycle has been led by its management of creditors (days, FY12/CY11)

0

1

2

3

4

5

6

7

HU

L

Dab

ur

Col

gate

GC

PL

Mar

ico

Nes

tle

GSK

Con

sum

er

Direct reach Total reach

(60)

(40)

(20)

-

20

40

60

80

100

HU

L

Nes

tle

GSK

Con

sum

er

Col

gate

GC

PL

Dab

ur

Mar

ico

Other current liabilities Working capital days

Source: Company, Ambit Capital research

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Hindustan Unilever

Ambit Capital Pvt Ltd 41

Company Background Exhibit 1: HUL’s portfolio mix

Category Key brands Key Competitors Market share

rank % of

turnover Estimated FY12

Growth

Soaps Lifebuoy, Lux, Dove, Pears, Hamam, Liril, Breeze, Rexona

Godrej Consumer, Reckitt Benckiser, Wipro

1 20% 9%

Detergents Surf Excel, Rin, Wheel, Comfort, Vim, Domex, Cif

P&G, Rohit Surfactants, Nirma

1 28% 29%

Oral care Pepsodent, Close-up Colgate, Dabur 2 5% 17%

Skin care Fair & Lovely, Vaseline, Dove, Ponds, Lakme, Aviance

L'Oreal, Marico, Beiersdorf, Emami

1 11% 18%

Hair care Clear, Clinic Plus, Tresemme, Dove, Sunsilk

P&G, CavinCare, Dabur, L'Oreal

1 8% 16%

Tea 3 Roses, Red Label, Taj Mahal, Taaza, Lipton

Tata Tea, Wagh Bakri 2

9% 9%

Coffee Bru Nestle 1 3% 18%

Ice Creams Kwality Walls Amul, Vadilal, Mother Dairy 2 2% 30%

Branded Staples Annapurna Aashirvaad 2 2% 11%

Culinary Products Knorr, Kissan Maggie NA 3% 11%

Source: Ambit Capital research

HUL is the largest and the most-diversified listed FMCG company in India. As of FY12, HUL derived around 48% of its revenues from soaps and detergents, 31%, from personal care, 12% from beverages and 9% from food and others. The soaps and detergents segment contributed to 37% of EBIT in FY12 vs 52% for personal care, and 11% from beverages (the food and others segments did not contribute to EBIT).

HUL has a market-leading portfolio and the company is the #1 player in soaps, detergents, skin care, hair care, culinary products and coffee and the #2 player in oral care, tea and ice creams.

Historical track record

HUL has reported revenue CAGR of 7% with EBIT CAGR of 6% over CY01-FY12. As shown in the charts below, over the past decade, revenue growth of the soaps and detergents (S&D) and personal products categories has outpaced the revenues of the beverages, food and other categories. Consequently, the proportion of revenues from S&D and personal product categories has increased from under 50% in CY01 to ~80% in FY12. However, a consistent decline in S&D EBIT margins from 22.8% in CY01 to 11.6% in FY12 has reduced the contribution of S&D to PBIT from 51% in CY01 to 37% in FY12.

Exhibit 2: Revenue contribution of soaps and detergents has risen from 43% in CY02 to 49% in FY13

0%

10%20%

30%40%

50%

60%70%

80%90%

100%

CY0

2

CY0

4

CY0

6

FY09

FY11

FY13

Exports/Others/Foods

Beverages

Personalproducts

Soap andDetergents

Source: Company, Ambit Capital research.

Exhibit 3: However, personal products’ share of PBIT has been increasing versus soaps and detergents

-20%

0%

20%

40%

60%

80%

100%

CY0

2

CY0

4

CY0

6

FY09

FY11

FY13

Exports/Others/Foods

Beverages

Personalproducts

Soap andDetergents

Source: Company, Ambit Capital research

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Hindustan Unilever

Ambit Capital Pvt Ltd 42

Distribution

HUL derives around 15% of its revenues from modern trade as against a 5-6% contribution of modern trade in overall FMCG consumption in India. Also, this has been the fastest-growing distribution channel for the company over the past decade. The current distribution reach for HUL stands at ~7mn outlets including a direct reach of ~2mn outlets (up from a direct reach of ~1mn in FY10). The company is currently focusing on building its direct reach rather than focusing on the overall reach.

SWOT analysis

Exhibit 4: SWOT analysis for HUL

Strengths Weaknesses

Heavy marketing efforts across brands have led to the creation of strong brands that are market leaders in most of the categories in which they have a presence in. (Advertisement spends are up from 7.2% in CY03 to 12.5% in FY13E.)

It has a portfolio that straddles all segments (from mass to premium) and in most categories, it has an established premium portfolio (market shares of over 50% in personal products and S&D), enabling HUL to be one of the largest beneficiaries of premiumisation.

Strict control over inventory (inventory days - 42 in FY12) and creditors (other current liabilities days - 91 in FY12) helps HUL have amongst the best working capital cycles (WC cycle of -55 days in FY12) in its peer group.

Amongst the best talent (one of the first FMCG companies to start recruiting from the IIMs) and distribution reach in India, reaching out to more than 7mn outlets.

Portfolio is skewed towards lower growth categories like soaps and detergents (48% of FY12 turnover) and beverages (11% of FY12 turnover) which are almost fully penetrated.

Whilst the skin care portfolio is a market leader in the mass market (Fair & Lovely), it faces tremendous competition in the premium market (Ponds faces strong competition from L’Oreal).

Opportunities Threats

HUL is building its portfolio in high-growth categories like premium skin care (over 20%), hair care (18%) and deodorants (30%) and is entering into emerging categories like hand wash and face wash (>25%).

Investing aggressively in the rural market, which is a segment that has been growing faster than urban areas since CY07.

Strong balance sheet with support from the parent company as well as access to its global brands and technology can lead to new product launches in India.

Increasing competitive intensity across categories (especially L’Oreal, Nestle and P&G) has led to market share losses and the company will likely see elevated advertisement spends going forward.

HUL has struggled to pass on price increases (especially in the mass skin care segment and the personal care segment). Raw material inflation can put pressure on margins especially as its competitors are MNCs with strong balance sheets.

Source: Company, Ambit Capital research, Industry

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Hindustan Unilever

Ambit Capital Pvt Ltd 43

Benefits from premiumisation, operational efficiencies and efficient capital allocation

Width and depth of the product portfolio As shown in the table below, HUL’s portfolio of products includes strong brands across economy, mid-tier as well premium products across most product categories. Currently, HUL derives around 15-20% of its overall revenues from premium brands (in bold font in the table below).

Exhibit 5: HUL’s product portfolio has a fair mix of mass, mid and premium brands

Category Key brands Market

position Contribution of

premium brand (%) Contribution of

segment (%)

Soaps Dove, Lux, Pears, Lifebuoy, Hamam, Liril

No.1 20% 20%

Detergents Wheel, Rin, Surf No.1 15% 25%

Skin care Fair & Lovely, Lakme, Vaseline, Ponds No.1 10% 18%

Hair care Dove, Clinic Plus, Sunsilk, Clear, Tresemme

No.1 20% 8%

Oral care Pepsodent, Closeup No.2 15% 5%

Tea Red Label, Taj Mahal, 3 Roses, Lipton, Taaza

No.1 15% 9%

Coffee Bru No.2 5% 3%

Foods Kissan, Knorr, Modern, Annapurna, Kwality Walls No.2 25%

6%

Others Axe, Vim, Domex No.1 NA 6%

Source: Company, Ambit Capital research. Note: Premium brands highlighted in bold

Such a diverse range of products is beneficial to the company for multiple reasons:

Riding the wave of evolution of consumption: The width and size of the product portfolio allows HUL to test launch new products and variants on a frequent basis despite having a low rate of success in these launches. Hence, HUL is able to either create new waves of consumption in several categories or ride the wave created by a competitor by being the #2 player in such a category.

Customer acquisition benefits: Many competitors (such as Rohit Surfactant’s Ghadi, Nirma, Wipro, and Reckitt Benckiser), in the S&D category, do not have products across the economy to premium segments. Moreover, with high penetration levels in categories such as S&D and tea, premiumisation is a major component of category growth. Consequently, players like HUL benefit disproportionately as against some of its peers through the acquisition of customers who premiumise away from competitor brands.

Premiumisation trends within HUL’s brands: Other players including P&G, L’Oreal and Colgate offer premium products across categories that are relevant to HUL; however, the company benefits from being able to offer premium products along with the promotions of the economy products within its portfolio of brands. This has helped the company premiumise customers from, for example, Fair & Lovely to Ponds and from Wheel to Rin.

Gross margin benefit: Due to a sharp differential in pricing between the mass and premium categories, especially in the soap and detergents segment, the incremental gross margin benefit is significant. Our calculations suggest that a differential of more than 40% on gross profits exists in detergents with gross margins of ~25%, ~40% and ~70% for Wheel, Rin and Surf respectively, as consumers straddle up the pyramid of brands. Also, the expansion of new high-margin categories like face washes, fabric conditioners, hair conditioners and tea bags is likely to provide a further impetus to gross margins. Consequently, as shown in the chart below, we forecast a gross margin expansion of 40bps per annum over FY13-15 for HUL.

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Hindustan Unilever

Ambit Capital Pvt Ltd 44

Exhibit 6: We factor in premiumisation-driven gross margin improvements of 40bps in FY14 and FY15 each (%)

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

CY06 CY07 FY09 FY10 FY11 FY12 FY13 FY14E FY15E

44%

45%

46%

47%

48%

49%

50%

51%

Change in gross margin (LHS) Gross margin

Source: Company, Ambit Capital research

Distribution network and working capital cycle The total distribution reach for HUL was 7mn outlets as on FY12 of which direct reach accounts for around 2mn outlets (as compared to 1mn outlets in FY10). With one of the largest overall distribution networks, HUL is now focussed on expanding its direct reach rather than the overall reach. Also, some of the distribution initiatives taken by the company in the past include:

Use of advanced analytics for its sales and distribution called Project IQ. This was developed over the past two years and has helped the company track stock information from its direct reach. These analytics enable the company to define a product assortment for each outlet and to assist in promoting the portfolio (especially premium and new launches) more efficiently to maximise sales based on the consumer profile.

By 2008, HUL had consolidated its distributors, which were previously segregated according to product categories. The total number of distributors was brought down from around 6,000 to less than 3,000. Whilst the company has not changed distributor margins, the supply chain is now efficient enough to ensure that distributors do not hold unsold stock for more than 1-2 days for the company.

Exhibit 7: HUL enjoys the highest distribution reach in the sector (mn outlets)

0

12

3

4

5

6

7

HU

L

Dab

ur

Col

gate

GC

PL

Mar

ico

Nes

tle

GSK

Con

sum

er

Total reach

Direct reach

Source: Company, Ambit Capital research

HUL also has one of the best working capital cycles in the industry due to its strong focus on working capital management (refer to the charts below). We believe this is due to:

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Hindustan Unilever

Ambit Capital Pvt Ltd 45

1. Working capital management being a component of the top management’s

compensation structure at HUL

2. Globally negotiated vendor contracts that provide favourable payment terms

3. Scale benefits that help negotiate favourable contracts with vendors in India

4. Taking measures to improve its inventory management by shifting away from legacy systems to SAP’s ERP and effecting changes in its ordering patterns from annual budgeted to monthly planning cycles for raw material procurement.

Through these measures, the company has further improved its working capital cycle from -39 days in CY04 to -55 days in FY12.

Exhibit 8: Working capital improved by reducing loans & advances and increasing current liabilities (days)

-

5

10

15

20

25

30

CY0

1

CY0

2

CY0

3

CY0

4

CY0

5

CY0

6

CY0

7

FY09

FY10

FY11

FY12

FY13

75

80

85

90

95

100

105

110

115

Loans and advances Current liabilities

Source: Company, Ambit Capital research

Exhibit 9: HUL’s working capital cycle has been led by its management of creditors (days, FY13/CY12)

(60)

(40)

(20)

-

20

40

60

80

100

HU

L

Nes

tle

GSK

Con

sum

er

Col

gate

GC

PL

Dab

ur

Mar

ico

Other current liabilities Working capital days

Source: Company, Ambit Capital research

Efficient capital utilisation strategy HUL ranks amongst the best allocators of capital on our competitive mapping, with over 80% of the cash generated over the past decade being deployed towards investments in the core business or share buybacks/dividend payouts to shareholders (see the exhibit below). As a result, HUL has consistently had high RoEs and RoCEs over the past ten years.

Exhibit 10: Avenues of capital deployment for various companies over FY03-12

-20%

0%

20%

40%

60%

80%

100%

HU

L

Nes

tle

Col

gate

GSK

CH

Dab

ur

Mar

ico

GC

PL

Investment in core Dividend Paid Non core investmentsChange in cash Others

Source: Company, Ambit Capital research

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Hindustan Unilever

Ambit Capital Pvt Ltd 46

Structural headwinds against growth in revenues and margins Volume growth moderation to 7% over FY13-15 HUL has seen an average volume growth of 10% over the past 12 quarters (refer to the table below). Whilst personal products have continued to expand consistently at ~16% YoY (we estimate volume growth of around 14%) during this period, S&D’s volume growth of ~7% YoY and beverages’ volume growth of ~6% YoY have been the biggest drivers of moderation in HUL’s overall volume growth.

Exhibit 11: Competitive intensity to lead to mid-to-high single-digit volume growth

0%

3%

6%

9%

12%

15%4Q

FY10

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

3%5%7%9%11%13%15%17%19%

Volume growth (LHS) Revenue growth

Source: Company, Ambit Capital research

We expect HUL’s overall volume growth rates to remain subdued at ~7% CAGR over FY13-15 due to the following factors:

Product mix skewed towards well-penetrated categories

HUL derives ~60% of its revenue from soaps, detergents and tea—three fully penetrated categories with limited potential for an increase in frequency of consumption. Consequently, volume growth in these three categories are likely to be in the low-to-mid single digits (refer to the table below).

Therefore, even with a category volume growth of ~10% for personal products in HUL’s portfolio, we expect the company’s overall volume growth rates to moderate to 7% CAGR over FY13-15.

Exhibit 12: HUL's portfolio spread across high and low growth categories

Category % of total revenues

Estimated volume growth for HUL (FY13-15)*

Estimated value growth for HUL (FY13-15)*

Tea 9% 2% 12%

Coffee 3% 4% 10%

Soaps 22% 5% 11%

Detergents 27% 5% 10%

Branded Staples 2% 5% 12%

Oral care 4% 8% 13%

Skin care 9% 8% 15%

Culinary Products 3% 12% 18%

Ice Creams 2% 12% 20%

Hair care 8% 12% 20%

Source: Company, Ambit Capital research, Industry; * Estimates based on anecdotal data for category growth and our expectations of market share gains/losses for HUL within respective categories

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Hindustan Unilever

Ambit Capital Pvt Ltd 47

Rising competitive intensity in personal products and beverages

As shown in the table below, amongst all product categories where HUL has a presence, we expect the company to lose market share in oral care, skin care and coffee, because of the following factors:

Oral care: We believe that HUL has lost market share of ~250bps to Colgate over the past four years, due to Colgate’s aggressive rural initiatives (‘Bright Smiles Bright Future’ campaign where it imparts information on dental hygiene to children and ‘Oral Health Month’ where it provides free oral care health check ups) and push-based demand built through exceptionally strong relationships with doctors in India. With such continued aggression from Colgate, we expect further market share loss of 60bps for HUL in its oral care portfolio over FY12-15. Competitive intensity is likely to rise further in this category, with P&G’s parent recently announcing the prospective launch of its Oral-B branded toothpaste over the next few months in India.

Skin care: HUL’s Fair & Lovely brand contributes to 60-70% of its skin care revenues (excluding cosmetics) and ~6% of overall revenues. Due to high price elasticity of demand (price increase of `7-8 taken on sachets in 2QFY13) in personal products, the company has reported value growth of ~10% YoY in CY11 and a volume decline YoY in 9MFY13. Whilst we expect the volume decline to abate by 1QFY14, as the effect of the price increase is fully absorbed, we expect volume growth to be in low single digits going forward, owing to a high penetration (more than 70%) of the fairness cream sub-segment in India. Moreover, with aggressive competition at the premium segment, L’Oreal’s marketing campaigns and strong product portfolio is likely to keep HUL’s growth below the category growth. We estimate a market share loss of 360bps over FY12-15.

Beverages: We expect market share loss for HUL in the coffee segment (after having gained more than 100bps share in FY13). Whilst HUL’s Bru coffee has a strong brand recall in the mass segment as against Nestle’s Sunrise, the company is likely to lose share of premiumisation due to a weaker brand recall of Bru Gold against Nescafe Classic (‘100% coffees‘).

These market share losses are likely to offset premiumisation gains for HUL in its soaps and ice creams categories due to a better-quality premium portfolio.

Exhibit 13: Category growth projections

Category Market Share

(FY12) Estimated Market

Share (FY15)* CAGR

FY12-15*

Soaps 45% 47% 15%

Detergents 38% 38% 13%

Oral care 23% 22% 13%

Skin care 58% 57% 13%

Hair care 43% 43% 19%

Tea 29% 29% 12%

Coffee 51% 50% 11%

Ice Creams 12% 14% 20%

Branded Staples NA NA 10%

Culinary Products NA NA 16%

Source: Ambit Capital research. * Estimates based on anecdotal data for category growth and our expectations of market share gains/losses for HUL within respective categories

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Hindustan Unilever

Ambit Capital Pvt Ltd 48

Rising pressure on PAT margins Whist we expect gross margin expansion of 40bps per annum over FY13-15 related to premiumisation of customers across a wide range of brands in its portfolio, we expect EBITDA margins for HUL to decline by 50bps over FY13-15, as shown in the chart below.

Exhibit 14: Gross and EBITDA margins trends and forecasts

46.5%

47.0%

47.5%

48.0%

48.5%

49.0%

49.5%

50.0%

FY10 FY11 FY12 FY13 FY14E FY15E

13.5%

14.0%

14.5%

15.0%

15.5%

16.0%

Gross Margins (%) (LHS) EBITDA Margins (%) (RHS)

Source: Company, Ambit Capital research

This margin compression is likely due to the factors explained below:

Rising A&P spends

HUL’s A&P spend to sales ratio has been increasing consistently from 7.2% in CY03 to 11.9% in FY12 (refer to the chart below). The recent increase of 90bps in this ratio in 9MFY13 has been predominantly driven by a reduction in input costs for the ‘soaps & detergents’ segment. Hence, the benefits to gross margins are invested in A&P. Going forward, even without any such input cost benefit, we expect HUL’s advertisement/sales ratio to increase by 110bps over FY12-15.

S&D: This segment has seen increased competitive intensity in Soaps and Detergents, with a renewed focus from GCPL (Cinthol’s premium rebranding in 2QFY13) and Wipro (entering the premium segment through brand Yardley). Given the high-penetration-led low volume growth for the segment, we expect a rise in A&P spends on HUL’s S&D portfolio.

P&G: As highlighted previously in the note, P&G Home Products’ (the entity with a presence in detergents, shampoos, skincare and diapers) has seen its A&P spends increase at a CAGR of 52% - from 12.3% of sales in FY06 to 28.9% of sales in FY11. With its recent equity infusion of `15.bn in 3QFY13, the company is likely to have a strong war chest to keep its A&P spends at elevated levels.

L’Oreal: As highlighted previously in the note, L’Oreal has seen revenue growth of 31% over CY08-11, with advertising spends as a percentage of sales of around 35%. With new launches at aggressive price points (especially shampoos), we do not expect any reduction in advertising spends and expect the competitive intensity to remain high in the segment. We expect L’Oreal’s strong brands and aggressive marketing to help it gain share in the cosmetics, hair care and skin care space.

Beverages: The tea segment is facing aggression from Tata Tea (which has been gaining market share recently). Tata Tea is now the volume market leader with a market share of 25%. With Nestle having identified the Nescafe coffee portfolio as one of its key areas of focus in the coming months, Nestle is increasingly focusing on supply chain and branding of Nescafe from FY13 onwards to gain market share from HUL.

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Hindustan Unilever

Ambit Capital Pvt Ltd 49

Consequently, we expect HUL’s A&P spends to remain at elevated levels whilst trying to prevent market share loss in response to heightened competitive intensity (refer to the chart below).

Exhibit 15: Rising A&P trends for HUL

-5,000

10,00015,00020,00025,00030,00035,00040,00045,000

CY0

4

CY0

5

CY0

6

CY0

7

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

Advertising spends As % of sale (%)

Source: Ambit Capital research

Increase in royalty and taxes

HUL recently announced an increase in royalty payments to its parent from 1.40% currently to 3.15% by FY18 (including 50bps in FY14). Ceteris paribus, this is likely to have an impact of 3% on FY14 EPS and a 11% cumulative impact on FY18 EPS. Moreover, the parent’s support to the company will not have any incremental benefits, other than what we have already factored into our forecasts. This is because our forecasts take into account an increase in market share for HUL in categories like S&D and ice creams (partly from the strong product portfolio, innovation across categories and leverage on the parent’s R&D). Also, one of the rationales behind an increase in royalty payment from HUL to the parent relates to the innovation and R&D success that HUL has had over the past five years through the parent’s support.

Exhibit 16: Royalty paid by FMCG MNCs in FY12

5.2%4.9%

4.0%3.5%

1.3%1.0% 1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Col

gate

P&G

Nes

tle

GSK

Con

sum

er

HU

L

Gill

ette

Bata

Source: Company, Ambit Capital research. Note: For companies with a calendar year-end, data pertains to CY11

Exhibit 17: Royalty paid by Unilever companies globally

1.3%

3.6%3.3%

2.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

HUL UnileverPakistan

UnileverIndonesia

UnileverNigeria

Source: Company, Ambit Capital research. Note: For companies with a calendar year-end, data pertains to CY11

HUL currently enjoys a tax holiday shelter in some of its manufacturing plants based in Himachal Pradesh. As these plants move out of the tax holiday over the next two years, HUL is likely to see its effective tax rates increase by ~200bps in FY14 to 27% and another 300bps in FY15 to ~30%

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Ambit Capital Pvt Ltd 50

Unilever’s open offer – investment in HUL’s leadership in India’s high-growth FMCG sector Unilever recently announced an open offer at `600/share to increase its ownership in HUL from 52.5% to 75%. Unilever’s open offer indicates the parent company’s confidence in HUL’s long-term leadership positioning in India’s fast growth consumption story. However, we do not expect revenue and EPS CAGR to see any incremental benefits through the parent’s increased ownership, owing to:

Existing collaboration with the parent: The existing royalty structure takes into account the support provided by Unilever to HUL on an ongoing basis.

Prospects of new brand introductions from Unilever’s non-India portfolio: Unilever currently has 33 ‘brands in action’ globally, of which 22 are present in India. Of the rest, as shown in the table below, only 3-4 brands currently have a good potential for a launch in India over the short to medium term.

Exhibit 18: Potential for launch of Unilever's 'Brands in action' not already present in India

Brand DES Potential in

India Comments

Flora Cholesterol friendly spreads

Strong Niche market but fast growing

Ben & Jerry's Premium ice cream Weak Premium ice cream market is expanding fast; however, a retail store in India faces hurdles around real estate cost, high staff attrition and lack of enough depth of demand on a pan-India basis

Bertolli Italian spreads and sauces

Strong Niche market but fast growing

Hellman's Mayonnaise Weak Market yet to be developed

Radox Premium bath products

Weak Market yet to be developed

Simple Colour, perfume free personal products

Weak May not be suitable for Indian markets given the preference for herbal products

St. Ives Natural skincare products

Strong Can be an attractive addition to the fast-growing premium skincare market

Sunlight Soaps Weak Saturated category already dominated by HUL

Timotei Shampoos Weak Saturated category already dominated by HUL

Toni & Guy Premium Salons Weak Already have Lakme salon range; depth of demand for premium salons not significant yet

VO5 Hair styling products Strong Attractive fast growing market; can complement TRESemme

Source: Ambit Capital research, Company

Consequently, we do not expect a material incremental benefit to HUL’s operations from Unilever’s increased ownership in the Indian entity through the open offer.

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Hindustan Unilever

Ambit Capital Pvt Ltd 51

Key assumptions Exhibit 19: Key assumptions and estimates for HUL’s revenues

FY12 FY13E FY14E FY15E Comments

Soaps

Industry Value Growth 12.0% 20.0% 10.0% 10.0%

Market share change NA 1.0% 0.5% 0.5%

Total revenue growth 9.2% 22.2% 11.1% 11.1%

Whilst FY13 has seen price-led growth, growth in FY14 and FY15 is likely to be much lower at 10% with volume growth of around 5%

Detergents

Industry Value Growth NA 18% 10% 10%

Market share change NA 0% 0% 0%

Total revenue growth 29.2% 18.0% 10.0% 10.0%

Pricing is the largest component in FY13, and detergents are likely to see strong product-mix-led growth in FY14 with volume growth of around 4-5%

Total S&D revenue growth % 20.9% 19.4% 10.9% 10.9%

Oral care

Industry Value Growth NA 14.0% 14.0% 14.0%

Market share change NA -0.1% -0.3% -0.2%

Total revenue growth 17.0% 13.6% 12.7% 13.1%

Forecast growth of around 13% in FY13-15, with a market share loss of 50bps, as HUL lags Colgate in terms of its dentist relationships and rural initiatives

Skin care

Industry Value Growth 18% 8% 15% 15%

Market share change (existing products) NA -2.0% -0.5% -0.1%

New product contribution NA 0.0% 2.0% 0.0%

Total revenue growth 18.0% 4.6% 16.1% 14.8%

Whilst the mass skin lightening segment is likely to see volume pressure, growth will be led by the premium ‘Ponds’ portfolio and the emerging face wash category

Hair care

Industry Value Growth 18% 18% 18% 18%

Market share change (existing products) -1.0% 0.0% 0.0% 0.0%

New product contribution NA 0.5% 2.0% 2.0%

Total revenue growth 15.7% 18.5% 20.0% 20.0%

Whilst competition remains strong in hair care, we expect HUL’s diversified portfolio to maintain market share. Market share losses to L’Oreal are likely to be made up by gains from Dabur and other smaller players

Total PP revenue growth % 17.0% 9.1% 17.6% 17.3%

Tea

Industry Value Growth 10% 15% 15% 10%

Market share change NA -0.4% 0.0% 0.0%

Total revenue growth 9.4% 13.9% 15.0% 10.0%

Whilst volume growth will remain in low single digits, FY14 is likely to see strong price-led growth due to a sharp increase in tea prices

Coffee

Industry Value Growth 12% 12% 12% 12%

Market share change 0% 1.0% -1.0% -1.0%

Total revenue growth 18.0% 13.0% 10.1% 10.0%

Forecast 10% revenue CAGR over FY13-15, with volume growth of 4-5% and market share losses to Nescafe as it will likely lose out in the premium ‘100% coffee’ segment

Total beverage revenue growth % 11.5% 13.6% 13.7% 10.0%

Ice Creams

Industry Value Growth 20% 15% 15% 15%

Market share change (existing products) 0.0% 0.5% 0.5% 0.5%

New product contribution NA 0.2% 0.5% 0.5%

Total revenue growth 30.3% 15.2% 19.7% 19.5%

Expect 20% CAGR over FY13-15 as the Kwality Walls brand gains market share led by frequent innovations and increasing distribution

Branded Staples

Industry Value Growth NA 2.0% 10.0% 10.0%

Market share change contribution NA 0.0% 0.0% 0.0%

Total revenue growth 11.4% 2.0% 10.0% 10.0%

Forecast moderate penetration-led growth in branded staples of 12% over FY13-15

Culinary Products

Industry Value Growth NA 11.5% 18.0% 18.0%

New product contribution NA 2.0% 0.0% 0.0%

Total revenue growth 10.6% 13.5% 18.0% 18.0%

Expect the culinary foods portfolio to deliver 18% CAGR over FY13-15 led by strong growth in the sauces and soups segment

Total food revenue growth % 15.4% 10.8% 16.4% 16.5%

Source: Company, Ambit Capital research

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Ambit Capital Pvt Ltd 52

Exhibit 20: Key assumptions and estimates (` mn)

FY12 FY13E FY14E FY15E Comments

Profit and loss

Total revenues 220,954 257,465 292,085 330,137

Growth (%) 12.1% 16.5% 13.4% 13.0%

Gross Profit 103,786 123,214 141,481 161,233

Gross margin (%) 46.9% 47.7% 48.4% 48.8%

HUL is likely to be a large beneficiary of premiumisation given its diverse portfolio

Employee cost (% of sale)

5.0% 5.1% 5.0% 5.0% Expect employee costs to remain stable

Advertising (% of sale) 11.9% 12.5% 12.8% 12.8% Expect advertising spends to increase going forward given higher competitive intensity and share of premium products

Carriage & freight (% of sale)

4.8% 0.0% 4.8% 4.8% Expect carriage and freight expenses to remain stable

Other expenses (% of sale)

9.0% 14.6% 8.7% 8.7% Expect other expenses to remain stable

EBITDA 32,913 40,038 44,509 50,307

EBITDA Margin 14.9% 15.5% 15.2% 15.2% Expect EBITDA margins to expand given the above assumptions

Tax rate 23.4% 26.7% 28.0% 29.0% Tax rate to increase going forward and the company will be a full tax paying company in FY16

Contribution from subsidiaries

993 1,092 1,201 1,321

Growth (%) NA 10.0% 10.0% 10.0% Expect 10% CAGR in contribution from subsidiaries

Net Profit margin 11.6% 12.4% 11.4% 11.4% Higher taxes to keep growth in net margins subdued

Balance Sheet

Capex 521 3,971 2,500 2,500

Capital Work in Progress

2,155 2,000 2,000 2,000 No material capex requirements expected over FY12-15

Working Capital days (55) (58) (56) (56) Expect working capital days to remain stable

Debtor days 11 12 12 12 Expect debtor days to reduce in FY12 (given lower CSD sales) and to increase in FY13 (given higher modern trade contribution)

Current Liabilities days 91 89 90 90 Expect current liabilities days to remain stable

Inventory days 42 36 39 39 Expect inventory days to remain stable

Net debt/(cash) to equity

(1.2) (1.4) (1.5) (1.5) No material changes in cash position expected

Cash flows (` mn)

Operating cash flows 32,139 41,792 39,589 45,936

Free cash flows 30,906 37,975 37,089 43,436

Expect free cash flows to increase strongly given low capex requirements and negative working capital

Source: Ambit Capital research

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Valuation

DCF valuation

Given the cash-generative nature of the business, we use a DCF-based model to arrive at a fair value for HUL. The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed zero debt on HUL’s balance sheet in the future given its strong cash position and free-cash-flow-generative business; hence, the company has enough surplus cash available on the balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for HUL. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years with sales CAGR of 13% and EPS CAGR of 13%. Stage 2 includes a decline in sales growth over eight years from 13% in FY19 to 7% in FY26 i.e. sales CAGR of 10% and free cash flow CAGR of 10% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `503/share (15% downside), implying an FY14 P/E multiple of 31.6x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 22: Cash flow profiles for HUL (` mn)

-5,000

10,00015,00020,00025,00030,00035,00040,00045,00050,000

CY0

5

CY0

6

CY0

7

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

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

Source: Ambit Capital research

Exhibit 23: Return profiles for HUL (%)

0%

20%

40%

60%

80%

100%

120%

CY0

5

CY0

6

CY0

7

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E-15%

-5%

5%

15%

25%

35%

ROE (%) (RHS) EBITDA margin (%)EPS growth (%) Sales growth (%)

Source: Ambit Capital research

Relative valuation HUL’s one-year forward P/E multiple of 37.3x is at a ~35% premium to its three-year and five-year historical average of 27.0-28.0x. However, given the ongoing and forthcoming drag on EBITDA margins as well as volume growth (HUL’s FY13-15E EPS CAGR of 11% is one of the lowest in the sector), we believe that the extent of this premium rating is not justified.

Unilever’s open offer indicates the parent company’s confidence in HUL’s long-term leadership positioning in India’s fast growth consumption story. However, we do not expect revenue and EPS CAGR to see any incremental benefits through the parent’s increased ownership.

Moreover, its high cash generation is already factored into the price/cash flow multiple, where the stock trades in line with the peer group average.

Exhibit 21: WACC calculation for DCF on HUL Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.55

Equity risk premium (%) 7

Cost of equity (%) 12.4

Cost of debt (%) 12.0

Debt/Equity ratio (%) 0

Tax rate (%) 30

WACC (%) 12.4

Source: Company, Ambit Capital research

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Hindustan Unilever

Ambit Capital Pvt Ltd 54

Exhibit 24: One-year forward P/E bands for HUL

180

230

280

330

380

430

480

530

580

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

24x

27x

33x

30x

36x

Source: Ambit Capital research

Exhibit 25: One-year forward EV/EBITDA bands for HUL

180

230

280

330

380

430

480

530

580

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

19x

16x

25x

22x

28x

Source: Ambit Capital research

Exhibit 26: Sensitivity analysis

Bull case Base case Bear case

Revenue growth

Expect revenue growth of 14% over FY13-23 driven by strong market share gains across categories. Our terminal growth rate assumption stands at 6%

Expect revenue growth of 12% over FY13-23 led by strong growth of around 15% in skin care, hair care and foods. Expect the soaps, detergents and beverages to grow slower at around 9% CAGR. Our terminal growth rate assumption stands at 5%

Assume a revenue growth of 10% over FY13-23 driven by no market share gains in any category and losses in oral care, skin care and coffee. Our terminal growth rate assumption stands at 4%

Operating margins

We assume EBITDA margin expansion of 30bps from 15.2% in FY14 to 15.5% in FY17 led by higher benefit from premiumisation (100bps over FY14-17) and lower advertisement spends (by 30bps) offset by higher royalty payout

Expect EBITDA margins to contract by 20bps over FY14-17 to 15%, with 100bps gross margin expansion to be partially offset by increases in advertising spends and royalty

Expect EBITDA margins to decline 70bps from 15.2% in FY14 to 14.5% in FY17 led by higher advertising expenditure due to high competitive intensity and high royalty payout to the parent

Fair value (`/share) 533 503 369

Upside/Downside -10% -15% -38%

Source: Ambit Capital research

Risks to our SELL stance Recovery in sales of Fair & Lovely: We believe that increasing competitive intensity and mass-market penetration levels for the price-sensitive Fair & Lovely will restrict volume growth (to low single digits); however, any recovery in demand as well as ability to absorb price increases by the market can boost revenues and aid overall margins. (Recent price increases of 5-14% on the Fair & Lovely portfolio led to volume declines.)

Reduction in competitive intensity can assist margins: We expect competitive intensity to rise across categories given strong MNC balance sheets and increasing A&P investments by local players. Reduction in competitive intensity will lead to the opposite trend in advertisement spends and lead to a sharp improvement in EBITDA margins.

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Ambit Capital Pvt Ltd 55

Catalysts Volume growth slowing down: 3QFY13 saw the first signs of a decline in

volume growth (5% growth vs 9% growth in 3QFY12); however, higher competitive intensity along with an increase in penetration of most categories in which HUL operates is likely to lead to further negative surprises around valuation multiples warranted by HUL’s growth prospects.

Increasing competitive intensity to hit margins: Increasing competitive intensity from L’Oreal, Nestle and P&G in the personal products, foods and detergents space are likely to put pressure on market shares, which will lead to HUL spending higher amounts on A&P. We expect a 30bps increase in A&P in FY14.

