India Consumer Sector - Credit Suisse

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22 August 2012 Asia Pacific/India Equity Research

Consumer Staples / OVERWEIGHT

India Consumer Sector INITIATION

Premium rush Figure 1: GSK, Emami, Marico, ITC and GCPL have strong growth prospects

and lower competitive risks

HUL

ITC

GCPL

Dabur

Marico

Emami

ColgateNestle

GSK

Competitive risk LOWHIGH

Micr

o dive

rsHI

GHHI

GHLO

W

Source: Company data, Credit Suisse estimates

We initiate coverage on the Indian FMCG sector. We expect its rich valuations to sustain, as most of the leading companies will likely deliver 15%-25% earnings CAGR over FY12-15 while maintaining high capital efficiencies. We initiate on ITC, Godrej Consumer, Emami, GSK Consumer, Marico and HUL with OUTPERFORM, Nestle with NEUTRAL, and Dabur and Colgate with UNDERPERFORM ratings.

■ Focus on micro over macro. Companies in our coverage universe cumulatively operate in over 25 categories, which have stark divergence in growth potential as they are at varying stages of penetration, consumption and premiumisation. We expect categories like skin care, shampoos, insecticides, hair oils, packaged foods and new segments including face washes and deodorants to outgrow the broad FMCG market. Companies with leading brands in these categories are likely to gain the most. GSK, Marico, GCPL, Emami and Nestle have the best positioned portfolio.

■ Companies with dominant positions to show margin resilience. We use a framework to assess the brand dominance of various companies analysing each brand in their portfolio. We believe ITC, GSK, Marico, GCPL and Emami have the highest margin resilience and scope for margin expansion.

■ Positive on managements investing in innovation and execution capabilities. Managements at ITC, HUL, GCPL, GSK, Marico and Emami have upped their investments in brand innovation and augmented their distribution and supply chains over the past three-four years, which would reflect in their superior performance in the next two-three years.

Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]

Akshay Saxena 91 22 6777 3825

[email protected]

22 August 2012

India Consumer Sector 2

Focus charts Figure 2: FMCG growth has stepped up post 2005 Figure 3: Rural turnaround has been a key driver

0%

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CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11

FMCG sector size (Rs bn) (RHS) FMCG market growth ( %YoY)

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CY03 CY05 CY07 CY09 CY11

Urban FMCG growth (YoY) Rural FMCG growth (YoY)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 4: Stark divergence in potential for categories Figure 5: Divergence reflects in company’s portfolio

Detergent

Soap

Skin

Shampoo

Value added oil

Coconut oil

Oral

Noodles

Malted

Insecticide

Hair colourCigarette

BalmBiscuit

Tea Coffee

Chocolate

Face wash

Deo

Chwayanprash

Edible oil

Baby food

Milk products

Prem

ium

isat

ion/

beha

viuo

r ta

ilwin

d

Penetration gap HIGH

HIG

H

LOW

HUL

ITC

DaburNestle

GCPLGSK

Marico

EmamiColgate

Penetration gap HIGHLOW

HIG

HPr

emiu

mis

atio

n/be

havi

uor

tailw

ind


Figure 6: Companies with more dominant brands will

have resilient margins

Figure 7: Indian FMCG basket has not rerated relative to

developed markets and emerging Asia staples

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ITC

(cig

aret

te)

GSK

Mar

ico

GCP

L

Emam

i

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Col

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% revenue share from dominant brands

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India premium overemerging asia

India premium overdeveloped markets

ITC premium over globaltobacco

Aug-11 Aug-12

Source: Company data, Credit Suisse estimates Source: IBES DataStream, Credit Suisse estimates

22 August 2012


Investment summary We initiate coverage on the FMCG sector. We expect most companies to sustain a 15%-plus revenue CAGR, deliver margin expansion and maintain high capital efficiencies over FY12-15. As such, we expect their historically rich valuations to sustain. We prefer companies with portfolios positioned for higher-than-industry growth and with brands dominant enough to minimise a medium-term risk to margins from competition. We initiate coverage on ITC, Godrej Consumer, GSK Consumer, Emami, Marico and HUL with OUTPERFORM, Nestle with NEUTRAL and Colgate and Dabur with UNDERPERFORM.

