Sunday, May 03, 2009
With a limited product portfolio and unexciting historic growth, GlaxoSmithkline Consumer Healthcare (GSK Consumer) has traded at a significant valuation discount to FMCG peers, in the stock market. However, the company’s stock now merits a re-rating, after renewed efforts by the company to enter new categories, an accelerated pace of new launches and strong profit growth in recent quarters.
Investors can consider accumulating the stock even after its 33 per cent gain from the March lows, as the stock’s discount to peers offers upside potential.
At its current price of Rs 828, the GSK Consumer stock trades at a PE of 16 times trailing 12-month earnings while multiples hover at 22-24 times for Nestle India, Colgate Palmolive, Godrej Consumer and Dabur. The stock is at about 14 times its estimated earnings for 2009, again at a sizeable discount to most rivals.
After managing a 14 per cent compounded annual growth in sales in the three years to 2007, GSK Consumer’s sales growth shot up to 21 per cent for 2008. Strong volume growth in the Horlicks franchise driven by higher offtake and brand extensions, higher realisations due to price increases and a surge in export revenues aided this improvement.
A sharp increase in input costs prevented the expansion in topline from being mirrored in net profits, which rose by a muted 15 per cent. 2008 saw a sharp upward spiral in prices of inputs such as wheat, malt extracts and milk.
Numbers for the March 2009 quarter show that the company has sustained its growth momentum this year. Net sales were higher by an impressive 31.4 per cent in the first quarter.
Though excise duty savings brought in about 3 per cent of this expansion, this was also backed by an impressive volume growth of 20 per cent (21 per cent in Horlicks, 8 per cent for Boost and 27 per cent for biscuits).
A 13 per cent growth in domestic offtake of malted drinks led mainly by Horlicks, a 3.5-4 per cent pipeline filling for new products and a surge in exports helped drive this growth.
Given that malted drinks remain an under-penetrated category, promotional efforts, better distribution reach and a value-oriented strategy hold further potential to increase domestic sales.
Leg up from exports
GSK Consumer’s exports to neighbouring markets such as Sri Lanka, Nepal, Bangladesh and West Asia have also been a key driver, seeing a 45 per cent expansion in the first quarter.
A shifting of the manufacturing base for some products to India (by the parent) and market share gains for brands for Horlicks and Boost in these markets have both helped this growth. The latter ties in with the headway made by many Indian FMCG brands in the neighbouring markets.
Exports, which have been a key contributor to GSK Consumer’s growth in recent quarters, also hold further potential for scaling up.
The March 2009 quarter saw GSK Consumer’s net profits expand by a higher than expected 48 per cent, on the back of higher operating profit margins.
Higher realisations resulting from price increases (of 5.5 per cent) taken in January 2009 and benefits from excise duty cuts (about 60 per cent of the company’s manufacture is subject to excise duty) triggered margin expansion.
Though input cost pressures did not abate materially (material/packaging costs up by 28 per cent over last year), they were more or less offset by the price increases and a cutback in advertising and promotional spends for the quarter, as the company temporarily “tightened its belt” on ad spend.
While inflationary pressures are likely to subside a little in 2009 (malt extract and packaging prices have corrected, while milk and sugar remain upward bound), the company is unlikely to see substantial savings in input costs, as will some other FMCG makers.
However, that is not a big concern, given GSK Consumer’s dominant share of malted drinks market (70 per cent, straddling brands such as Boost, Viva and Maltova and Horlicks) which endows it with strong pricing power.
While the company has delivered exceptional profit growth in the latest March quarter, growth of this order is unlikely to be sustained in the coming months and may moderate to the 20 per cent range.
As GSK Consumer steps up its pace of product launches and supports them with brand building efforts, ad spends may climb back to 13-14 per cent of sales, from the current 11.5 per cent.
Broadening the basket
GSK Consumer has already embarked on a two-pronged strategy to expand its somewhat narrow product portfolio.
First, it plans to leverage the Horlicks brand to launch a wider range of nutrition products and functional foods. Second, it plans to draw more actively on its parents’ portfolio for the Indian markets.
Junior Horlicks and Mother’s Horlicks have already captured key niches in the beverage market and Horlicks Lite (suited to Diabetics) Women’s Horlicks (specially formulated for women) have added to this set of extensions in 2008.
The first quarter of 2009 has seen GSK Consumer’s foray into functional foods through the launch of Horlicks Nutribar, a healthy snacking option for young adults. ActiGrow, a high-protein baby food, was also rolled out this quarter. These supplement Horlicks and Lite Bite biscuits which are targeted at children.