Ambit vs consensus

Exhibit 27: Ambit vs consensus

Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn) 292,085 288,312 1% Our forecasts on the top-line are broadly in line with consensus forecasts

EBITDA (` mn) 44,509 45,376 -2%

EPS (`/share) 15.4 16.7 -5%

We expect higher competitive intensity to have a negative impact on EBITDA margins through higher promotions and advertisement spends

FY15E

Net Sales (` mn) 330,137 327,366 1% Our forecasts on the top-line are broadly in line with consensus forecasts

EBITDA (` mn) 50,307 51,995 -3%

We expect higher competitive intensity to have a negative impact on EBITDA margins through higher promotions and advertisement spends

EPS (`/share) 17.5 18.5 -2% We factor in a 100bps increase in tax rate to 29% in FY15 due to lower benefits from their tax exempt facility

Source: Ambit Capital research

Exhibit 28: Explanation for our forensic accounting scores on the first page

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, albeit generally there have been positive surprises over the past eight quarters.

Earnings momentum RED In the past six months, consensus estimates have been downgraded by 6% for FY14 and 7% for FY15.

Source: Ambit Capital research

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Ambit Capital Pvt Ltd 56

Balance sheet (` mn) Year to March FY11 FY12 FY13 FY14E FY15E

Shareholders' equity 2,160 2,162 2,163 2,163 2,163

Reserves & surpluses 24,436 32,968 24,578 32,525 42,464

Total net worth 26,595 35,129 26,740 34,688 44,626

Deferred tax liability (2,097) (2,142) (2,048) (2,048) (2,048)

Total liabilities 24,499 32,987 24,692 32,640 42,578

Gross block 37,596 38,117 42,088 44,588 47,088

Net block 21,691 21,475 23,085 23,267 23,428

CWIP 2,888 2,155 2,000 2,000 2,000

Investments 12,607 24,382 23,307 38,307 46,307

Cash & equivalents 16,285 18,300 17,079 13,879 21,494

Debtors 9,432 6,790 8,335 9,603 10,854

Inventory 28,108 25,167 25,270 31,209 35,275

Loans & advances 8,167 8,820 10,326 12,003 13,567

Other current assets 354 353 3,676 3,201 3,618

Total current assets 62,345 59,429 64,685 69,895 84,808

Current liabilities 57,828 54,994 62,601 72,021 81,404

Provisions 17,203 19,459 25,784 28,808 32,561

Total current liabilities 75,031 74,453 88,385 100,829 113,965

Net current assets (12,687) (15,024) (23,700) (30,934) (29,157)

Miscellaneous - - - - -

Total assets 24,499 32,987 24,692 32,640 42,578

Source: Company, Ambit Capital research

Income statement (` mn) Year to March FY11 FY12 FY13 FY14E FY15E

Operating income 197,355 221,164 258,102 292,085 330,137

% growth 11.3% 12.1% 16.7% 13.2% 13.0%

Operating expenditure 170,571 188,250 218,065 247,576 279,829

EBITDA 26,784 32,913 40,038 44,509 50,307

% growth -2.6% 22.9% 21.6% 11.2% 13.0%

Depreciation 2,208 2,183 2,360 2,318 2,339

EBIT 24,576 30,731 37,677 42,191 47,969

Interest expenditure 2 12 251 30 30

Non-operating income 2,729 2,783 6,069 4,001 5,243

Adjusted PBT 27,302 33,502 43,495 46,162 53,182

Tax 6,280 7,853 11,612 12,925 15,423

Adjusted PAT/ Net profit 21,022 25,649 31,883 33,236 37,759

% growth 0.6% 22.0% 24.3% 4.2% 13.6%

Extraordinaries (31) 77 - - -

Reported PAT / Net profit 21,053 25,572 31,883 33,236 37,759

Share of associates (99) 993 323 1,201 1,321

Adjusted Consolidated net profit 20,953 26,565 32,206 34,437 39,080

Reported Consolidated net profit 20,953 26,565 32,206 34,437 39,080

Source: Company, Ambit Capital research

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Hindustan Unilever

Ambit Capital Pvt Ltd 57

Cash flow statement Year to March FY11 FY12 FY13E FY14E FY15E

EBIT 27,304 33,514 43,746 46,192 53,212

Depreciation 2,208 2,183 2,360 2,318 2,339

Others 389 (58) (157) (30) (30)

Tax (6,280) (7,853) (11,612) (12,925) (15,423)

(Incr) / decr in net working capital (3,605) 4,353 7,454 4,034 5,838

Cash flow from operations 20,017 32,139 41,792 39,589 45,936

Capex (2,426) (1,233) (3,816) (2,500) (2,500)

(Incr) / decr in investments 34 (11,775) 1,076 (15,000) (8,000)

Others - - - - -

Cash flow from investments (2,392) (13,009) (2,741) (17,500) (10,500)

Interest paid (2) (12) (251) (30) (30)

Dividend paid (16,539) (17,546) (46,834) (27,847) (30,379)

Others (3,720) 444 6,813 2,588 2,588

Cash flow from financing (20,262) (17,115) (40,272) (25,289) (27,821)

Net change in cash (2,637) 2,016 (1,222) (3,200) 7,615

Closing cash balance 16,285 18,300 17,079 13,879 21,494

Free cash flow 17,591 30,906 37,975 37,089 43,436

Source: Company, Ambit Capital research

Ratio analysis Year to March FY11 FY12 FY13 FY14E FY15E

Gross margin (%) 48.9% 46.9% 47.7% 48.4% 48.8%

EBITDA margin (%) 13.6% 14.9% 15.5% 15.2% 15.2%

EBIT margin (%) 13.8% 15.2% 16.9% 15.8% 16.1%

Net profit margin (%) 10.7% 11.6% 12.4% 11.4% 11.4%

Dividend payout ratio (%) 78.7% 68.4% 146.9% 83.8% 80.5%

Net debt: equity (x) (1.0) (1.2) (1.4) (1.5) (1.5)

Working capital turnover (x) (6.8) (6.6) (6.3) (6.5) (6.5)

Gross block turnover (x) 5.2 5.8 6.1 6.6 7.0

RoCE (%) 80.2% 83.1% 103.7% 108.3% 95.3%

RoE (%) 80.2% 83.1% 103.1% 108.2% 95.2%

Source: Company, Ambit Capital research

Valuation parameters Year to March FY11 FY12 FY13 FY14E FY15E

EPS (`) 9.7 12.3 14.9 15.9 18.1

Diluted EPS (`) 9.7 12.3 14.9 15.9 18.1

Book value per share (`) 12.3 16.2 12.4 16.0 20.6

Dividend per share (`) 6.6 7.0 18.5 11.0 12.0

P/E (x) 61.1 48.0 39.7 37.2 32.8

P/BV (x) 48.1 36.4 47.9 36.9 28.7

EV/EBITDA (x) 47.1 38.3 31.5 28.5 25.0

Price/Sales (x) 6.5 5.8 5.0 4.4 3.9 Source: Company, Ambit Capital research

Page 58: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Consumer Goods June 04, 2013

Nestlé Bloomberg: NEST IN EQUITY Reuters: NEST.NS

Accounting: GREEN Predictability: AMBER Earnings momentum: RED

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to December CY10 CY11 CY12 CY13E CY14E

Operating income (` mn) 62,547 74,908 83,023 94,569 109,304 EBITDA(` mn) 12,313 14,955 17,931 20,440 23,406 EBITDA Margin (%) 19.7% 20.0% 21.6% 21.6% 21.4% Adjusted PAT(` mn) 8,187 9,615 10,679 11,886 13,952 Adjusted EPS (`) 84.9 99.7 110.8 123.3 144.7 RoE (%) 114.0% 90.3% 69.5% 60.3% 61.1% P/E (x) 62.5 53.2 47.9 43.0 36.7

Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `5,306

Target Price (March ‘14): `4,389

Previous TP: NA

Downside (%) 17%

EPS (CY13E): `123.3 Change from previous (%) NA

Variance from consensus (%) -2%

Stock Information

Mkt cap: `506bn/US$9,036mn

52-wk H/L: `5,544/4,300

3M ADV: `187mn/US$3.3mn

Beta: 0.5x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute 11 10 16 5

Rel. to Sensex 7 3 -7 1

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Oct-12 Jan-13 M ay-13

4200

4600

5000

5400

Sensex Nestle India

1-year forward P/E band chart

100014001800220026003000340038004200460050005400

Jan-

08

May

-08

Sep-

08

Feb-

09

Jun-

09

Oct

-09

Mar

-10

Jul-

10

Nov

-10

Mar

-11

Aug

-11

Dec

-11

Apr

-12

Aug

-12

Jan-

13

May

-13

2 1 x

4 1 x

3 6 x

3 1 x

2 6 x

Source: Bloomberg, Ambit Capital research

Attack on the nest eggs Nestlé’s leadership position in chocolates, baby foods, noodles and premium coffees has historically been unchallenged; however, the company has been facing increasing competition over the past 18 months from Ferrero and Cadbury’s in the chocolates segment, from HUL in the premium coffee segment, and from ITC and HUL in the noodles segment. Nestlé will NOT be able to defend its market share against this threat given its willingness to sacrifice volumes for EBITDA margins. Also, Nestlé’s biggest cash cow, the baby foods segment, faces risk of market share loss from the increasing market presence of Danone and Mead Johnson in the future. The stock is currently trading at 43x CY13 P/E. We initiate coverage with a SELL stance.

Competitive position: STRONG Change to this position: STABLE

Market share loss across categories: Nestlé is facing intense competition from Ferrero and Cadbury’s in the chocolates segment, from ITC and HUL in the noodles segment, and from HUL in the premium coffees segment. Nestlé did not face any competition in these categories over the past decade. Moreover, Nestlé’s focus on maintaining high EBITDA margins despite a loss of sales growth momentum has meant that the company has reported volume decline of 5% in milk products, 5% in beverages and 9% in chocolates in CY12. Given the high competitive intensity, we expect the market share loss for the company in these categories to continue in the future as well even if macro-economic conditions are stable.

Competition to intensify in the baby foods segment over the long term: The baby foods portfolio has been the biggest cash cow for Nestlé given the low advertising spends and weak competition until now. Whilst Nestlé, Mead Johnson and Danone dominate the global baby foods market, in India, the market has historically had only two key players—Nestlé and Wockhardt (brand Farex). However, in the coming months/years, Danone (targets to double sales in three years through the Wockhardt acquisition) and Mead Johnson (organic growth) are likely to expand their presence in India, given the high birth rates and low penetration of baby foods in India.

Valuation: Nestlé has a dominant presence in some of the fastest-growing categories in the sector. Whilst this characteristic deserves a premium rating for Nestlé as compared to its peers, the stock currently trades at a 26% premium to the sector average on P/E multiples. Given the headwinds highlighted above across its portfolio both in the near term as well as the long term, a smaller premium rating vs peers is justified. Our DCF-based valuation generates a TP of `4,389/share (17% downside), an implied CY13 P/E multiple of 35.6x and CY14 multiple of 29.4x.

Page 59: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 59

Company Financial Snapshot

Profit and Loss (` mn) CY12 CY13E CY14E Net sales 83,023 94,569 109,304 Optg. Exp(Adj for OI.) 65,092 74,129 85,898 EBIDTA 17,931 20,440 23,406 Depreciation 2,772 3,327 3,220 Interest Expense 266 370 200 PBT 15,526 17,479 20,823 Tax 4,847 5,593 6,872 Adj. PAT 10,679 11,886 13,952 Profit and Loss Ratios EBIDTA Margin % 21.6% 21.6% 21.4% Adj Net Margin % 12.9% 12.6% 12.8% P/E (X) 47.9 43.0 36.7 EV/EBIDTA (X) 29.0 25.2 21.8 Dividend Yield (%) 0.9% 1.4% 1.9%

Company Background

Nestlé India is a subsidiary of Nestlé S.A. of Switzerland, with 62.8% being held by the parent company. With seven factories and a distribution reach of over 4mn outlets, the company is the market leader in baby foods, noodles and sauces.

The company has a presence in milk products and nutrition, chocolates and confectionery, prepared dishes & cooking aids and beverages. Its key brands include Nescafé, Maggi, Everyday, KitKat and Cerelac, most of which are market leaders in their respective categories.

Balance Sheet (` mn)

CY12 CY13E CY14E Total Assets 51,639 55,700 56,281 Net Fixed Assets 35,484 35,716 34,696 Current Assets 12,507 16,336 17,936 Other Assets 3,649 3,649 3,649 Total Liabilities 51,639 55,700 56,281 Networth 17,984 21,466 24,212 Debt 10,502 8,000 2,000 Current Liabilities 21,532 24,614 28,449 Deferred Tax 1,621 1,621 1,621 Balance Sheet Ratios ROE % 69.5% 60.3% 61.1% ROCE % 41.0% 39.7% 47.8% Net Debt/Equity 0.5 0.2 (0.1) Equity/Total Assets 0.6 0.7 0.9 P/BV (X) 28.1 23.6 20.9

Cash Flow (` mn) CY12 CY13E CY14E PBT 15,526 17,479 20,823 Depreciation 2,772 3,327 3,220 Tax (4,847) (5,593) (6,872) Change in Wkg Cap 718 1,301 1,978 Others 1,186 - - CF from Operations 15,355 16,513 19,149 Capex (8,311) (3,559) (2,200) Investments (2,305) - - CF from Investing (10,616) (3,559) (2,200) Change in Equity - - - Debt 793 (2,502) (6,000) Dividends (5,435) (8,404) (11,206) Others - - - CF from Financing (4,642) (10,906) (17,206) Change in Cash 97 2,048 (256)

Maggi’s share of portfolio has increased whilst Nescafé’s has declined over CY04-12

Nestlé has amongst the best working capital cycles in the FMCG space (days, FY13/CY12)

5%

10%

15%

20%

25%

30%

35%

40%

45%

Milk &Nutrition

Beverages PackagedFoods

Chocolates

CY04 CY06 CY08 CY10 CY12

(58)(50) (47) (45)

30

46

(1)

(70)

(50)

(30)

(10)

10

30

50

70

HU

L

Nes

tle

GSK

Con

sum

er

Col

gate

GC

PL

Dab

ur

Mar

ico

Source: Company, Ambit Capital research

Page 60: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 60

Background Exhibit 1: Nestlé’s portfolio mix

Category Key brands Key competitors

Market share rank

% of domestic turnover

CY09-11 growth

Milk Products & Nutrition

Cerelac, Nan Lactogen, A+ Milk, Slim Dahi, Milkmaid, Everyday Dairy Whitener

Danone, Amul, Britannia

1 45% 20%

Beverages Nescafé Classic, Nescafé Sunrise, Nestea Iced tea

HUL 1* 13% 15%

Prepared Dishes & Cooking Aids

Maggi Noodles, Maggi Soups, Maggi Sauces, Maggi Magic cubes

ITC, HUL 1 29% 27%

Chocolates Kit Kat, Munch, Bar One, Polo, Eclairs, Milky bar

Cadbury 2 13% 19%

Source: Ambit Capital research. Note:* pertains to value market share; HUL leads in volume market share.

As highlighted in the table above, Nestlé enjoys a leadership position in most of the product categories that it operates in. We estimate that around 70% of Nestlé’s revenues relate to products where it is a market leader.

Also, as shown in the chart below, Nestlé’s portfolio mix has seen no change (over CY03-11) in the proportion of revenues from milk/nutrition and chocolates whilst the slow growth in beverages (Nescafé) has been offset by strong growth in packaged foods (Maggi) over the past decade.

Exhibit 2: Maggi’s share of portfolio has increased as Nescafé’s has declined over CY03-11 (%)

5%

10%

15%

20%

25%

30%35%

40%

45%

Milk &Nutrition

Beverages PackagedFoods

Chocolates

CY04 CY06 CY08 CY10 CY12

Source: Company, Ambit Capital research

Exhibit 3: Segment volume growth for Nestlé

-10%

-5%

0%

5%

10%

15%

20%

25%

30%C

Y04

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

MilkProducts&NutritionBeverages

PreparedDishes &CookingAidsChocolates

Source: Company, Ambit Capital research

Exhibit 4: Market-leading portfolio across categories

Segment Market leadership

Milk Products & Nutrition Baby food, infant formula, dairy whitener

Beverages Instant coffee

Prepared Dishes & Cooking aids Instant noodles, sauces, paste and No.2 in sauces

Chocolates Wafer chocolates, white chocolates

Source: Company, Ambit Capital research

Nestlé’s total distribution reach currently stands at around 4mn outlets. The company had indicated that its focus will now be on generating distribution efficiencies as against aggressive outlet expansion. Nestlé has undertaken capacity expansion over CY11 and CY12 to double capacity in almost every segment.

Page 61: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 61

Exhibit 5: Distribution expansion by Nestlé (mn outlets)

2.5

3.6

0.30.4

0.4

0.5

-

0.6

1.2

1.8

2.4

3.0

3.6

4.2

CY08 CY09 CY10 CY11 CY12Distribution Addition

Source: Company, Ambit Capital research

Exhibit 6: Capex stepped up in CY11 and CY12 (` mn)

-

4,000

8,000

12,000

16,000

20,000

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Capex Net Fixed Assets (RHS)

Source: Company, Ambit Capital research

SWOT analysis

Exhibit 7: SWOT analysis for Nestlé

Strengths Weaknesses

Strong balance sheet support available from the parent for expansion and market-building purposes. Nestlé has invested US$500mn in India over the past three years, which has been funded through a low-cost loan (US$182mn) from the parent company.

Strong brand equity supports the premium positioning of its portfolio, enabling it to be one of the largest beneficiaries of premiumisation. Nestlé’s products sell at a premium to the sector in baby foods, milk products, beverages and packaged foods.

It is a market leader in segments like baby foods that have high entry barriers (restriction on advertising under the Infant Milk Substitute Act, 1992) and thus provides insulation from competition.

Strict control over inventory (CY11 inventory days at 36) and creditors (CY11 other current liabilities days at 49) helps Nestlé have amongst the best working capital cycles (CY11 working capital cycle was -52 days) in its peer group.

Too much focus on margins leads to compromising volumes and market share (volume growth in CY12 has been in the low single digits, coupled with market share losses as the company focused on expanding gross margins which improved by 240bps YoY to 54.5%)

Response to competition has been weak, leading to loss of market share in noodles, chocolates and coffee. Nestlé’s A&P spend was only 4.4% (in CY11) as against a sector average of around 13%.

Opportunities Threats

Play on aspirational categories (such as baby foods, chocolates, instant coffee and packaged foods) where high growth is sustainable.

Access to the brand portfolio and the technology of the parent company. The company has recently highlighted its intent to enter the breakfast cereal space in India with its global brands.

Increasing competitive intensity across categories (especially in noodles, coffee and chocolates by ITC, HUL and Cadbury respectively) can force the company to increase advertisement spend (we estimate a 100bps increase in advertisement spend over CY11-13)

The company can be adversely affected if the slowdown in packaged food growth sustains. Nestlé’s volume growth has declined from 17% in CY10 to around 3% in CY12. We do not expect this to reverse in the near future until discretionary spending returns.

Source: Company, Industry, Ambit Capital research

Page 62: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 62

A well-managed business The proportion of Nestlé’s portfolio that is positioned as premium (around 70% of total revenues) in its respective categories is amongst the highest in its peer group. These premium products are Nescafé Classic, Maggi Atta Noodles, Nan, etc. Whilst nominal per capita incomes in India have risen at around 13% over FY07-12, Nestlé has seen revenue CAGR of 22% over CY06-11. We expect the proportion of premium products in the portfolio to rise to around 80% of revenues (from 70% currently) over the next five years due to the following factors:

Benefits of a global footprint: Nestlé's R&D has been a source of competitive advantage at a global level. Moreover, the company recently set up a new R&D centre in India to create India-specific new product innovations with a focus on: (a) localisation; (b) technology; (c) cuisine; and (d) popularly positioned products. This will help the company to enter new categories where it does not have a presence currently and help localise its product offering. Beyond its existing products in India, Nestlé’s global portfolio of products includes breakfast cereals, bottled water, frozen food, fruit and health drinks, healthcare, ice creams, pet care and sports nutrition. However, note that consumption trends in India are yet to evolve and to accept some of the product categories on the company’s global platform.

Tight control on working capital cycle: Nestlé has improved its working capital cycle significantly over the past decade (refer to the chart below) by using its global expertise on working capital management and its tight control over inventory and loans and advances. The company thereby generates operating cash flows that are stronger than most of its MNC peers and well ahead of its Indian counterparts.

Exhibit 8: Lower loans and advances helped in reducing working capital cycle (days)

(55)

(50)

(45)

(40)

(35)

(30)

(25)

(20)

CY05CY06CY07CY08CY09CY10CY11CY12

6

8

10

12

14

16

18

20

22

Working Capital days (LHS) Loans and advances (RHS)

Source: Company, Ambit Capital research

Exhibit 9: Nestlé has amongst the best working capital cycles in the FMCG space (days, FY12/CY11)

(58)(50) (47) (45)

30

46

(1)

(70)

(50)

(30)

(10)

10

30

50

70

HU

L

Nes

tle

GSK

Con

sum

er

Col

gate

GC

PL

Dab

ur

Mar

ico

Source: Company, Ambit Capital research

Page 63: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 63

Current valuation does not factor in key risks The stock is currently trading at CY13E P/E multiple of 43x, one of the richest valuations in the consumer sector. Nestlé deserves to trade at a premium to most players in the FMCG sector given its strong cash generation and superior brand recall and leadership control over some of the fastest-growing aspirational consumption sectors currently in India. However, we believe that the current valuations do not factor in the expected loss of market share by Nestlé in some of its key product categories, a phenomenon that Nestlé has experienced in countries outside India as well (China, for instance). We forecast a moderation in earnings growth from 21% CAGR over CY07-12 to 14% over CY12-14.

Market share loss likely across several categories Media reports and our discussions with primary data contacts suggest that Nestlé has lost significant market share in beverages (HUL is now the volume market leader in instant coffee), chocolates (Nestlé’s market share of around 20% in CY11 has slipped by at least 100-200bps in CY12) and noodles (Nestlé is facing pressure due to increased aggression from ITC’s Yippee) over the past few quarters. These market share losses have been driven by the following factors (with the distinct likelihood of such trends continuing in the future):

Focus on margins rather than volumes

In the wake of moderation in discretionary consumption categories over the past 12 months (moderation in growth rates reported by Britannia, HUL’s food division, Agro Tech Foods and United Spirits) and high food inflation over the past 18 months, Nestlé has focused on operating margins rather than volume growth in CY11 and CY12. Consequently, whilst most of its competitors have taken price increases of 3-8% in CY12, Nestlé’s price increases have been at 6-12%. Aggressive price increases have led to a widening price gap between Nestlé and its competitors. Consequently, as shown in the chart below, over the past 18 months, Nestlé has reported consistent declines in revenues and volumes for steady gross margins. As a result, EPS CAGR for the company has moderated from 26% over CY07-10 to 16% over CY10-12.

Exhibit 10: Gross margins picked up from 3QCY11 whilst sales growth tapered off

49%

50%

51%

52%

53%

54%

55%

56%

4QCY09

1QCY10

2QCY10

3QCY10

4QCY10

1QCY11

2QCY11

3QCY11

4QCY11

1QCY12

2QCY12

3QCY12

4QCY12

1QCY13

-5%

0%

5%

10%

15%

20%

25%

30%

Volume Growth (RHS) Gross margins (LHS)Revenue growth (RHS)

Source: Ambit Capital research

Page 64: June 04, 2013 Consumer Staples - webambit.ambit.cowebambit.ambit.co/reports/Ambit_ConsumerStaples_SectorInitiation... · June 04, 2013 Consumer Staples ... (diversification and category

Nestlé India

Ambit Capital Pvt Ltd 64

Exhibit 11: Category-wise volume, value and price growth in CY12

-10%

-5%

0%

5%

10%

15%

20%

Milk & Nutrition Beverages Packaged Foods Chocolates

Value Growth Volume Growth Realisation growth

Source: Company, Ambit Capital research

These declining volume and revenue trends clearly highlight high price elasticity of demand for Nestlé’s products despite the company having built strong brands in each of its product categories. Therefore, we expect Nestlé to continue losing market share in the future even during periods of stable macro-economic factors.

High competitive intensity in coffee, packaged foods and chocolates Nestlé’s product portfolio has seen increased competition across a large part of its product portfolio as highlighted below:

Instant coffee (13% of revenues) – Nescafé is NO longer the only premium coffee: Aggressive campaigns by HUL for the Bru brand have helped the company gain share against Nestlé’s Nescafé despite a new advertising campaign by Nestlé. Also, HUL has launched new premium variants like Bru Gold (launched in 2011) and Bru Exotica (launched in 2012) to compete against Nescafé’s premium offering.

Packaged foods (28% of revenues) – renewed aggression from ITC and HUL: The company has lost market share in the noodles category owing to high advertising spends by ITC for its Yippee brand and an inadequate response from Nestlé despite its new advertising campaign featuring the top Indian celebrity, Mr. Amitabh Bachchan. Also, HUL’s Knorr Soupy Noodles have been relaunched in 2012.

Chocolates (14% of revenues) – Ferrero and Cadbury’s: Ferrero India has reported over 30% YoY growth for the year-ending August 2012 against Nestlé’s CY12 YoY growth in chocolates of 8-10%. This has been due to a combination of: (a) substantial increase in distribution reach of Ferrero Rocher chocolates, Kinder Joy and Tic Tac; and (b) innovation-led promotions (like kids toys inside Kinder Joy chocolates). Also, Cadbury’s has stepped up its advertising push for Toblerone in the premium segment and for Perk (which competes with Nestlé’s highest-selling chocolate, Munch) in the mass segment.

Nestlé’s advertising spends: Due to Nestlé’s inability to advertise its nutrition business under the Infant Milk Substitute Act, 1992, its overall advertisement spends were at only 4.3% of sales in CY12. However, even after adjusting for the baby foods business, Nestlé’s advertising spend was at 5.2% of revenues in CY12, well below its peer group average of 12-16%. We expect Nestlé’s overall advertisement spend to sales ratio to increase from 4.3% in CY12 to 5.4% in CY14 in response to this increase in competitive intensity (and we forecast revenue growth for Nestlé to rise to 17% over CY12-14). This increase in advertising spends is likely to have a 5% negative impact on EPS for CY13 and CY14.

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Nestlé India

Ambit Capital Pvt Ltd 65

Exhibit 12: We expect advertisement expenses to rise in the wake of falling market share

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

CY0

4

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3E

CY1

4E

4.2%

4.4%

4.6%

4.8%

5.0%

5.2%

5.4%

5.6%

Advertising & sales promotion (Rs mn) Adv as % of sales (%)

Source: Ambit Capital research

Competitive intensity likely to rise in baby foods in the long term The Baby foods segment currently forms around 20% of Nestlé’s overall revenues. However, with low advertising spends, weak competitive intensity and a strong revenue growth rate of 20% in baby foods, this segment is the biggest cash cow for Nestlé.

Whilst globally, Nestlé, Mead Johnson and Danone dominate the baby foods market, in India, the market has historically had only two key players—Nestlé and Wockhardt (brand Farex). However, over the past two years, the following steps have been taken by its competitors:

Danone’s entry in the Indian baby food market was through its acquisition of Wockhardt’s Farex brand in CY12. With a global presence in 137 countries, Danone is a market leader in most Asia-Pacific countries. The company plans to double its revenue in three years by consolidating its locally acquired brands and then introducing select brands from its international nutrition portfolio.

Mead Johnson, a leader in baby foods in Asia and Latin America, with brands including Enfamil, Enfagrow and Lactum, has set up an office in India. The company is focused on emerging markets and plans to launch its baby food portfolio in India.

Nestlé’s strategy of focusing on price whilst allowing market share declines is unlikely to help it respond to rising competitive intensity in the baby foods category. Therefore, as the market penetration of baby foods increases in India, we do not expect Nestlé’s baby foods business to continue to be a cash cow for the company in its current shape over the long term.

Due to a combination of the factors discussed above, we expect:

The milk product business to record a CAGR of 11% YoY over CY12-14 (marginally ahead of market growth) led by growth in value-added products like Milkmaid and Dahi.

Increased aggression from Danone in its newly acquired baby food business to lead to Nestlé’s market share declining from 90% in CY11 to 87% in CY14 (nutrition segment growth of 17% CAGR over CY12-14).

Despite share losses in beverages during CY12 (we estimate 2%), we expect Nestlé’s strong brand equity and premium portfolio to help it recover its lost share in CY13 and CY14 and record a CAGR of 14% over CY12-14.

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Nestlé India

Ambit Capital Pvt Ltd 66

Strong growth in the noodles and sauces space will likely make packaged

foods the fastest-growing category for Nestlé (CAGR of 18% over CY12-14).

Market share reduction in chocolates to 18% in CY14 from 20% in CY11 due to increased aggression from Cadbury could lead to revenue CAGR of 14% in chocolates over CY12-14 for Nestlé.

Overall revenue CAGR of 15% (vs 19% CAGR over CY07-12) and EPS CAGR of 14% (vs 21% CAGR over CY07-12) over CY12-14.

Exhibit 13: Category growth projections for Nestlé

Category Estimated Market

Share (CY11) Estimated Market

Share (CY14)* CAGR CY12-14

Milk Products NA NA 11%

Nutrition 90% 87% 17%

Beverages 49% 50% 14%

Prepared Dishes & Cooking Aids

NA NA 18%

Chocolates 20% 18% 14%

Source: Ambit Capital research. * This is based on market share gains and category growth rates as highlighted in our assumptions table in the following section.

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Nestlé India

Ambit Capital Pvt Ltd 67

Key assumptions Exhibit 14: Key assumptions and estimates (` mn)

Contribution to

revenues CY12 CY13E CY14E Comments

Profit and loss

Milk Products growth 27.2% 12.8% 10.0% 12.0%

Industry growth 12.8% 10.0% 12.0%

Market share related growth

0.0% 0.0% 0.0%

Expect 11% CAGR in the milk products business over CY12-14. Growth is likely to be driven by value added products like milkmaid, dahi and dairy whiteners.

Nutrition growth 19.3% 18.7% 16.7% 17.1%

Industry growth 20.0% 18.0% 18.0%

Market share related growth

-1.3% -1.3% -0.9%

Expect strong penetration led growth to sustain in the segment. However, we expect Nestle to lose market share going forward as Danone increases its India presence and Mead Johnson looks to start distribution in India

Beverages growth 13.1% 5.1% 13.2% 14.4%

Industry growth 12.0% 12.0% 12.0%

Market share related growth -6.9% 1.2% 2.4%

Expect recovery in CY13-14 from share loss in CY12 led by higher advertising spends and stronger brand specially in the '100% coffee' segment leading to effective CAGR of 13% over CY12-14

Prepared dishes and cooking aids growth

28.3% 12.8% 16.2% 19.2%

Industry growth 12.8% 15.0% 18.0%

Market share related growth

0.0% 1.2% 1.2%

Expect a CAGR of 17% over CY12-14 led by penetration led growth in noodles and sauces under the Maggi brand

Chocolate and Confectionery growth 13.6% 6.3% 13.8% 13.7%

Industry growth 15.0% 15.0% 15.0%

Market share related growth

-8.7% -1.3% -1.3%

Expect further losses in market share as Nestle only participates in the wafer chocolate segment and its investments in the category are substantially lower than market leader Cadbury

Gross Profit 45,259 51,742 60,023

Gross margin (%) 54.5% 54.7% 54.9%

Expect 40bps gross margin expansion over CY12-14 due to improving product mix

Employee cost (% of sale) 8.0% 7.8% 7.7% Expect higher employee costs in CY12 to reduce as Nestle sees scale benefits from new plants in CY13-14

Advertising (% of sale) 4.3% 5.0% 5.3% Expect advertising spends to increase going forward given higher competitive intensity and share losses

Carriage & freight (% of sale) 4.6% 4.7% 4.7% Expect carriage and freight expenses to remain stable

Other expenses (% of sale) 15.0% 15.6% 15.8% Expect other expenditure to normailse over CY13-14 after the sudden drop in other expenditure in CY12

EBITDA 17,931 20,440 23,406

EBITDA Margin 21.6% 21.6% 21.4%

Expect EBITDA margins to remain flat over CY12-14 given above assumptions

Tax rate 31.2% 32.0% 33.0% Tax rate to increase in CY13 given higher surcharge and marginally henceforth as benefits from the Pantnagar plant expire

Net Profit margin 12.9% 12.6% 12.8% Expect net margins to decline marginally over CY12-14 given higher depreciation expense from new plants and increase in tax rate

Balance Sheet (` mn)

Capex 18,753 6,000 2,200

Capital Work in Progress 3,441 1,000 1,000 Material capex undertaken in CY12, to be completed by CY13

Working Capital days (50) (49) (49) Expect working capital days to remain stable

Debtor days 4 4 4 Expect debtor days to remain stable

Current Liabilities days 48 48 48 Expect current liabilities days to remain stable

Inventory days 33 34 34 Expect inventory days to remain stable

Net debt/(cash) to equity 0.5 0.2 (0.1) Expect company to turn debt free in CY14

Cash flows (` mn)

Operating cash flows 15,355 16,513 19,149

Free cash flows 7,044 12,954 16,949

Expect free cash flows to grow strongly CY13 onwards once capex is through

Source: Ambit Capital research

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Nestlé India

Ambit Capital Pvt Ltd 68

Valuation

DCF valuation The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed the company to be debt-free, because the strong cash flow generation will lead to Nestlé turning into a net cash company in CY14. Hence, the company would have enough surplus cash available on its balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for Nestlé. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years with sales CAGR of 15% and EPS CAGR of 16%. Stage 2 includes a decline in sales growth over eight years from 16% in CY17 to 6% in CY26 i.e. sales CAGR of 10% and a free cash flow CAGR of 10% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `4,389/share (17% downside), implying an CY13 P/E multiple of 34.6x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 16: Cash flow profiles for Nestlé (` mn)

(6,000)

(2,000)

2,000

6,000

10,000

14,000

18,000

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3E

CY1

4E

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

Source: Ambit Capital research

Exhibit 17: Return profiles for Nestlé (%)

0%

5%

10%

15%

20%

25%

30%

35%

CY0

5C

Y06

CY0

7C

Y08

CY0

9C

Y10

CY1

1C

Y12

CY1

3EC

Y14E

60%

70%

80%

90%

100%

110%

120%

130%

ROE(RHS)

EPSGrowth

Salesgrowth

EBITDAMargin

Source: Ambit Capital research

Relative valuation Nestlé has been the premium rated stock in the FMCG sector historically. Whilst its premium rating has been justified because it has had: (a) one of the highest EPS CAGR of 21% in the sector over CY07-12; (b) one of the most-efficient working capital cycles, leading to high cash generation; and (c) an unchallenged leadership position in its categories of operation such as chocolates, premium coffee, noodles and baby foods. However, we expect the extent of the premium that Nestlé deserves to be lower going forward due to the likelihood of market share loss across chocolates, noodles and beverages given intensifying competition amidst Nestlé’s focus on margins.