Focus on the micro over macro Companies in our coverage universe cumulatively operate in over 25 categories, which have stark divergence in growth potential and stage of development. In the past three years, the growth rates for this set of categories have ranged between 11% and 25%. There is also an overarching trend of premiumisation across categories. Analysing trends on penetration, growth of premium segments and trends in consumer behaviour change, we expect categories like skin care, shampoos, insecticides, hair oils and packaged foods along with relatively new categories including deodorants and face washes to outgrow the broader FMCG market. Companies that have a large share of revenues coming from leading brands in these categories or have brands that can gain from premiumisation would grow ahead of the broader FMCG market. GSK, Marico, GCPL, Nestle and Emami are likely to outperform on revenue growth as over 50% of their domestic revenues come from brands that are positioned to gain on these trends.

Companies with dominant positions will show margin resilience Most of the companies have seen only a marginal dip in EBITDA margins in the past two years despite the steep commodity inflation, as they were able to take price hikes without much resistance. The key risk to margins can come from heightened competition from a deep-pocketed player wanting to gain market share. In the past 10 years we have seen large categories like detergents, soaps and biscuits seeing sharp dips in margins due to rising competitive intensity. We use a framework to assess the pricing power of companies looking at each brand for relative market shares, growth headroom, presence of deep-pocketed competitors and unbranded competition. We believe ITC, GSK, Marico, GCPL and Emami have over 50% of their revenues from brands that have very strong pricing power. These companies would have the highest margin resilience when commodity prices flare up and the maximum possibility for margin expansion over if commodity costs stabilise or soften.

Bet on managements investing in innovation and execution capabilities Successful brand innovation and execution capabilities like distribution and supply chain are key to consistent growth in the FMCG business. However, given the nature of the business, it takes a few years for any change in these capabilities to reflect in a change in growth trajectory for a company. Hence, we prefer companies that have disproportionately invested in innovation and execution capability in the past three years relative to competitors, which should reflect in their superior performance in the next two-three years. Managements at ITC, HUL, GCPL, GSK, Marico and Emami have significantly increased the pace and success rate of innovations in the past three-four years. These companies have also augmented their distribution systems through enhanced use of technology and new models for rural expansion. Companies like GCPL and Marico have also beefed up management bandwidth and processes in their expanding international business.

We expect rich valuations to sustain as stable earnings growth and high capital efficiencies will continue

Companies in our coverage universe operate in over 25 categories which have wide divergence in growth potential and stage of development

ITC, GSK, Marico and GCPL have the highest margin residence as they draw over 50% revenues from brands that have very strong pricing power

ITC, HUL, GCPL, GSK, Marico and Emami have upped investment in innovation and distribution in the past three-four years

22 August 2012


Financial summary Figure 8: Key recommendations Company Rating CMP TP Upside M-cap Dividend P/E ROE(%) EV/EBITDA

(%) (USD Bn) Yield (%) T+1 T+2 T+1 T+2 T+1 T+2

ITC OUTPERFORM 261 300 15% 37.0 2.2% 27.9 23.3 35% 37% 19.7 16.4

Hindustan Unilever OUTPERFORM 514 564 10% 20.1 2.1% 34.2 29.2 79% 79% 26.6 22.4

Nestle NEUTRAL 4,591 4,590 0% 8.0 1.2% 41.2 34.1 62% 69% 23.8 19.6

GCPL OUTPERFORM 665 790 19% 4.1 1.3% 30.2 24.3 20% 22% 20.5 16.1

Dabur UNDERPERFORM 119 117 -2% 3.8 1.5% 27.8 23.3 36% 36% 20.5 17.2

Colgate UNDERPERFORM 1,169 1,147 -2% 2.9 2.7% 30.5 26.5 112% 117% 25.6 21.8

Marico OUTPERFORM 192 228 19% 2.2 0.47% 26.9 22.2 23% 22% 18.9 16.2

GSK Consumer OUTPERFORM 2,812 3,428 22% 2.1 1.5% 27.5 22.6 31% 32% 21.1 16.9

Emami OUTPERFORM 475 619 30% 1.3 1.7% 23.1 19.4 36% 35% 20.4 15.9

Source: Company data, Credit Suisse estimates, Closing price as of 21-Aug-12

Figure 9: Global valuation table Company Currency CMP Market cap P/E EV/EBITDA ROE