The brand Horlicks has also been extended into the ready to drink (RTD) segment, through tetra packs. While a foray into RTD has already been attempted in the past, the foray into functional foods holds considerable promise for broadening the company’s portfolio.
While the new category forays will peg up advertising and brand building spends over the next two years, they have the potential to reduce the company’s significant reliance on one brand (Horlicks) and one category (malted drinks) for growth and profitability. That may remove a key impediment to better valuations for the stock.
We reiterate our buy on the stock of Shree Cement at the current price of Rs 774 as there is potential for upside, given the stock’s discounted valuation and emerging strengths.
The stock is up 34 per cent from our earlier ‘Buy’ recommendation in September at Rs 576. The stock trades at a price-to-earnings ratio of just five times, at a sizeable discount to leading players such as ACC and Ultra Tech Cement (7-10 times).
A rising contribution from the company’s power division, improved cost control measures and the falling pet coke prices lend support to earnings prospects. Capacity additions (2.5 mtpa by end FY10) may also give a volume advantage, if strong trends in cement demand sustain.
The risks to prospects of the entire cement sector arise mainly from the addition of new capacities (37 mtpa estimated for FY10) and the likely fall in utilisation rates for players over the next year or two.
If this entire capacity materialises, the market would see a surplus of around 30 million tonne at a 6 per cent demand growth.
However, the recent trend in cement despatches, if sustained, could substantially reduce the expected surpluses.
With a cement capacity of 10 million tonnes and power generation capacity of 117 mega watts, Shree Cement appears to be well placed to capitalise on strong demand for cement and surplus power in its region. In the March 2009 quarter, 20 per cent of the company’s revenues were from power sales.
Power revenues Help
With realisations on surplus power rising and costs falling, the power segment matched the cement division’s contribution to profits during the quarter. Of the Rs 281 crore of profits before interest and tax in the segmental results, cement chipped in Rs 127 crore and power Rs 154 crore.
Revenues from power sales are expected to increase further with the company’s plan of adding another 85 mega watts of power by FY10. The company’s sales growth, at 21.7 per cent for the March quarter was helped by higher power sales, and volume additions which were backed by despatches growth (17.6 per cent for the quarter). Realisations for the company were more or less flat compared to last year.
The company’s cost cutting initiatives and also the falling pet coke prices have brought substantial relief from cost pressures, helping to expand operating profit margins for the quarter. Though Shree Cement’s power and fuel costs in the March 2009 quarter were higher by 28 per cent year-on-year, they saw a sequential decline of 12.6 per cent.
Investments to pay off
Shree Cement has outlined a capex of Rs 1,200 crore for FY10. Half of this would go towards setting up two grinding units, one each at Rajasthan and Uttarakhand which would increase the cement production capacity of the company by 2.5 million tonnes by end-March 2010.
Being a player in the high demand potential region of North, Shree Cement can expect these volume additions to turn to its favour given signs of a pick-up in demand.
While all India cement despatches for the March 2009 quarter were higher by 8.5 per cent year on year and by 11 per cent sequentially, the Northern region has seen a 16.8 per cent growth in consumption in this period. Another Rs 600 crore of capex will go towards building two captive power plants of 85 mega watts.
The company plans to fund 80 per cent of its estimated Rs 1,200 crore capex through internal accruals and the balance by debt. Given the company’s extremely comfortable interest cover (about 13 times for FY09), additional debt can be easily serviced without straining profitability.
Due to a changeover to the written down value method of charging depreciation (high in the initial periods of new machinery installation and lower as the useful life reduces), Shree Cement has been witnessing sharp fall in depreciation write-offs in recent quarters.
Lower depreciation and interest costs, even as margins expanded, contributed to a fourfold expansion in net profits for the March quarter. However even at the operating level, the company recorded a good 26 per cent growth (ACC and UltraTech reported a growth of 22 per cent and 8.6 per cent in PBIDT for March 2009 quarter).
Operating profit margins too have reported an expansion of 129 basis points year-on-year; on lower costs and revenues from the power division.
Fresh investments can be considered in the Bank of Baroda (BoB) stock as the valuations look cheap relative to the bank’s growth prospects. The stock (at Rs 327) is trading at a marginal premium to its March 2009 book value of Rs 312 – at a price earnings multiple of 5.3.
Strong growth in advances, diversified branch network and a high proportion of fee income point to good growth potential, while a low proportion of non-performing assets alleviates concerns on asset quality. Given the stock’s performance in the recent rally, investors should accumulate it in a phased manner.