The company has recently invested around `20bn on capacity expansion, doubling its capacity in almost every segment, and thus, Nestlé will see efficient utilisation of capacity only after a while, considering the weak volume growth in the current environment. The effect of this expansion is likely to lead to a decline in its RoCEs from 109% in CY10 to 48% in CY14 and to a decline in its RoEs from 114% in CY11 to 61% in CY14.

Exhibit 15: WACC calculation for DCF on Nestle Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.52

Equity risk premium (%) 7.0

Cost of equity (%) 12.1

Cost of debt (%) 12.0

Debt/Equity ratio (%) 0.0

Tax rate (%) 30.0

WACC (%) 12.1

Source: Company, Ambit Capital research

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Nestlé India

Ambit Capital Pvt Ltd 69

Risks to our SELL stance Strong recovery in demand: With the overall demand environment for packaged foods currently under pressure, a strong recovery in demand for packaged foods is likely to have a positive impact on volume growth for Nestlé and arrest the volume decline.

Market share gains in beverages and chocolates: Whilst CY12 has seen strong market share declines for Nestlé across categories (especially beverages and chocolates), any reversal in the trend will help Nestlé see a recovery in volume growth.

Exhibit 18: One-year forward P/E bands for Nestlé

100014001800220026003000340038004200460050005400

Jan-

08M

ay-0

8Se

p-08

Feb-

09Ju

n-09

Oct

-09

Mar

-10

Jul-

10N

ov-1

0M

ar-1

1A

ug-1

1D

ec-1

1

Apr

-12

Aug

-12

Jan-

13M

ay-1

3

21x

41x

36x

31x

26x

Source: Ambit Capital research

Exhibit 19: One-year forward EV/EBITDA bands for Nestlé

100014001800220026003000340038004200460050005400

Jan-

08M

ay-0

8Se

p-08

Feb-

09Ju

n-09

Oct

-09

Mar

-10

Jul-

10N

ov-1

0M

ar-1

1A

ug-1

1D

ec-1

1A

pr-1

2A

ug-1

2Ja

n-13

May

-13

13x

16x

19x

22x

25x

Source: Ambit Capital research

Exhibit 20: Sensitivity analysis

Bull case Base case Bear case

Revenue growth

In our bull case, we model a revenue CAGR of around 17% over CY12-22 led by market share gains in beverages and packaged foods and no market share losses in any category. Our terminal growth rate assumption stands at 6%

Expect revenue growth of 15% over CY12-22 led by strong growth in the baby food segment (despite small market share losses) and prepared dishes and cooking aids segment. Expect slower growth in the milk products segment. Our terminal growth rate assumption stands at 5%

Expect revenue growth of 13% over CY12-22 led by market share losses in baby foods and chocolates and no market share gains in any categories. Our terminal growth rate assumption stands at 4%

Operating margins

We assume EBITDA margin expansion of 70bps over CY12-16 to 22.3%, entirely led by gross margin expansion due to premiumisation of the portfolio

Expect EBITDA margins to expand by 30bps over CY12-17 to 20.9%, with gross margin expansion of 80bps to be partially offset by increases in advertising spends

Expect EBITDA margins to decline 80bps from 21.6% in CY12 to 20.8% in CY16 due to competitive-intensity-led increase in advertising spends and no increase in gross margins

Fair value (`/share)

5,424 4,389 3,503

Upside/ Downside

2% -17% -34%

Source: Ambit Capital research

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Nestlé India

Ambit Capital Pvt Ltd 70

Ambit vs consensus

Exhibit 21: Ambit vs consensus

Ambit vs Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn) 94,569 94,889 0% Our forecasts are in line with consensus expectations

EBITDA (` mn) 20,440 21,237 -4% Increase in advertisement spends due to competitive intensity to affect EBITDA margins

EPS (`/share) 123.3 125.2 -2% Higher depreciation from the capex undertaken is likely to impact net profit

FY15E

Net Sales (` mn) 109,304 111,255 -2% Expect market share losses in chocolates and nutrition to lead to growth that is lower than consensus expectations

EBITDA (` mn) 23,406 24,727 -5% Increase in advertisement spends due to competitive intensity to affect EBITDA margins

EPS (`/share) 144.7 148.3 -2% Above impact on EBITDA likely to flow down to the net profit level

Source: Ambit Capital research

Catalysts Slowdown in revenue growth may sustain: Whilst volume growth in CY12

was in the low single digits, we believe a sustained slowdown in discretionary spending will lead to volume growth remaining at subdued levels which could be a potential trigger for the stock to be derated.

EBITDA margin contraction: Rising competitive intensity might likely lead to Nestlé deviating from its current strategy of focussing on gross margins. The company may take pricing actions to support its historical volume growth trajectory, which could also be supported by a large increase in its advertising spends which currently are amongst the lowest in the industry.

Exhibit 22: Explanation for our forensic accounting scores on the first page

Segment Score Comments

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 AMBER With discretionary spending under pressure over the past few quarters, Nestlé’s revenue growth has been well below the FMCG average and consensus estimates. However, EBITDA margins have been more stable, within a 200bps band.

Earnings momentum RED In the last six months, consensus estimates have been downgraded by 3% for FY14 and 5% for FY15.

Source: Ambit Capital research

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Nestlé India

Ambit Capital Pvt Ltd 71

Balance sheet (` mn)

Year to December CY10 CY11 CY12 CY13E CY14E

Shareholders' equity 964 964 964 964 964

Reserves & surpluses 7,590 11,775 17,020 20,502 23,247

Total net worth 8,554 12,739 17,984 21,466 24,212

Debt - 9,709 10,502 8,000 2,000

Deferred tax liability 333 435 1,621 1,621 1,621

Total liabilities 8,887 22,883 30,107 31,087 27,832

Gross block 18,547 25,522 44,276 50,276 52,476

Net block 10,127 15,758 32,043 34,716 33,696

CWIP 3,489 14,186 3,441 1,000 1,000

Goodwill - - - - -

Investments 1,507 1,344 3,649 3,649 3,649

Cash & equivalents 2,553 2,272 2,369 4,417 4,161

Debtors 633 1,154 876 1,036 1,198

Inventory 5,760 7,340 7,456 8,809 10,182

Loans & advances 1,514 1,961 1,796 2,073 2,396

Other current assets - 3 10 - -

Total current assets 10,460 12,730 12,507 16,336 17,936

Current liabilities 7,617 10,096 10,974 12,436 14,374

Provisions 9,079 11,038 10,558 12,177 14,075

Total current liabilities 16,696 21,135 21,532 24,614 28,449

Net current assets (6,236) (8,404) (9,025) (8,278) (10,513)

Total assets 8,887 22,883 30,107 31,087 27,832 Source: Company, Ambit Capital research

Income statement (` mn)

Year to December CY10 CY11 CY12 CY13E CY14E

Operating income 62,547 74,908 83,023 94,569 109,304

% growth 21.9% 19.8% 10.8% 13.9% 15.6%

Operating expenditure 50,235 59,953 65,092 74,129 85,898

EBITDA 12,313 14,955 17,931 20,440 23,406

% growth 24.1% 21.5% 19.9% 14.0% 14.5%

Depreciation 1,278 1,533 2,772 3,327 3,220

EBIT 11,035 13,421 15,159 17,113 20,187

Interest expenditure 11 51 266 370 200

Non-operating income 427 509 633 736 837

Adjusted PBT 11,451 13,879 15,526 17,479 20,823

Tax 3,264 4,264 4,847 5,593 6,872

Adjusted PAT/ Net profit 8,187 9,615 10,679 11,886 13,952

% growth 25.0% 17.5% 11.1% 11.3% 17.4%

Extraordinaries - - - - -

Reported PAT / Net profit 8,187 9,615 10,679 11,886 13,952

Adjusted Consolidated net profit 8,187 9,615 10,679 11,886 13,952

Reported Consolidated net profit 8,187 9,615 10,679 11,886 13,952 Source: Company, Ambit Capital research

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Nestlé India

Ambit Capital Pvt Ltd 72

Cash flow statement (` mn)

Year to December CY10 CY11 CY12E CY13E CY14E

EBIT 11,462 13,930 15,792 17,849 21,023

Depreciation 1,278 1,533 2,772 3,327 3,220

Others 2 51 920 (370) (200)

Tax (3,264) (4,264) (4,847) (5,593) (6,872)

(Incr) / decr in net working capital 1,575 1,887 718 1,301 1,978

Cash flow from operations 11,052 13,138 15,355 16,513 19,149

Capex (5,136) (17,861) (8,311) (3,559) (2,200)

(Incr) / decr in investments 526 163 (2,305) - -

Cash flow from investments (4,610) (17,698) (10,616) (3,559) (2,200)

Net borrowings - 9,709 793 (2,502) (6,000)

Interest paid 11 51 266 370 200

Dividend paid (5,448) (5,430) (5,435) (8,404) (11,206)

Others (8) (51) (266) (370) (200)

Cash flow from financing (5,445) 4,279 (4,642) (10,906) (17,206)

Net change in cash 997 (281) 97 2,048 (256)

Closing cash balance 2,553 2,272 2,369 4,417 4,161

Year to March 5,916 (4,723) 7,044 12,954 16,949 Source: Company, Ambit Capital research

Ratio analysis

Year to December CY10 CY11 CY12 CY13E CY14E

Gross margin (%) 51.1% 52.1% 54.5% 54.7% 54.9%

EBITDA margin (%) 19.7% 20.0% 21.6% 21.6% 21.4%

EBIT margin (%) 18.3% 18.6% 19.0% 18.9% 19.2%

Net profit margin (%) 13.1% 12.8% 12.9% 12.6% 12.8%

Dividend payout ratio (%) 66.5% 56.5% 50.9% 70.7% 80.3%

Net debt: equity (x) (0.3) 0.6 0.5 0.2 (0.1)

Working capital turnover (x) (7.1) (7.0) (7.3) (7.4) (7.4)

Gross block turnover (x) 3.4 2.9 1.9 1.9 2.1

RoCE (%) 109.1% 60.8% 41.0% 39.7% 47.8%

RoE (%) 114.0% 90.3% 69.5% 60.3% 61.1%Source: Company, Ambit Capital research

Valuation parameters

Year to December CY10 CY11 CY12E CY13E CY14E

EPS (`) 84.9 99.7 110.8 123.3 144.7

Diluted EPS (`) 84.9 99.7 110.8 123.3 144.7

Book value per share (`) 88.7 132.1 186.5 222.6 251.1

Dividend per share (`) 48.5 48.5 48.5 75.0 100.0

P/E (x) 62.5 53.2 47.9 43.0 36.7

P/BV (x) 59.8 40.2 28.4 23.8 21.1

EV/EBITDA (x) 41.3 34.7 29.0 25.2 21.8

Price/Sales (x) 8.2 6.8 6.2 5.4 4.7 Source: Company, Ambit Capital research

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Consumer Goods June 04, 2013

Godrej Consumer Bloomberg: GCPL IN EQUITY Reuters: GOCP.NS

Accounting: GREEN Predictability: AMBER Earnings momentum: RED

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income (` mn) 36,461 48,662 64,074 78,636 90,185 EBITDA(` mn) 6,438 8,554 9,824 13,401 15,730 EBITDA Margin (%) 17.7% 17.6% 15.3% 17.0% 17.4% Adjusted PAT(` mn) 5,147 7,268 7,961 9,108 10,910 Adjusted EPS (`) 14.9 15.5 19.6 26.8 32.1 RoE (%) 35.9% 24.3% 23.4% 26.9% 27.3% P/E (x) 58.6 56.4 44.5 32.6 27.2

Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `873

Target Price (Mar ‘ 14): `792

Previous TP: NA

Downside (%) 9%

EPS (FY14E): `26.8 Change from previous (%) NA

Variance from consensus (%) 3%

Stock Information

Mkt cap: `297bn/US$5,263mn

52-wk H/L: `965/465

3M ADV: `176mn/US$3.1mn

Beta: 0.6x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute 4 17 55 21

Rel. to Sensex 4 13 33 20

Performance (%)

14,000

16,000

18,000

20,000

22,000

Jun-12 Oct-12 Jan-13 M ay-13

400

600

800

1000

Sensex Godrej Consumer

1-year fwd P/E band charts

100

200

300

400

500

600

700

800

900

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

14x

18x

22x

26x

30x

Source: Bloomberg, Ambit Capital research

Capital allocation concerns Godrej Consumer’s (GCPL) domestic business is highly cash-generative, with a constantly evolving product portfolio across soaps, insecticides and hair colours, which is likely to help GCPL gain market share in each of these categories over FY13-15. However, our analysis on capital allocation towards M&A of foreign subsidiaries (just under 50% of consolidated revenues) suggests sub-par returns along with a high risk of drag from integration hurdles, economic/infrastructural uncertainties and acquisition of more such entities in the future. Our DCF generates a fair value of `792, 9% downside. We initiate coverage with a SELL stance.

Competitive position: MODERATE Change to this position: STABLE

Strength of the domestic franchise: GCPL’s domestic business is highly cash-generative, with a negative net working capital. Whilst operational efficiencies targeted through the Sara Lee acquisition are yet to be fully exploited, the company is likely to gain market share across soaps, home insecticides, and hair care. This will be driven by: (a) premiumisation of its soaps portfolio through the relaunch of Cinthol in a fully penetrated soaps market; (b) expansion of the hair colour portfolio through the crème format; and (c) distribution expansion and frequent innovation in its insecticides portfolio. Also, in FY13, the company has launched a wide range of new products such as air fresheners, shower gels, and deodorants.

Surplus capital deployment not value generative: ~60% of GCPL’s capital generated over the past five years has been deployed towards M&A, predominantly outside India, thereby leading to a reduction in the dividend payout ratio from ~90% to ~30% and reduction in RoCE from 51% to 13% over this period. Our analysis suggests that the incremental returns generated on this capital retained have been lower than the cost of equity of 13% so far. Also, the management is likely to continue exploring such opportunities in emerging markets over the longer term. The Group has successfully integrated the Indonesian business and has derived synergies mainly relating to raw material procurement; however, the smooth integration of the African and Latin American businesses in the coming quarters faces substantial risk of drag from economic/infrastructural uncertainties and intense competition from incumbents. Evidence of this is visible in the high volatility of margins reported by these businesses over the past eight quarters.

Valuation: GCPL currently trades at 32.6x FY14 P/E, at a 15% premium to its three-year historical average on one-year forward P/E multiples. This multiple is at a 12% discount to the broader FMCG peer group average which we believe is warranted given the inefficient capital allocation history. Our DCF-based valuation generates a TP of `792/share (9% downside), implying FY14 P/E multiple of 29.6x.

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Godrej Consumer Products

Ambit Capital Pvt Ltd 74

Company Financial Snapshot

Profit and Loss (consolidated) (` mn) FY13 FY14E FY15E Net sales 64,074 78,636 90,185 Optg. Exp(Adj for OI.) 54,251 65,234 74,455 EBITDA 9,824 13,401 15,730 Depreciation 770 904 907 Interest Expense 775 679 429 PBT 8,957 12,597 15,290 Tax 1,792 2,897 3,670 Adj. PAT 7,961 9,108 10,910 Profit and Loss Ratios EBIDTA Margin % 15.3% 17.0% 17.4% Adj Net Margin % 11.2% 12.3% 12.9% P/E (X) 44.5 32.6 27.2 EV/EBIDTA (X) 31.3 22.5 18.7 Dividend Yield (%) 0.7% 0.9% 1.1%

Company Background

Godrej Consumer, a household and personal care products company, is a leader in the insecticides space with key brands such as Good Knight and HIT (Insecticides), Cinthol and Godrej No.1 (Soaps) and Expert (Hair Care).

Through a flurry of international acquisitions, the company has a sizable presence in Africa, Latin America, Indonesia and the UK, with the bulk of its investments made in hair care. The firm’s overseas businesses now account for 40% of revenues.

The company is promoted by the conglomerate, Godrej Group, which holds 64% of equity and is professionally managed.

Balance Sheet (consolidated) (` mn)

FY13 FY14E FY15E Total Assets 76,811 82,869 86,913 Net Fixed Assets 17,285 17,380 17,473 Current Assets 30,441 36,404 40,356 Other Assets 29,085 29,085 29,085 Total Liabilities 76,811 82,869 86,913 Networth 33,130 39,064 46,006 Debt 19,486 14,486 6,986 Current Liabilities 24,334 29,459 34,061 Deferred Tax (140) (140) (140) Balance Sheet Ratios ROE % 23.4% 26.9% 27.3% ROCE % 15.1% 18.4% 21.2% Net Debt/Equity 0.3 0.1 (0.1) Equity/Total Assets 0.6 0.7 0.8 P/BV (X) 8.5 7.2 6.1

Cash Flow (consolidated) (` mn) FY13 FY14E FY15E PBT 8,957 12,597 15,290 Depreciation 770 904 907 Tax (1,792) (2,897) (3,670) Change in Wkg Cap 8,475 9,905 9,964 Others (2,806) (9,741) (9,286) CF from Operations 13,604 10,768 13,206 Capex (9,845) (1,000) (1,000) Investments - - - CF from Investing (9,845) (1,000) (1,000) Change in Equity - - - Debt 717 (5,000) (7,500) Dividends (2,381) (3,174) (3,968) Others 194 (592) (710) CF from Financing (1,470) (8,766) (12,178) Change in Cash 2,289 1,001 28

Revenue contribution of soaps declined from 63% in FY05 to 21% in FY12 (%)

Quarterly revenue growth trends for soaps and insecticides (%)

0%

20%

40%

60%

80%

100%

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Others

International

Homeinsecticides

Hair care

Soaps

5%

10%15%

20%

25%

30%35%

40%

45%

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Soaps Home insecticides

Source: Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 75

Background From a domestic soap manufacturer to an emerging market MNC

Over the past decade, Godrej Consumer (GCPL) has evolved from a domestic market soap manufacturer to a diversified emerging market MNC. The proportion of soaps in GCPL’s consolidated revenues has reduced to ~20% in FY13 from 63% in FY05. This transition has happened predominantly due to the Sara Lee’s acquisition of the home insecticides portfolio and a series of international acquisitions since 2005 across Africa, Latin America, Indonesia and the UK. The company has seen strong market share gains in the soaps segment (share up by 100bps to 11%) and home insecticides segment (share up by 350bps to 40%) in FY12. The company is the market leader in home insecticides, powder hair dyes and liquid detergents.

Sara Lee: After the company acquired Sara Lee’s 51% stake in their JV in May 2010 (renamed as Godrej Household Products - GHPL), the access to increased distribution network and the home insecticides (29% of FY12 consolidated revenues) portfolio of GHPL helped GCPL further diversify the distribution of their domestic business. GHPL was subsequently merged into GCPL in FY11.

International acquisitions: Whilst GCPL’s international ambitions took off in 2005 with an acquisition in the UK (Keyline brands), 2010 was the turning point for its global aspirations, with four acquisitions across emerging markets (Africa, Latin America and Indonesia).

Exhibit 1: Revenue contribution of soaps down from 63% in FY05 to 21% in FY12

0%10%20%30%40%50%60%70%80%90%

100%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Others

International

Homeinsecticides

Hair care

Soaps

Source: Company, Ambit Capital research.

Exhibit 2: Godrej Consumer’s domestic portfolio mix (FY13)

Category Key brands Key competitors % of domestic

turnover % of overall

turnover FY10-12

CAGR

Insecticides GoodKnight, Hit SC Johnson, Reckitt Benckiser 45% 25% 26%*

Soaps Godrej No. 1, Cinthol HUL, Wipro, Reckitt Benckiser 35% 20% 15%

Hair Colour Godrej Expert, Renew L'Oreal, Cavin Care, Hygiene Research Institute 10% 6% 11%

Liquid Detergents/ Exports

Ezee, Genteel, Godrej Dish Wash Amway, HUL 10% 6% 38%

Source: Ambit Capital research. Note: *FY12 growth, as the business was acquired in FY11

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Godrej Consumer Products

Ambit Capital Pvt Ltd 76

Exhibit 3: Godrej Consumer’s international portfolio mix

Geography Category Presence Key brands % of global

turnover % of overall

turnover

Indonesia Insecticides, baby wipes, air fresheners

Hit Magic, Mitu, Stella 44% 20%

Africa Haircare, skincare Inecto, Tura, Kinky, Darling 25% 11%

Latin America Haircare, skincare, colour cosmetics

Pamela Grant, U2, Roby, Ilicit, 919, Issue, Villeneuve

19% 8%

UK Haircare, skincare Touch of Silver, Cuticura, Soft & Gentle

10% 4%

Source: Company, Ambit Capital research

Distribution: Godrej’s distribution network spans across more than 5mn outlets in FY13. It added more than 0.6mn outlets in FY12. The company is planning to use the Darling Group’s distribution network in Africa to launch home insecticides in Nigeria.

SWOT analysis

Exhibit 4: SWOT analysis for Godrej Consumer

Strengths Weaknesses

Investments in talent (recruitments from top management colleges) over the past 4-5 years have led to the creation of a strong team and processes.

Access to technology from its global portfolio (Eg. using the crème format hair colour technology from its LatAm business) will enable the company to launch new products across markets that it operates in.

Has a strong distribution network in emerging markets especially Africa where it can cross sell products from other markets.

It is a market leader in household insecticides, a segment that has high entry barriers (due to cumbersome and time consuming regulatory approvals). It continues to deliver strong market share gains in the category (42% market share in FY12).

Management of working capital has been poorer than its MNC counterparts. However, this is due to the acquisitions made by the company over the past five years. The domestic business enjoys a negative working capital unlike its other domestic peers.

Lack of scale in its Latin American and European markets puts margin pressure on the company when competitive intensity rises.

Opportunities Threats

Shifting its portfolio from being dominant on the low-growth soaps category to higher-growth markets like hair care and insecticides (contribution from soaps is down from 63% in FY05 to ~20% in FY13E).

Potential upsides from ability to gain operational synergies in its emerging market acquisitions and leverage their distribution channels.

Increasing competitive intensity, especially in categories like hair colours, where there is a strong MNC presence can force the company to increase advertisement spends (A&P spends have risen from 9.9% in FY09 to 12.1% in FY12).

With most of its soaps portfolio (we estimate over 80%) in the low-value category, it is sensitive to raw material price fluctuations.

Source: Industry, Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 77

Strong foothold of the domestic operations Over the past eight quarters, the soaps and insecticides businesses have delivered above market growth, averaging 24% (market growth of around 15%) and 27% (market growth of around 12%) respectively. We believe GCPL has gained around 200bps market share in soaps (increase from 10% to 12%) and more than 500bps market share in home insecticides (from 37% to 42%) over the past eight quarters.

Exhibit 5: Quarterly growth trends for soaps and insecticides (%)

5%10%15%20%25%30%35%40%45%

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Soaps Home insecticides

Source: Company, Ambit Capital research

We expect market share gains to continue for GCPL in each of the three categories of presence in India – soaps, home insecticides and hair colour – due to the following strengths:

Insecticide segment: We expect the `30bn insecticides market to increase 12%-14% over FY12-15, as it increases penetration especially in the rural areas (59% urban penetration and 18% rural penetration) and the frequency of consumption increases. The acquisition of Sara Lee has provided GCPL with a strong portfolio of household insecticides under the brand name ‘HIT’. This segment contributes to around 47% of the total domestic revenues for GCPL. Moreover, GCPL plans to achieve between `2.0bn and 2.5bn of cost synergies over FY11-15 by leveraging on operational and supply chain efficiencies of the Sara Lee business. This is likely to help gain market share from Reckitt Benckiser and SC Johnson.

Godrej Expert portfolio expansion: The firm’s hair colour portfolio has expanded with the company’s entry into crème format hair colour by leveraging on the technological access through its Latin American acquisition in 2010.

Cinthol relaunch: Premiumisation of its soap portfolio through the relaunch of Cinthol, which has now been repositioned as a premium brand.

Product innovation and new launches: In addition to the Godrej Expert crème format and Cinthol’s rebranding, the company has launched a range of new products, as highlighted in the table below. This includes its entry into air fresheners, hand sanitisers, shower gels, and deodorants this year.

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Godrej Consumer Products

Ambit Capital Pvt Ltd 78

Exhibit 6: Recent new launches by GCPL in India

Launch Use New product/ Product Extension

Category

Good Knight Naturals Mosquito cream New product Home care

Good Knight Advanced Low Smoke Coil

Repellent coil Product extension Home care

Godrej No.1 (new variants) Soap Product extension Personal wash

Godrej Protekt Hand sanitizer New product Others

Godrej Expert Care Hair colour Product extension Hair care

Godrej Expert Advanced Hair colour Product extension Hair care

Godrej Expert Rich Crème Hair colour New product Hair care

Cinthol Soaps (new variants) Soap Product extension Personal wash

Cinthol Deodorants Deodorants Re launched Others

Cinthol Shower Gel Shower gel New product Personal wash

Aer Air freshener New product Others

Hit Anti-Roach Gel Gel format insecticide New product Home care

Source: Ambit Capital research

Investments behind talent: Based on our primary data checks, over the past couple of years, Godrej has started focusing on attracting the best possible talent available and is revamping the business across functions and getting processes in order.

Exhibit 7: Increasing investments in talent

-

1,000

2,000

3,000

4,000

5,000

6,000

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

5.0%5.5%6.0%6.5%7.0%7.5%8.0%8.5%9.0%9.5%

Employee Costs (Rs mn) (LHS) As % of sales

Source: Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 79

Sub-par surplus capital deployment so far GCPL’s growth over the past decade can be divided into three phases:

FY02-05 – moderate domestic growth; highly cash generative: During this period, GCPL reported standalone revenue CAGR of 7%, with an EBITDA margin of 16-18% and an EBITDA CAGR of 10%. However, the firm was generating an RoE and RoCE of over 100% and an average dividend payout ratio of ~90% and a negative net working capital cycle (minus 15-20 days on average). Whilst the firm had predominantly expanded organically over this period, it had clearly indicated that M&A was going to be the preferred means of capital deployment and hence expansion by the end of this period.

FY05-10 – Indian operations gather pace, and so does the M&A strategy: This period was characterised by a change in the management team with Mr. Mahendran (ex-Godrej-Sara Lee), becoming the Managing Director from 1 July 2010. During this period, GCPL reported standalone revenue CAGR of 18% with an EBITDA margin of 19-20% and an EBITDA CAGR of 24%. However, the proportion of revenues from international operations increased from ~5% in FY06 to ~20% in FY09 and ~35% in FY10. To fund these acquisitions, the dividend payout ratio declined from 90% to 45% over this period and new capital was raised both through debt as well as equity. Due to these acquisitions, working capital cycle for the consolidated entity became positive (minus 8 days in FY06 to positive 62 days in FY10).

FY10-13 – more inorganic than organic growth: This period saw another management change with Mr. Vivek Gambhir, who was previously a strategy consultant at Bain India, becoming the company’s Chief Strategy Officer in 2009. He will take over as the Managing Director from 1 July 2013. Through the acquisition of the home insecticides business of Sara Lee in India and M&As in Indonesia, Africa and Latin America, GCPL’s consolidated revenues reported a CAGR of 46% over FY09-13.

Exhibit 8: Increasing proportion of international revenues

-

5,000

10,000

15,000

20,000

25,000

30,000

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

0%5%10%15%20%25%30%35%40%45%50%

International revenues (Rs mn) (LHS) Proportion of total revenues (%)

Source: Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 80

Exhibit 9: Godrej’s international acquisitions are targeted at market leaders

Year Company acquired

Country Market position

2005 Keyline brands UK Hair care and skin care products

2006 Rapidol South Africa Leader in ethnic hair colour

2008 Kinky South Africa Manufacturer of hair accessories

2010 Tura Nigeria Manufactures soaps and skin creams

2010 Megasari Indonesia Leader in baby wipes, air fresheners and No.2 in household insecticides

2010 Issue Latin America Hair care products

2010 Argencos Argentina Leader in hair sprays, focused on hair colour

2011 Darling (ongoing) Pan-Africa Leader in hair extensions

2012 Cosmetica Nacional

Chile Leader in hair colour

2012 Soft & Gentle UK Fourth-largest female deodorant brand

Source: Company, Ambit Capital research

As a result of this acquisition approach towards capital deployment, over the past decade, GCPL stood out in the FMCG pack with the highest proportion of capital deployed towards M&A/non-core investments.

Exhibit 10: Avenues of capital deployment for various companies over FY03-12

-20%

0%

20%

40%

60%

80%

100%

HU

L

Col

gate

Nes

tle

GSK

Con

sum

er

Dab

ur

GC

PL

Mar

ico

Investment in core Dividend Paid Non core Inv./Intl. M&A Change in cash Others

Source: Company, Ambit Capital research; Note: height of the bar for each company indicates the sum of operating cash flows, new equity raised and increase in gross debt over the past ten years

Performance of the international businesses

Indonesia: Of the various new geographies in which GCPL has made acquisitions, Indonesia has been the most successful integration, with the firm deriving substantial synergies in the form of reduction in working capital cycle mainly through streamlining of raw material procurement and cross-pollination of products between the company’s Indonesian and Indian businesses. Through the launch of HIT Magic in 1QFY12 (a paper format mosquito repellant) and through distribution expansion for the overall business, GCPL’s Indonesian business has reported revenue CAGR of 33% over FY11-13E.

Africa: GCPL's hair extensions business under the brand of Darling is well managed and has earnings growth prospects of 12-14% CAGR over the short to medium term, with a potential to expand the company’s insecticides business in these countries by leveraging on Darling’s existing distribution network. However, we do not expect the Darling acquisition to offer as strong an earnings growth as that achieved in the Indonesian acquisitions. Whilst Africa’s macro-economic indicators around the evolution of a middle class and growth potential of sectors, like construction, cement, and infrastructure, remain strong in countries like Kenya, other factors, like evolution of consumerism and foreign direct investments

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Godrej Consumer Products

Ambit Capital Pvt Ltd 81

in the country, are likely to remain a challenge in the near to medium term. Also, the company will not be fully shielded from events like the recent transporters’ strike in South Africa, fuel price increases, and growth moderation related to government elections in Kenya.

Latin America: GCPL controls the second-largest market share in hair colors in Chile and Argentina. Latin America offers opportunities such as: (a) per capita income growth to remain at around 4%; and (b) large middle class population spending incrementally on premiumisation. However, the LatAm market is not likely to be suitable for cross-pollination through soaps or insecticides given the already high penetration levels for soaps and SC Johnson controlling 80-90% market share of the insecticides segment in most LatAm markets.

Overall conclusions on international acquisitions: As highlighted in the thematic section of this note, our analysis suggests that the incremental earnings generated by GCPL through its international business are lower than the cost of equity deployed over FY08-12. Also, as shown in the exhibit below, EBITDA margins for the international subsidiaries have been highly volatile due to frequent one-off unexpected gain/losses over the past few quarters.

Exhibit 11: EBITDA margin trends for the international business have been highly volatile in the past

0%

5%

10%

15%

20%

25%

30%

Dec

-10

Mar

-11

Jun-

11

Sep-

11

Dec

-11

Mar

-12

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Indonesia Africa Latin America UK

Source: Company, Ambit Capital research

Our discussions with GCPL’s management team suggest that the company is likely to focus on the subsequent phases of integration of the Darling acquisition in Africa rather than seeking new M&A opportunities over the next 12-18 months. The surplus cash generated from its existing businesses in the near future is likely to be used for consolidation of Darling in Africa, debt repayment, and growth of the acquired businesses.

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Godrej Consumer Products

Ambit Capital Pvt Ltd 82

Key assumptions Exhibit 12: Key assumptions and estimates for revenues

Contribution to revenues

FY13 FY14E FY15E Comments

Domestic business

Soaps growth 19.6% 27.5% 12.7% 11.8%

Industry growth 20.0% 10.0% 10.0%

Growth from market share change 6.2% 2.5% 1.6%

Expect GCPL to gain from repositioning of the Cinthol brand to the premium segment and growth in line with the market for the Godrej No.1 brand

Hair colour growth 5.8 % 13.6% 25.0% 20.0%

Industry growth 19.0% 20.0% 18.0%

Growth from market share change -5.4% 5.0% 2.0%

Growth to be driven by share gain through the newly launched crème format hair colour at a disruptive price segment

Insecticide growth 25.2% 22.9% 16.0% 16.0%

Industry growth 14.0% 14.0% 14.0%

Growth from market share change 8.9% 2.0% 2.0%

Growth to be driven by: (1) distribution benefits from the GHPL merger; and (2) frequent innovation and strong marketing investments

Others 5.4% -3.9% 16.0% 16.0% Entry into new categories like deodorants, air fresheners, hand sanitisers and talcum powder likely to see strong growth

Total domestic growth 20.2% 15.8% 15.0%

International business

Indonesia 19.6% 35.0% 18.0% 18.0%

Industry growth 13.0% 13.0% 13.0%

Growth from market share change 2.0% 5.0% 5.0%

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 11.1% 68.5% 60.6% 13.6%

Industry growth 10.6% 10.6% 10.6%

Growth from market share change 70.0% 50.0% 3.0%

Revenue growth to be a function of consolidation of revenues from the Darling acquisition and market growth led by penetration and share gains by new product innovation and launching of insecticides

Latin America 8.2% 83.9% 14.0% 14.0%

Industry growth 16.0% 14.0% 14.0%

Growth from market share change 60.0% 0.0% 0.0%

Expect market share gains in the competitive market led by aggressive innovation and promotions and strong market growth

Europe 4.5% 40.8% 5.0% 5.0%

Industry growth 4.0% 4.0% 4.0%

Growth from market share change 6.0% 1.0% 1.0%

Factor in growth only marginally ahead of the FMCG average in the slow-growth UK market despite the company having a strong historical performance

Others 0.7% 5.4% 10.0% 10.0% Factor in 10% growth in the other international businesses

Total international growth 49.9% 31.5% 14.3%

Overall growth 31.7% 22.7% 14.7%

Source: Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 83

Exhibit 13: Key assumptions and estimates - others

Profit and loss FY12 FY13 FY14E FY15E Comments

Domestic revenues 29,801 35,810 41,461 47,682

Growth (%) 20.8% 20.2% 15.8% 15.0%

Expect hair care and household insecticides to be the drivers of growth led by new launches in hair care and market share gains in insecticides

International revenues 18,861 28,264 37,174 42,503

Growth (%) 31.8% 31.7% 22.7% 14.7%

Besides consolidation of acquisitions in Africa and Chile, growth from emerging markets and cross pollination of products to lead to strong growth in the international business

Total revenues 48,661 64,074 78,636 90,185

Growth (%) 33.5% 31.7% 22.7% 14.7%

Gross Profit 25,477 34,563 42,732 49,189

Gross margin (%) 52.4% 53.9% 54.3% 54.5%

Expect premiumisation effects in the soaps and hair colour business to lead to increase in gross margins

Employee cost (% of sale) 8.1% 9.2% 9.0% 8.8% Expect operational and scale efficiencies to lead to benefits in employee costs

Advertising (% of sale) 12.1% NA 12.6% 12.6% Expect advertising spends to be maintained

Freight & forwarding (% of sale) 3.2% NA 3.4% 3.4% Expect freight expenses to remain stable

Other expenses (% of sale) 11.4% NA 12.3% 12.3% Expect minor operational efficiencies in other expenses

EBITDA 8,554 9,824 13,401 15,730

EBITDA Margin 17.6% 15.3% 17.0% 17.4%

Above changes to lead to improvement in EBITDA margins in FY14 and FY15

Tax rate 29.1% 20.0% 23.0% 24.0% Tax benefits gains in Africa in FY13; FY14 and FY15 should see effective tax rates inching upwards

Net Profit margin 11.3% 11.2% 12.3% 12.9% Lower interest costs and slower increase in depreciation to help boost net profit margin

Balance Sheet

Capex 1,256 2,215 1,000 1,000

Capital Work in Progress 376 376 376 376 No material capex requirements for FY14 and FY15

Working Capital days 33 (1) 1 1 Expect working capital days to remain stable

Debtor days 35 42 42 42 Expect debtor days to remain stable

Current Liabilities days 87 122 120 120 Expect current liabilities to remain stable

Inventory days 59 60 59 59 Better inventory management to lead to decrease in inventory days

Net debt/(cash) to equity 0.4 0.3 0.1 (0.1) Expect GCPL to turn into a net cash company in FY15

Cash flows (` mn)

Operating cash flows 7,033 13,604 10,768 13,206

Free cash flows 6,076 11,389 9,768 12,206

With no material capex requirements, free cash flows to increase strongly over FY12-15

Source: Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 84

Valuation

DCF valuation

Given the cash-generative nature of the business, we use a DCF-based model to arrive at a fair value for Godrej Consumer. The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed zero debt on GCPL’s balance sheet in the future given its strong cash generation. Hence, the company would have enough surplus cash available on its balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for GCPL. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years, with sales CAGR of 16% and EPS CAGR of 21%. Stage 2 includes a decline in PBIT growth over six years from 14% in FY18 to 7% in FY26 i.e. CAGR of 11% and a free cash flow CAGR of 9% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model arrives at a target pr ice of `792/share (5% downside), implying an FY14 P/E multiple of 29.6x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 15: Cash flow profiles for GCPL (` mn)

-

2,000

4,000

6,000

8,000

10,000

12,000

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

(12,000)

(9,000)

(6,000)

(3,000)

-

3,000

6,000

9,000

12,000

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

Source: Ambit Capital research

Exhibit 16: Return profiles for GCPL (%)

-20%

10%

40%

70%

100%

130%

160%

190%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E -20%

0%

20%

40%

60%

80%

100%

120%

ROE (LHS) EBITDA Margin EPS Growth YoY Growth in sales

Source: Ambit Capital research

Exhibit 14: WACC calculation for DCF on GCPL Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.52

Equity risk premium (%) 7

Cost of equity (%) 12.1

Cost of debt (%) 11.0

Debt/Equity ratio (%) 10.0

Tax rate (%) 30

WACC (%) 12.0

Source: Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 85

Relative valuation GCPL currently trades at 32.6x FY14 P/E multiple. This rating is at a 12% discount to the sector average of 37.2x. GCPL’s domestic business has a strong portfolio positioning with the likelihood of market share gains across soaps, insecticides as well as hair colors. However, given the sub-par incremental returns generated from the capital allocated towards international acquisitions and given the uncertainties attached to its international portfolio around events like the recent transporters’ strike in South Africa, fuel price increases, and growth moderation related to government elections in Kenya, we expect GCPL to trade at a discount to the broader FMCG pack on P/E multiples.