(LC) (US$ bn) 2012 2013 2014 2012 2013 2014 2012 2013 2014

Global

Unilever GBP 23 103 14.4 12.9 11.9 10.9 9.8 9.1 30.3 31.2 28.8

Procter & Gamble Co. USD 67 184 17.2 17.1 15.8 11.1 10.9 10.3 16.8 17.3 18.1

L'Oreal EUR 102 77 21.5 19.9 18.3 13.5 12.3 11.1 15.5 15.4 15.4

Colgate-Palmolive USD 106 50 19.7 18.0 16.5 12.2 11.4 10.6 105.8 111.7

Nestle CHF 60 201 17.8 16.4 15.2 12.0 11.0 10.1 17.8 18.6 19.1

Danone EUR 51 41 16.4 15.0 13.7 10.6 9.6 8.7 14.1 14.4 14.5

Reckitt Benckiser GBP 36 41 14.6 14.4 13.7 10.3 10.0 9.2 29.4 26.7 25.2

Henkel EUR 60 29 16.4 15.1 13.7 9.1 8.1 7.1 16.7 16.1 15.7

Mead Johnson Nutrition Co. USD 71 14 22.9 20.2 17.8 14.6 13.0 11.2 120.5

Kraft Foods, Inc. USD 41 73 16.5 14.9 13.5 10.4 9.6 8.6 11.8 12.5 13.0

Kellogg Company USD 51 18 15.6 14.4 13.2 11.1 10.1 9.4 56.1 50.7 47.6

H.J. Heinz Company USD 55 18 16.6 15.8 14.7 10.6 10.3 9.5 37.0 34.1 33.7

Emerging Asia

Unilever Indonesia IDR 25,550 21 41.7 35.7 31.5 29.6 25.5 22.5 109.4 107.7 111.3

Hengan International HKD 75 12 26.2 21.3 18.0 18.8 15.3 12.5 27.0 29.3 30.5

Want Want China Holdings HKD 10 16 29.6 23.4 20.0 20.2 16.0 13.3 38.1 39.6 39.8

Indofood CBP IDR 6,650 4 16.7 15.0 14.0 11.0 10.0 9.3 20.9 20.3 19.6

LG Household & Healthcare KRW 607,000 8 30.3 25.3 21.4 16.4 14.1 12.3 28.6 26.9 25.8

Thai Union Frozen Products THB 71 3 13.8 12.0 10.4 9.7 8.5 7.5 18.4 17.3 17.7

Kalbe Farma IDR 3,925 4 21.8 18.8 16.5 16.1 13.9 12.0 24.9 25.8 26.1

Amorepacific Corp KRW 1,070,000 6 21.5 18.7 16.5 12.2 10.9 9.7 13.9 14.2 14.2

Uni-President Enterprises TWD 51 8 21.6 19.6 18.1 84.9 75.6 76.6 15.6 16.3 16.7

Orion KRW 850,000 4 29.9 23.8 19.4 13.5 11.6 9.9 17.0 18.3 18.9

Tobacco

Philip Morris International USD 92 155 17.7 15.9 14.4 11.3 10.8 10.5

British American Tobacco GBP 33 103 16.1 14.7 13.4 11.7 11.0 10.2 48.5 52.2 52.1

Altria Group, Inc. USD 34 70 15.6 14.5 13.6 10.7 10.3 10.1 112.6 113.9 106.6

Japan Tobacco JPY 2,415 58 14.3 13.5 12.4 8.0 7.3 6.9 20.3 20.2

KT&G Corp KRW 86,100 10 13.3 12.3 11.6 8.8 8.3 7.8 17.2 17.0 16.7

Gudang Garam IDR 51,600 10 19.5 16.0 13.9 12.7 10.6 9.2 19.1 21.0 21.4

Source: Company data, Credit Suisse estimates, I/B/E/S Datastream.All estimates are consensus estimates. Closing price as of 21-Aug-12

22 August 2012


Table of contents Focus charts 2 Investment summary 3

Focus on the micro over macro 3 Companies with dominant positions will show margin resilience 3 Bet on managements investing in innovation and execution capabilities 3

Financial summary 4 Focus on the micro over macro 8

While overall FMCG demand is buoyant ... 8 FMCG growth has picked up post 2005 8

… wide divergence in growth potential of categories 14 Penetration, consumption and premiumisation –three pillars of FMCG growth 14 Skin care, shampoos, insecticides, hair oils and some packaged foods consumers have the highest headroom for penetration 15

Smaller categories to see explosive growth on consumer behaviour shifts 16 ITC and Marico best placed to gain from premiumisation, GCPL, Emami and HUL also beneficiaries 18

Who has the best portfolio? 18 Dominant positions key to margin resilience 22

Disruptive competition the key threat to margins 22 P&G will continue to be a key threat in some categories 22 ITC is also a threat in all large personal-care categories 24