BoB’s recent quarter numbers have bettered expectations, with advances growing by 34.9 per cent for the latest fiscal, topping off a 31 per cent compounded annual growth between 2004 and 2008. The proportion of retail advances has come down from 19.79 per cent last year to 17.9 per cent, while the return on assets and return on equity improved considerably to 1.09 per cent (0.89 per cent) and 19.56 per cent (15.3 per cent) respectively in a year.
For 2008-09, the bank’s net profit grew by 55 per cent, buoyed by better net interest income. Profit growth also received support from a 34 per cent expansion in other income. Within this head, the triple-digit growth of the treasury component may not be sustainable. Domestic net interest margin of 3.21 per cent has improved due to rising yields and the falling cost of deposits. Going forward, maintaining margins at these levels may be a challenge as the lending rates fall at a faster clip than cost of capital. BoB’s low-cost deposit base remains at healthy levels of 34.8 per cent, with bulk deposits falling to 16.9 per cent.
BoB’s recent numbers have also alleviated asset quality concerns, with net NPA ratio falling from 0.47 per cent in FY08 to 0.31 per cent, low relative to peers. The capital adequacy of BoB stands at a comfortable 14.05 per cent, and there is no immediate need for the bank to raise tier-1 capital.
The bank has restructured only Rs 2,659 crore (1.8 per cent of total advances) worth of loans. It may have to incur higher operating costs over the next few quarters as only 66 per cent of its total branches are ‘Core Banking’-enabled, which may pay-off later in the form of higher fee income for the bank.
Shareholders can continue to hold the stocks of Carborundum Universal, an established player in the abrasives and industrial ceramics space. Helped by a well-diversified user industry base, the company appears to have done well to stave off any drastic slowdown in its revenues.
For the quarter ended March 2009, CUMI reported only a marginal decline in revenues despite the production cutbacks and capex call-offs across its user industries. However, higher interest outgo, fall in contributions from its abrasive segment and forex losses took a toll on its bottom-line.
At the current market price of Rs 102, the stock trades at about 16 times its FY09 per share earnings. Going forward, the earnings may improve, thanks to interest rates cooling off and initiatives by the company to reduce the overall debt burden.
Besides a diversified user base, CUMI is fairly well spread out in terms of geographical presence and revenue stream. This appears to have helped the company in the present challenging times. Healthy dispatches in the cement sector, pick up in auto numbers and sustained activity in the mining sector too may have supportedthe company’s overall revenues and offset the impact of a lower off-take in other industries such as construction.
In terms of segment-wise revenues for the quarter-ended March 2009, the abrasives division, which is also CUMI’s largest revenue contributor, reported a 12 per cent decline in sales. As a result, its share in the overall revenue pie fell to about 53 per cent from 60 per cent a year ago.
While the slowdown in the manufacturing and capital goods sectors may explain the declining sales of the division, the fall hasn’t been as drastic if we consider the full year sales numbers. With the economy beginning to show signs of a slight revival, abrasive sales may also see an up-tick in the coming quarters.
Besides, since abrasives find extensive usage in essential and critical applications across sectors, this division is unlikely to see any significant fall in its sales.
The quarter also saw the company’s non-abrasive divisions — electro-minerals and ceramics — chip in with better performance. Both electro-minerals (15 per cent) and ceramics (7 per cent) divisions reported healthy growth in sales. While higher depreciation led by the commissioning of a new plant saw the ceramics division report a decline in profits, the electro-minerals division more than doubled its profitability (PBIT). Incidentally, the company had doubled its capacity for producing electro-minerals in December 2008.
Consolidated sales for the year recorded a growth on 31 per cent, driven by higher contributions from its operations in Russia and Australia. Volzhsky Abrasive Works (VAW), the Russian company that CUMI had acquired earlier (September 2007), turned in better numbers led by strong silicon carbide sales and improved product-mix.
The abrasive business of VAW however was unimpressive owing to a lacklustre market for it in Russia. CUMI Australia, too, reported healthy performance, what with over a 50 per cent increase in sales.
The management attributed this to the strong order flows from the minerals and coal-handling sectors, which are expanding their capacities. However, CUMI’s joint venture in China turned in only a modest performance owing to lower export off-takes from the facility.
Despite the upward revision of product prices that was carried out early last year, CUMI’s operating margins have declined significantly, both for the quarter and for the full year.
The company’s operating profit margins for the quarter declined by over 5 percentage points to 13.5 per cent. This decline, despite flat to moderate growth in sales, suggests that there could be pressure on volumes.
The management has said that its margins may be maintained at current levels and that it has resorted to cost cutting initiatives for this purpose.
Investors may nevertheless have to keep a tab on CUMI’s performance over the next few quarters.