As shown in the charts below, GCPL has consistently traded at a P/E multiple band of 25.0x to 29.0x. Given the high quality of its domestic business, we believe this valuation band is justified. Consequently, on our DCF-based fair value, GCPL trades at an implied FY14 P/E multiple of 29.6x.

Exhibit 17: 1-year forward P/E bands for GCPL

100

200

300

400

500

600

700

800

900

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

14x

18x

22x

26x

30x

Source: Bloomberg, Ambit Capital research

Exhibit 18: 1-year forward EV/EBITDA bands for GCPL

100

200

300

400

500

600

700

800

900

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

21x

18x

24x

12x

15x

Source: Bloomberg, Ambit Capital research

Sensitivity analysis

Exhibit 19: Sensitivity analysis

Bull case Base case Bear case

Revenue growth

We model a revenue CAGR of around 16% over FY14-23 led by strong market share gains in soaps and household insecticides in the domestic business and strong revenue growth in the Indonesian business with no market share losses in any category. Our terminal growth rate assumption stands at 6%

Expect revenue growth of 14% over FY14-23 assuming market share gains in soaps and household insecticides and strong growth in Indonesia. Our terminal growth rate assumption stands at 5%

Expect revenue growth of 13% over FY14-23 assuming no market share gains in soaps and household insecticides and slowing down of growth in the Indonesia business. Our terminal growth rate assumption stands at 4%

Operating margins

Expect EBITDA margins to expand to 19% by FY17, led by gross margin expansion and efficiencies in employee costs with no increase in advertisement spends

Expect EBITDA margins to expand by 100bps over FY14-17 to 18%, led by gross margin expansion and efficiencies in employee costs being partially offset by increase in advertisement spends

Expect EBITDA margins to decline by 10bps to 17.9% in over FY14-17 led by gross margin expansion being partially offset by an increase in advertisement spends

Fair value (`/share) 998 792 650

Upside/Downside 14% -9% -26%

Source: Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 86

Risks to our SELL stance Emerging market economic growth: A sudden rise of the middle class

population in emerging market economies can lead to a strong growth for segments in which GCPL operates internationally.

New acquisitions at cheap multiples: With the management’s view of continued focus on M&A as one of the growth drivers over the longer term, the acquisition of an asset at a cheap valuation can lead to an upside potential for the stock from the current levels.

Catalysts Acquisition and integration risks: As highlighted previously in this note, GCPL has had a volatile trend of EBITDA margins over the past eight quarters driven mainly by unexpected one-off events linked either to the economy, politics or infrastructure. Also, as GCPL integrates the acquired businesses and attempts to generate operational synergies, there is a risk of execution-related issues like departure of key personnel or infrastructure-related issues, which can lead to a substantial drag on the overall business of GCPL.

Increasing competitive intensity: With the company’s entry into the more premium segment of both hair colour and soaps, higher competitive intensity from the 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.

Currency risks: With the contribution from its overseas business crossing 40% of revenues in FY13, the company is subject to significant currency risk and any material depreciation in currencies can pose translation risks for the company.

Ambit vs consensus Exhibit 20: Ambit v/s consensus

Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn) 78,636 77,293 2% Expect strong growth in the domestic insecticide and hair colour business and Indonesia in the international business

EBITDA (` mn) 13,401 13,118 2% Expect GCPL to gain from gross margin expansion and efficiencies of scale in operations

EPS (`/share) 26.8 26.0 3% Above-mentioned expectations to lead to EPS around 3% above consensus.

FY15E

Net Sales (` mn) 90,185 91,843 -2% Our revenue forecasts are broadly in line with consensus

EBITDA (` mn) 15,730 15,866 -1% Expect GCPL to gain from gross margin expansion and efficiencies of scale in operations

EPS (`/share) 32.1 31.6 1% Above-mentioned expectations to lead to EPS marginally above consensus

Source: Ambit Capital research

Exhibit 21: Explanation for our forensic accounting scores on the first page

Segment Score Comments

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 tend to bring volatility in its reported numbers at the EBITDA margin level.

Earnings momentum RED Consensus EPS estimates have been downgraded by 6% in FY14 and 7% in FY15.

Source: Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 87

Balance sheet (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Shareholders' equity 323 340 340 340 340

Reserves & surpluses 16,928 27,812 32,790 38,724 45,666

Total networth 17,251 28,152 33,130 39,064 46,006

Minority Interest - 882 2,095 2,687 3,397

Debt 20,054 18,769 19,486 14,486 6,986

Other long term liabilities - 294 273 273 273

Deferred tax liability 14 (5) (140) (140) (140)

Total liabilities 37,319 48,092 54,844 56,369 56,522

Gross block 19,147 20,403 22,618 23,618 24,618

Net block 15,373 15,464 16,909 17,005 17,097

CWIP 154 376 376 376 376

Goodwill 15,404 21,454 29,085 29,085 29,085

Cash & equivalents 2,269 6,399 8,688 9,689 9,717

Debtors 3,840 4,725 7,288 9,048 10,377

Inventory 4,394 7,839 10,471 12,711 14,578

Loans & advances 4,559 3,911 3,995 4,955 5,683

Other current assets - - - - -

Total current assets 15,062 22,874 30,441 36,404 40,356

Current liabilities 8,448 11,555 21,381 25,853 29,650

Provisions 225 521 585 646 741

Total current liabilities 8,673 12,075 21,967 26,499 30,391

Net current assets 6,389 10,799 8,475 9,905 9,964

Total assets 37,319 48,092 54,844 56,369 56,522 Source: Company, Ambit Capital research

Income statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income 36,461 48,662 64,074 78,636 90,185

% growth 78.4% 33.5% 31.7% 22.7% 14.7%

Operating expenditure 30,023 40,108 54,251 65,234 74,455

EBITDA 6,438 8,554 9,824 13,401 15,730

% growth 57.1% 32.9% 14.8% 36.4% 17.4%

Depreciation 499 644 770 904 907

EBIT 5,939 7,910 9,054 12,497 14,823

Interest expenditure 519 658 775 679 429

Non-operating income 698 520 678 779 896

Adjusted PBT 6,118 7,772 8,957 12,597 15,290

Tax 1,302 2,261 1,792 2,897 3,670

Adjusted PAT/ Net profit 4,816 5,511 7,165 9,700 11,620

% growth 45.7% 27.0% 15.2% 40.6% 21.4%

Extraordinaries 331 2,002 1,289 - -

Reported PAT / Net profit 5,147 7,513 8,454 9,700 11,620

Minority Interest - (245) (493) (592) (710)

Adjusted Consolidated net profit 5,147 7,268 7,961 9,108 10,910

Reported Consolidated net profit 5,147 7,268 7,961 9,108 10,910 Source: Company, Ambit Capital research

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Godrej Consumer Products

Ambit Capital Pvt Ltd 88

Cash flow statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

EBIT 6,637 8,430 9,732 13,277 15,719

Depreciation 499 644 770 904 907

Others (571) 499 282 (87) 281

Tax (1,302) (2,261) (1,792) (2,897) (3,670)

(Incr) / decr in net working capital (3,604) (280) 4,613 (428) (32)

Cash flow from operations 1,658 7,033 13,604 10,768 13,206

Capex (25,686) (7,007) (9,845) (1,000) (1,000)

(Incr) / decr in investments 670 - - - -

Cash flow from investments (25,016) (7,007) (9,845) (1,000) (1,000)

Net borrowings 19,686 (1,285) 717 (5,000) (7,500)

Interest paid (519) (658) (775) (679) (429)

Dividend paid (1,966) (1,948) (2,381) (3,174) (3,968)

Others 5,374 7,995 969 87 (281)

Cash flow from financing 22,574 4,104 (1,470) (8,766) (12,178)

Net change in cash (783) 4,130 2,289 1,001 28

Closing cash balance 2,269 6,399 8,688 9,689 9,717

Free cash flow (24,027) 26 3,759 9,768 12,206 Source: Company, Ambit Capital research

Ratio analysis

Year to March FY11 FY12 FY13 FY14E FY15E

Gross margin (%) 52.0% 52.4% 53.9% 54.3% 54.5%

EBITDA margin (%) 17.7% 17.6% 15.3% 17.0% 17.4%

EBIT margin (%) 18.2% 17.3% 15.2% 16.9% 17.4%

Net profit margin (%) 13.2% 11.3% 11.2% 12.3% 12.9%

Dividend payout ratio (%) 40.8% 35.3% 33.2% 32.7% 34.1%

Net debt: equity (x) 1.0 0.4 0.3 0.1 (0.1)

Working capital turnover (x) 8.8 11.1 (301.0) 365.0 365.0

Gross block turnover (x) 1.9 2.4 2.8 3.3 3.7

RoCE (%) 22.1% 14.0% 15.1% 18.4% 21.2%

RoE (%) 35.9% 24.3% 23.4% 26.9% 27.3%Source: Company, Ambit Capital research

Valuation parameters

Year to March FY11 FY12 FY13 FY14E FY15E

EPS (`) 14.9 15.5 19.6 26.8 32.1

Diluted EPS (`) 14.9 15.5 19.6 26.8 32.1

Book value per share (`) 50.7 82.7 97.4 114.8 135.2

Dividend per share (`) 5.0 4.8 6.0 8.0 10.0

P/E (x) 58.6 56.4 44.5 32.6 27.2

P/BV (x) 17.2 10.6 9.0 7.6 6.5

EV/EBITDA (x) 46.6 36.2 31.3 22.5 18.7

Price/Sales (x) 7.7 6.1 4.6 3.8 3.3 Source: Company, Ambit Capital research

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Consumer Staples June 04, 2013

Dabur Bloomberg: DABUR IN EQUITY Reuters: DABU.NS

Accounting: GREEN Predictability: AMBER Earnings momentum: GREEN

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income (` mn) 41,045 53,054 61,761 70,346 80,031 EBITDA(` mn) 8,013 8,902 10,298 11,827 13,455 EBITDA Margin (%) 19.5% 16.8% 16.7% 16.8% 16.8% Adjusted PAT(` mn) 5,686 6,449 7,726 8,821 10,216 Adjusted EPS (`) 3.3 3.7 4.4 5.1 5.9 RoE (%) 48.9% 41.5% 40.0% 37.0% 34.9% P/E (x) 48.4 42.7 35.9 31.2 27.0 Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `158

Target Price (Mar ‘14): `136

Previous TP: NA

Downside (%) 14%

EPS (FY14E): `5.1 Change from previous (%) NA

Variance from consensus (%) -5%

Stock Information

Mkt cap: `274bn/US$4,891mn

52-wk H/L: `166/101

3M ADV: `191mn/US$3.4mn

Beta: 0.5x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute (2) 22 53 23

Rel. to Sensex (2) 18 30 22

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Sep-12 Jan-13 M ay-13

90

110

130

150

170

Sensex Dabur India

1-year forward P/E band chart

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

14x

30x

26x

22x

18x

Source: Bloomberg, Ambit Capital research

Stuck in the mass market Dabur’s sales growth is expected to moderate from 21% CAGR (supported by M&A) over FY08-13 to 14% CAGR over FY13-15. More than two-thirds of Dabur’s domestic product portfolio positioning does not leave much scope for premiumisation or market share gains. Also, the drag on its international business from Namaste is unlikely to recede over the next 12 months. The stock is currently trading at an 16% discount to its peer group average (based on its 1-year forward P/E). We believe this is justified given the company’s relatively weaker cash generation and growth profile. We initiate coverage with a SELL stance.

Competitive position: MODERATE Change to this position: STABLE

Whilst Dabur has reported revenue CAGR of 21% over FY08-13, supported by international acquisitions. We expect a moderation in growth from 16% YoY in FY13 to 13.8% over FY13-16 due to :

Weak portfolio positioning: 45% of Dabur’s domestic revenues comes from oral care, hair care and skin care, which face headwinds from a combination of mass-market positioning, intense competition from Colgate, Marico and HUL, and relatively high penetration of these segments (especially in urban India). Another 23% of the portfolio includes health supplements and digestives, which offers no scope for premiumisation. Moreover, products such as Hajmola have achieved more than 80% market penetration in India and Glucose-D faces tough competition from Heinz’s Glucon-D. These factors limit Dabur’s scope for strong revenue growth, gross margin benefits and better defense against competition. The juices and home care segments (15% of consolidated revenues) remain the only two areas of strength in its portfolio.

Capital allocation risk: Based on our capital allocation analysis, whilst Dabur’s organic expansion in the Middle East has performed well in the past, its capital deployment towards M&A, especially for the Namaste business has been disappointing so far, due to: (a) distribution-related disruptions; (b) rebranding of the US portfolio in FY13 due to regulatory constraints; and (c) fairly large management reshuffles in the US business. Hence, Namaste’s growth rates are unlikely to normalise for at least another 12 months. With ~`10bn of surplus capital currently on the balance sheet which will most likely be deployed towards M&A in India in the coming years, Dabur will face a capital allocation risk.

Valuation: Dabur currently trades at 31x FY14 earnings, towards the bottom end of the FMCG sector range. Given the factors highlighted above, we believe this discount is justified. Our DCF-based valuation generates a target price of `136 (14% downside), implying 26.8x FY14 P/E.

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Dabur

Ambit Capital Pvt Ltd 90

Company Financial Snapshot

Profit and Loss (` mn) FY13 FY14E FY15E Net sales 61,761 70,346 80,031 Optg. Exp(Adj for OI.) 51,463 58,519 66,576 EBITDA 10,298 11,827 13,455 Depreciation 1,124 1,160 1,199 Interest Expense 589 601 451 PBT 9,530 11,027 12,932 Tax 1,826 2,205 2,716 Adj. PAT 7,704 8,821 10,216 Profit and Loss Ratios EBIDTA Margin % 16.7% 16.8% 16.8% Adj Net Margin % 12.4% 12.5% 12.8% P/E (X) 35.9 31.2 27.0 EV/EBIDTA (X) 27.4 23.5 20.3 Dividend Yield (%) 0.9% 1.1% 1.4%

Company Background

Dabur, a healthcare products manufacturer, was formed in 1884 and promoted by the Burman family (68.7% stake).

The company’s product lines include Ayurvedic Products, Personal care, Healthcare, Homecare and Foods. Key brands for the company include Dabur, Vatika, Hajmola, Real and Fem.

The company has 17 manufacturing facilities with a presence in more than 60 countries. It is currently headed by Mr. Sunil Duggal.

Balance Sheet (consolidated) (` mn)

FY13 FY14E FY15E Total Assets 47,365 51,990 58,470 Net Fixed Assets 16,745 17,385 17,986 Current Assets 24,301 28,286 34,165 Other Assets 6,319 6,319 6,319 Total Liabilities 47,365 51,990 58,470 Networth 21,244 26,419 32,179 Debt 11,634 8,634 6,634 Current Liabilities 14,125 16,575 19,295 Deferred Tax 362 362 362 Balance Sheet Ratios ROE % 40.0% 37.0% 34.9% ROCE % 26.5% 27.1% 28.3% Net Debt/Equity 0.5 0.3 0.2 Equity/Total Assets 0.6 0.7 0.8 P/BV (X) 13.0 10.4 8.6

Cash Flow (consolidated) (` mn) FY13E FY14E FY14E PBT 9,530 11,027 12,932 Depreciation 1,124 1,160 1,199 Tax (1,826) (2,205) (2,716) Change in Wkg Cap (3,537) (541) (331) Others 741 601 451 CF from Operations 6,031 10,041 11,535 Capex (1,189) (1,800) (1,800) Investments (775) - - CF from Investing (1,964) (1,800) (1,800) Change in Equity - - - Debt 770 (3,000) (2,000) Dividends (3,038) (3,646) (4,456) Others (1,156) (601) (451) CF from Financing (3,424) (7,247) (6,907) Change in Cash 644 994 2,828

Hair oils segment’s revenue growth muted due to Parachute’s entry into the amla hair oil market

Dabur’s oral care revenues have increased slower than that of Colgate over the past eight quarters

19%

13% 12%

18%

10%

27%

22%20%

8% 9%12%

0%

5%

10%

15%

20%

25%

30%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

3%

6%

9%

12%

15%

18%

21%

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

FY13

E

FY14

E

FY15

E

Dabur Colgate

Source: Company, Ambit Capital Research

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Dabur

Ambit Capital Pvt Ltd 91

Background Exhibit 1: Dabur’s domestic portfolio mix

Category Key brands Key Competitors Market

share rank % of

turnover FY10-13

CAGR

Hair care Amla Hair Oil, Vatika Shampoo

Parachute, CavinKare, HUL

3 18% 9%

Health supplements

Dabur Chyawanprash, Dabur Honey, Dabur Glucose-D

Emami, Heinz, Baidyanath

1* 12% 18%

Oral care Babool, Red, Meswak Colgate, HUL 3 10% 12%

Foods Real, Hommade Pepsico 1 10% 25%

Digestives Hajmola, Pudin Hara SSG Pharma, Anil Foods

1 5% 10%

OTC & ethicals

Honitus, Lal Tail J&J, Pfizer NA

7% 12%

Home care Odomos, Odonil, Odopic, Sanifresh

Reckitt Benchiser, Godrej Consumer, HUL

NA 4% 25%

Skin care Gulabari, Fem, Uveda HUL, L'Oreal, Jolen NA 4% 13%

International business

Hobby, Organic root stimulator

Local players, L'Oreal, P&G

NA 30% 21%

Source: Ambit Capital research. Note:* Market share rank of #2 in Glucose-D

Dabur has a presence in categories that have historically had low competition. Nearly 60-70% of its domestic portfolio is exposed to strong competitive intensity from MNCs (note that Amla hair oil, health supplements, digestives and OTC are fairly insulated from MNC pressure).

Dabur’s international business is essentially focused on hair care (with a presence in the US, Africa, the Middle East and Asia) and oral care (strong Middle Eastern presence). Whilst the company has expanded organically in geographies, such as Asia and the Middle East, its presence in markets such as Africa, Turkey and the US has been achieved through acquisitions over the past three years.

Over FY07-12, Dabur has delivered a consolidated revenue CAGR of 21% and a PAT CAGR of 18% (boosted by its overseas acquisitions), whilst its EBITDA margins have contracted by 30bps from 17.1% in FY07 to 16.8% in FY12. Whilst the fruit juices, hair oils and home care segments have been the strongest segments for Dabur over FY10-12 (mainly led by higher market penetration), increased competitive intensity has taken its toll on the shampoo, oral care and skin care segments. Even the health supplements segment has seen moderation in revenue growth in FY12 (8% YoY) after delivering strong growth in FY11 (31% YoY).

The company’s distribution network spans 3.5mn outlets for its most widely distributed product (Vatika shampoo), whilst its total reach in all outlets stands at 5.8mn. The company has a direct reach of 0.8mn outlets.

Over the past two years, Dabur has undertaken two distribution initiatives: (1) Project Double – distribution reach of villages to be increased from 14,000 villages to 27,000 villages, and (2) Project Speed – merger of the Consumer Health division with the HPC division (now called Consumer Care). The purpose of this initiative was to give the chemist channels access to the entire portfolio. This is likely to have around an incremental positive impact of 1-2% on volumes for the company’s Indian business through increased penetration of rural markets.

International business segment

Revenue share

Africa 22%

Middle East 33%

Asia 18%

USA 22%

Others 5%

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Dabur

Ambit Capital Pvt Ltd 92

SWOT analysis

Exhibit 2: SWOT analysis for Dabur

Strengths Weaknesses

Well-established distribution and brand recall in India’s rural markets in oral care, hair care, digestives, health supplements and skin care.

It is a market leader in segments like digestives, chyawanprash and honey and also in categories like fruit juices where it has successfully taken on MNCs.

Gaining from distribution by: (1) leveraging its access to the chemist channels through its consumer and health division, and (2) doubling its rural reach from 14,000 to 30,000 villages.

Cannot use the doctor channel because doctors are better incentivised by pharmaceutical companies to promote conventional medicines.

Response to competition has been weak and has led to loss of market share in shampoos, toothpastes and hair oil.

Presence in categories and product positioning with limited ability to premiumise consumers. Eg. Hajmola’s Re1 price point; difficulty in premiumising digestives, honey, ethicals etc.

Opportunities Threats

Entry into new categories based on Ayurvedic healthcare, where it has expertise and has established brand equity.

Access to an international distribution channel through its acquisitions as well as ability to cross sell its international portfolio in India.

Loss of share in MNC-dominated categories can force the company to increase advertisement spends.

Rebranding of its US business due to regulatory restrictions on the keyword ‘Organic’ may lead to loss of revenues as consumers may switch brands.

Source: Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 93

Constrained by portfolio positioning and international business drag As shown in the chart below, whilst Dabur has been able to generate a strong revenue CAGR of 21% over FY08-13, the firm has reported: (a) moderation in consolidated revenue growth from 29.3% YoY in FY12 to 16.4% YoY in FY13; (b) gross margin reduction of 350bps over the past three years; and (c) EBITDA margin reduction of 250bps over the past three years.

Exhibit 3: Dabur’s revenue growth and margin profile

12%14%16%18%20%22%24%26%28%30%

FY08 FY09 FY10 FY11 FY12 FY13

48%

49%

50%

51%

52%

53%

54%

55%

Revenue growth EBITDA Margin (%) Gross Margin (%) (RHS)

Source: Company, Ambit Capital research

We expect Dabur’s EBITDA margins to remain under pressure and overall revenue growth to moderate in the future because: (a) the positioning of its product portfolio does not leave significant scope for growth acceleration, premiumisation, or market share gains; and (b) the drag on its international business from Namaste is not likely to recede significantly over the next 12 months.

Constraints related to portfolio positioning As shown in the table below, whilst we expect strong revenue growth in juices and home care products (22% of domestic revenues), we expect an overhang on overall revenue growth from most other products including digestives, oral care, health supplements, hair care and skin care (~66% of domestic revenues), either due to slow category growth or due to prospective market share losses.

Exhibit 4: Our category-wise revenue growth expectations for Dabur

Category Contribution to

consolidated revenues

Revenue growth reported over

FY11-13

FY13-15 revenue CAGR

expectation Comments

Hair care 18% 12% 14% Higher competitive intensity in hair care with slower market growth in amla hair oils.

Health Supplements

12% 12% 13% Slower market growth in Chyawanprash is likely to offset the stronger penetration-led growth in Glucose-D.

Foods 11% 26% 20% Juices to drive growth in the segment driven by higher penetration and frequency of consumption.

Oral care 10% 10% 11% We expect weak product portfolio to lead to market share losses and hence record slower than industry category growth.

OTC and Ethical 7% 12% 15%

We expect the OTC segment to drive the growth of this segment through strong growth in 'Lal Tail'.

Digestives 4% 8% 11% High penetration and inability to premiumise Hajmola is likely to be an overhang despite strong growth in the OTC Pudin Hara.

Home care 4% 20% 18% Strong penetration-led growth in surface cleaners would likely lead segment growth.

Skin care 3% 13% 13% Weak portfolio with a mass focus and low marketing spends to lead to market share losses in the category.

International 31% 23% 13% Namaste is likely to be an overhang on the international business despite strong penetration-led growth in the Middle East

Source: Company, Ambit Capital research.

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Dabur

Ambit Capital Pvt Ltd 94

Oral care (15% of domestic revenues) – drag from toothpowder’s shrinking category size and Babool’s mass market presence

Dabur derives around 25-30% of its oral care revenues from toothpowders, a category which is shrinking in size by around 3-5% in revenue terms annually, as consumers shift from toothpowders to toothpastes.

Half of the remaining oral care portfolio includes Babool toothpaste which has a mass market positioning and hence despite new variant launches it will at best report flat YoY growth. Over the past two years, Babool has suffered from its inability to pass on price increases. As a result, the company has taken initiatives which, even the management believes, are likely to stem the shrinkage in size of its Babool portfolio without any scope for increase in the size of this portfolio over time. These initiatives include: (a) introduction of value-added variants like ‘Babool Salt’; and (b) marginal price increases through grammage reductions. Low price has been one of the key drivers for Babool to expand its market share in the past. Also, a large proportion of Dabur’s oral care portfolio includes toothpowder, which given the shrinking category size, leads to underperformance of Dabur against Colgate in the overall oral care portfolio. We expect the gradual premiumisation of customers away from Dabur’s Babool towards Colgate, Pepsodent and Close-up.

As highlighted in the chart below, we expect Dabur’s recent underperformance in revenue growth vis-à-vis the market leader Colgate to continue going forward.

Exhibit 5: Dabur’s oral care revenue has increased slower than Colgate consistently over the past eight quarters

3%

6%

9%

12%

15%

18%

21%

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

FY13

FY14

E

FY15

E

Dabur Colgate

Source: Company, Ambit Capital research

Hair care (26% of domestic revenues) – drag from weak amla hair oil category growth and lack of a premium offering in premiumisation-led shampoos category

Dabur has a strong brand recall in the mass market in both the hair oil as well as the shampoo category (with Dabur Amla and Vatika Shampoo, respectively). However, with rising competitive intensity in both these categories, we expect Dabur to lose its market share to competitors.

Hair oils: Anecdotal industry data suggests that the amla category’s revenue CAGR of ~12% is lower than the overall hair oil category growth of around 15% due to higher growth in the light hair oil segment. This works against Dabur’s amla-oriented hair oils portfolio. Moreover, after the price cuts over FY10-12, Marico’s amla product offering, under the Shanti Amla brand, is now 40% cheaper than that of Dabur. Also, the company saw a moderation in hair oils revenue growth due to a price hike taken on its Vatika branded coconut oils portfolio. Consequently, as shown in the exhibits below, Dabur’s revenue growth in the hair oil segment has been under pressure over the past three quarters and we expect this moderation in growth rates to continue.

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Dabur

Ambit Capital Pvt Ltd 95

Shampoos: Vatika is Dabur’s only offering in the shampoo market and is

priced at a ~25% discount to premium shampoo brands like Pantene and Dove. However, as highlighted in the thematic section of this report, premiumisation is the biggest driver of growth in the shampoo category. Hence, within the overall shampoo category’s revenue growth of 18% over FY12-15, premium shampoos are likely to significantly outperform the mass market brands. Also, after a sudden rise in competitive intensity from premium brands (including a sachet product of HUL’s Dove in FY11 and FY12), Dabur’s shampoo segment revenues have reported negative growth rates for six consecutive quarters (see the exhibit below). Although Dabur had reported high revenue growth in the shampoo segment during FY13 (owing to a low base effect and receding competition from Dove in the sachet format), we expect the medium- to long-term growth of Dabur’s portfolio to lag significantly behind its premium branded competitors.

Exhibit 6: Hair oil segment’s revenue growth muted due to Parachute’s entry into the amla hair oil segment

19%

13%12%

18%

10%

27%

22%20%

8% 9%12%

7%

0%

5%

10%

15%

20%

25%

30%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

Source: Company, Ambit Capital research

Exhibit 7: Shampoo segment’s revenues declined due to aggression from MNCs in the sachet format

-30%-22% -25%

4%

17%23%

40%

30%29%

-17%-15% -19%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

Source: Company, Ambit Capital research

Skin care – lack of product width; susceptible to rising competitive intensity

Dabur’s skin care portfolio includes: (a) Uveda branded skin creams; (b) Fem branded bleach and hand washes; and (c) Gulabari branded skin creams.

Of these three products, we expect revenue growth for the Gulabari and Uveda brands to be in single digits going forward due to: (a) weak promotional spends for the Uveda brand; and (b) the Gulabari portfolio being positioned for the mass market, which is expanding at a materially slower pace than the premium market (we estimate the mass market growth to be at ~10% as against ~25% for the premium market). Although we expect the Fem portfolio to maintain its market leadership in bleaches (led by strong brand and regular innovation), we expect market share losses for Dabur’s overall skin care segment, given its lack of range of products and hence susceptibility to increase in competitive intensity.

Health supplements – strong competition from Heinz and Emami

Dabur’s health supplements portfolio includes Chyawanprash, Honey and Glucose-D. Chyawanprash forms around 50% of the health supplements category and has seen a market growth of around 10-12% YoY. Competition from Emami’s Sona Chandi Chywanprash in the chyawanprash category is likely to be a significant drag on overall revenue growth for the health supplements category. We expect the honey category, with its new positioning as a slimming aid, to help bring in new consumers on the ‘wellness’ platform and thereby sustain its current growth trajectory of around 15%. For Glucose-D, we expect no gains in market share given strong competition from the market leader Heinz’s Glucon-D (55%

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Dabur

Ambit Capital Pvt Ltd 96

market share vs Dabur’s 25%). However, we expect revenue growth of ~15% in this product for Dabur since the segment itself is increasing at 15-20% currently.

Digestives – high penetration and mass-market focus will constrain price increases to offset input cost inflation

Although we expect the OTC Pudin Hara to record revenue CAGR of 14% (impacted by reclassification), Dabur’s Hajmola portfolio is likely to be a significant overhang on the digestives portfolio growth due to: (a) high penetration of around 80%; and (b) mass market focus of the Hajmola product, which does not allow premiumisation or frequent price increases to offset cost inflation over time. Consequently, we expect the Hajmola digestive tablet to record revenue growth in the high single-digits going forward vis-à-vis Dabur’s overall digestives portfolio revenue growth of 11% over FY13-15.

Overall challenges due to limited scope of premiumisation

Exhibit 8: Dabur will struggle to premiumise its product offering

Category Ability to premiumise

Comment

Honey Low Difficult to introduce commercial value-added variants

Chyawanprash Medium Whilst the company can introduce premium variants, consumer acceptance to a higher price point remains a challenge

Digestives Low Difficult to introduce commercial value-added variants

OTC & Ethicals Low Difficult to introduce commercial value-added variants

Glucose Medium Flavoured variants can be introduced at a higher price point; however, at a discount to Heinz's Glucon-D, to avoid market share losses

Hair care Medium Whilst the segment offers high potential to premiumise, Dabur's ability is restricted due to its mass-oriented brand image (Vatika brand) and herbal offering

Home care Low Limited ability to premiumise, given its presence in utility products; premium offerings may lead to consumers shifting to MNC offerings at similar price points

Oral Care High Strong ability to premiumise, because the company is the strongest player in the herbal toothpaste category

Skin Care Medium Given the mass segment image that Dabur currently enjoys, it will struggle to premiumise consumers whilst encountering MNC competition

Foods (Juices) High Being a market leader in the segment, the opportunity to shift consumers to Real Activ is strong

Source: Company, Ambit Capital research

Almost 35% of Dabur’s domestic revenues are positioned at the lower end of the consumption spectrum. Also, unlike most of the mass-market products of its competitors (including, HUL, Colgate and Marico), Dabur’s portfolio offers limited potential to premiumise consumers in the relevant product categories. This characteristic of Dabur’s product portfolio creates the following challenges:

Limited gross margin benefit related to product mix change towards premium variants/brands over time.

Limited revenue growth vis-à-vis its peers since revenues from premium products in most categories are increasing faster than mass-market products.

Limited scope to defend its market share whenever competitive intensity from, say MNCs, rises in the future. Whilst its competitors can plough back gross margin benefits from their premium-positioned portfolio towards higher advertising spends, Dabur will not enjoy such a luxury given the limited likelihood of margin expansion on its existing portfolio.

High price elasticity of demand in mass-market products does not enable even strong brands like Babool to undertake price increases without sacrificing volume growth. Consequently, as shown in the exhibit below, Dabur has reported a gross margin decline of ~300bps over the past three years.

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Dabur

Ambit Capital Pvt Ltd 97

Drag from the international business Dabur derives around 30% of its consolidated revenues from its international subsidiaries. One-third of these international revenues are related to its acquired portfolio of Namaste branded hair care products.

The Namaste business was acquired in FY11 for US$100mn (or `4.5bn) with an aim to leverage on its strong US presence and to expand in Africa. Currently, two-thirds of Namaste’s overall revenues are derived from the US whilst the balance comes from Africa. The management expects to achieve 6-8% revenue CAGR in the US business and 15-20% revenue CAGR in the African business from the Namaste portfolio with plans to set up in-house manufacturing in Africa to better manage its supply chain and localise it to reduce the impact of import duties (which are quite severe for some African nations).