We prefer the relative safety of dominant brands 26 A framework to assess brand dominance 26 Dominant brands in packaged foods, hair oils, skin care, insecticides and niche segments 27 GSK, Emami, Nestle, Godrej Consumer and Marico have the highest share of revenues from dominant brands 28

Home and personal care gross margins likely to improve for companies with dominant brands 28 Ad spends – companies who did not curtail spends in FY12 have higher potential for margin expansion 31

Positive on managements investing in innovation and execution 33 Profitable innovation the key to stable growth 33 ITC’s packaged foods foray has been one of the biggest FMCG success stories 33 GCPL is transforming into an innovation driven organisation 34 GSK: New product pipeline has been expanding 35 HUL: Innovation has seen a step jump in quantity and quality 36 Emami: Innovation focus has transformed it into a diversified FMCG play 36 Execution capabilities getting sharper for some 37

HUL: Widening the distribution edge gap with competition 37 Emami: Getting ready for the big league 37 GSK: Distribution expansion a big ticket opportunity 38

Valuations 38 ITC Ltd (ITC.BO / ITC IN) 40

Resilient earnings growth 40 Company snapshot 41 Cigarette EBIT growth is exceptionally resilient 41

ITC’s cigarette dominance to remain unchallenged 42 Management likely to focus on profitability over volumes in adverse years 42

Other FMCG business likely to break even 43 Uncertainly on VAT to persist; packaging changes not a risk 44 Valuation 44 Key risks 45

22 August 2012


Financial summary 46 Hindustan Unilever Ltd (HLL.BO / HUVR IN) 47

Turnaround story playing out 47 Company snapshot 48 Sustainable turnaround in business momentum 48 Margin expansion potential limited post 1H FY13 49 Slowdown in soaps and detergents a key risk 50 Valuation 51 Key risks 51 Financial summary 52

Godrej Consumer Products Ltd (GOCP.BO / GCPL IN) 53 In a new Avatar 53 Company snapshot 54 Domestic business has transformed into a stronger entity 54 Valuation 58 Key risks 58 Financial Summary 59

Nestle India (NEST.BO / NEST IN) 60 Near term headwinds 60 Company Snapshot 61 Most diversified play on packaged foods 61

Packaged foods likely to be one of the fastest growing categories in India 61 Nestlé’s innovation track record is strong; India getting increasing support from the parent 62

Volume slowdown a concern, but we expect a recovery 62 Margin expansion unlikely post CY12; depreciation and interest cost to be drags 63 Valuation 63 Key risks 64 Financial summary 65

Marico Ltd (MRCO.BO / MRCO IN) 66 Consistently delivering results 66 Company Snapshot 67 India business delivering market share gain-led growth 67 International business likely to recover in 2H FY13 69 Valuation 70 Key risks 71 Financial summary 72

Dabur India (DABU.BO / DABUR IN) 73 Strategy in transition 73 Company snapshot 74 A substantial part of the domestic and international portfolio is weak relative to competition 74 EBITDA margin expansion likely on a weak base in 2H FY13, but will unlikely recover fully 76 Valuation 77 Key risks 77 Financial summary 78

Emami (EMAM.BO / HMN IN) 79 Unique portfolio 79 Company snapshot 80 Unique portfolio of leading brands in niche categories 80 Management has strong innovation track record 81 Margin expansion likely in 2H FY13, international business also likely to see a revival 82

International business likely to revive on a weak base; Bangladesh and Egypt capacity commissioning a key trigger 83

Valuation 83

22 August 2012


Key risks 84 Financial summary 85

Glaxo Smithkline Consumer Healthcare (GLSM.BO / SKB IN) 86 Malted bastion 86 Multiple growth drivers for the malted foods portfolio 87

Malted foods has high headroom for growth 87 Distribution expansion and low unit packs a low hanging fruit for GSK 87 Value added products will increase in share, new categories an option value 88

Category dominance imparts very high pricing power 89 Margins expansion possible as ad spends have peaked 89 Valuation 90 Key risks 91 Financial summary 92

Colgate-Palmolive India (COLG.BO / CLGT IN) 93 Stable growth but high competitive risks 93 Stronghold on the toothpaste market to sustain 94 Premiumisation focus a long term positive 94 P&G risk will continue to be an overhang 95 Valuation 96 Key risks 96 Financial summary 97 Companies mentioned (Price as of 21-Aug-12) 98

22 August 2012


Focus on the micro over macro While overall FMCG demand is buoyant ... FMCG growth has picked up post 2005

The FMCG market has seen a phase of very strong and consistent growth post 2005. As against a CAGR of 5.7% over CY01-05, the FMCG market has seen a CAGR of 18.7% over CY05-11. A confluence of economic and behavioural factors helped this structural shift in growth rates in the FMCG markets. In our view, the two key drivers for this change have been (1) a significant acceleration in rural income growth and (2) rising consumption aspirations of mid and lower income groups due to sustained increase in media penetration leading to shift from unbranded to branded products and premiumisation. While overall economic growth is seeing a slowdown and would have some impact on consumer incomes and sentiment, we expect key drivers like rural income growth and rising aspirations in mid and lower income groups to help largely sustain the growth momentum in the sector.

