Jyothy Labs (IPO): Invest at cut-off

Via Businessline


Investors can subscribe to the initial public offering from Jyothy Laboratories at the cut-off price. Private equity investors in the company are seeking to offload their stake to the public through this offer for sale in the price band of Rs 620-690 per share. This mid-sized FMCG company has managed healthy profit growth and market share gains over the past five years by focussing on lucrative niche segments within FMCGs such as fabric care, dish wash and insect repellents.

The company also has an extensive rural reach, with over 60 per cent of sales originating from outside Urban India.

The risk to earnings prospects arise from possible entry by multinationals/Indian competitors into some of the company’s business segments, requiring higher promotional outlays. However, balancing out this risk, the offer price factors in a significant valuation discount to other FMCG players.

At the two ends of the price band, this offer values Jyothy Labs at 19-21 times its earnings for the year-ended June 2007. FMCG players such as Emami, Marico and Dabur trade at trailing P-E multiples of 25-35 now.
Local players re-rated

The past couple of years have seen a rapid re-rating of home-grown FMCG companies such as Dabur or Marico in the stock markets. As a result, the valuation discount that such companies historically suffered vis-À-vis their multinational peers has been effectively wiped out.

Local and smaller FMCG companies have managed superior growth rates by adopting two sets of strategies.

Those such as Marico (hair oil, conditioners, edible oil) and Dabur (health supplements, foods, herbal personal-care products) have focussed on segments and geographies where MNCs do not have a significant presence, thus insulating themselves from the bruising price wars and competition seen in big FMCG categories such as laundry or shampoos.

A second set of players such as Emami and Cavinkare have managed to carve out a market share in larger categories despite MNC presence. They have used competitive pricing and deep regional distribution to address the under-served mass market for FMCGs.
Mass market focus

Jyothy Labs appears to have used a combination of both strategies. It has focused on niche products, targeting value-conscious consumers in the rural and semi-urban markets through low-priced products. Having entered the fabric care market through its flagship whitening brand — Ujala — Jyothy Labs has managed to carve out a 72.7 per cent share of this market (as of July 2007), wresting share away from Reckitt Benckiser (Robin Blue) and Unilever (Ala) which were established in this segment. Jyothy’s subsequent product launches — Maxo mosquito coils and Exo Dishwash bars — have also met with reasonable success by acquiring a strong presence in South India.

Ujala Stiff N Shine (a liquid instant starch), a recent launch, has also captured a lucrative niche. This is despite competition from players such as Reckitt and Unilever in each of these segments.

The company also has significant distribution reach in rural and semi-urban centres, especially in the southern markets. The distribution network gives the company an edge over larger players which do not have a significant presence outside of the urban centres. The rural and semi-urban markets for FMCG products have also been witnessing higher rates of growth than urban markets over the past couple of years.
Growth rates

Though the company’s foray into larger FMCG categories such as laundry (Ujala Washing Powder) and soaps (Jeeva) has not been successful, a national rollout of brands such as Exo and Ujala Stiff N Shine, planned by 2008, could help sustain growth.

Unlike categories such as laundry, personal wash or shampoos, segments such as fabric care and insect repellents are characterised by low levels of market penetration and, thus, offer higher growth potential, even if new players do enter the fray. Jyothy’s businesses — fabric care, repellents and dish wash products — have managed CAGRs of 13, 9 and 48 per cent respectively over the past three years, ahead of category growth rates. The company has seen its sales grow at about 7 per cent and net profits at about 50 per cent CAGR over the past four years. While Jyothy Labs’ growth rates have beaten the sector, its return ratio (RONW) is significantly lower, at 16.5 per cent than that of other listed FMCG players. However, the lower returns are a function of the company’s reliance on own manufacture rather than third party vendors for sourcing of products.

Recent investments (Rs 110 crore capex in 2007), to build manufacturing facilities at multiple locations/tax havens across India, may give the company greater control over its margins, given the savings in taxes and logistics costs. As the company’s products are mainly positioned on the “value-for-money” plank, the cost advantage may be crucial.
Risks

Despite its track record, investors in Jyothy Labs have to take cognizance of certain risks. The company has a narrow brand portfolio with Ujala and Maxo accounting for the lion’s share of its sales/profits. A foray by any large FMCG rival into either of these categories could hurt the company’s earnings significantly. The company has traditionally contained its adspend-to-sales ratio in the 9-10 per cent range; but a spike may be unavoidable if a battle for turf ensues. As a relatively small player in the FMCG business, the company may lack staying power, should a large MNC or domestic competitor attempt to break into one of its key categories. Second, the manufacturing-led model will lead to less flexibility in the cost structure, should the demand environment slow down.

However, the company’s brand portfolio and its extensive distribution network would make it a desirable acquisition candidate in the event of heightened competition.

Offer details: The offer for sale seeks to raise Rs 275-306 crore at the two ends of the price band and the proceeds will go to a set of institutional investors. There is no equity dilution resulting from the offer, promoters will continue to hold 69 per cent of the post-offer equity. The offer opened on November 22 and will close on November 27.