However, over the past three quarters, the Namaste portfolio has reported weak revenue growth due to the factors mentioned below. Whilst the management has guided for a recovery in the US business by 1QFY14, we expect the Namaste portfolio to continue to be a drag on the overall business in FY14 due to the following:

Rebranding: A recent legislation in the US requires the company to change the name of its key brand, Organic Root Stimulator (as the use of the word Organic was not permitted). The company has rebranded the product as ‘ORS’ across the United States. As a result, Dabur’s Namaste portfolio saw a 10% YoY decline in revenues in FY13 which, we expect, was a combination of a 20-30% YoY decline in the US and a broadly flat YoY growth in Africa. Whilst the drag from this rebranding exercise will be felt in the base quarter from 1QFY14 onwards, we do not expect the new brand to gather significant momentum before at least another 12 months.

Management reshuffles: As confirmed by the management during the quarterly conference calls, the Namaste senior management team is undergoing significant reshuffles, with Dabur moving senior personnel from India and Dubai to Chicago to manage its US operations. Changes such as these do not indicate a likelihood of a significant recovery in the business in a short span of time.

Execution issues in Africa: According to the management’s comments during the recent quarterly conference calls, Namaste’s African business is undergoing a restructuring of its distribution network.

International margins will be dragged downwards by Namaste: Until the Namaste business returns to the normal growth rates, it will have to be supported by strong marketing-related investments given the need for product rebranding in the US.

Macro-economic scenario in Africa: Based on our discussions with economic experts in Africa, we believe that the fastest-growing African countries like Kenya have seen a revenue CAGR of 12-14% in hair care product category over the past five years. Moreover, whilst there exists a significant middle-class population in some of these African countries, we see limited potential for a hair care brand to derive sustainable high growth rates in the continent because: (a) the hair care market is highly fragmented; (b) the concept of consumerism is yet to pick up materially outside of South Africa; and (c) poor infrastructure around rail, road and ports increases the complexity of distribution for a pan-African player.

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Dabur

Ambit Capital Pvt Ltd 98

Dabur’s Middle Eastern business which contributes to one-third of the overall international business has been the only jewel in the crown of the company’s international portfolio. This business has been developed organically for Dabur over the past two decades. Dabur’s portfolio of products in the Middle East predominantly includes hair oils, hair creams and shampoos with a focus on the herbal proposition.

Consequently, whilst we forecast 16.5% revenue CAGR for Dabur’s Middle Eastern business over FY13-15, we forecast 6.9% revenue CAGR in the US business, 12.0% for the Africa business and 14.2% for the rest of Dabur’s international business over the same period.

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Dabur

Ambit Capital Pvt Ltd 99

Key assumptions Exhibit 9: Key assumptions and estimates for revenues (` mn)

Share of

revenues FY13E FY14E FY15E Comments

Domestic business

Health Supplements Growth 12.2% 16.2% 12.9% 12.4%

Market Growth 15.6% 12.0% 12.0%

Growth led by market share change 0.5% 0.8% 0.4%

Whilst glucose will likely remain the fastest growing segment, we expect weakness from lower penetration and higher competitive intensity to affect the Chyawanprash business

Digestives Growth 4.1% 3.9% 10.6% 10.6%

Market Growth 6.0% 10.0% 10.0%

Growth led by market share change -2.0% 0.5% 0.5%

Difficulty in undertaking prices increases along with high category penetration is likely to lead to slow growth for Hajmola, with the OTC Pudin Hara likely to grow around the health proposition

OTC & Ethicals Growth 6.9% 16.1% 15.0% 15.0%

Market Growth 15.0% 15.0% 15.0%

Growth led by market share change 1.1% 0.0% 0.0%

Expect stronger growth in the OTC category owing to market-led growth in Dabur ‘Lal Tail’ (baby oils segment)

Hair care Growth 16.7% 11.7% 14.0% 13.0%

Market Growth 15.0% 16.0% 16.0%

Growth led by market share change -2.8% -1.7% -2.6%

Expect market share losses in hair care due to: (1) high competitive intensity, (2) mass positioning, and (3) slower growth in the amla segment

Home care Growth 3.7% 25.3% 18.0% 18.0%

Market Growth 20.0% 20.0% 20.0%

Growth led by market share change 3.3% -2.0% -2.0%

Expect market-led growth in home care, with air fresheners and surface cleaners driving growth for the category

Oral Care Growth 9.3% 10.3% 11.3% 11.2%

Market Growth 13.0% 14.0% 14.0%

Growth led by market share change -2.4% -2.4% -2.4%

Expect weak product portfolio to lead to market share losses and large contribution of toothpowder to lead to slower than category growth

Skin Care Growth 3.5% 15.4% 14.0% 14.0%

Market Growth 12.0% 15.0% 15.0%

Growth led by market share change 3.4% -1.0% -1.0%

Expect market share losses due to: (1) weak product portfolio due to its mass focus (2) low marketing spends and (3) high competitive intensity from the MNCs

Foods Growth 10.8% 24.7% 20.0% 20.0%

Market Growth 22.3% 20.0% 20.0%

Growth led by market share change 1.9% 0.0% 0.0%

Expect market-driven growth and share to be maintained despite new entrants in the space driven by the strong brand and frequent innovation

Other Domestic Growth 3.2% 34.1% 12.0% 12.0% Expect growth in line with the market

Total Domestic growth 15.8% 14.4% 14.1%

International business

Africa - Growth 6.4% 15.6% 12.0% 12.0%

Market growth 10.6% 8.0% 8.0%

Growth led by market share change 5.0% 4.0% 4.0%

Whilst we assume growth in line with the hair care market in Africa, we highlight that growth will remain difficult despite entering new geographies as execution has remained a challenge for Dabur

Middle East - Growth 9.6% 27% 17% 16%

Market growth 9.0% 9.0% 9.0%

Growth led by market share change 18.0% 8.0% 7.0%

The Middle East is likely to remain a fast-growing market for Dabur, given the under-penetration of the portfolio and the potential demand for ayurvedic oral and hair care products in view of the regional tastes and preferences

Asia - Growth 5.2% 30.0% 15.0% 15.0%

Market growth 10.0% 10.0% 10.0%

Growth led by market share change 20.0% 5.0% 5.0%

Accounting for around 16% of the international business, the Asian market is likely to see growth led mainly by expanding the distribution of its portfolio

USA - Growth 6.5% -0.6% 6.4% 7.4%

Market growth 4.4% 4.4% 4.4%

Growth led by market share change -5.0% 2.0% 3.0%

Expect mid-single-digit growth in the US business as the rebranding of the Namaste portfolio is likely to have an adverse impact of revenues and is likely to be associated with large rebranding and restructuring expenses

Others - International 1.8% 16.0% 12.0% 12.0% Assume growth broadly in line with Dabur's international revenues

Total International growth 17.1% 12.9% 12.9%

Total growth 16.2% 14.0% 13.8%

Source: Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 100

Exhibit 10: Key assumptions and estimates (` mn)

FY12 FY13E FY14E FY15E Comments

Profit and loss

Domestic revenues 37,428 43,331 49,568 56,575

Growth (%) 14.7% 15.8% 14.4% 14.1%

Expect domestic revenue growth to be led by fruit juices and home care, whilst oral care and skin care will be laggards

International revenues 15,461 18,110 20,451 23,096

Growth (%) 87.7% 17.1% 12.9% 12.9%

Expect strong growth in Middle East and Hobi business, whilst rebranding of products in the US business may lead to muted growth

Total revenues (ex-other income) 52,889 61,442 70,019 79,671

Growth (%) 29.4% 16.2% 14.0% 13.8%

Gross Profit 26,202 31,568 36,026 41,066

Gross margin (%) 49.4% 51.1% 51.2% 51.3%

Expect only nominal increase in gross margins as the rate of premiumisation will be much slower than competitors given its mass focused portfolio

Employee cost (% of sale) 7.3% 7.6% 7.5% 7.5% Expect operational efficiencies to lead to minor benefits in employee costs

Advertising (% of sale) 12.4% 13.6% 13.8% 13.9% Increasing competitive intensity to lead to higher advertisement spends

Freight & forwarding (% of sale) 2.0% NA 2.0% 2.0% Expect freight expenses to remain stable

Other expenses (% of sale) 10.9% NA 11.1% 11.1% Expect minor operational efficiencies in other expenses

EBITDA 8,902 10,298 11,827 13,455

EBITDA Margin 16.8% 16.7% 16.8% 16.8% Above changes to lead to improvement in EBITDA margins in FY14 and FY15

Tax rate 18.5% 19.2% 20.0% 21.0% Tax rates to increase only marginally until FY16, after which tax benefits will start to fade

Net Profit margin 12.2% 12.4% 12.5% 12.8% Lower interest costs and slower increase in depreciation to help boost net profit margin

Balance Sheet

Capex 2,500 1,189 1,800 1,800

Capital Work in Progress 226 226 226 226 No material capex requirements for FY14 and FY15

Working Capital days 10 30 29 27 Marginal improvement in working capital cycle due to inventory and creditor management

Debtor days 32 29 30 30 Minor increase in debtors led by increasing share of modern trade

Current Liabilities days 67 70 70 70 Expect current liabilities days to remain stable

Inventory days 57 50 50 50 Better inventory management to lead to decrease in inventory days

Net debt/(cash) to equity 0.0 0.0 (0.1) (0.3) Expect Dabur to turn into a net cash company in FY13

Cash flows (` mn)

Operating cash flows 7,075 5,442 9,440 11,084

Free cash flows 4,673 4,253 7,640 9,284 Expect free cash flows to increase strongly over FY12-15E

Source: Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 101

Valuation

DCF valuation

Given the cash-generative nature of the business, we use a DCF-based model to arrive at a fair value for Dabur. The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed zero debt on Dabur’s balance sheet in the future given its strong cash generation. Hence, the company has enough surplus cash available on its balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for Dabur. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years, with sales CAGR of 14% and EPS CAGR of 16%. Stage 2 includes a decline in sales growth over six years from 14% in FY18 to 7% in FY26 i.e. sales CAGR of 10% and a free cash flow CAGR of 10% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `136 per share (14% downside), implying an FY14 P/E multiple of 26.8x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 12: Cash flow profiles for Dabur (` mn)

-

2,000

4,000

6,000

8,000

10,000

12,000

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

8,000

10,000

CFO Free Cash Flow

Source: Ambit Capital research

Exhibit 13: Return profiles for Dabur (%)

0%

10%

20%

30%

40%

50%

60%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E0%

10%

20%

30%

40%

50%

60%

70%

80%

ROE (LHS) EBITDA MarginEPS Growth YoY Growth in sales

Source: Ambit Capital research

Relative valuation Dabur currently trades at 31x FY14 P/E multiple, towards the bottom end of the current range of the FMCG sector on this metric. We believe this discount is justified given:

Portfolio positioning vs peers: Since Dabur’s portfolio is skewed towards mass brands, the company loses out to its peers on premiumisation across segments such as oral care and hair care.

International portfolio’s drag: Given the underperformance of the Namaste portfolio, Dabur deserves to trade at a discount to its peers, given the relatively higher probability of unexpected events dragging the overall earnings growth for the company.

Exhibit 11: WACC calculation for DCF on Dabur Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.55

Equity risk premium (%) 7

Cost of equity (%) 12.4

Cost of debt (%) 12.0

Debt/Equity ratio (%) 0

Tax rate (%) 30

WACC (%) 12.4

Source: Company, Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 102

On one-year forward P/E multiples, Dabur currently trades at a 16% premium to its three-year average of 26.6x. However, given the moderation in its revenue CAGR and EPS CAGR (FY13-15 EPS CAGR of 14% vs 19% over FY08-13), we believe the stock deserves to trade at a discount to its historical average trading multiple.

Exhibit 14: 1-year forward P/E bands for Dabur

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

14x

30x

26x

22x

18x

Source: Ambit Capital research

Exhibit 15: 1-year forward EV/EBITDA bands for Dabur

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

11x

14x

17x

20x

23x

Source: Ambit Capital research

Sensitivity analysis

Exhibit 16: Sensitivity analysis

Bull case Base case Bear case

Revenue CAGR over FY13-23

13% driven by strong growth in both domestic and international business (assume recovery in Namaste). Terminal growth rate = 6%

13% with similar growth profiles in both the domestic business and the international business. Terminal growth rate = 5%

12% driven by only 9% growth in the international business as the Namaste business does not pick up pace. Terminal growth rate = 4%

Operating margins

Increase from 16.6% in FY13 to 17.3% in FY17 driven by premiumisation-led gross margin expansion and lower advertising spends and remain stable thereafter

Increase from 16.7% in FY13 to 17% in FY18 mainly through gross margin benefits. Advertisement spends grow 40bps and remain stable at 14%

Decline marginally to 16.5% in FY17 led by higher advertising expenditure due to high competitive intensity

Fair value (` mn) 166 136 100

Upside/Downside 5% -14% -37%

Source: Ambit Capital research

Risks to our SELL stance Strong market share gains in fruit juice segment: Dabur’s fruit juice

segment has seen strong traction by consistently maintaining its market share (over Pepsi’s Tropicana) to remain the largest fruit juice player in the category. Continuing market share gains (we factor in unchanged market share going forward) along with easing raw material pressure could lead to improvement in revenues and margins.

Vatika relaunch and growth in hair oil portfolio: Increasing competition from Parachute has led to market share losses in the hair oil portfolio for Dabur. Dabur’s ability to pull back any market share losses in the category as well as success in the shampoo space (with Vatika shampoo being relaunched in a premium avatar) can lead to potential upsides to our valuation.

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Dabur

Ambit Capital Pvt Ltd 103

Catalysts Inability to recover in the Namaste business: Whilst the management has guided that the Namaste business in the US will see a recovery in FY14, we believe Dabur will face an uphill task to create the brand recall and record strong revenue growth. Whilst we expect a full recovery to take at least four quarters, a decline in revenues is likely to be a negative trigger for the stock.

Decline in volume growth in the domestic business: Whilst the management has guided for volume growth to sustain between 8% and 12%, the inability to meet the guidance or only the bottom of the guidance will be a key negative catalyst. We expect volume growth to sustain around 8% levels given the heightened competitive intensity in hair care, oral care and skin care.

Ambit vs Consensus Exhibit 17: Ambit vs consensus

Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn)

70,346 71,459 -2%

Expect market share losses in haircare, oral care and skin care to lead to revenues growth below consensus

EBITDA (` mn)

11,827 12,298 -4%

Higher spends on A&P due to high competitive intensity will likely lead to lower than consensus EBITDA margins

EPS (`/share) 5.1 5.3 -5% Above expectations to lead to EPS 5% below consensus

FY15E

Net Sales (` mn)

80,031 82,546 -3%

Expect market share losses in haircare, oral care and skin care to lead to revenues growth below consensus

EBITDA (` mn)

13,455 14,378 -6%

Higher spends on A&P due to high competitive intensity will likely lead to lower than consensus EBITDA margins

EPS (`/share) 5.9 6.3 -7% Above expectations to lead to EPS 7% below consensus

Source: Bloomberg, Ambit Capital research

Exhibit 18: Explanation for our forensic accounting scores on the first page

Segment Score Comments

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 Dabur’s earnings trajectory has been slightly volatile and has been strongly influenced by the level of competitive intensity during the quarter and input cost pressures.

Earnings momentum GREEN Over the past six months, easing raw material prices have led to an upgrade in consensus forecasts for Dabur by 2% for FY14 and FY15.

Source: Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 104

Balance sheet (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Shareholders' equity 1,741 1,742 1,743 1,743 1,743

Reserves & surpluses 12,170 15,427 19,501 24,676 30,436

Total networth 13,911 17,169 21,244 26,419 32,179

Minority Interest 41 33 121 121 121

Debt 10,208 10,743 11,514 8,514 6,514

Deferred tax liability 189 274 362 362 362

Total liabilities 24,349 28,219 33,240 35,415 39,175

Gross block 19,337 21,837 23,026 24,826 26,626

Net block 14,986 16,454 16,519 17,159 17,760

CWIP 325 226 226 226 226

Investments 5,207 5,544 6,319 6,319 6,319

Cash & equivalents 2,805 4,484 5,128 6,122 8,950

Debtors 3,555 4,617 4,841 5,782 6,578

Inventory 7,085 8,239 8,439 9,636 10,963

Loans & advances 4,666 5,869 2,173 2,505 2,850

Other current assets 601 789 3,720 4,240 4,824

Total current assets 18,712 23,999 24,301 28,286 34,165

Current liabilities 7,696 9,790 11,764 13,491 15,348

Provisions 7,184 8,214 2,361 3,084 3,947

Total current liabilities 14,880 18,004 14,125 16,575 19,295

Net current assets 3,832 5,995 10,176 11,711 14,870

Total assets 24,349 28,219 33,240 35,415 39,175 Source: Company, Ambit Capital research

Income statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income 41,045 53,054 61,761 70,346 80,031

% growth 20.2% 29.3% 16.4% 13.9% 13.8%

Operating expenditure 33,032 44,153 51,463 58,519 66,576

EBITDA 8,013 8,902 10,298 11,827 13,455

% growth 22.4% 11.1% 15.7% 14.8% 13.8%

Depreciation 952 1,032 1,124 1,160 1,199

EBIT 7,061 7,869 9,174 10,667 12,256

Interest expenditure 303 538 589 601 451

Non-operating income 321 574 945 960 1,126

Adjusted PBT 7,079 7,905 9,530 11,027 12,932

Tax 1,390 1,464 1,826 2,205 2,716

Adjusted PAT/ Net profit 5,689 6,441 7,704 8,821 10,216

% growth 13.7% 13.2% 19.6% 14.5% 15.8%

Extraordinaries - - (46) - -

Reported PAT / Net profit 5,689 6,441 7,750 8,821 10,216

Minority Interest (3) 8 (24) - -

Share of associates - - - - -

Adjusted Consolidated net profit 5,686 6,449 7,726 8,821 10,216

Reported Consolidated net profit 5,686 6,449 7,726 8,821 10,216 Source: Company, Ambit Capital research

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Dabur

Ambit Capital Pvt Ltd 105

Cash flow statement (` mn)

Year to March FY11 FY12 FY13E FY14E FY15E

EBIT 7,382 8,443 10,119 11,627 13,383

Depreciation 952 1,032 1,124 1,160 1,199

Others 110 85 152 (0) (0)

Tax (1,390) (1,464) (1,826) (2,205) (2,716)

(Incr) / decr in net working capital (1,095) (484) (3,537) (541) (331)

Cash flow from operations 5,960 7,613 6,031 10,041 11,535

Capex (9,496) (2,402) (1,189) (1,800) (1,800)

(Incr) / decrin investments (2,566) (338) (775) - -

Cash flow from investments (12,061) (2,739) (1,964) (1,800) (1,800)

Net borrowings 8,415 535 770 (3,000) (2,000)

Interest paid (303) (538) (589) (601) (451)

Dividend paid (2,241) (2,632) (3,038) (3,646) (4,456)

Others 1,113 (559) (567) - -

Cash flow from financing 6,983 (3,194) (3,424) (7,247) (6,907)

Net change in cash 881 1,680 644 994 2,828

Closing cash balance 2,805 4,484 5,128 6,122 8,950

Free cash flow (3,536) 5,211 4,842 8,241 9,735 Source: Company, Ambit Capital research

Ratio analysis

Year to March FY11 FY12 FY13 FY14E FY15E

Gross margin (%) 52.8% 49.4% 41.4% 51.2% 51.3%

EBITDA margin (%) 19.5% 16.8% 16.7% 16.8% 16.8%

EBIT margin (%) 18.0% 15.9% 16.4% 16.5% 16.7%

Net profit margin (%) 13.9% 12.2% 12.4% 12.5% 12.8%

Dividend payout ratio (%) 39.4% 40.8% 39.6% 41.3% 43.6%

Net debt: equity (x) 0.7 0.6 0.5 0.3 0.2

Working capital turnover (x) 40.0 35.1 12.2 12.6 13.5

Gross block turnover (x) 2.1 2.4 2.7 2.8 3.0

RoCE (%) 33.3% 26.2% 26.5% 27.1% 28.3%

RoE (%) 48.9% 41.5% 40.0% 37.0% 34.9%Source: Company, Ambit Capital research

Valuation parameters

Year to March FY11 FY12 FY13 FY14E FY15E

EPS (`) 3.3 3.7 4.4 5.1 5.9

Diluted EPS (`) 3.3 3.7 4.4 5.1 5.9

Book value per share (`) 8.0 9.9 12.2 15.2 18.5

Dividend per share (`) 1.1 1.3 1.5 1.8 2.2

P/E (x) 48.4 42.7 35.9 31.2 27.0

P/BV (x) 19.8 16.0 13.0 10.4 8.6

EV/EBITDA (x) 35.2 31.6 27.4 23.5 20.3

Price/Sales (x) 6.7 5.2 4.5 3.9 3.4

Source: Company, Ambit Capital research

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Consumer Goods June 04, 2013

GSK Consumer Bloomberg: SKB IN EQUITY Reuters: GLSM.NS

Accounting: GREEN Predictability: GREEN Earnings momentum: AMBER

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to December CY10 CY11 CY12 CY13E CY14E Operating income (` mn) 23,061 26,855 30,794 35,577 40,992 EBITDA(` mn) 3,741 4,249 4,653 5,584 6,556 EBITDA Margin (%) 16.2% 15.8% 15.1% 15.7% 16.0% Adjusted PAT(` mn) 2,999 3,552 4,368 5,099 6,099 Adjusted EPS (`) 71.2 86.0 103.8 121.2 145.0 RoE (%) 32.1% 34.4% 34.9% 34.7% 35.9% P/E (x) 77.4 64.1 53.1 45.5 38.0 Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `5,515

Target Price (Mar’14): `3,945

Previous TP: NA

Downside (%) 29%

EPS (CY13E): `121.2 Change from previous (%) NA

Variance from consensus (%) 1%

Stock Information

Mkt cap: `232bn/US$4,112mn

52-wk H/L: `6,348/2,179

3M ADV: `175mn/US$3.1mn

Beta: 0.5x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute 36 38 100 45

Rel. to Sensex 36 34 77 44

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Oct-12 Jan-13 May-13

2000

3000

4000

5000

6000

Sensex GSK Consumer

1-year forward P/E band chart

40010001600

22002800

340040004600

52005800

Jan-

08M

ay-0

8Se

p-08

Feb-

09Ju

n-09

Oct

-09

Mar

-10

Jul-

10N

ov-1

0M

ar-1

1A

ug-1

1D

ec-1

1A

pr-1

2A

ug-1

2Ja

n-13

May

-13

17x

45x

38x

31x

24x

Source: Bloomberg, Ambit Capital research

Growth beyond Horlicks? GSK Consumer currently benefits from the strength of its Horlicks franchise in south and east India and from its capital-light auxiliary income stream. However, its milk food drinks (MFD) portfolio currently faces headwinds from growth moderation in the south and east market, given the high penetration levels and market share loss in the north and west (due to increased competitive intensity from Complan). Despite 23% CAGR in auxiliary income over CY12-15E, EPS CAGR over the same period is likely to be only 18%. We initiate coverage with a SELL stance and a target price of `3,945 (29% downside).

Competitive position: MODERATE Change to this position: STABLE

We expect EBITDA margin expansion of ~100bps over CY12-15 led by higher in-house manufacturing (after the recent capacity expansion), product mix change and the recent pricing action. However, we expect PAT CAGR to moderate from 22% over CY07-12 to 18% over CY12-15 due to:

Moderation in volume growth: GSK’s MFD market share in south and east (S&E) India is around 74% vs around 30% in north and west (N&W) India. Over the past five years, it has lost market share to Complan and we expect this trend to continue due to: (a) high penetration levels of MFDs in S&E (50% currently) leading to moderation in category growth rates vs historical rates; (b) weak presence of Horlicks in the premium MFD segment where competitive intensity is rising (dominated by Abbott’s Pediasure); (c) strong competition from Complan in N&W; and (d) the mass-market brand recall of Horlicks constraining a successful super-premium variant launch.

Risks around capital allocation: Over `10bn of surplus cash accumulated over the past five years will be used to fund portfolio diversification. Given the unsuccessful attempts at diversifying beyond the MFD segment in the past, this surplus capital would either remain unutilised over the next 2-3 years or be deployed towards M&A, which, given the current high valuations in the overall FMCG sector, is not likely to be significantly value accretive.

Potential of the auxiliary portfolio: We assume sales CAGR of 40% for Sensodyne and 22% for Eno over CY12-15 to drive 23% CAGR in auxiliary income for GSK Consumer over this period (vs 28% over CY09-12). Whilst this remains the biggest attraction for GSK’s future growth potential, even a highly successful new launch is not likely to add more than 50bps to its revenue CAGR over the next three years.

Valuation: The stock’s CY13E P/E multiple of 45.5x is at a 22% premium to its peers. Given the factors around moderating earnings growth, we find this premium to be unjustified. Our DCF-based valuation generates a TP of `3,945/share (29% downside), implying FY14 P/E multiple of 32.5x.

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GSK Consumer

Ambit Capital Pvt Ltd 106

Company Financial Snapshot

Profit and Loss (` mn) CY12 CY13E CY14E Net sales 30,794 35,577 40,992 Optg. Exp(Adj for OI.) 26,141 29,993 34,435 EBITDA 4,653 5,584 6,556 Depreciation 361 493 544 Interest Expense 24 - - PBT 6,487 7,714 9,131 Tax 2,120 2,615 3,031 Adj. PAT 4,367 5,099 6,099 Profit and Loss Ratios EBIDTA Margin % 15.1% 15.7% 16.0% Adj Net Margin % 14.2% 14.3% 14.9% P/E (X) 53.1 45.5 38.0 EV/EBIDTA (X) 46.7 38.4 32.3 Dividend Yield (%) 0.8% 1.1% 1.4%

Company Background

GlaxoSmithKline Consumer Healthcare (GSK Consumer) is one of the largest players in the health food drinks industry in India. Its flagship brand, Horlicks is more than 100 years old in India.

The company is an Indian associate of GlaxoSmithKline Plc, UK, and it has more than 2,700 employees in India and direct coverage of 0.7mn retail outlets.

The company also manufactures Boost, Maltova, Viva, biscuits, noodles (brand Foodles) and promotes and distributes OTC products such as Eno, Crocin and Iodex.

Balance Sheet (` mn) CY12 CY13E CY14E Total Assets 24,928 28,893 33,407 Net Fixed Assets 3,911 4,146 4,402 Current Assets 21,018 24,748 29,005 Other Assets - - - Total Liabilities 24,928 28,893 33,407 Networth 13,610 15,766 18,188 Debt - - - Current Liabilities 11,935 13,743 15,835 Deferred Tax (616) (616) (616) Balance Sheet Ratios ROE % 34.9% 34.7% 35.9% ROCE % 36.5% 36.2% 37.3% Net Debt/Equity (1.1) (1.1) (1.1) Equity/Total Assets 1.0 1.0 1.0 P/BV (X) 17.0 14.7 12.8

Cash Flow (` mn) CY12 CY13E CY14E PBT 6,487 7,714 9,131 Depreciation 361 493 544 Tax (2,120) (2,615) (3,031) Change in Wkg Cap 2,088 776 964 Others (217) - - CF from Operations 6,599 6,367 7,608 Capex (554) (2,200) (800) Investments - - CF from Investing (554) (2,200) (800) Change in Equity - - - Debt - - - Dividends (2,199) (2,942) (3,678) Others 0 - - CF from Financing (2,199) (2,942) (3,678) Change in Cash 3,846 2,697 3,130

Recent moderation in volume growth for GSK Consumer

Indexed revenue growth by the incumbents over CY07-11

0%

2%4%

6%8%

10%12%

14%16%

1QC

Y11

2QC

Y11

3QC

Y11

4QC

Y11

1QC

Y12

2QC

Y12

3QC

Y12

4QC

Y12

1QC

Y13

Volume Growth Price Increase

100

120

140

160

180

200

220

240

CY07 CY08 CY09 CY10 CY11GSK Consumer Bournvita (Cadbury)Complan (Heinz)

Source: Company, Ministry of Company Affairs, Ambit Capital research

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GSK Consumer

Ambit Capital Pvt Ltd 107

Background Exhibit 1: GSK Consumer’s portfolio mix

Category Key brands Key competitors Market

share rank % of turnover

(CY12) CY09-12

CAGR Milk Food Drinks

Horlicks, Boost, Viva, Maltova

Complan, Bournvita 1

85% 17%

Biscuits Horlicks, Nutribic Britannia, Parle, ITC Low 7% 30%

Exports (MFD) Horlicks, Boost NA NA 8%

Category Key brands Key competitors Market

share rank % of PBT

(CY12) CY09-12

CAGR Auxiliary income

Sensodyne, Iodex, Eno, Crocin

Colgate, Vicks, Digene

15% 28%

Source: Ambit Capital research

As highlighted in the table above, GSK Consumer’s presence in India relates predominantly to Milk Food Drinks (MFD). The company’s key brands are Horlicks (in the ’white‘ category) and Boost (in the ’brown‘ category). Thanks to these brands, the firm controls ~60% of the MFD category. Over the past two decades, the company has diversified into the biscuits and noodles categories with a minority share in both. The company also derives auxiliary income, equivalent to ~15% of PBT, through a distribution alliance with GSK Asia (for Sensodyne, Crocin and Eno) and GSK Pharma (for Iodex). Under this alliance, GSK distributes the products and in turn receives a revenue-based commission of 16.7% from GSK Asia and 10.5% from GSK Pharma for the distribution of these products. There is no material incremental capital employed by GSK Consumer for this revenue stream. Exports to the Middle East, Nepal, Bangladesh and Sri Lanka account for around 8% of revenues.

As shown in the chart below, north and west India contribute to only ~10% of GSK Consumer’s overall revenues, with the south and the east contributing to the lion’s share. Whilst the company controls a market share of 75-80% in both south as well as east India, it controls a market share of ~25-30% in the north and west. The bulk of the disparity between N/W and S/E markets relates to Horlicks capitalising on the lack of milk availability in the south and east (which results in strong demand for MFDs as milk substitutes).

Exhibit 2: Geographic revenue split (CY11)

Exports, 8%West, 4%

South, 46%

East, 37%

North, 6%

Source: Company, Ambit Capital research

Exhibit 3: GSK market share in milk food drinks (CY11)

Others, 1%Abbot, 3%Cadbury,

13%

Heinz, 20% GSK

Consumer, 63%

Source: Company, Ambit Capital research

The company has three manufacturing facilities in Nabha (Punjab), Rajamundry (Andhra Pradesh) and Sonepat (Haryana). It is currently expanding capacity in its current facilities for the MFD business with a capex of around `3.5bn (equal to around 23% its CY12 year-ending capital employed). This capacity expansion will fully come on stream by June 2013.

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GSK Consumer

Ambit Capital Pvt Ltd 108

Direct distribution reach stands at around 0.75mn outlets for the MFD business and around 0.4mn outlets for the biscuits business (around 1.2mn outlets overall for the MFD business). The company is looking at expanding its rural penetration (currently accounting for around 26% of sales) by around 10,000 villages in CY12 (from 50,000 villages currently), leading to around `750mn of incremental revenue (~2% of overall revenues).

SWOT analysis

Exhibit 4: SWOT analysis for GSK Consumer

Strengths Weaknesses

Strong market-leading health-focused brand (Horlicks) with around 63% market share.

Strong balance sheet with more than `11bn of cash balance that the company can use for new product launches as well as inorganic growth.

Has successfully taken on new entrants like HUL, Nestle and Dabur earlier, all of which eventually exited the milk food drinks market over 2008-11.

Strict control over inventory (inventory days of 50 in CY11) and creditors (other current liabilities days of 91 in CY11) helps GSK Consumer rank favourably in its peer group for working capital cycles (working capital cycle of -47 days in CY11).

More than 93% of its revenues are dependent on only milk food drinks whilst biscuits and oats account for less than 6% of revenues.

Has a relatively weak premium portfolio (Its premium variant Horlicks Gold is a relatively new product and does not have a product in the super-premium category) and is likely to lose share to Heinz in the fast-growing premium category.

Have seen multiple product failures in the past whilst trying to enter new categories like toothpastes, nutrition bars, energy drinks, etc.

Opportunities Threats

Health-focused brand that can be extended into other health-based categories. Current brand extensions include biscuits and oats.

Has a presence in an under-penetrated category (MFD category penetration stands at 22% for urban and 11% for rural) where the potential for growth remains significant.

Support from the parent’s global portfolio for new product launches (mainly OTC products), both in terms of distribution arrangements and new product development.

Increasing competitive intensity can force the company to increase advertisement spends (which already stand at a high 16.3% of sales in CY11) especially as it tries to build its presence in the north and west where it has been traditionally weak.

The company can be adversely affected if the slowdown in packaged food growth seen during CY12 is sustained.

Source: Industry, Company, Ambit Capital research

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GSK Consumer

Ambit Capital Pvt Ltd 109

Volume growth moderation likely Whilst GSK Consumer has reported volume CAGR of around 10% over CY10-12, the volume growth has been moderating significantly in recent quarters, as shown in the chart below.

Exhibit 5: Recent volume growth trends for GSK Consumer (%)

0%2%4%6%8%

10%12%14%16%

1QC

Y11

2QC

Y11

3QC

Y11

4QC

Y11

1QC

Y12

2QC

Y12

3QC

Y12

4QC

Y12

1QC

Y13

Volume Growth Price Increase

Source: Company, Ambit Capital research

At the same time, Heinz India (~62% of revenue contribution from milk food drinks under the brand Complan) has reported revenue CAGR of 27% over FY06-11 with EBITDA CAGR of 30% over FY06-11 (see the table below). Glucon-D, medicated powders (Nycil) and sauces form 26%, 10% and 1% of revenues for Heinz respectively, three categories which are likely to have recorded less than 25% CAGR over this period. Therefore, we expect Heinz India’s revenue growth to have been led predominantly by ~30% CAGR in revenues from Complan over the past five years, thereby suggesting substantial market share gains by Complan from Horlicks in the recent past.

Exhibit 1: Heinz India - financial summary (` mn)

Heinz FY06 FY07 FY08 FY09 FY10 FY11

Net Sales 3,650 4,962 6,049 7,207 9,332 11,973

YoY growth in sales 36% 22% 19% 29% 28% EBITDA Margin 18.9% 16.6% 16.4% 17.7% 18.6% 21.0%

PAT Margin 9.5% 8.9% 9.5% 10.2% 11.3% 16.3%

YoY growth in PAT 27% 30% 28% 44% 84%

Source: Ambit Capital research

Complan’s market share gains against both Horlicks as well as Bournvita are also visible from the chart shown below.

Exhibit 6: Indexed revenue growth by the incumbents over CY07-11

100

120

140

160

180

200

220

240

CY07 CY08 CY09 CY10 CY11

GSK Consumer Bournvita (Cadbury) Complan (Heinz)

Source: Company, Ambit Capital research. Note: Complan growth pertains to FY07-11.

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GSK Consumer

Ambit Capital Pvt Ltd 110

Whilst penetration of MFDs in India currently stands at around 45-50% in south and east India (S&E), it is as low as 10-12% in north and west India (N&W). GSK’s management claims that N&W presents a bigger opportunity for Horlicks as compared to S&E through a focus on distribution expansion in N&W regions and in rural India. However, as shown in the chart below, GSK’s share of revenues from S&E regions has not reduced in recent quarters, which implies that N&W regions for GSK Consumer have NOT grown faster than S&E regions in recent quarters.