Figure 10: FMCG market growth picked up post CY05 and has sustained

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FMCG sector size (Rs bn) (RHS) FMCG market growth ( %YoY)


Rural turnaround has been a key driver for FMCG markets

Rural consumption growth has been a key driver for the FMCG market over the past four-five years. Rural Monthly Per Capita Expenditure (MPCE) saw a 17.5% CAGR over FY10-12 as compared to a 10.6% CAGR over FY05-10 and an abysmal CAGR of 2.8% over FY00-05, clearly representing the shift in growth trajectory for overall rural consumption. FMCG market growth data also shows rural growth catching up with urban growth as compared to the pre-2006 era where rural growth lagged urban growth by a wide margin. The FMCG market growth has seen a strong correlation with nominal agri GDP growth.

As against a CAGR of 5.7% over CY01-05, the FMCG market has seen a CAGR if 18.7% over CY05-CY11

Rural MPCE saw a 17.5% CAGR over FY10-12 as compared to 10.6% CAGR over FY05-10 and an abysmal CAGR of 2.8% over FY00-05

22 August 2012


Figure 11: Rural no longer a drag on FMCG growth Figure 12: Rural consumption growth has picked up

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CY03 CY05 CY07 CY09 CY11

Urban FMCG growth (YoY) Rural FMCG growth (YoY)

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FY00-05 FY05-10 FY10-12

Rural MPCE CAGR

Source: Company data, Credit Suisse estimates Source: NSSO, Credit Suisse estimates

Figure 13: Nominal private final consumption and nominal agri GDP has grown strongly

together in the past six years

-5.0%

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FY92

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Nominal PFCE growth Nominal agri GDP growth

Source: Government of India, Credit Suisse estimates

Rural is also a very substantial portion of the total sales in many FMCG categories. Rural consumption dominates categories like detergents and soaps with over 50% volume share. In personal care categories, the rural share of revenues is also substantial in the range of 30-40%. It is only the packaged foods category where rural contribution to revenues has dipped below 25%.

22 August 2012


Figure 14: Rural is a substantial contributor to many

FMCG categories

Figure 15: In volume share, rural is larger than urban in

many FMCG categories

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Rural volume share (%)

Source: NSSO, Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

The headroom for higher-than-market growth for FMCG categories in rural areas continues to be substantial as the gap in penetration of various FMCG companies between urban and rural households is still very high in most personal care and foods categories.

Drivers for rural growth remain intact

The strong turnaround in rural consumption has many drivers, most of which should sustain in the medium term despite the current economic slowdown. We highlight some of the key drivers which should continue to be tailwinds for FMCG growth.

#1 Nominal agri GDP growth has tailwinds as agri price increases continue: One of the key drivers for the acceleration in rural growth has been the strong growth in agri-commodity prices in India over the past five years. Minimum Support Prices (MSPs) of major crops announced by the government has seen a CAGR of 9.6% over FY05-12 as compared to 2.2% over FY01-06. In FY13 too, the government has hiked MSPs in rice by 16%. Inflation in fruits & vegetables, milk, eggs and meat have all seen sharp jump in the FY06-12 period as compared to the FY01-06 period. Trends on food inflation in recent quarters also suggest sustenance of growth in prices of agri-commodities. As a result nominal agri-GDP has seen a very strong acceleration in growth rates which is likely to sustain into the next two-three years.

Minimum Support Prices (MSPs) of major crops announced by the government has seen a CAGR of 9.6% over FY05-12 as compared to 2.2% over FY01-06

22 August 2012


Figure 16: Minimum support price for cereals has been

hiked sharply in recent years

Figure 17: Price increases in many agri products have

been higher in recent years

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Rice Wheat

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Fruits & vegetables Milk Eggs, meat, Fish

Source: Ministry of Agriculture, Credit Suisse estimates Source: Government of India, Credit Suisse estimates

#2 Shift in farming away from staples augmenting incomes: While staples are still form a sizable part of farming acreage in India, there is a clear shift towards other crops like pulses, cotton, vegetables and oilseeds. This should continue as more farmers become conscious of the higher realisations from non-staple crops.