Increasing interest burden is a cause for concern. While the management had earlier said that it planned to move a considerable amount of debt to the books of its overseas holding company, CUMI International Ltd, and later dilute stake in it to reduce debt, there appears to be no visible development on that front.
The company currently has a standalone debt of over Rs 347 crore. Apart from poor profit margin and higher interest outgo, forex losses and lower-non-operating income have played spoilsport and resulted in lower profits.
Profits for the quarter declined by 69 per cent; it fell by 39 per cent on a standalone basis for the full year.
* For FY10, the management expects overall positive revenue growth and expect improvement in profitability on the back of better capacity utilization, continued focus on productivity gains and stabilization of ramp.
* Q1FY10 would see fall in collections business due to seasonality.
* The Healthcare segment is seeing impact. The State Governments are under budgetary pressures. This is impacting the providers of healthcare services. The payment cycle has increased.
* The credit card collection is seeing impact and would remain depressed.
* The Company is seeing sporadic cases for price reduction. The healthcare segment is seeing pricing pressure.
* The management expects EBIT to be stable with upward bias.
* For the quarter ended March 2009, FSL reported 6% sequential rise in operating revenues at Rs 472.30 crore. In US dollar terms, the growth was 4.6% and on constant currency basis it was 7.1%. OPM improved 250bps at 12.8% on stabilization of ramp in domestic business and benefit of seasonal collection business due to tax refunds in US.
* For FY09, FSL reported 35% growth in operating revenues at Rs 1749.37 crore. The growth in US dollar terms was 16.1% and on constant currency it was 25%. On organic basis, the growth was 10.6% on constant currency basis. OPM was down 480bps at 13.2% on the back of stress on healthcare and credit card collection segment and high ramp. Other Income was at expense of Rs 33.67 crore includes MTM losses of Rs 23.6 crore, translation/consolidation losses Rs 13.4 crore.
* For the quarter, the MTM loss on undesignated hedges was Rs 23.6 crore and translation and consolidation loss was Rs 6.5 crore.
* During the quarter, the Company bought back FCCBs worth US$ 49.7 million at a discount of Rs 63.5 crore, which has been treated as gains. The FCCB buyback has been financed thru ECB both in US dollar and GBP. The cost of ECB is slightly less than 10%. The effective yield for FCCBs is 6.75%.
* During the quarter, the Company restructured and rationalized its delivery centres at a cost of Rs 13.8 crore. The Company added 2 new delivery centres in Coimbatore and Bangalore in India and it shut down a centre in North America.
* The Company has outstanding hedges of US$ 82 million: 70% in GBP and 30% in US dollars. For FY10, 100% of US dollars are covered and 50% of GBP is covered. For FY11, 100% of US dollars are covered. The rate for FY10 is Rs 45/US$ and Rs 75/GBP and for FY11 is Rs 46/US$.
* Average realized rate for the quarter was Rs 49/US$ against 45.17/US$ in the sequential quarter.
* The seat fill factor was down at 70% against 74% in the sequential quarter on account of addition of centres so number of seats available increased.
* The capex for FY09 was Rs 98.1 crore. For FY10, the capex was US$ 15 million. The depreciation charge for FY10 would be about 5.5-6% of revenues.
* Cash & cash equivalents were Rs 96.69 crore and debt including FCCBs is Rs 1394.56 crore. Average cost of debt other than FCCBs is 8%.
* The Company reduced 950 employees during the quarter taking the total number of employees at the end of the quarter to 21570 (22520 at end sequential quarter). Employees in India increased to 16859 (17991 at end sequential quarter) and outside India to 4711 (4529 at end sequential quarter). The number of seats increased at 18932 (17715 at end sequential quarter) with seat fill factor at 70% (74% at end sequential quarter).
* For quarter ended March 2009, geographically, US contributed 63.6% against 63.9% in the sequential quarter. India contributed 11.9% down from 10.1% in the sequential quarter. UK contribution dipped at 24% down from 25.4%.
o For the quarter, BFSI contributed 24.3% up from 23.2% in the sequential quarter due to increase in seasonal collection business; Telecom & Media contribution at 33.7% up from 32.3% and Healthcare contribution was down at 39.8% from 41.5% in the sequential quarter.
o Offshore contribution to revenues was at 28.3% down from 30.6% in the sequential quarter, domestic was 11.9% up from 10.1% and onshore was 59.8% up from 59.3%.
o Top client contribution grew 8.3% at 10.7%, top 2-5 client contribution grew 7.3% at 31.7% and other than top 5 have increased 5.9% at 68.3%.