Exhibit 7: Quarterly trend of geographical revenue split

6% 6% 6% 6% 6%

35%38% 36% 38% 36%

47% 45% 45% 45% 44%

4% 4% 4% 5% 5%9%

6%9%

5%8%

0%

10%

20%

30%

40%

50%

1QCY11 3QCY11 1QCY12 3QCY12 1QCY13North East South West Exports

Source: Ambit Capital research

We expect a moderation in volume growth to 8% over CY12-15 and revenue CAGR of 15% over CY12-15 due to the following reasons: (a) saturation of market share in S&E India, (b) moderation of category growth rate in S&E India given high penetration levels, and (c) market share loss to Heinz’s Complan brand especially in N&W regions. Each of these factors is elaborated in subsequent pages.

Penetration saturation in S&E and rising competition in N&W

Based on companies’ reported data and anecdotal data, we believe that whilst GSK Consumer’s MFD market share in south and east (S&E) is around 74%, its market share in north and west (N&W) is around 30% (see the table below). Moreover, we reckon that both Complan as well as Bournvita control higher market shares than GSK Consumer in the N&W regions.

Exhibit 8: Region-wise market shares in the MFD space

Market Share in Zone (%)

Pan-India

GSK brands market share 63%

Complan market share 20%

Bournvita market share 13%

South & East (75% of Indian MFD)

GSK brands market share 74%

Complan market share 15%

Bournvita market share 7%

North & West (25% of Indian MFD)

GSK brands market share 30%

Complan market share 35%

Bournvita market share 30%

Source: Company, Ambit Capital research

We believe that GSK Consumer’s market share loss in the MFD space has been driven by the following factors (which the company is not likely to overcome in the near term):

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GSK Consumer

Ambit Capital Pvt Ltd 111

Weak positioning in the premium segment: As shown in the table below,

Horlicks’ current portfolio is skewed towards the bottom-end of the MFD market’s price range. Therefore, Horlicks is unfavourably placed to capitalise on the faster growth in the premium segment.

Exhibit 9: Horlicks is positioned at the mass-end whilst Pediasure is a super-premium brand

Brand Manufacturer Price* (`) Weight (gms) Price/100gms (`)

Horlicks – Chocolate GSK Consumer 170 500 34

Bournvita – 5 Star Magic Cadbury 171 500 34

Horlicks – base GSK Consumer 174 500 35

Complan – base Heinz 192 500 38

Boost GSK Consumer 173 450 38

Horlicks Gold GSK Consumer 200 500 40

Horlicks Junior GSK Consumer 200 500 40

Complan - Chocolate Heinz 416 1000 42

Horlicks Lite GSK Consumer 217 500 43

Mother's Horlicks GSK Consumer 326 500 65

Pediasure Abbot 1019 1000 102

Source: Company, Ambit Capital research; *Prices as of March 2013

Brand extensions have not helped gain market share so far: The premium MFD segment has been expanding by around 33% over the past few years as compared to 16% revenue CAGR for the overall MFD segment. To capitalise on this fast-growing segment, GSK Consumer has sought to leverage the Horlicks brand – the firm has introduced not only premium extensions of Horlicks in MFD, but also biscuits, noodles and oats, as shown in the table below. However, Horlicks’ non-MFD variants form only around 8% of GSK Consumer’s overall revenues (up from 5% three years ago).

Exhibit 10: Leveraging the Horlicks brand

Year Product Target Estimated Revenues

(` mn)*

New categories

1992 Horlicks Biscuits Available in both cookies and cream formats with a nutrition focus

1,000

2009 Horlicks Foodles Positioned on a health-based platform 500

2011 Horlicks Oats Health-focused breakfast cereal targeted at adults 300

MFD Extension

1997 Mother's Horlicks

For lactating women and breast-feeding mothers 250

1997 Junior Horlicks For children between the ages of 2 and 5 2,200

2005 Horlicks Lite High fiber, low fat formulation for adults and diabetics

250

2008 Women's Horlicks

Targeted at health-conscious urban working women

300

2011 Horlicks Gold Premium offering to meet the increasing nutritional requirements of kids

400

Source: Ambit Capital research. * As of CY11

A new super-premium variant unlikely to change its fortunes: After the recent success of Abbot’s super-premium MFD brand, Pediasure (3-4% market share, with most of the gains over the last 24 months), GSK Consumer intends to introduce a super premium variant of Horlicks in the coming quarters. However, with Horlicks’ brand recall being related to a mass-market product rather than a premium discretionary product, we do not believe that a brand extension of Horlicks in the super premium category is likely to help the company gain market share in the overall MFD market.

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GSK Consumer

Ambit Capital Pvt Ltd 112

Consequently, we expect 14.7% revenue CAGR for GSK Consumer in the MFD space over CY12-14 (vs 17% CAGR from CY08-12). This is around 30bps lower than the market growth rate, because we expect the market share of Horlicks and Boost to decline from 63% in CY11 to 62% in CY14). We also expect the biscuits and oats business to record a revenue CAGR of 23% and 29% respectively over CY12-14, led by distribution expansion and the launch of new variants in these categories.

Exhibit 11: Category growth projections for GSK Consumer*

Category Market Share (CY11) Market share (CY14) CAGR CY12-14

Milk Food Drinks 63% 62% 15%

Biscuits NA NA 23%

Oats 11% 12% 29%

Source: Ambit Capital research. * This is based on anecdotal data for category growth rates and our assumptions around market share changes in the various categories

Potential to expand auxiliary income GSK Consumer receives commission for distributing products of its group entities (classified as auxiliary income). It has a distribution alliance with GSK Asia (for Sensodyne, Crocin and Eno) and GSK Pharma (for Iodex) where GSK distributes the product and in turn receives a commission of 16.7% from GSK Asia and 10.5% from GSK Pharma. Consequently, there is no material incremental capital employed by GSK Consumer for this revenue stream. Auxiliary income currently forms around 15% of GSK’s PBT.

Exhibit 12: Contribution of auxiliary income to GSK’s PBT

050

100150200250300350

1QC

Y10

2QC

Y10

3QC

Y10

4QC

Y10

1QC

Y11

2QC

Y11

3QC

Y11

4QC

Y11

1QC

Y12

2QC

Y12

3QC

Y12

4QC

Y12

1QC

Y13

9%10%11%12%13%14%15%16%17%18%

Auxillary Income (Rs mn) As % of PBT

Source: Company, Ambit Capital research

The gradual rise in auxiliary income as a percentage of PBT has been led by a 27% CAGR in consignment sales for GSK Consumer over CY09-12, which in turn has been driven by two key products: (a) Eno, which reported a revenue CAGR of 31% over this period; and (b) Sensodyne, which has achieved sales of ~`1.4bn in CY12, up from only `37mn in CY10. Over CY12-15, we expect Sensodyne to report a 40% CAGR in revenues as it maintains its dominant market positioning in the sensitive toothpaste segment which is growing at ~35-40% YoY currently. Also, we expect Eno to report a 22% CAGR in revenues over CY12-15 as its brand recall in the antacid segment is unchallenged currently. Consequently, we expect 23% CAGR in auxiliary sales for GSK Consumer over CY12-15.

Prospects of successfully adding new products to auxiliary sales going forward: The recent open offer made by the parent for GSK Consumer to acquire 31.8% of the entity’s shareholding at `3,900, a premium of around 30% to the then prevailing share price, raises the possibility that the parent intends to: (a) launch new products from the parent’s portfolio through the auxiliary income route; or (b) enter into new product categories.

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GSK Consumer

Ambit Capital Pvt Ltd 113

However, given a history of launches that have not met with success (Lucozade, Nutribars, Foodles, Aquafresh, Horlicks Chilled Doodh, etc), we believe it is pre-mature to expect a new launch to lead to a revenue growth that is as strong as that reported by Sensodyne over CY10-12.

Surplus capital utilisation prospects Whilst GSK Consumer’s working capital management and cash generation is amongst the best in the sector, the company’s dividend payout ratio has ranged between 35% and 50% over the past ten years, leaving around 50% of cash generated unutilised over the past ten years (after capex). Attempts to leverage on the Horlicks brand to enter into categories like biscuits, noodles, energy drinks and health bars have not been successful in most cases. Consequently, GSK Consumer’s RoEs have been consistently at 20-30% over the past ten years, several notches below that of its peers.

The firm currently holds ~`10.8bn of surplus capital on its balance sheet, equivalent to 95% of overall net worth. Over the past three years, the company has highlighted prospective M&A as a mode of surplus capital deployment. Moreover, over the past four years, GSK Consumer has tried to leverage on the brand recall of Horlicks and Boost to enter into new product categories including biscuits, cookies, nutribars and has also tried to launch new brands/products including Foodles (noodles). Most of these initiatives are yet to materially gather momentum for GSK Consumer. Based on a combination of these factors/initiatives/comments made by the company we believe that: (a) GSK Consumer is NOT likely to repatriate a significant proportion of surplus capital; and b) The risk of making a non-core acquisition remains high in the future, and until then, surplus capital will remain a drag on return ratios.

Implications of recent capex of `2.4bn In 2010, the company had announced a capex of `2.4bn for 18,000 tonnes of capacity expansion (~18% increase in installed capacity) which was commissioned in February 2013. This plan was launched because the total production of malt-based foods had already exceeded 85% of installed capacity in CY10. Consequently, we do NOT see the capacity expansion initiative to either be: (a) an indication of stronger growth expectations from the business internally; or (b) a material capital deployment initiative since the quantum of this capex was only 2% of the cash available on the balance sheet.

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GSK Consumer

Ambit Capital Pvt Ltd 114

Key assumptions Exhibit 13: Key assumptions and estimates (` mn)

CY11 CY12 CY13E CY14E Comments

Profit and loss

Milk Food Drinks 26,560 30,556 35,083 40,281

Market Growth 15.0% 15.0% 15.0% 15.0%

Growth led by market share changes

1.3% -0.7% -0.4% -0.2%

Growth (%) 16.3% 14.3% 14.6% 14.8%

Expect a mix of volume growth of around 8% and price increase of 6% from increasing penetration. Weak presence in the premium segment will likely lead to market share losses to Complan and Pediasure

Biscuits and Oats 1,761 2,031 2,417 2,927

Market Growth 12.0% 10.0% 12.0% 12.0%

Growth led by market share changes

12.4% 11.2% 9.1% 9.1%

Growth (%) 24.4% 21.2% 21.1% 21.1%

Whilst market growth remains around 12%, new product launches in biscuits and expansion into other geographies to lead to market share gains in biscuits

Gross revenues 28,321 32,586 37,500 43,208

Growth (%) 16.5% 15.1% 15.1% 15.2%

Gross Profit 16,628 19,275 22,376 25,864

Gross margin (%) 61.9% 62.6% 62.9% 63.1%

Increasing premium mix in the Horlicks portfolio to offset lower gross margin biscuits and oats portfolio

Employee cost (% of sale) 9.6% 9.8% 9.8% 9.8% Do not expect scale benefits as new plant will keep employee costs elevated

Advertising (% of sale) 16.3% 16.1% 16.2% 16.3% Expect advertising spends to increase as competitive intensity rises

Carriage & Freight (% of sale)

4.9% 5.1% 5.1% 5.0% Expect minor benefits in CY14 as new plant leads to freight efficiencies

Royalty (% of sale) 3.5% 3.4% 3.4% 3.4% Expect royalty to remain stable

Other expenses (% of sale) 11.8% 13.1% 12.7% 12.6% Expect minor benefits from lower conversion charges paid to third parties and scale efficiencies

EBITDA 4,249 4,653 5,584 6,556 Above changes to lead to EBITDA margin expansion of 90bps over CY11-14

EBITDA Margin 15.8% 15.1% 15.7% 16.0%

Other Income 1,648 2,219 2,623 3,118

Growth (%) 40.3% 34.7% 18.2% 18.9%

Other income growth to be led by a CAGR of 23% in auxiliary commissions, 10% in interest income and 11% in miscellaneous income over CY11-14

Tax rate 33.0% 32.7% 33.9% 33.2% Expect tax rates to be stable at the maximum marginal rate

Net Profit margin 13.5% 14.2% 14.3% 14.9% Expect net profit margin increase of 90bps over CY11-14

Balance Sheet

Capex 377 196 2,200 800

Capital Work in Progress 1,711 1,972 500 500 `2.5bn expansion to be completed in CY13

Working Capital days (47) (66) (65) (65) Expect working capital days to be stable

Debtor days 13 13 13 13 Expect debtor days to be stable

Current Liabilities days 42 43 43 43 Expect current liabilities days to be stable

Inventory days 50 44 45 45 Expect inventory days to be stable

Net debt/(cash) to equity (0.9) (1.1) (1.1) (1.1) Expect net cash balance to increase to `17bn by CY14

Cash flows (` mn)

Operating cash flows 3,884 6,599 6,367 7,608

Free cash flows 2,813 6,045 5,640 6,808

Free cash flows to improve materially in CY14 as no incremental funds are required for capex

Source: Company, Ambit Capital research.

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GSK Consumer

Ambit Capital Pvt Ltd 115

Valuation

DCF valuation

Given the cash-generative nature of the business, we use a DCF-based model to arrive at a fair value for GSK Consumer. The assumptions for weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed zero debt on GSK’s balance sheet in the future given its strong cash generation. Hence, the company would have enough surplus cash available on its balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for GSK Consumer. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years, with sales CAGR of 15% and EPS CAGR of 17%. Stage 2 includes a decline in sales growth over eight years from 16% in CY17 to 5% in CY25 i.e. sales CAGR of 12% and free cash flow CAGR of 12% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `3,945/share (29% downside), implying an FY14 P/E multiple of 32.5x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 15: Cash flow profiles for GSK Consumer (` mn)

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3E

CY1

4E

Operating Cashflow Free cash flow

Source: Ambit Capital research

Exhibit 16: Return profiles for GSK Consumer (%)

10%

15%

20%

25%

30%

35%

40%

45%

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1E

CY1

2

CY1

3E

CY1

4EYoY EPS Growth (%) ROE (%) YoY Sales growth (%) EBIT Margin (%)

Source: Ambit Capital research

Relative valuation Over the past three years, GSK Consumer has consistently traded in a band of 22.0x-26.0x one-year forward P/E multiple. However, after the parent company’s open offer at a 30% premium to the then prevailing price for an increase in stake from 43% to a maximum of 75%, the stock rerated by over 50%. It currently trades at a CY13E P/E multiple of 45.5x. However, we believe this rerating is unjustified:

Yet to prove its capability to expand auxiliary income: Whilst the auxiliary income offers GSK Consumer a healthy revenue stream with zero capital employed, given a history of unsuccessful auxiliary product launches (Lucozade, Nutribars, Foodles, Aquafresh and Horlicks Chilled Doodh), we believe it is premature to attach a significant value to the parent’s potential of introducing new OTC products through GSK Consumer’s distribution network and achieve significant success.

Exhibit 14: WACC calculation for DCF on GSK Consumer Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.55

Equity risk premium (%) 7

Cost of equity (%) 12.4

Cost of debt (%) 12.0

Debt/Equity ratio (%) 0

Tax rate (%) 30

WACC (%) 12.4

Source: Company, Ambit Capital research

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GSK Consumer

Ambit Capital Pvt Ltd 116

Risk of surplus capital deployment: Surplus cash on GSK Consumer’s

balance sheet currently amounts to `14bn, almost 100% of its net worth. Also, the company’s dividend payout ratio has hovered between 38% and 82% (special dividend) over the past three years. Given the limited scope for rapid product diversification through its only successful brand (Horlicks), there exists a risk of capital deployment towards areas/M&A which could be a drag on the growth momentum or return profiles of GSK Consumer.

Exhibit 17: One-year forward P/E bands for GSK

400

10001600

22002800

34004000

4600

52005800

Jan-

08M

ay-0

8Se

p-08

Feb-

09Ju

n-09

Oct

-09

Mar

-10

Jul-

10N

ov-1

0M

ar-1

1A

ug-1

1D

ec-1

1A

pr-1

2A

ug-1

2Ja

n-13

May

-13

17x

45x

38x

31x

24x

Source: Bloomberg, Ambit Capital research

Exhibit 18: One-year forward EV/EBITDA bands for GSK

400

10001600

22002800

34004000

4600

52005800

Jan-

08M

ay-0

8Se

p-08

Feb-

09Ju

n-09

Oct

-09

Mar

-10

Jul-

10N

ov-1

0M

ar-1

1A

ug-1

1D

ec-1

1A

pr-1

2A

ug-1

2Ja

n-13

May

-13

10x

17x

24x

35x

42x

Source: Bloomberg, Ambit Capital research

Exhibit 19: Sensitivity analysis

Bull case Base case Bear case

Revenue growth

In our bull case, we model a revenue CAGR of around 15% over CY13-22 led by market share gains in Horlicks and distribution-led gains in the biscuits and oats segment. Our terminal growth rate assumption stands at 6%

We expect a revenue CAGR of around 12% over CY13-22 led by 10bps market share loss annually in Horlicks over FY15-17. The biscuit and oats portfolio is likely to see distribution expansion related gains. Our terminal growth rate assumption stands at 5%

We expect a revenue CAGR of around 10% over CY13-22 led by 100bps market share loss annually in Horlicks over FY15-17. We assume no distribution-related gains in the biscuits and oats portfolio. Our terminal growth rate assumption stands at 4%

Operating margins

We assume EBITDA margins expansion of 170bps over CY11-FY17 to 17.4%, led by gross margin expansion due to premiumisation of the portfolio as well as lower advertisement spends assuming cooling down of competitive intensity in the segment

We expect EBITDA margins expansion of 130bps over CY12-FY17 to 16.4%, led by gross margin expansion due to premiumisation of the portfolio as well as stable advertisement spends assuming competitive intensity remains unchanged.

Expect EBITDA margins to expand 30bps from 15.7% in CY11 to 16.0% in FY17, factoring in small gains from gross margin expansion which are offset by competitive-intensity-led increase in advertising spends

Fair value (`/share) 4,658 3,945 3,005

Upside/Downside -16% -29% -46%

Source: Ambit Capital research

Risks to our SELL stance Capital deployment: If GSK Consumer deploys its surplus capital towards an

acquisition or expansion initiative in a highly efficient manner, this could lead to an increase in the firm’s return ratios and our earnings forecasts.

Auxiliary income: A highly successful launch of a range of new products by the parent company can potentially add to our auxiliary income forecasts and hence earnings growth estimates on the company.

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GSK Consumer

Ambit Capital Pvt Ltd 117

Ambit vs consensus

Exhibit 20: Ambit vs consensus

Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments

CY13E

Net Sales (` mn) 35,577 35,938 -1% Broadly in line with consensus

EBITDA (` mn) 5,584 6,151 -9%

Expect EBITDA margin expansion of 60bps to 15.7% over CY11-FY14. Our estimates do not factor in auxiliary income, which is likely the cause for deviation from consensus

EPS (`/share) 121.2 120.2 1% Our EPS forecast for FY14 is broadly in line with consensus

CY14E

Net Sales (` mn) 40,992 42,038 -2% Our EPS forecast for FY15 is broadly in line with consensus

EBITDA (` mn) 6,556 7,310 -10%

Expect premiumisation-led EBITDA margin expansion of 30bps to 16% in FY15. Our estimates do not factor in auxiliary income, which is the likely cause for deviation from consensus

EPS (`/share) 145.0 143.9 1% Our EPS forecast for FY15 is broadly in line with consensus

Source: Ambit Capital research

Catalysts Value-destructive M&A announcement: Given the large quantum of

surplus capital and hence a substantial drag on RoE, there is a high likelihood of an announcement around M&A activity by the company. With high current valuations in the entire FMCG sector, such an M&A transaction is likely to be at valuations which are not earnings accretive for shareholders at least over the short to medium term.

Rising competitive intensity and input cost inflation could adversely affect margins: Whilst GSK has seen an average input cost inflation of around 7-8%, sustained inflation at high levels will likely impact gross margins. Competitive intensity, especially for the premium segment products, could lead to market share losses for GSK, which could necessitate a rise in A&P spends.

Exhibit 21: Explanation for our forensic accounting scores on the first page

Segment Score Comments

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 GREEN Although discretionary spending has been under pressure over the past few quarters, GSK has maintained a strong revenue growth run rate. It has also maintained a strong margin profile due to gross margin expansion.

Earnings momentum AMBER In the last six months, consensus EPS estimates have been downgraded by 2% for CY13 and remained unchanged for CY14.

Source: Ambit Capital research

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GSK Consumer

Ambit Capital Pvt Ltd 118

Balance sheet (` mn)

Year to December CY10 CY11 CY12 CY13E CY14E

Shareholders' equity 421 421 421 421 421

Reserves & surpluses 9,180 11,021 13,189 15,346 17,767

Total net worth 9,600 11,442 13,610 15,766 18,188

Deferred tax liability (267) (399) (616) (616) (616)

Total liabilities 9,333 11,043 12,994 15,150 17,572

Gross block 5,990 6,367 6,562 8,762 9,562

Net block 2,023 2,007 1,938 3,646 3,902

CWIP 1,083 1,711 1,972 500 500

Investments 0 - - - -

Cash & equivalents 9,761 10,797 14,642 17,340 20,470

Debtors 505 992 1,126 1,267 1,460

Inventory 3,120 3,700 3,696 4,386 5,054

Loans & advances 501 721 1,115 1,267 1,460

Other current assets 344 492 438 487 562

Total current assets 14,231 16,701 21,018 24,748 29,005

Current liabilities 1,134 3,067 3,630 4,191 4,829

Provisions 3,300 2,712 3,521 3,996 4,605

Total current liabilities 4,435 5,779 7,151 8,188 9,434

Net current assets 9,796 10,922 13,867 16,560 19,571

Miscellaneous - - - - -

Total assets 12,902 14,639 17,778 20,706 23,973 Source: Company, Ambit Capital research

Income statement (` mn)

Year to December CY10 CY11 CY12 CY13E CY14E

Operating income 23,061 26,855 30,794 35,577 40,992

% growth 20.0% 16.5% 14.7% 15.5% 15.2%

Operating expenditure 19,320 22,606 26,141 29,993 34,435

EBITDA 3,741 4,249 4,653 5,584 6,556

% growth 22.0% 13.6% 9.5% 20.0% 17.4%

Depreciation 397 460 361 493 544

EBIT 3,344 3,790 4,292 5,091 6,013

Interest expenditure - 35 24 - -

Non-operating income 1,174 1,648 2,219 2,623 3,118

Adjusted PBT 4,518 5,403 6,487 7,714 9,131

Tax 1,522 1,784 2,120 2,615 3,031

Adjusted PAT/ Net profit 2,996 3,619 4,367 5,099 6,099

% growth 30.1% 20.8% 20.7% 16.7% 19.6%

Extraordinaries (3) 66 (0) - -

Reported PAT / Net profit 2,999 3,552 4,368 5,099 6,099

Adjusted Consolidated net profit 2,999 3,552 4,368 5,099 6,099

Reported Consolidated net profit 2,999 3,552 4,368 5,099 6,099

Source: Company, Ambit Capital research

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GSK Consumer

Ambit Capital Pvt Ltd 119

Cash flow statement (` mn)

Year to December CY10 CY11 CY12 CY13E CY14E

EBIT 4,518 5,437 6,511 7,714 9,131

Depreciation 397 460 361 493 544

Others (157) (166) (242) - -

Tax (1,522) (1,784) (2,120) (2,615) (3,031)

(Incr) / decr in net working capital 1,954 (62) 2,088 776 964

Cash flow from operations 5,189 3,884 6,599 6,367 7,608

Capex (1,180) (1,072) (554) (2,200) (800)

Cash flow from investments (1,180) (1,072) (554) (2,200) (800)

Interest paid - 35 24 - -

Dividend paid (2,452) (1,711) (2,199) (2,942) (3,678)

Others 6 (101) (24) - -

Cash flow from financing (2,446) (1,777) (2,199) (2,942) (3,678)

Net change in cash 1,563 1,036 3,846 2,697 3,130

Closing cash balance 9,761 10,797 14,642 17,340 20,470

Free cash flow 4,009 2,813 6,045 5,640 6,808 Source: Company, Ambit Capital research

Ratio analysis

Year to December CY10 CY11 CY12 CY13E CY14E

Gross margin (%) 62.5% 61.9% 62.6% 62.9% 63.1%

EBITDA margin (%) 16.2% 15.8% 15.1% 15.7% 16.0%

EBIT margin (%) 19.6% 20.2% 21.1% 21.7% 22.3%

Net profit margin (%) 13.0% 13.5% 14.2% 14.3% 14.9%

Dividend payout ratio (%) 81.9% 47.3% 50.4% 57.7% 60.3%

Net debt: equity (x) (1.0) (0.9) (1.1) (1.1) (1.1)

Working capital turnover (x) (6.5) (7.7) (5.5) (5.6) (5.6)

Gross block turnover (x) 3.9 4.2 4.7 4.1 4.3

RoCE (%) 32.8% 35.7% 36.5% 36.2% 37.3%

RoE (%) 32.1% 34.4% 34.9% 34.7% 35.9%Source: Company, Ambit Capital research

Valuation parameters

Year to December CY10 CY11 CY12 CY13E CY14E

EPS (`) 71.2 86.0 103.8 121.2 145.0

Diluted EPS (`) 71.2 86.0 103.8 121.2 145.0

Book value per share (`) 228.3 272.1 323.6 374.9 432.5

Dividend per share (`) 50.0 35.0 45.0 60.0 75.0

P/E (x) 77.4 64.1 53.1 45.5 38.0

P/BV (x) 24.2 20.3 17.0 14.7 12.8

EV/EBITDA (x) 59.4 52.0 46.7 38.4 32.3

Price/Sales (x) 10.1 8.6 7.5 6.5 5.7 Source: Company, Ambit Capital research

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Consumer Goods June 04, 2013

Colgate Palmolive Bloomberg: CLGT IN EQUITY Reuters: COLG.NS

Accounting: GREEN Predictability: RED Earnings momentum: RED

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income (` mn) 22,861 26,932 31,638 36,501 42,106 EBITDA(` mn) 5,146 5,785 6,568 7,185 8,415 EBITDA Margin (%) 22.5% 21.5% 20.8% 19.7% 20.0% Adjusted PAT(` mn) 4,026 4,465 4,968 5,179 5,839 Adjusted EPS (`) 29.6 32.8 36.5 38.1 42.9 RoE (%) 113.4% 109.0% 107.4% 101.6% 107.4% P/E (x) 49.0 44.2 39.7 38.1 33.8

Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `1,451

Target Price (Mar’14): `1,227

Previous TP: NA

Downside (%) 15%

EPS (FY14E): `38.1 Change from previous (%) NA

Variance from consensus (%) -12%

Stock Information

Mkt cap: `197bn/US$3.5bn

52-wk H/L: `1,580/1,097

3M ADV: `169mn/US$3mn

Beta: 0.54x

BSE Sensex: 19,610

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute (4) 11 23 (7)

Rel. to Sensex (4) 7 (0) (8)

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Oct-12 Jan-13 M ay-13

1000

1200

1400

1600

Sensex Colgate Palmolive

1-year fwd P/E bandchart

200

400

600

800

1000

1200

1400

1600

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

15x

39x

33x

27x

21x

Source: Bloomberg, Ambit Capital research

All foamed out Colgate’s EBITDA CAGR of 30% over FY07-12 was supported by gross margin expansion. We do NOT expect further market share gains given the aggression from P&G (Oral-B toothpaste launch next month), GSK Consumer (Sensodyne) and the rumoured entry of ITC in this segment. We also model declining gross margins given limited scope for further consolidation of contract manufacturing and shift towards toothpaste from toothpowder. Rising advert to sales ratio and tax rate will lead to only 8% EPS CAGR over FY13-15, lower than the 24% reported over FY07-12. Current valuations of 38x FY14 EPS do not appear to factor in this approaching growth moderation and rising competitive intensity. We initiate coverage with a SELL stance.

Competitive position: MODERATE Changes to this position: STABLE

Colgate’s leadership presence is supported by: (a) focused initiatives around dentists and rural consumers that are stronger than HUL’s; and (b) a broader oral care portfolio allowing premiumisation. We expect significant moderation in EBITDA CAGR from 30% over FY07-12 to 8% over FY13-15 due to:

High competitive intensity: Since oral care is one of the highest gross margin categories (~60%) in the FMCG universe, the competitive intensity has increased substantially with the successful new entry of players like GSK (Sensodyne and Paradontax), proposed launch of Oral-B toothpaste by P&G next month, and rumours of ITC’s entry into this segment. Consequently, we expect the A&P spends to sales ratio to increase by ~100bps over FY13-15 and hence be a substantial drag on earnings growth.

Consolidation of contract manufacturing: Replacement of contractual outsourced manufacturing locations with Colgate’s in-house manufacturing units over the past decade has led to a gross margin benefit of 13-15 percentage points. However, with the ‘purchase of traded goods:sales’ ratio declining from 42% in FY02 to 7% in FY12, there is only a limited scope for further consolidation.

Shift from toothpowder to toothpastes: Due to consumers shifting from toothpowder to toothpaste, the contribution of toothpowder to Colgate’s overall revenues has declined from 22% in FY01 to 11% in FY12, providing a 200bps benefit to EBITDA margins over the past decade. Once again, we see limited potential for further reduction in this ratio going forward.

Valuation: Colgate’s FY14 P/E multiple of 38.1x is at ~45% premium to its historical (FY10-13) average one-year forward trading multiple of 26.4x. Given our expectation of a moderation in earnings growth, as discussed above, we believe this premium is unjustified. Our DCF-based valuation generates a TP of `1,227/share, 15% downside (implied FY14 P/E of 32.2x).

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Colgate Palmolive

Ambit Capital Pvt Ltd 121

Company Financial Snapshot

Profit and Loss (` mn)

FY13 FY14E FY15E Net sales 31,638 36,501 42,106 Optg. Exp (Adj for OI.) 25,070 29,316 33,691 EBITDA 6,568 7,185 8,415 Depreciation 437 627 734 Interest Expense - - - PBT 6,630 7,046 8,109 Tax 1,663 1,867 2,271 Adj. PAT 4,968 5,179 5,839 Profit and Loss Ratios EBIDTA Margin % 20.8% 19.7% 20.0% Adj Net Margin % 15.7% 14.2% 13.9% P/E (X) 39.7 38.1 33.8 EV/EBIDTA (X) 29.4 27.1 23.1 Dividend Yield (%) 1.7% 1.9% 2.1%

Company Background

Colgate entered into the Indian market in 1937 and soon became a market leader in the toothpaste segment. The company currently has a market share of 54% in this segment. Its product portfolio comprises toothpastes, toothbrushes, and toothpowder under the Colgate brand and a small personal care portfolio under the Palmolive brand.

Colgate enjoys a distribution reach of around 4.6mn outlets. With the support of its parent Colgate-Palmolive (51% holding), the company benefits from access to the parent’s global portfolio and brand equity.

Balance Sheet (` mn)

FY13 FY14E FY15E Total Assets 12,843 14,477 16,190 Net Fixed Assets 3,826 5,700 6,466 Current Assets 8,546 8,277 9,224 Other Assets 471 500 500 Total Liabilities 12,843 14,477 16,190 Networth 4,896 5,301 5,571 Debt - - - Current Liabilities 8,172 9,400 10,844 Deferred Tax (224) (224) (224) Balance Sheet Ratios ROE % 107.4% 101.6% 107.4% ROCE % 111.6% 106.3% 112.0% Net Debt(cash)/Equity (0.9) (0.5) (0.5) Equity/Total Assets 1.0 1.0 1.0 P/BV (X) 41.1 38.0 36.1

Cash Flow (` mn) FY13E FY14E FY15E PBT 6,630 7,046 8,109 Depreciation 437 627 734 Tax (1,663) (1,867) (2,271) Change in Wkg Cap 1,339 86 614 Others (103) - - CF from Operations 6,641 5,892 7,186 Capex (1,025) (2,500) (1,500) Investments 0 (29) - CF from Investing (1,025) (2,529) (1,500) Change in Equity - - - Debt - - - Dividends (4,296) (4,774) (5,569) Others (129) - - CF from Financing (4,425) (4,774) (5,569) Change in Cash 1,190 (1,411) 117

Market penetration of oral care products in India (%) Colgate’s A&P/sales ratio vs other FMCG players (FY12)

69 70 71 72 73 74 76 78 79 79 82

44 44 44 45 4650 51 54 57 59

6470

36 35 36 34 35 35 35 3531 28 26

8284

66

242120

30

40

50

60

70

80

90

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Dentrifrice Toothpaste Toothpowder

3%

5%

7%

9%

11%

13%

15%

17%

GSK

Con

sum

er

Col

gate

Dab

ur

GC

PL

HU

L

Mar

ico

Nes

tle

Note: Company, Ambit Capital research; Note: Dentifrice comprises toothpaste, toothpowder and mouthwash

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Colgate Palmolive

Ambit Capital Pvt Ltd 122

Background Exhibit 1: Colgate’s portfolio matrix

Category Key brands Key competitors Market

share rank % of

turnover FY10-13

CAGR

Toothpaste Colgate Dental Cream, Total, Max Fresh, Sensitive, Cibaca, Active Salt

HUL, Dabur, GSK Consumer, Vicco, Anchor

1 74% 15%

Toothbrush Colgate 360, Sensitive, Extra Clean, Zig Zag P&G, HUL, Anchor

1 13% 17%

Toothpowder Colgate Toothpowder Dabur, Anchor 1 8% -5%

Personal/Home Products

Palmolive portfolio of hand wash, body wash, shower gel, shaving cream, skin cream, Axion dishwash J&J, Elder Health

NA 4% 10%

Mouthwash Colgate Plax HUL, L'Oreal, Gillette

2 1% 30%

Source: Company, Ambit Capital research

As shown in the table above, 96% of Colgate’s revenues are derived from oral care products and the company is the market leader across all categories of products in oral care. Its personal products portfolio forms less than 4% of revenues and the company is currently not focusing on this category. Colgate’s key competitors in the oral care market include HUL (Close-Up and Pepsodent), P&G (Oral-B) and GSK (Sensodyne and Paradontax). Over the past five years, Colgate has increased its market share in the toothpaste segment from around 49% in 2008 to 54% in 2012.

As highlighted in the charts below, over FY04-13, Colgate has reported a 13% revenue CAGR, 12% volume CAGR and 520bps EBITDA margin expansion.

Exhibit 2: Revenue growth vs volume growth

-5%

0%

5%

10%

15%

20%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

5%

7%

9%

11%

13%

15%

17%

Revenue growth Volume growth

Source: Company, Ambit Capital research

Exhibit 3: EBITDA vs EBITDA margin

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

10%

12%

14%

16%

18%

20%

22%

24%

26%

EBITDA EBITDA Margin

Source: Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 123

Distribution The oral care brand ‘Colgate’ is the second most-distributed brand (after Lifebuoy) in India. The company currently enjoys a reach of 5.5mn outlets (direct reach of 1mn) from around 4mn outlets in 2008. As shown in the table below, the distribution-led penetration of Colgate’s products in the relevant markets (as defined by the company) is almost completely saturated.