Figure 18: Farmers are growing more of non-staples Figure 19: Acreage expansion has been in non-staple

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Production growth (2001-2012)

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Source: Ministry of Agriculture, Credit Suisse estimates Source: Ministry of Agriculture, Credit Suisse estimates

#3 Shift to non-agri employment: As we had highlighted in our recent strategy report ‘The great India equalization’, there is a very dramatic shift that has happened in rural employment away from agriculture. As against 714 males per 1000 employed in rural areas for agriculture in 2000, the number had dipped sharply to 550 in just 10 years. The trend is similar among working females where numbers have dropped from 854 to 670 in the same duration. Employment growth has been the highest in services and construction, which are more semi-skilled or skilled in nature as against un-skilled agri labour, thus increasing wages by both improving quality of work and stretching the labour pool.

The number of rural males per 1000 employed in agriculture has dipped from 714 to 550 in just a decade

22 August 2012


Figure 20: Rural employment shifting out of agriculture Figure 21: Rural employment in services and construction

has seen the biggest jump

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1978 1983 1988 1994 2000 2005 2010

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2000 2010

Source: Employment survey, Credit Suisse estimates Source: Employment survey, Credit Suisse estimates

Change in aspirations, wealth effect, lagged impact of pay commission are other drivers

Besides quantifiable drivers, there are other drivers for consumption growth which are not directly linked to income growth and fall in the area of changing consumer behaviour.

#1: Penetration of satellite television: The massive increased reach of satellite television over the past decade has gradually narrowed the exposure across income groups to consumer products. Over the past five years alone, cable and satellite television penetration within TV households has jumped from 60% to ~85%. The aspiration for using products like skin care and packaged food has gradually seen a rise which is not linked with income growth.

#2: Gold and land – the wealth effect: According to estimates, India has by far the world’s largest holding of gold in private hands at 20,000-25,000 tonnes. This is also a very widely held asset class, cutting across rural and urban and income groups. For a large proportion of lower income consumers, gold is the only investment asset. The rise in gold prices from cRs800/gram in 2008 to over Rs3,000/gram in 2012, has notionally created over Rs48,400 bn (US$870 bn) of wealth for households across India. This figure is close to 50% of India’s nominal GDP. While this wealth is clearly notional unless the gold is sold, it does create a wealth effect to positively impact sentiment. Similarly, land prices have risen very sharply in the last decade across rural and urban India, which has created notional wealth.

#3: Lagged effect of pay commission: In 2009, the government of India hiked salaries across government jobs significantly, besides paying a large lump sum as arrears. This move impacted millions of households across urban and rural India. While the initial consumption spurt would have been in durables due to this steep jump, the impact on FMCG consumption would likely be with a lag as many consumers would slowly build aspiration for premium products.

Monsoon failure had minimal impact on agri-growth 2009, stark similarities in 2012 visible

Data on rainfall and agri production clearly shows that prior to 2004, there was a significant adverse impact of a failure in monsoons on agri production. In 2002, a 21% deficiency in the monsoons caused a 7% dip in agri production. However, 2009 was a study in contrast where despite a 20% monsoon deficiency, agri production rose by 1%. The other factor that impacted rural incomes was that in 2002 agri commodity prices did

2009 saw one of the worst monsoon deficiencies, yet agri production rose 1% YoY

22 August 2012


not rise meaningfully despite the production shortfall, thus further denting rural agri income as nominal agri-GDP grew only 4.3% YoY. As compared to that in 2009, with a 1% YoY growth in production, agri prices rose 13.4% which led to nominal agri-GDP growing strongly by 14.4%.

The potential reasons for this change are better availability of electricity for farmers to pump out ground water, improved irrigation and the fact that the 2009 monsoon failure was concentrated in North Western India which is the best in terms of irrigation reach. Similar to 2009, the 2012 monsoon deficiency is the most severe in North West India at over 60%. The absolute deficiency in monsoons in 2012 is lower than that of 2009 at 17%.

Figure 22: While 2012 is a poor rainfall year, it is better

than 2009 which had not impacted production

Figure 23: Sowing in some key crops has picked up to

average levels in the past week

-25

-20

-15

-10

-5

0

5

10

15

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Rainfall deviation from average (%) Real agri GDP change (YoY)

-20%

-15%

-10%

-5%

0%

5%

10%

15%

Rice

Suga

rcan

e

Oils

eeds

Cotto

n

Coar

se

Puls

es

Jute

Sowing area deviation (as on 17th August vs average)

Source: Indian Meteorological Department, Credit Suisse estimates Source: Ministry of Agriculture, Credit Suisse estimates

Monsoon charts of 2009 and 2012 in appendix along with temporal distribution charts

Figure 24: Rainfall has picked up in the past couple of

weeks

Figure 25: Reservoir levels at an all-India level are not

significantly below average

-36%-33%

30%6%

19%-26%

11%-36%

43%32%

153%29%

-60%-33%

-42%-4%

-100% -50% 0% 50% 100% 150% 200%

HPPunjab

RajasthanJharkhand

OrissaWB

GujaratMaharashtra

UPUttranchal

MPChattisgarh

APKarnataka

Tamil NaduAll India

Filling position of reservoirs (departure from normal storage)

Source: Indian Meteorological Department, Credit Suisse estimates Source: Government of India, Credit Suisse estimates

22 August 2012


Figure 26: The geographic spread of rainfall deficiency in 2012 is similar to 2009 Key state 2012YTD (divergence from normal) 2009 (divergence from normal)

All India -15% -20%

Punjab -68% -34%

Uttar Pradesh -21% -40%

Maharashtra -17% -21%

West Bengal -24% -15%

Bihar -23% -28%

Andhra Pradesh 4% -24%

Madhya Pradesh 9% -30%

Karnataka -34% 25%

Rajasthan -45% -34%

Odisha -6% 0%

Kerala -41% -9%

Jharkhand -15% -23%

Chattisgarh 6% -34%

Source: Indian Meteorological Department, Credit Suisse estimates

… wide divergence in growth potential of categories The companies under our coverage universe cumulatively operate in over 25 FMCG categories. There is a wide divergence in the growth potential of these categories as they are in different stages of maturity. This divergence can be seen in the revenue CAGR of these categories in the past four years which ranges from 11% to 25%. Thus companies with a higher share of turnover from categories that have the highest growth potential are likely to grow revenues faster.

Figure 27: Growth rates for FMCG categories has been divergent

0%

5%

10%

15%

20%

25%

30%

Noo

dles

Hair

Oil

Skin

Car

e

Mal

ted

food

s

Choc

olat

es

Hai

r Col

ours

Inse

ctici

des

Bisc

uits

Dete

rgen

t

Toot

hpas

te

Soap

Category CAGR (CY06-10)


Penetration, consumption and premiumisation –three pillars of FMCG growth

There are three ways any FMCG category can grow in revenues – more consumers use the category (penetration), existing consumers consume more from the category (consumption) and consumers upgrade to using more value-added products which have higher unit prices (up-gradation). Penetration for any category is defined as the proportion of households using products from the category at least once a month. Per capita consumption is the average usage of the category per household. The potential for upgrades can be estimated by looking at the current category mix between the discount, mid and premium segments. The 25 categories in which companies in our coverage

The companies under our coverage universe cumulatively operate in over 25 FMCG categories where revenue CAGR has ranged from 11% to 25% in the past 4 years

22 August 2012


universe operate, are at varying stages of penetration, consumption and upgrade, thus creating a large divergence in growth potential. For a detailed analysis of relative consumption patterns across 30 product categories and the outlook for potential growth, please see a report published by Viktor Shvets and Karim P. Salamatian, CFA titled “APAC: Consumption S curve”

Skin care, shampoos, insecticides, hair oils and some packaged foods consumers have the highest headroom for penetration

In our assessment, skin care, home insecticides, hair oils and many packaged foods categories have the highest growth potential over the next three years. Categories with lower monthly penetration levels have stronger growth potential provided the category relevance in not decreasing (e.g., toothpowders and talcum powders where consumers are structurally moving away from the category to higher value-added categories like toothpaste and deodorants). Similarly categories where the gap in per capita consumption between India and other emerging markets are the widest would have high growth potential. Categories where the bulk of consumption is in the discount segments have the highest room for upgrades.