Exhibit 4: Distribution reach at relevant outlets for Colgate

2008 2009 2010 2012

Urban 97% 97% 97% NA

Rural 93% 95% 94% NA

Urban + rural 95% 96% 96% 98%

Source: Company, Ambit Capital research

SWOT

Exhibit 5: SWOT analysis for Colgate

Strengths Weaknesses

Debt-free balance sheet and strong free cash flow generation enables cash availability for capex and high dividend payouts (averaged 86% payout ratio over FY07-12).

One of the strongest brands in the country – likely to be the main beneficiary of penetration and premiumisation.

Colgate’s distribution reach is 4.6mn outlets, around 98% of its targeted distribution reach.

Strict control over inventory and creditors helps Colgate maintain a negative working capital cycle of around 35 days.

Fully dependent on one category—oral care. Its personal product portfolio is not a meaningful contributor (less than 4% of revenues).

Colgate has limited competitive advantages in toothbrushes and mouthwashes (the fastest categories in the oral care space, with toothbrushes being a commoditised product and Listerine being a market leader in mouthwashes).

Opportunities Threats

The category has a penetration of only 91% in urban and 63% in rural markets.

Colgate is well positioned to be a disproportionate beneficiary of consumers migrating to more premium toothpastes and categories like mouthwashes.

New entrants like GSK Consumer are aggressively targeting the fast-growing sensitive teeth market and P&G is likely to enter the market in CY15 with Crest.

Increasing competitive intensity especially from HUL is likely to keep advertisement spends at an elevated level.

Source: Industry, Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 124

Growth drivers for Colgate We expect the overall market for oral care to record a revenue CAGR of 12-13% in the coming years aided by: (a) increased penetration (owing to ~91% penetration of organised oral care products in urban markets and ~63% penetration in rural markets currently); (b) a shift in consumption from toothpowders towards toothpastes; and (c) premiumisation trends within the toothpaste and toothbrush categories. However, we expect Colgate to record 16% revenue CAGR over FY13-15, faster than the broader oral care market growth rates, due to:

Push through dentists: Based on our discussions with dentists across India, we believe that the quantum of benefits provided and hence the strength of Colgate’s association with dentists is significantly higher than that of HUL. These benefits include: (a) free product samples to dentists; (b) subsidised product packs available for sale to patients through dentists; (c) alliances with dental schools; and (d) participation in dental conventions in India. Our discussions with dentists suggest that none of these initiatives are followed by either HUL or Dabur for their oral care brands and hence most dentists recommend Colgate’s products to their patients.

Rural initiatives: Colgate has launched aggressive rural initiatives like: (a) the ‘Bright Smiles Bright Future’ campaign where it goes to schools in rural areas and imparts information on dental hygiene to children and distributes free samples; and (b) oral care month (started in 2004 and extended to two months since 2009) where the company provides free oral care health check-ups to consumers in rural areas.

Wide product portfolio: Colgate is the only player in oral care with a leadership presence in all segments (mass, mid and premium) and a portfolio that has a material presence across all categories (toothpaste, toothbrush, mouthwash and toothpowder), thereby helping customers upgrade to premium products within Colgate’s portfolio.

Exhibit 6: Colgate’s volume market share has increased over 300bps since FY09

51.0%

51.5%

52.0%

52.5%

53.0%

53.5%

54.0%

54.5%

55.0%

55.5%

Q1F

Y10

Q3F

Y10

Q1F

Y11

Q3F

Y11

Q1F

Y12

Q3F

Y12

Q1F

Y13

Q3F

Y13

Source: Company, Ambit Capital research

Exhibit 7: Dentist participation in oral care month

0

200

400

600

800

1000

1200

2005 2007 2010 2012

0

5000

10000

15000

20000

25000

30000

Towns Covered (LHS)Dentist participation (RHS)

Source: Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 125

Moderation in EPS CAGR likely Colgate’s rerating historically (as shown in the chart below) has been led by an EPS CAGR of 25% and EBITDA CAGR of 31% over FY07-12. Even though the company has reported revenue CAGR of only 16% over FY07-12E (helped by 500bps market share gains over this period), EBITDA margin expansion has been the primary reason for strong earnings growth over this period.

Exhibit 8: One-year forward P/E band chart for Colgate

200

400

600

800

1000

1200

1400

1600

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

15x

39x

33x

27x

21x

Source: Bloomberg, Ambit Capital research

Whilst we expect revenue CAGR of 15% over FY13-15, we expect only 8% EPS CAGR for Colgate over this period, as we expect competitive intensity to rise and hence exert downward pressure on EBITDA margins over the next 24 months. The reasons for the same are elaborated below.

Rising competitive intensity will constrain market share gains and EBITDA margin expansion… As shown in the chart below, growth in the overall oral care market in India over the past five years has been led predominantly by an increase in penetration and a shift from toothpowder to toothpaste. We expect 14% CAGR for the oral care market over FY13-15, with Colgate likely to gain share by only 20bps each year, underpinned by its competitive advantages (highlighted on the previous page).

Exhibit 9: Penetration of oral care in India

69 70 71 72 73 74 76 78 79 79 82 82 84

44 44 44 45 4650 51 54 57 59

6470

36 35 36 34 35 35 35 3531 28 26 24

66

2120

30

40

50

60

70

80

90

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Dentrifrice Toothpaste Toothpowder

Source: Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 126

However, the rate of this market share gain will be limited by rising competitive intensity in the oral care segment. Oral care is one of the highest gross margin categories in the FMCG universe (~60% as against an FMCG average of ~50%), and thus, competitive intensity is likely to remain high in this category. New entrants (such as GSK) have already been aggressively pushing their premium brands (such as Sensodyne and Paradontax) over the past 12 months. Also, it is widely speculated that P&G is looking to enter the Indian oral care markets by 2015.

As shown in the chart below, Colgate’s advertisement spends to sales ratio (A:S ratio) is one of the highest in the industry. In the wake of increased competitive intensity, we expect Colgate’s A:S ratio to rise gradually towards its historical average of 15.5% from FY15 onwards (up from an average of 15.1% over FY10-12).

Exhibit 10: A&P trends for Colgate

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

EFY

14E

FY15

E

13%

14%

15%

16%

17%

18%

19%

20%

21%

Advertising spends Adv as % of sale

Source: Company, Ambit Capital research

Exhibit 11: Colgate’s A&P vs its FMCG peers (FY12)

3%

5%

7%

9%

11%

13%

15%

17%

GSK

Con

sum

er

Col

gate

Dab

ur

GC

PL

HU

L

Mar

ico

Nes

tle

Source: Company, Ambit Capital research

During the previous instance of increase in competitive intensity between HUL and Colgate over FY01-03, A&P spends for Colgate averaged around 20% of sales (FY01-03) as against an average of 15-16% over FY04-12. Consequently, given Colgate’s reliance on a single product category and given its push to premiumise its customers to Colgate Total and Colgate Sensitive, we see a high risk of increase in the A:S ratio in the future and hence pressure on EBITDA margins in the future.

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Colgate Palmolive

Ambit Capital Pvt Ltd 127

… and gross margin expansion is unlikely Colgate’s gross margins have expanded by 13 percentage points since FY04 (see the table below) helped by the following factors:

Consolidation of contract manufacturing: As shown in the chart below, Colgate’s margin expansion has been driven predominantly by replacement of contractual outsourced manufacturing locations with Colgate’s in-house manufacturing units. We expect this to have led to a gross margin benefit of ~13-15% over the past eight years. However, note that this gross margin benefit was partly offset by the increase in royalty payouts from 1% in FY04 to 5.2% in FY12.

Exhibit 12: Share of traded goods has reduced sharply as contract manufacturers were merged into Colgate (%)

0%10%20%30%40%50%60%70%80%90%

100%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Raw material consumed Purchase of traded goods

Source: Company, Ambit Capital research

Exhibit 13: Lower contract manufacturing led to royalty payments being made from the standalone entity (%)

45%

47%49%

51%

53%55%

57%

59%61%

63%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

0%

1%

2%

3%

4%

5%

6%

Gross Margin Royalty (as % of sale) (RHS)

Source: Company, Ambit Capital research

Shift from toothpowder to toothpaste: The contribution of toothpowder to Colgate’s overall revenues has declined from 22% in FY01 to 11% in FY12. This, we believe, has led to a ~200bps expansion in gross margins over the past ten years.

Premiumisation: We believe that premiumisation within Colgate’s toothpaste portfolio is likely to have contributed to around gross margin expansion of 150bps over the past ten years.

We do not expect any further material gross margin benefits from the three factors highlighted above, because: (a) purchase of traded goods as a proportion of net sales has reduced from 42% in FY02 to only 7% in FY12, leaving limited scope for further consolidation; (b) proportion of toothpowder in overall dentrifice has reduced from 45% in 2001 to less than 25% in 2000. Consequently, we expect an annual gross margin expansion of only 100bps for Colgate until FY18 (after which we expect margins to stabilise) driven by premiumisation of its product mix.

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Colgate Palmolive

Ambit Capital Pvt Ltd 128

Tax benefits will expire in FY16 Colgate’s tax holiday (excise and corporate tax) on production from its unit in Baddi, Himachal Pradesh, is set to expire in FY15-16. The new units in Gujarat and Andhra Pradesh will not be eligible for any tax benefits, resulting in the effective tax rate rising from around 22% currently to around 33% in FY16. This is likely to have a significant negative impact on Colgate’s EPS growth over FY14-17.

Key assumptions

Exhibit 14: Key assumptions and estimates (` mn)

FY12 FY13E FY14E FY15E Comments

Profit and loss

Toothpaste revenues (including mouthwash and toothpowder)

24,138 28,435 32,819 37,880

Market growth 16.0% 14.0% 15.0% 15.0%

Growth from market share change

1.2% 3.8% 0.4% 0.4%

Growth (%) 17.2% 17.8% 15.4% 15.4%

Growth led by 15% industry growth and factor in 0.5% market share gains from Dabur and HUL in FY14 and FY15 as Colgate benefits from a stronger product portfolio, distribution and aggressive rural initiatives

Toothbrush revenues 3,198 3,700 4,292 4,979

Market Growth 27.9% 16.0% 16.0% 16.0%

Growth from market share change

0.0% -0.3% 0.0% 0.0%

Growth (%) 27.9% 15.7% 16.0% 16.0%

Growth led by 16% industry growth and expect Colgate to maintain share in the segment due to high competitive intensity from Oral B

Total revenues 26,932 31,638 36,501 42,106

Growth (%) 17.8% 17.5% 15.4% 15.4%

Gross Profit 16,430 19,136 22,150 25,636

Gross margin (%) 61.0% 60.5% 60.7% 60.9%

Estimate gains in gross margins led by positive mix change as the share of toothpowder reduces and mouthwash and premium toothpaste gain

Employee cost (% of sale) 8.0% 7.9% 7.8% 7.7% Expect marginal benefits from employee cost leverage in FY15

Advertising (% of sale) 15.3% NA 16.5% 16.5% Advertising cost to rise as the premium products are advertised more and competitive intensity rises

Royalty (% of sale) 5.2% 5.3% 5.3% 5.3% Expect royalty payouts to remain stable at 5.3%

Other expenses (% of sale) 11.0% 35.1% 11.4% 11.4% Expect other expenses to remain flat

EBITDA 5,785 6,568 7,185 8,415

EBITDA margin 21.5% 20.8% 19.7% 20.0%

Above changes to lead to margins improvement in EBITDA margins in FY15

Tax rate 24.1% 25.1% 26.5% 28.0% Whilst tax rates should increase moderately till FY15, FY16 will see a rise in tax rates as the tax holiday expires

Net profit margin 16.6% 15.7% 14.2% 13.9% Effect of higher depreciation from new plants and higher tax rates to lead to decline in net profit margins

Balance Sheet

Capex 333 1,719 2,000 1,500

Capital Work in Progress 694 - 500 500

Capex relates to 2 new plants for toothpaste in Gujarat and toothbrushes in Andhra Pradesh

Working capital days (35) (45) (40) (40) Do not expect material changes in working capital days

Debtor days 12 9 10 10 Marginal increase led by increasing contribution from modern trade

Current liabilities days 80 83 82 82 Expect current liabilities days to stay constant

Inventory days 30 21 25 25 Do not expect material changes in inventory days

Net debt/(cash) to equity (0.7) (0.9) (0.5) (0.5) Colgate is a net cash company with a high dividend payout

Cash flows (` mn)

Operating cash flows 4,181 6,641 5,892 7,186

Free cash flows 3,182 5,615 3,392 5,686

Free cash flows to grow strongly in FY16 as expansion related capex ceases in FY15

Source: Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 129

Valuation

DCF valuation

The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed zero debt on Colgate’s balance sheet in the future given its strong cash generation and hence we have assumed that enough surplus cash would be available for capital expenditure in the future.

We use a three-stage DCF approach for Colgate Palmolive. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next five years, with sales CAGR of 15% and EPS CAGR of 14%. Stage 2 includes a decline in sales growth over eight years from 15.4% in FY18 to 6% in FY23 i.e. sales CAGR of 11% and free cash flow CAGR of 11% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `1,227/share (15% downside), implying an FY14 P/E multiple of 32.2x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 16: Cash flow profile for Colgate

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

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

Source: Ambit Capital research

Exhibit 17: Return profiles for Colgate

-10%

0%

10%

20%

30%

40%

50%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E-30%

-10%

10%

30%

50%

70%

90%

110%

130%

150%

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

Source: Ambit Capital research

Relative valuation As shown in the charts below, Colgate’s current one-year forward P/E multiple of 38x is at a 41% premium to its historical (FY10-13) average one-year forward trading multiple of ~27.0x. Historically, the stock’s trading multiples have been supported by significant margin expansion through the consolidation of manufacturing units, shift from powder to paste, and reduction in competitive intensity. However, in the absence of these supporting levers going forward, we believe this premium rating is unjustified.

Moreover, Colgate’s current valuation multiples deserve a derating owing to: (a) `4bn of surplus cash on the balance sheet – as Colgate is a single product company, there are limited avenues for deployment of this surplus cash to expand its current product franchise. Hence, it raises the possibility of deployment towards initiatives which can be value-destructive. (b) Threat of increased competition:

Exhibit 15: WACC calculation for DCF on Colgate Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.54

Equity risk premium (%) 7

Cost of equity (%) 12.3

Cost of debt (%) 12.0

Debt/Equity ratio (%) 0

Tax rate (%) 30

WACC (%) 12.3

Source: Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 130

Colgate currently faces tough competition predominantly from HUL’s Close-up and Pepsodent brands and GSK’s Sensodyne brand. Also, P&G has recently announced its intention to launch Oral-B toothpastes over the next few months to capitalise on the rapid growth of oral care and the brand recall of Oral-B in India.

Exhibit 18: 1-year forward P/E bands for Colgate

200

400

600

800

1000

1200

1400

1600

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

15x

39x

33x

27x

21x

Source: Bloomberg, Ambit Capital research

Exhibit 19: 1-year forward EV/EBITDA bands for Colgate

200

400

600

800

1000

1200

1400

1600

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

11x

27x

15x

23x

19x

Source: Bloomberg, Ambit Capital research

Exhibit 20: Sensitivity analysis

Bull Case Base Case Bear Case

Revenue Growth

We have modeled a revenue CAGR of 15% over FY13-23 assuming higher market growth rates and market share gains of 400bps over FY13-17. Our terminal growth rate assumption is at 6%.

We have modeled a revenue CAGR of 13% over FY13-23 assuming market growth of 15% and market share gains of 100bps over FY13-17. Our terminal growth rate assumption stands at 5%.

We have modeled a revenue CAGR of 11% over FY13-23 assuming higher market growth rates and no changes in market share over FY13-17. Our terminal growth rate assumption is at 4%.

Operating margins

We assume EBITDA margins to increase to 22.6% by FY17 and stabilise thereafter assisted by an increase in gross margins and lower advertisement spends.

We assume EBITDA margins to increase from 20.8% in FY13 to 21.5% in FY18 and stabilise thereafter assisted by an increase in gross margins.

We assume EBITDA margins to increase only marginally to 22% by FY17, as the increase in gross margins would be partially offset by an increase in A&P. We expect margins to stabilise at 22%.

Fair Value (`/share) 1,413 1,227 907

Upside -3% -15% -38%

Source: Ambit Capital research

Risks to our SELL stance Market share gains: We expect Colgate to gain a market share of 50bps every year over FY13-15, and any share increase above this level could warrant an upgrade to our earnings forecasts and hence valuation.

Competitive intensity in the segment cooling off: Any reduction of competitive intensity in the oral care segment will ease the pressure on A&P spends and positively impact margins.

Buyback from the parent: Colgate’s global parent owns a 51% equity stake in the company. After the recently announced buyback from HUL and GSK Consumer, Colgate’s parent company could increase its stake in Colgate with a view to either invest in India’s long-term growth story or expand the Palmolive-branded portfolio of the company.

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Colgate Palmolive

Ambit Capital Pvt Ltd 131

Catalysts

Things to watch out for over the next six months

Volume growth coming under pressure: Higher penetration level (of 84%) in oral care is likely to lead to volume growth tapering lower to single digits from the current 10-12% levels.

Increasing competitive intensity to hit margins: Increasing competitive intensity from HUL and GSK in the premium market and from Dabur in the mass market is likely to impact margins, as the company undertakes higher A&P spends to protect its market share.

Ambit vs consensus

Exhibit 21: Ambit vs consensus

Ambit vs Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn) 36,501 36,091 1%

EBITDA (` mn) 7,185 7,790 -8%

Divergence since our forecasts assume a 120bps increase in advert spends to sales ratio over FY12-14 given rising competitive intensity.

EPS (`/share) 38.1 43.2 -12% Factor in higher tax rates, as the production from tax-free zones is at full capacity and incremental production is fully taxable

FY15E

Net Sales (` mn) 42,106 41,846 1% Divergence likely due to our expectation of market share gains of 20bps annually for Colgate

EBITDA (` mn) 8,415 9,126 -8% Factor in higher advertisement spends, as we expect competitive intensity to increase

EPS (`/share) 42.9 49.9 -14% Factor in higher tax rates, as the production from tax-free zones is at full capacity and incremental production is fully taxable

Source: Bloomberg, Ambit Capital research

Exhibit 22: Explanation for our forensic accounting scores on the first page

Segment Score Comments

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 very 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 downgraded by 6% for FY14 and FY15.

Source: Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 132

Balance sheet (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Shareholders' equity 136 136 136 136 136

Reserves & surpluses 3,705 4,218 4,760 5,165 5,435

Total networth 3,841 4,354 4,896 5,301 5,571

Debt 1 - - - -

Deferred tax liability (168) (121) (224) (224) (224)

Total liabilities 3,673 4,233 4,672 5,077 5,346

Gross block 5,798 6,132 7,851 9,851 11,351

Net block 2,550 2,544 3,826 5,200 5,966

CWIP 82 694 - 500 500

Investments 387 471 471 500 500

Cash & equivalents 3,951 3,098 4,288 2,877 2,995

Debtors 753 873 812 1,000 1,154

Inventory 1,537 2,177 1,853 2,500 2,884

Loans & advances 837 1,254 1,548 1,800 2,076

Other current assets 73 64 45 100 115

Total current assets 7,152 7,466 8,546 8,277 9,224

Current liabilities 5,916 5,870 7,177 8,200 9,459

Provisions 583 1,073 995 1,200 1,384

Total current liabilities 6,499 6,942 8,172 9,400 10,844

Net current assets 653 524 374 (1,123) (1,620)

Miscellaneous - - - - -

Total assets 3,673 4,233 4,672 5,077 5,346 Source: Company, Ambit Capital research

Income statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income 22,861 26,932 31,638 36,501 42,106

% growth 12.3% 17.8% 17.5% 15.4% 15.4%

Operating expenditure 17,715 21,147 25,070 29,316 33,691

EBITDA 5,146 5,785 6,568 7,185 8,415

% growth 3.3% 12.4% 13.5% 9.4% 17.1%

Depreciation 342 393 437 627 734

EBIT 4,803 5,392 6,131 6,558 7,681

Interest expenditure 16 15 - - -

Non-operating income 412 507 499 488 428

Adjusted PBT 5,199 5,884 6,630 7,046 8,109

Tax 1,174 1,419 1,663 1,867 2,271

Adjusted PAT/ Net profit 4,026 4,465 4,968 5,179 5,839

% growth -4.9% 10.9% 11.3% 4.3% 12.7%

Reported PAT / Net profit 4,026 4,465 4,968 5,179 5,839

Adjusted Consolidated net profit 4,026 4,465 4,968 5,179 5,839

Reported Consolidated net profit 4,026 4,465 4,968 5,179 5,839 Source: Company, Ambit Capital research

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Colgate Palmolive

Ambit Capital Pvt Ltd 133

Cash flow statement (` mn)

Year to March FY11 FY12 FY13E FY14E FY15E

EBIT 5,216 5,899 6,630 7,046 8,109

Depreciation 342 393 437 627 734

Others (6) 32 (103) - -

Tax (1,174) (1,419) (1,663) (1,867) (2,271)

(Incr) / decr in net working capital 210 (724) 1,339 86 614

Cash flow from operations 4,588 4,181 6,641 5,892 7,186

Capex (444) (999) (1,025) (2,500) (1,500)

(Incr) / decr in investments (177) (84) 0 (29) -

Cash flow from investments (621) (1,082) (1,025) (2,529) (1,500)

Net borrowings (45) (1) - - -

Interest paid (16) (15) - - -

Dividend paid (3,489) (3,951) (4,296) (4,774) (5,569)

Others 59 15 (129) - -

Cash flow from financing (3,492) (3,952) (4,425) (4,774) (5,569)

Net change in cash 476 (853) 1,190 (1,411) 117

Closing cash balance 3,951 3,098 4,288 2,877 2,995

Free cash flow 4,145 3,182 5,615 3,392 5,686 Source: Company, Ambit Capital research

Ratio analysis

Year to March FY11 FY12 FY13 FY14E FY15E

Gross margin (%) 61.9% 61.0% 60.5% 60.7% 60.9%

EBITDA margin (%) 22.5% 21.5% 20.8% 19.7% 20.0%

EBIT margin(%) 22.8% 21.9% 21.0% 19.3% 19.3%

Net profit margin (%) 17.6% 16.6% 15.7% 14.2% 13.9%

Dividend payout ratio (%) 86.7% 88.5% 86.5% 92.2% 95.4%

Net debt: equity (x) (1.0) (0.7) (0.9) (0.5) (0.5)

Working capital turnover (x) (6.9) (10.5) (8.1) (9.1) (9.1)

Gross block turnover (x) 3.9 4.4 4.0 3.7 3.7

RoCE (%) 118.8% 113.2% 111.6% 106.3% 112.0%

RoE (%) 113.4% 109.0% 107.4% 101.6% 107.4%Source: Company, Ambit Capital research

Valuation parameters

Year to March FY11 FY12 FY13 FY14E FY15E

EPS (`) 29.6 32.8 36.5 38.1 42.9

Diluted EPS (`) 29.6 32.8 36.5 38.1 42.9

Book value per share (`) 28.2 32.0 36.0 39.0 41.0

Dividend per share (`) 22.0 25.0 27.0 30.0 35.0

P/E (x) 49.0 44.2 39.7 38.1 33.8

P/BV (x) 51.4 45.3 40.3 37.2 35.4

EV/EBITDA (x) 37.6 33.6 29.4 27.1 23.1

Price/Sales (x) 8.6 7.3 6.2 5.4 4.7 Source: Company, Ambit Capital research

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Consumer Goods June 04, 2013

Marico Bloomberg: MRCO IN EQUITY Reuters: MRCO.NS

Accounting: AMBER Predictability: AMBER Earnings momentum: RED

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.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13E FY14E FY15E

Operating income (` mn) 31,350 40,083 45,962 48,587 55,255 EBITDA(` mn) 4,181 4,844 6,258 7,297 8,354 EBITDA Margin (%) 13.3% 12.1% 13.6% 15.0% 15.1% Adjusted PAT(` mn) 2,864 3,171 3,959 4,589 5,578 Adjusted EPS (`) 3.9 5.2 5.6 7.1 8.7 RoE (%) 30.3% 31.0% 23.2% 22.0% 23.4% P/E (x) 60.7 45.2 41.7 33.0 27.1

Source: Company, Ambit Capital research

INITIATING COVERAGE

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

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `234

Target Price (Mar’14): `198

Previous TP: NA

Downside (%) 16%

EPS (FY14E): `7.1 Change from previous (%) NA

Variance from consensus (%) -4%

Stock Information

Mkt cap: `151bn/US$2,647mn

52-wk H/L: `252/165

3M ADV: `55mn/US$1.0mn

Beta: 0.45x

BSE Sensex: 19,160

Nifty: 5,939

Stock Performance (%)

1M 3M 12M YTD

Absolute 8 7 38 7

Rel. to Sensex 8 3 15 6

Performance (%)

15,000

17,000

19,000

21,000

Jun-12 Oct-12 Jan-13 M ay-13

160

200

240

Sensex M arico

1-year forward P/E band chart

406080

100120140160180200220240

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10

Jan-

11M

ay-1

1

Sep-

11

Jan-

12M

ay-1

2

Sep-

12

Jan-

13M

ay-1

3

16x

32x

28x

24x

20x

Source: Bloomberg, Ambit Capital research

On a slippery slope Marico’s moderation in volume growth in both the coconut oils as well as edible oils segment is likely to continue going forward. Weak copra prices will continue to favour unorganised coconut oil players, thereby hampering the growth prospects of organised players. Also, a ~100% price premium of safflower oil over sunflower oil will keep Saffola at a disadvantage to Agro Tech’s Sundrop. Price cuts and higher advertising spends will put pressure on margins. With an unimpressive track record of managing international expansion in the past, Marico’s intended capital allocation towards becoming an ‘emerging market MNC’ is a substantial risk to future earnings. Execution-related issues in its MENA business and portfolio constraints in Bangladesh will continue to be a drag in FY14. We initiate coverage with a SELL stance.

Competitive position: MODERATE Change to this position: STABLE

Whilst the management has targeted double-digit volume growth from FY14 onwards, we expect only 13.9% revenue CAGR over FY13-16 driven by:

Coconut oils – high penetration, competition from unorganised market: Despite gross margin benefits from the 30-40% decline in copra prices over the past 18 months, intense competition from unorganised coconut oil players has constrained the growth in the organised market. Although market share gains from organised peers are likely due to recent price cuts and rise in advert spends to sales ratio, we expect Marico to record 11% revenue CAGR over FY13-15 in the coconut oils segment with pressure on EBITDA margins.

Edible oils – rising competition and adverse commodity price trends: Assuming no change in commodity prices from the current levels, we expect Saffola to face headwinds from: (a) ~100% higher raw material cost as compared to sunflower-based oils like Sundrop; (b) the recent increase in competitive intensity from rice-bran-based oil brand Fortune; and (c) drag on gross margins from ~2% price cuts undertaken recently.

Capital allocation risks: Based on our discussions with the management, Marico is targeting M&A in countries like Indonesia and Africa to become an emerging market MNC. This could be a significant risk to earnings growth given its historical track record of generating incremental returns through M&As and international expansions. Also, lack of execution capabilities around re-packaging of its hair cream portfolio in the MENA region and portfolio-related constraints around market share gains in Bangladesh are likely to continue to be a drag on performance in FY14.

Valuation: Given the correlation between commodity prices and volume growth of the coconut hair oil and premium edible oil segments, and given the uncertainty around growth prospects of international operations, we do not regard Marico to be as defensive as its peers in the broader FMCG sector. Our DCF-based valuation generates a TP of `198/share (including `6/share for Kaya), a 16% downside and an implied FY14 P/E multiple of 27.8x.

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Marico

Ambit Capital Pvt Ltd 135

Company Financial Snapshot

Profit and Loss (` mn) FY13 FY14E FY15E Net sales 45,962 48,587 55,255 Optg. Exp(Adj for OI.) 39,704 41,290 46,901 EBITDA 6,258 7,297 8,354 Depreciation 866 969 962 Interest Expense 580 500 276 PBT 5,187 6,212 7,543 Tax 1,462 1,553 1,886 Adj. PAT 3,959 4,589 5,578 Profit and Loss Ratios EBIDTA Margin % 13.6% 15.0% 15.1% Adj Net Margin % 7.9% 9.4% 10.1% P/E (X) 41.7 33.0 27.1 EV/EBIDTA (X) 25.0 21.0 17.9 Dividend Yield (%) 0.4% 0.5% 0.6%

Company Background

Marico is a consumer products and services company in thebeauty and wellness space. The company is promoted by the Mariwalas (62.8% stake) and is the leading hair oil manufacturer in India.

Marico has a presence in more than 25 countries across Asia and Africa. The company recorded revenues of `40bn in FY12(of which 24% was from the overseas businesses).

Marico has a presence in the hair care, skin care and edible oils segments. Its portfolio includes brands such as Parachute,Saffola, Hair & Care, Nihar, Mediker, Revive and Manjal.

Balance Sheet (consolidated) (` mn)

FY13 FY14E FY15E Total Assets 37,072 35,302 38,672 Net Fixed Assets 18,180 17,460 17,698 Current Assets 17,376 16,325 19,458 Other Assets 1,516 1,516 1,516 Total Liabilities 37,072 35,302 38,672 Net worth 19,815 21,860 25,828 Debt 8,258 5,015 2,795 Current Liabilities 8,941 8,369 9,991 Deferred Tax 58 58 58 Balance Sheet Ratios ROE % 23.2% 22.0% 23.4% ROCE % 17.1% 18.0% 20.8% Net Debt/Equity 0.3 0.1 (0.0) Equity/Total Assets 0.7 0.8 0.9 P/BV (X) 7.3 6.6 5.6

Cash Flow (consolidated) (` mn) FY13E FY14E FY15E PBT 5,187 6,212 7,543 Depreciation 866 969 962 Tax (1,462) (1,553) (1,886) Change in Wkg Cap (201) 395 (531) Others 285 (0) 0 CF from Operations 4,675 6,024 6,089 Capex (10,072) (1,000) (1,200) Investments 1,440 - - CF from Investing (8,632) (1,000) (1,200) Change in Equity - - - Debt 278 (3,313) (2,300) Dividends (752) (902) (1,128) Others 5,510 (1,642) (482) CF from Financing 5,036 (5,857) (3,910) Change in Cash 1,079 (83) 979

Volume growth trends for Marico Market share trends for Marico’s portfolio (%)

2%4%

6%8%

10%12%14%

16%18%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

Parachute Saffola Overall volumes

50

52

54

56

58

60

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

2021222324

25262728

Coconut Oils Saffola Hair Oils (RHS)

Source: Company, Ambit Capital research

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Marico

Ambit Capital Pvt Ltd 136

Company background Exhibit 1: Marico’s portfolio mix (FY13)

Category Key brands Key competitors % of domestic

turnover % of overall

turnover Estimated

FY13 growth*

Coconut Oils Parachute, Nihar uttam Dabur, KLF Nirmal 36% 26% 9%

Value-added hair oils Parachute advansed, Hair & care, Nihar Naturals

Dabur, Bajaj Corp, Emami

22% 16% 28%

Branded edible oils Saffola Agro Tech 21% 15% 12%

Skin care products Parachute advansed HUL, Beiersdorf, L'Oreal 1% 1% 48%

Foods Saffola Oats, Saffola muesli, Saffola Cholesterol Management, Saffola Arise

Kellogg, GSK Consumer, Quaker

5% 4% 7%

Deodorants Set Wet, Zatak HUL, Raymond, Mcnroe Consumer Products 2% 1% 20%

Hair gels Set Wet Gatsby, HUL 1% 1% 18%

Post wash conditioners Livon, Silk and Shine NA 2% 1% 17%

Skin Clinics Kaya VLCC, HUL NA 7% 20%

Others Mediker, Manjal, Revive NA 10% 4% NA

Source: Company, Ambit Capital research; Note: * The skin care range was launched in FY11 and growth in the foods category was on a small base; growth in deodorants, hair gels and post wash conditioners pertains to market growth (acquired in FY13)

In the past, Marico’s domestic business has predominantly been a combination of its coconut hair oil brand, Parachute, and premium edible oil brand, Saffola. Parachute, one of the strongest brands in the hair oil space, controls more than 55% of the coconut oil market and 25% of the value-added hair oil market. Saffola, on the other hand, controls ~58% market share in the premium edible oils market, and Sundrop is its key competitor.

Over the past six years, Marico has expanded outside India through acquisitions (except for Bangladesh and Middle East where it has expanded organically), as shown in the tables below.

Exhibit 2: Marico’s global portfolio

Region % of

turnover

% of international

revenues

Year of Expansion

Type Category

Bangladesh 9% 42% 2000 Greenfield Coconut Oil, Edible Oils, Soaps, Hair Colour

Middle East & North Africa

4% 20% Middle East – 1990s; North Africa – 2006

Middle East – Greenfield; North Africa – Acquisition in Egypt

Hair Care, Skin Care

South Africa 2% 10% 2007 Acquisition of Enaleni Pharma’s consumer division

Hair care, Healthcare

South East Asia

5% 24% 2011 Acquisition of International Consumer Products in Vietnam

Hair care, Foods, Home care

Source: Company, Ambit Capital research

Marico has built its global presence through six international acquisitions, with reasons varying from building an emerging market presence to strengthening its skin clinic portfolio. Marico is a market leader in hair oils in Bangladesh with 80% market share through the Parachute brand. It is currently looking to expand its product base in Bangladesh by diversifying its presence.

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Marico

Ambit Capital Pvt Ltd 137

Exhibit 3: Marico’s acquisitions since 2006

Company/Brand Year of acquisition Country of acquisition Category

Nihar 2006 India Coconut Oil

Manjal 2006 India Soaps

Hair Code and Fiancee 2006 Egypt Male grooming

Enaleni (Consumer Division) 2007 South Africa Hair care

Code 10 2010 Malaysia Male grooming

Derma Rx 2010 Singapore Skin care solutions

Ingwe 2010 South Africa OTC Health care

ICP (85%) 2011 Vietnam Male grooming

Halite (Paras) 2012 India Male grooming

Source: Company, Ambit Capital research

Exhibit 4: Volume growth trends for Marico

2%4%

6%8%

10%12%14%

16%18%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

Parachute Saffola Overall volumes

Source: Company, Ambit Capital research

Exhibit 5: Market share trends for Marico’s portfolio

50

52

54

56

58

60

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

2021

222324

2526

2728

Coconut Oils Saffola Hair Oils (RHS)

Source: Company, Ambit Capital research

Marico recently entered into the deodorant, hair oil and post wash hair conditioning space through the acquisition of the consumer business of the erstwhile Paras Pharmaceuticals from Reckitt Benckiser (with a turnover of `1.5bn in FY12). Marico has also recently organically extended into the oats and muesli categories through brand extensions of Saffola.

Exhibit 6: Newly acquired `1.5bn personal care portfolio

Category Market size

(` bn) Market Growth

Marico’s market Share

Key brands acquired

Key competitors

Post wash conditioners

1 15% 84% Livon NA

Deodorants 14 35% 6% Set wet, Zatak HUL, Raymond, Mcnroe Consumer Products

Hair gels 2 20% 36% Set wet Gatsby, HUL

Source: Company, Ambit Capital research.

Marico’s total distribution reach in India is around 4mn outlets and it has recorded a CAGR of around 10% over the past five years. Its direct reach accounts for around 1mn outlets.

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Marico

Ambit Capital Pvt Ltd 138

SWOT analysis

Exhibit 7: SWOT analysis for Marico

Strengths Weaknesses

Parachute’s strong brand equity has led to strong brand loyalty, with only a few consumers switching away from the brand.

Strong pricing power in hair oils (the company is the price maker). Prices increases taken by Marico in the past have not resulted in volume growth coming off.

Distribution reach of more than 4mn outlets of which the direct distribution reach stands at around 1mn outlets.

Diversified portfolio in foods, personal care and services. Hair oils which formed a dominant part of the portfolio earlier have now reduced to 40% of the overall portfolio, with a presence in foods, personal care and edible oils.

Marico has a working capital cycle of 51 days (in FY12) which is amongst the poorest in the FMCG space.

Its international portfolio has been a drag on the overall business with its Bangladesh portfolio (40% of international revenues) and MENA portfolio (25% of international revenues) struggling for growth.

Opportunities Threats

Can leverage its distribution network in its newly acquired personal care portfolio of the erstwhile Paras Pharmaceuticals.

Has a presence in high-growth aspirational categories like premium edible oils, breakfast foods and skincare. Whilst skin care has a market size of around `40bn, premium edible oils and breakfast foods are nascent categories with a market size of `10bn each.

Has the ability to extend the Parachute power brand to other categories (has already extended to skin care).

Still building a presence in packaged foods and skin care, segments in which it competes with MNCs with strong balance sheets.

High penetration levels (80% in urban, 67% in rural) in hair oils will likely see volume growth coming off at an industry level.

The company can be affected if the slowdown in packaged food growth sustains.

Source: Industry, Company, Ambit Capital research

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Marico

Ambit Capital Pvt Ltd 139

Domestic portfolio adversely affected by commodity prices and competition Of the three segments of Marico’s domestic product portfolio—coconut oils, value-added hair oils and premium edible oils—the only segment which has NOT seen a substantial moderation in revenue growth in the recent quarters has been value-added hair oils. As shown in the chart below, volume growth for both of Marico’s flagship brands—Parachute (coconut oil) and Saffola—have moderated substantially in FY13.

Exhibit 8: Parachute and Saffola - volume growth trends

2468

1012141618

4QFY

10

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

Parachute Volume Growth (%) Saffola Volume Growth (%)

Source: Company, Ambit Capital research

The factors driving the volume growth moderation in coconut oils and premium edible oils have been linked to the changes in their respective commodity prices over the past 12-24 months. Whilst a softening of copra prices has led to increase in competition from unorganised players, a rise in the commodity price of safflower oil as compared to sunflower and rice bran oil has led to Marico’s edible oils product portfolio being priced at a substantial disadvantage to its peers.

Coconut oils – drag from unorganised competition amidst softening commodity prices As highlighted previously in this note, anecdotal evidence suggests that the hair oils market in India has reached penetration levels of around 80% in the urban markets and around 67% in the rural markets. Around 65% of the overall coconut hair oil market in India is controlled by organised players, with Parachute controlling 58% of the organised market. Given that copra is the main raw material for coconut oil, input costs for coconut oil manufacturers have been significantly volatile in the past (refer to the charts below)

Exhibit 9: Copra prices have been volatile over the past two years

3,0003,5004,0004,5005,0005,5006,0006,5007,000

Jan-

08

Apr

-08

Aug

-08

Dec

-08

Mar

-09

Jul-

09

Nov

-09

Feb-

10

Jun-

10

Oct

-10

Jan-

11

May

-11

Aug

-11

Dec

-11

Apr

-12

Jul-

12

Nov

-12

Mar

-13

Copra Price (Rs/100Kg)

Source: Company, Ambit Capital research

Around 65% of the overall coconut hair oil market in India is controlled by organised players, with Parachute controlling 58% of the organised market.

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Marico

Ambit Capital Pvt Ltd 140

Organised competitors of Parachute (highlighted in the table below) do not possess as strong a brand recall or as wide a distribution network as that of Parachute. This has allowed Marico to gain substantial market share from its peers in the coconut oil segment over the past few years (refer to the chart below).

Exhibit 10: Market shares in the branded coconut oil market (FY12)

Brand Market Share

Parachute 58%

Shalimar 9%

VVD Coconut Oil 4%

Dabur Anmol 3%

Others 26%

Source: Company, Ambit Capital research

Exhibit 11: Parachute’s volume growth and market share

2

6

10

14

18

3QFY

10

4QFY

10

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

52

53

54

55

56

57

58

Volume growth Market share (RHS) Source: Company, Ambit Capital research; Note: Black shaded region indicates price increase taken during the quarter

However, weaker prices of copra (the raw material for coconut oil) leads to competition from unorganised players who bring the proposition of ‘freshly prepared oil’, thereby disincentivising consumers from switching over to branded coconut oils. This, as shown in the chart below, has led to a significant moderation in the overall growth rate for the coconut oil market despite continued market share gains and gross margin expansion for Parachute.

Exhibit 12: Industry volumes follow copra prices with a two-quarter lag

-20%-15%-10%-5%0%5%

10%15%20%25%30%35%

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

-5%

0%

5%

10%

15%

20%

Change in copra price (QoQ) Branded Coconut Oil Industry growth (RHS)

Source: Company, Ambit Capital research

In response to this increase in competitive intensity, Parachute has cut prices by 3-7% across various SKUs during Feb-Mar 2013. We expect these price cuts to have a drag of 100-150bps on Marico’s consolidated gross margins in FY14, with continued moderation in volume growth despite market share gains in the overall coconut oil segment.

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Ambit Capital Pvt Ltd 141

Exhibit 13: Marico’s coconut and value-added hair oil growth forecasts

Coconut oils

FY12 FY13E FY14E FY15E

Revenues 10,822 12,122 13,477 14,982

Market share 53.9% 55.9% 56.5% 57.1%

Marico growth 38% 12.0% 11.2% 11.2%

Market growth 10% 5% 10% 10%

Source: Ambit Capital research

Consequently, as highlighted in the table above, assuming that commodity prices remain unchanged going forward, we expect only 10% revenue CAGR for the market and 11% revenue CAGR for Marico’s coconut oil segment over FY13-15.

Saffola – adverse commodity fluctuations; rising competitive intensity from Adani Wilmar Sundrop has historically been the only competitor in the premium edible oils segment for Saffola. As shown in the chart below, Marico’s average volume growth rate in premium edible oils was at ~14% during FY11 and FY12. Whilst this momentum was driven by market share gains from Sundrop over this period, the segment has seen a trend reversal over the past 12 months, with a substantial moderation in volume growth for Marico to ~5% YoY in FY13.

Exhibit 14: Saffola volume growth and market share trends

2

5

8

11

14

17

20

1QFY

11

2QFY

11

3QFY

11

4QFY

11

1QFY

12

2QFY

12

3QFY

12

4QFY

12

1QFY

13

2QFY

13

3QFY

13

4QFY

13

50

52

54

56

58

60

Saffola Volume growth (%) Market Share (%) (RHS)

Source: Company, Ambit Capital research.

We view Saffola’s brand recall in the premium edible oils segment to be substantially superior to that of Sundrop, and we acknowledge the investments behind the Saffola brand by Marico including customer initiatives like ‘World Heart Day’ and ‘Heart Age Calculator’. However, we do not expect any incremental market share gains for Marico in the edible oils portfolio over the next five years due to:

Rising competitive intensity: With the aggressive pricing and advertising campaign by Adani Wilmar for its rice brand premium edible oils brand ‘Fortune’, competitive intensity in this segment has increased substantially over the past six months.

At a disadvantage vs competition on input costs: With the widening price gap between sunflower oil and safflower oil over the past five quarters, and price cuts by manufacturers of sunflower-based edible oils, there has been a significant moderation in the rate of market share gains for Saffola over Sundrop. Whilst Marico has reduced its product prices by 2-3% on average across the edible oils portfolio in Feb-Mar 2013, this is not likely to materially benefit Marico’s volume growth in this segment until safflower prices soften materially from the current levels.

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Marico

Ambit Capital Pvt Ltd 142

Exhibit 15: Premium of safflower oil (kardi oil) over sunflower oil

-10%

10%

30%

50%

70%

90%

110%

Nov

-10

Jan-

11

Mar

-11

May

-11

Jul-

11

Sep-

11

Nov

-11

Jan-

12

Mar

-12

May

-12

Jul-

12

Sep-

12

Nov

-12

Jan-

13

Mar

-13

Premium of Kardi Oil over Sunflower Oil

Source: Company, Ambit Capital research

Exhibit 16: Marico’s Saffola - growth forecasts

FY12 FY13E FY14E FY15E

Revenues 6,012 6,704 7,642 8,712

Market Share 58.0% 58.0% 58.0% 58.0%

Market Growth 5% 12% 14% 14%

Saffola growth 28% 12% 14% 14%

Source: Ambit Capital research

Value-added hair oils – benefitting from strong category growth Value-added hair oils, which contributed to 16% of overall revenues for Marico in FY13, is the only area of strong growth momentum in Marico’s domestic portfolio with strong revenue growth reported over the past three years. This growth momentum, we believe, is driven by a combination of: (a) premiumisation towards value-added hair oils in the fully penetrated hair oils category; and (b) Marico’s ability to leverage on Parachute’s strong brand recall through its brand extensions. However, we do not expect the value-added hair oils segment to be a significant driver of earnings growth for Marico because: (a) the company makes substantially weak margins in this segment as compared to the rest of its domestic product portfolio; and (b) competitive intensity is substantially high with significant aggression from peers like Emami, Bajaj Corp and Dabur in this segment.

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Marico

Ambit Capital Pvt Ltd 143

Capital allocation risks and the drag from international businesses Marico’s dividend payout ratio has reduced from more than 50% until FY07 to ~20% currently. This retained cash flow has been predominantly deployed towards the expansion of the international portfolio. As highlighted previously in our capital allocation section of the note, Marico’s capital allocation towards non-core/international businesses in the past has not generated significant incremental returns relative to the corresponding capital investments behind these initiatives.

Revenue growth from Marico’s international operations has moderated from 18% (organic) in FY12 to 5% in FY13E, as shown in the chart below. Marico’s South-East Asian business has reported strong growth over the past two years. Whilst the company’s South African business had reported a temporary drag from the transporters’ strike in 2QFY13, other geographies including Bangladesh and the MENA region have reported weakness related largely to company specific factors, which we believe are unlikely to be shortly resolved.

Exhibit 17: International business has been a drag in FY13

% of FY12 revenues

FY12 FY13E FY14E

Bangladesh 9.6% 11% 0% 10%

Middle East and North Africa 6.0% 35% 1% 9%

South Africa 2.4% ~10% 10% 10%

South East Asia 6.0% NA 15% 13%

Source: Company, Ambit Capital research

Bangladesh Marico’s Bangladesh business relates almost entirely to Parachute branded hair oils. Underperformance in the Bangladesh business over the past two years is related to:

Market-share-related limitations: Marico’s market share in the coconut oil segment has increased from ~70% 12 months ago to ~80% currently. Consequently, there is a limited potential to gain further market share for Marico in Bangladesh’s coconut oil market.

Overall moderation in consumption growth for the country? Our discussion with the management suggests that Bangladesh has seen high inflation in FY12 and FY13 (10.6% and 7.6% respectively) along with a moderation in GDP growth from 6.7% in FY11 to 6.3% in FY12. However, players like Reckitt Benckiser have reported a revival in growth in CY12, with 13% YoY growth in 9MCY12 and 4% YoY growth in CY11.

Other external factors: Factors such as strikes during 3QFY13 have also contributed to the weak performance.

In response to the market-share-related limitations in the coconut oil segment, Marico is currently investing in advertising and R&D in the value-added hair oils and hair dyes segments and the contribution from coconut oil has reduced to to 90% from 100% over the past two years. Whilst we expect factors such as strikes to be temporary, we expect the drag on revenues related to portfolio constraints and consumption spends to sustain at least over the next few years.

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Marico

Ambit Capital Pvt Ltd 144

MENA region Marico’s operations in the Middle East have been a drag, owing to:

Packaging changes: Marico introduced certain packaging-related changes in its hair cream in 2QFY13, with the intention to make it more attractive as well as cost efficient. However, due to a lack of good-quality execution of this re-packaging initiative, consumer response to the hair cream was significantly poor than the company’s expectation.

Distribution restructuring: Marico has also undertaken distribution restructuring initiatives in FY13 in certain MENA markets which has led to lower off-take of sales and inventory pipeline reduction in the distribution channel.

These factors of underperformance are related specifically to Marico’s execution of strategy, and thus we do not expect the business to show a rapid turnaround in a short period of time.

Kaya and the impact from its demerger We believe the management’s recent announcement to demerge the Kaya business from Marico into a separate listed entity (owned by the shareholders of Marico) is likely to marginally benefit shareholders of Marico because: (1) it removes the drag on net profit that Kaya brought to Marico’s consolidated accounts; (2) it positively impacts EBITDA margins and return ratios, as it reduces the capital employed in the core Marico business (its FY12 RoCE would rise by 410bps from 23.3% to 27.4% if the Kaya business were to be excluded); (3) it gives investors the option of separately investing in the non-core Kaya business; and (4) it is value accretive for shareholders, as the drag on net profit (because it was making losses) will be given a positive value when the Kaya business is listed separately. We estimate the drag on EBIT margin to be 160bps in FY12.

Valuation of Kaya: Based on an assumed valuation of 1.0x revenue (lower than Marico’s 2.8x FY14 revenues, given that the business is loss making), we estimate Kaya’s valuation to be `6/share for existing shareholders of Marico.

Exhibit 18: Impact of the Kaya business demerger on Marico (` mn)

Marico (ex-Kaya) Kaya Marico (incl Kaya)

Revenues 37,293 2,790 40,083

EBIT 4,735 (291) 4,444

EBIT Margin (%) 12.7 (10.4) 11.1

Capital Employed 17,252 1,807 19,059

ROCE (%) 27.4 (16.1) 23.3

Source: Company, Ambit Capital research

Capital allocation strategy going forward Our recent discussions with the management team indicate that the company intends to focus initially on increasing the volume growth of its Indian portfolio into double digits, following which the firm is likely to focus on capital allocation towards M&A in countries like Indonesia and Africa with the intent to evolve as an emerging market MNC in the future.

Given the track record of generating returns on capital retained and deployed towards M&A so far, we see this as a substantial long-term risk on Marico’s earnings growth potential.

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Marico

Ambit Capital Pvt Ltd 145

Key assumptions Exhibit 19: Key assumptions and estimates for Marico’s revenues

Contribution to revenues

FY13E FY14E FY15E Comments

Domestic business

Coconut Oils growth 27.0% 9.0% 11.1% 11.1%

Industry growth 2.4% 10.0% 10.0%

Market share change growth 6.6% 1.1% 1.1%

High penetration levels and slowdown in discretionary spending is likely to affect overall market growth for coconut oils. However, market share gains are likely to continue on the back of the strong brand

Value added hair oils growth

17.4% 28.3% 17.7% 17.7%

Industry growth 14.5% 16.0% 16.0%

Market share change growth 13.8% 1.7% 1.7%

Expect premiumisation to continue aggressively benefiting the 'Parachute advansed' portfolio. Expect market share gains for Parachute on the back of strong brands, wide portfolio and aggressive pricing in segments where they are not market leaders

Saffola edible oils growth

15.7% 11.5% 14.0% 14.0%

Industry growth 11.5% 14.0% 14.0%

Market share change growth 0.0% 0.0% 0.0%

With the discretionary segment continuing to be under pressure, the market growth is likely to be below historical levels. Expect the rate of market share gains to come off its historical levels as raw material inflation restricts its ability on pricing

Skin care growth 1.1% 48.4% 31.4% 22.2%

Industry growth 6.0% 15.0% 15.0%

Market share change growth 42.4% 16.4% 7.2%

Gains here likely to be driven by increasing its distribution and the high growth is a function of the low base it enjoys

Saffola Foods growth 4.2% 7.1% 26.5% 26.5%

Industry growth 2.0% 15.0% 15.0%

Market share change growth 5.1% 11.5% 11.5%

Whilst its rice and atta offerings have not met with success, the growth is likely to be led by its launches in the oats and muesli segment where it has already captured around 12% market share

Others 7.2% 2.8% 10.0% 10.0% Includes brands like Mediker, Manjal, Oil of Malabar and Revive which are not focus areas for Marico

Deodorants growth 1.8% 17.7% 17.0% 17.0%

Industry growth 28.0% 25.0% 25.0%

Market share change growth -10.3% -8.0% -8.0%

Strong competitive intensity is likely to affect market share as brands like Park Avenue and Wildstone have started gaining share

Hair gels growth 1.4% 17.7% 17.0% 17.0%

Industry growth 16.0% 16.0% 16.0%

Market share change growth 1.7% 1.0% 1.0%

Expect low market share gains for the segment as the company sees the benefit of leveraging its distribution over the acquired distribution

Post wash conditioner growth

1.6% 17.3% 17.3% 14.4%

Industry growth 18.0% 18.0% 15.0%

Market share change growth -0.7% -0.7% -0.6%

With almost 90% market share, the company is likely to expand slower than the market as it faces market share related restrictions with increasing competition from L'Oreal

Total domestic business

77.5% 17.6% 15.8% 14.6%

International business

Bangladesh growth 9.6% 10.0% 10.0% 10.0%

Market growth 12.0% 12.0% 12.0%

Market share related growth -2.0% -2.0% -2.0%

Do not expect the issues in Bangladesh, both macro and internal, to be resolved immediately and expect the growth to be below the market

MENA growth 4.1% -16.2% -1.0% 9.0%

Market growth 9.0% 9.0% 9.0%

Market share related growth -25.2% -10.0% 0.0%

Whilst the market holds strong potential, Marico's execution in the region has been poor. Do not expect above market growth until the company can establish sustained execution capabilities

South Africa growth 2.3% 4.8% 10.2% 10.2%

Market growth 6.2% 6.2% 6.2%

Market share related growth -1.4% 4.0% 4.0%

Whilst the business has seen disruptions, expect around 10% sustainable growth as the company holds a strong premium hair care portfolio

South East Asia growth 5.6% 0.6% 13.0% 13.0%

Market growth 10.0% 10.0% 10.0%

Market share related growth -9.4% 3.0% 3.0%

The company has seen strong growth in its South East Asian business as its market-leading hair care brands have seen market share gains, one of Marico's most successful acquisitions yet

Total international business 21.9% 22.5% 21.9%

Total revenue growth 14.7% 14.4% 14.5%

Source: Ambit Capital research

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Marico

Ambit Capital Pvt Ltd 146

Exhibit 20: Key assumptions and estimates [` mn]

FY12 FY13E FY14E FY15E Comments

Profit and loss

Domestic revenues 27,657 32,527 37,651 43,161

Growth (%) 37.0% 17.6% 15.8% 14.6%

Expect growth to be driven by value-added hair oils and the new personal care business

International revenues 9,620 10,076 10,936 12,094

Growth (%) 30.0% 4.7% 8.5% 10.6%

Expect South East Asia business to expand fastest at 15% and recovery in Bangladesh business (CAGR of 12% over FY12-15)

Kaya 2,790 3,360 3,994 4,971

Growth (%) 16.7% 20.4% 18.9% 24.4%

Expect same-store growth of 15% and addition of ten stores in FY14 and FY15 each

Total revenues 40,083 45,962 48,587 55,255

Growth (%) 27.9% 14.7% 5.7% 13.7%

Gross Profit 19,096 23,863 25,080 28,632

Gross margin (%) 47.6% 51.9% 51.6% 51.8%

Expect mix benefit led by premiumisation, changing business mix and reversal of exceptionally low raw material costs in FY13

Employee cost (% of sale) 7.7% 8.3% 7.2% 7.2% Expect marginal benefit due to scale advantages

Advertising (% of sale) 11.2% 13.0% 12.8% 12.9% Expect advertising spends to rise led by changing portfolio mix

Carriage & freight (% of sale) 4.2% 4.2% 4.2% 4.2% Expect carriage and freight expenses to remain stable

Other expenses (% of sale) 12.5% 20.4% 12.4% 12.4% Expect other expenses to remain stable

EBITDA 4,844 6,258 7,297 8,354

EBITDA Margin 12.1% 13.6% 15.0% 15.1%

Expect improvement in EBITDA margins led by the above changes

Tax rate 19.5% 28.2% 25.0% 25.0% Expect tax rates to rise as the proportion of fully taxable hair oils rises and tax holidays expire

Net Profit margin 8.0% 7.9% 9.4% 10.1% Lower interest costs and slower depreciation growth to help net profit margins

Balance Sheet

Capex 1,400 10,072 1,000 1,200

Capital Work in Progress 94 94 94 94 No material capex requirements in FY14 and FY15

Working Capital days 51 46 40 39 Expect working capital days to remain stable

Debtor days 17 16 18 18 Expect debtor days to rise as the proportion of modern trade increases

Current Liabilities days 53 52 61 56 Expect stable current liabilities days

Inventory days 66 69 66 55 Expect improvement in inventory days as FY13 will hold higher stock due to lower raw material prices

Net debt/(cash) to equity 0.5 0.3 0.1 (0.0) Expect Marico to turn into a net cash company in FY15

Cash flows (` mn)

Operating cash flows 3,103 4,675 6,024 6,089

Free cash flows 1,937 (5,397) 5,774 4,889

Strong growth in free cash flows as capex requirements are low

Source: Ambit Capital research

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Marico

Ambit Capital Pvt Ltd 147

Valuation

DCF-based valuation

Given the cash-generative nature of the business, we use a DCF-based model to arrive at a fair value for Marico. The assumptions for the weighted average cost of capital and terminal growth rates are shown in the exhibit below. We have assumed marginal debt (debt:equity of 0.1) on Marico’s balance sheet in the future given its strong cash position and free cash flow generative business. Hence, the company has enough surplus cash available on its balance sheet for capital expenditure in the future.

We use a three-stage DCF approach for Marico. Stage 1 includes explicit forecasts for the income statement and balance sheet for the next four years (FY14-18) with sales CAGR of 14% (adjusted for the Kaya de-merger) and EPS CAGR of 20%. Stage 2 includes a decline in sales growth over eight years from 14% in FY19 to 7% in FY26 i.e. sales CAGR of 10% and free cash flow CAGR of 9% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

The discount rate assumptions used in our DCF model are shown in the exhibit below. Our model generates a target price of `198/share (including `6/share for the to-be-demerged Kaya business, based on 1x revenues), a 16% downside and implying an FY14 P/E multiple of 27.6x.

The cash flow and return profiles generated by our model are shown in the exhibits below:

Exhibit 22: Cash flow profiles for Marico (` mn)

(5,400)

(3,400)

(1,400)

600

2,600

4,600

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

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

Source: Ambit Capital research; Note: FY14 cash flows reflect the impact of the Kaya demerger

Exhibit 23: Return profiles for Marico (%)

0%

10%

20%

30%

40%

50%

60%

70%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

E

FY15

E

-10%

0%

10%

20%

30%

40%

50%

60%

ROE (LHS) EBITDA MarginEPS Growth YoY Growth in sales

Source: Ambit Capital research

Relative valuation As highlighted previously in this note, our analysis of Marico’s capital deployment over the past decade suggests a sub-par performance with a likelihood of increased M&A activity by the company as it targets to expand into an emerging market MNC. Moreover, as explained in the earlier sections of this note, the company is likely to face increasing downward pressure on gross margins both for its Parachute as well as Saffola franchises owing to recent product price cuts.

As shown in the chart below, over the past 12 months, Marico has been re-rated (in line with the re-rating of the broader FMCG sector) by 25-30% from 24.0x one-

Exhibit 21: WACC calculation for DCF on Marico Item Value

Risk free rate (%) 8.5

Beta (2-year monthly) 0.55

Equity risk premium (%) 7.0

Cost of equity (%) 12.4

Cost of debt (%) 10.0

Debt/Equity ratio (%) 10.0

Tax rate (%) 30.0

WACC (%) 12.0

Source: Company, Ambit Capital research

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year forward P/E multiple to 33.0x FY14 P/E multiple currently. As a result, the stock currently trades at a ~35% premium to its three-year historical average trading multiple.

Exhibit 24: 1-year forward P/E bands for Marico

406080

100120140160180200220240

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

16x

32x

28x

24x

20x

Source: Bloomberg, Ambit Capital research

Exhibit 25: 1-year forward EV/EBITDA bands for Marico

406080

100120140160180200220240

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

Sep-

12Ja

n-13

May

-13

12x

14x

16x

18x20x

Source: Bloomberg, Ambit Capital research

Given the correlation between commodity prices and volume growth prospects of the coconut hair oil and premium edible oil segments, and given the uncertainty around the growth prospects of the international operations including Bangladesh and MENA regions, we do not regard Marico to be as defensive as its peers in the broader FMCG sector.

Consequently, we expect the relative valuation multiples of the stock to reflect an overhang from a disadvantaged positioning given the current commodity prices and drag from the international subsidiaries on growth.

Exhibit 26: Sensitivity analysis

Bull case Base case Bear case

Revenue growth

Expect revenue growth of 17% over FY13-23 driven by strong market share gains across categories and a recovery in the international business led by Bangladesh. Our terminal growth rate assumption stands at 6%

Expect revenue growth of 14% over FY13-23 led by strong growth (~16%) in the value-added hair oils segment. Expect the coconut oil and international business to record around 10% CAGR. Our terminal growth rate assumption stands at 5%

Assume a revenue growth of 12% over FY13-23 driven by no market share gains and around 15% growth in the value-added hair oils segment and around 9% growth in the hair oils segment and the international business. Our terminal growth rate assumption stands at 4%

Operating margins

We assume EBITDA margin expansion of 120bps from 14.7% in FY14 to 15.9% in FY17 led by higher benefit from premiumisation (90bps) and lower advertisement spends lower by 30bps

Expect EBITDA margins to expand by 50bps over FY14-18 to 15%, with 80bps gross margin expansion to be partially offset by increases in advertising spends.

Expect EBITDA margins to decline 30bps from 14.7% in FY14 to 14.4% in FY17 led by higher advertising expenditure due to high competitive intensity and no benefit from premiumisation led gross margin expansion

Fair value (`/share) 248 198 144

Upside/Downside 6% -16% -39%

Source: Ambit Capital research

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Risks to our SELL stance Reversal of commodity price movements: A combination of a significant

increase in copra prices and a significant reduction in safflower prices is likely to lead to a volume growth revival for the organised coconut oil segment and a gross margin revival for the Saffola portfolio.

Valuation of Marico’s Kaya business on listing: In case the company is successful at listing its Kaya business later this year at a significant premium to our current expectations, then the benefits for Marico’s current shareholders from this demerger would be more than what we have priced in.

Catalysts

Things to watch out for over the next 6 months

Volume growth under pressure: We expect volume growth for both Saffola and Parachute Coconut Oil to be under pressure owing to: (1) subdued discretionary consumption growth; (2) increasing penetration in the coconut hair oil segment; and (3) unfavourable movement of raw material prices.

Rising raw material costs to impact gross margins: With raw material prices for both copra and safflower increasing, the gross margin benefit that Marico enjoyed through FY13 is likely to reverse. As competitor pricing still remains aggressive, it will be a challenge for Marico to pass on prices to the consumers.

Ambit vs consensus

Exhibit 27: Ambit vs consensus

Ambit vs Consensus Ambit Consensus Divergence from consensus Comments

FY14E

Net Sales (` mn) 48,587 52,208 -7% We factor in the demerger of the Kaya business in our numbers and we expect a decline in volume growth in the coconut oil and Saffola business

EBITDA (` mn) 7,297 7,334 -1% Expect EBITDA margin expansion of 60bps in FY14 led by the Kaya demerger and 10bps in FY15 led by the net effect of gross margin expansion and increased advertisement spends

EPS (`/share) 7.1 7.4 -4% Expect tax rates to stay at elevated levels (25%) as we expect the Saffola business (tax-exempt) to remain under pressure in FY14

FY15E

Net Sales (` mn) 55,255 60,534 -9% Variation from consensus due to a combination of the Kaya demerger and lower volume growth expectations for Saffola and Parachute coconut oil.

EBITDA (` mn) 8,354 8,589 -3% Expect 10bps EBITDA margin expansion led by the net effect of gross margin expansion and increased advertisement spends

EPS (`/share) 8.7 9.0 -3% Expect tax rates to stay at elevated levels (25%) as we expect the Saffola business (tax-exempt) to remain under pressure

Source: Bloomberg, Ambit Capital research

Exhibit 28: Explanation for our forensic accounting scores on the first page

Segment Score Comments

Accounting AMBER In the past, Marico has reported strong cash conversion, management of working capital and low levels of loans and advances, but it still stands 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 past six months, consensus estimates have been downgraded by 8% for FY14 and FY15.

Source: Ambit Capital research

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Balance sheet (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Shareholders' equity 614 615 645 645 645

Reserves & surpluses 8,540 10,815 19,170 21,215 25,183

Total net worth 9,155 11,430 19,815 21,860 25,828

Minority Interest 219 249 351 421 501

Debt 7,224 7,629 7,907 4,594 2,294

Deferred tax liability (299) (223) 58 58 58

Total liabilities 16,299 19,084 28,131 26,933 28,681

Gross block 7,615 9,015 19,087 19,337 20,537

Net block 4,250 4,924 14,130 13,411 13,649

CWIP 328 94 94 94 94

Goodwill 3,976 3,955 3,955 3,955 3,955

Investments 889 2,956 1,516 1,516 1,516

Cash & equivalents 2,206 1,588 2,667 2,584 3,563

Debtors 1,779 1,816 1,966 2,346 2,725

Inventory 6,011 7,202 8,627 7,286 8,326

Loans & advances 1,556 1,995 2,555 2,562 3,028

Other current assets 1,038 1,416 1,562 1,547 1,817

Total current assets 12,590 14,017 17,376 16,325 19,458

Current liabilities 4,537 5,665 7,727 7,004 8,326

Provisions 1,197 1,197 1,214 1,364 1,665

Total current liabilities 5,734 6,862 8,941 8,369 9,991

Net current assets 6,856 7,155 8,435 7,957 9,467

Total assets 16,299 19,084 28,131 26,933 28,681 Source: Company, Ambit Capital research

Income statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

Operating income 31,350 40,083 45,962 48,587 55,255

% growth 17.8% 27.9% 14.7% 5.7% 13.7%

Operating expenditure 27,169 35,239 39,704 41,290 46,901

EBITDA 4,181 4,844 6,258 7,297 8,354

% growth 11.5% 15.8% 29.2% 16.6% 14.5%

Depreciation 708 725 866 969 962

EBIT 3,473 4,118 5,392 6,328 7,391

Interest expenditure 410 424 580 500 276

Non-operating income 212 326 375 384 428

Adjusted PBT 3,275 4,020 5,187 6,212 7,543

Tax 850 783 1,462 1,553 1,886

Adjusted PAT/ Net profit 2,425 3,238 3,725 4,659 5,658

% growth -0.3% 33.5% 15.0% 25.1% 21.4%

Extraordinaries 489 (18) 332 - -

Reported PAT / Net profit 2,914 3,220 4,057 4,659 5,658

Minority Interest 50 50 98 70 80

Share of associates - - - - -

Adjusted Consolidated net profit 2,864 3,171 3,959 4,589 5,578

Reported Consolidated net profit 2,864 3,171 3,959 4,589 5,578 Source: Company, Ambit Capital research

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Cash flow statement (` mn)

Year to March FY11 FY12 FY13 FY14E FY15E

EBIT 3,685 4,444 5,767 6,712 7,819

Depreciation 708 725 866 969 962

Others (49) (368) (295) (500) (276)

Tax (850) (783) (1,462) (1,553) (1,886)

(Incr) / decr in net working capital (932) (916) (201) 395 (531)

Cash flow from operations 2,562 3,103 4,675 6,024 6,089

Capex (1,289) (1,166) (10,072) (1,000) (1,200)

(Incr) / decr in investments (3,188) (2,046) 1,440 - -

Others - - - - -

Cash flow from investments (4,477) (3,212) (8,632) (250) (1,200)

Net borrowings 2,765 405 278 (3,313) (2,300)

Interest paid (410) (424) (580) (500) (276)

Dividend paid (472) (501) (752) (902) (1,128)

Others 1,122 12 6,090 (1,142) (206)

Cash flow from financing 3,005 (509) 5,036 (5,857) (3,910)

Net change in cash 1,091 (618) 1,079 (83) 979

Closing cash balance 2,206 1,588 2,667 2,584 3,563

Free cash flow 1,273 1,937 (5,397) 5,774 4,889 Source: Company, Ambit Capital research

Ratio analysis

Year to March FY11 FY12 FY13 FY14E FY15E

Gross margin (%) 48.4% 47.6% 51.9% 51.6% 51.8%

EBITDA margin (%) 13.3% 12.1% 13.6% 15.0% 15.1%

EBIT margin (%) 11.8% 11.1% 12.5% 13.8% 14.2%

Net profit margin (%) 7.6% 8.0% 7.9% 9.4% 10.1%

Dividend payout ratio (%) 16.5% 15.8% 19.0% 19.7% 20.2%

Net debt: equity (x) 0.5 0.5 0.3 0.1 (0.0)

Working capital turnover (x) 6.7 7.2 8.0 9.0 9.4

Gross block turnover (x) 4.1 4.4 2.4 2.5 2.7

RoCE (%) 20.0% 20.0% 17.1% 18.0% 20.8%

RoE (%) 30.3% 31.0% 23.2% 22.0% 23.4%Source: Company, Ambit Capital research

Valuation parameters

Year to March FY11 FY12 FY13 FY14E FY15E

EPS (`) 3.9 5.2 5.6 7.1 8.7

Diluted EPS (`) 3.9 5.2 5.6 7.1 8.7

Book value per share (`) 14.9 18.6 32.2 35.5 42.0

Dividend per share (`) 0.66 0.70 1.00 1.20 1.50

P/E (x) 60.7 45.2 41.7 33.0 27.1

P/BV (x) 15.8 12.6 7.3 6.6 5.6

EV/EBITDA (x) 35.7 31.0 25.0 21.0 17.9

Price/Sales (x) 4.6 3.6 3.3 3.1 2.7 Source: Company, Ambit Capital research

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Institutional Equities Team

Saurabh Mukherjea, CFA Head of Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking / NBFCs (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 [email protected]

Ashvin Shetty Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta Strategy / Derivatives Research (022) 30433255 [email protected]

Harshit Vaid Power / Capital Goods (022) 30433259 [email protected]

Jatin Kotian Metals & Mining / Healthcare (022) 30433261 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 [email protected]

Nitin Jain Technology (022) 30433291 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Pratik Singhania Real Estate / Retail (022) 30433264 [email protected]

Parita Ashar Metals & Mining (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 [email protected]

Ritika Mankar Mukherjee Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Healthcare (022) 30433292 [email protected]

Ravi Singh Banking / NBFCs (022) 30433181 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Tanuj Mukhija E&C / Infrastructure (022) 30433203 [email protected]

Utsav Mehta Telecom / Media (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / Europe / USA (022) 30433053 [email protected]

Parees Purohit, CFA USA (022) 30433169 [email protected]

Pramod Gubbi, CFA India / Asia (022) 30433228 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

E&C = Engineering & Construction

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Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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