Figure 28: Penetration levels are starkly different across FMCG categories; packaged

foods, skin care, insecticides and hair oils have high penetration headroom

0%

20%

40%

60%

80%

100%

Det

erge

nt

Soap Tea

Bisc

uits

Toot

hpas

te

Sham

poo

Ute

nsil

clean

ers

Bran

ded

hair

oil

Skin

car

e

Inse

ctic

ides

Hai

r Col

ours

Mal

ted

food

s

Inst

ant

Nood

les

Penetration % (CY10)


22 August 2012


Figure 29: Key divers for categories we find attractive Category Drivers

Skin Care • Appreciation of specific skin problems and expertise needed in solving them • Aspiration of using international premium skin brands • Growing proportion of working women. Even women who are not working are

spending higher portion of their time outside home Insecticides • Rising awareness of mosquito borne diseases

• Up-trading from unbranded coils which have low efficacy • Wider reach of electricity which is allowing the use of electric repellents.

Shampoos • Consumers moving beyond basic hair washing to specific hair needs • Growing proportion of working women. Even women who are not working are

spending higher portion of their time outside home. Hair oils • Loose oil constitutes 40-50% of consumption. Consumers up-trading to

packaged oil for better quality. • Hair oil has very strong connotation with nutrition in India. Hence despite being

a traditional category usage is not dropping among the youth. Malted foods • Growing awareness of nutritional supplements and desire for adding to the

nutritional inputs for kids.


Smaller categories to see explosive growth on consumer behaviour shifts Among smaller categories, we see an inflection point in face washes and deodorants, which are already sizable in terms of revenues at Rs8-12 bn and are likely to upstage some of the existing large categories in terms of market size in three-four years. The key drivers in both these categories are consumers moving on from very large but lower efficacy categories for the same usage. In case of face washes which is Rs8 bn in market size having seen a CAGR of 40% in the past three years, consumers are changing usage from the Rs140 bn soaps market to face wash. In case of deodorants, it is a combination of consumers upgrading from talcum powders and soaps for de-odorising. Within skin care, we have seen explosive growth in premium skin lightening. We do not however see a similar explosion in hair conditioners in the near term, as consumers in India still view hair oils as a more natural and efficacious way of nourishing hair as compared to conditioners.

Figure 30: Face wash revenues have grown 3X in 3 years Figure 31: Deodorant revenues have grown 2X in 2 years

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2008 2009 2010 2011

Face Wash (Rs mn)

0

2000

4000

6000

8000

10000

12000

14000

16000

CY09 CY10 CY11 MAT CY12

Deoderant (Rs mn)


New categories like face wash, deodorants, premium skin lightning, hand wash and fabric conditioners are seeing explosive growth

22 August 2012


Figure 32: Face wash revenues have grown 3x in 3 years Figure 33: Hair conditioner revenues have doubled

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2008 2009 2010 2011

Premium Skin Lightning

-

500

1,000

1,500

2,000

2,500

2008 2009 2010 2011

Hair conditioners


Premiumisation an overarching trend across categories One of the drivers of revenue growth has been the increasing share of premium products within each category. Consumers in the past two-three years have been shifting to national brands and products which deliver higher value to them in terms of efficacy or sensorial. We are seeing this trend very strongly in all home and personal care categories. In cigarettes too we have seen ITC’s premium cigarette brands (king size segment) growing faster than the rest of the portfolio for the past few years. In foods, this trend is weaker as consumers have mixed usage of branded and unbranded products in many food categories.

Figure 34: Skin care premium segments growing faster Figure 35: Insecticide premium segments growing faster

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Premium Mid Mass

Skin care CAGR (CY09-11)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Coils Electricals Aerosols

Insecticide CAGR (FY07-10)


22 August 2012


ITC and Marico best placed to gain from premiumisation, GCPL, Emami and HUL also beneficiaries

Analysing the portfolio of the companies under our coverage we see ITC, HUL, GCPL, Marico and GSK as best placed to gain from this trend. Marico has over 80% of its domestic portfolio in categories where consumers are moving to from cheaper alternatives. ITC is also well positioned within cigarettes to gain from the premiumisation trend. HUL, Godrej Consumer and Emami are moderately well positioned to gain from premiumisation.

Figure 36: Companies differently positioned for premiumisation Company Brands positioned for premiumisation Estimated share of domestic

revenues HUL Surf Excel (detergents); Dove, Lux, Pears (soaps);

Ponds, Lakme, Vaseline (skin care); Face wash range, Dove (shampoo), Close-up (toothpaste); Taj Mahal, Red Label (tea); Knorr (foods); Axe (Deodorant)

26%

ITC (Cigarettes) Classic, Gold Flake Kings, Gold Flake RSFT, Navy Cut,

50%

Godrej Consumer Good Knight, Hit 35%

Marico Saffola, Parachute 60%

Nestle Baby food, packaged milk 20%

Colgate Colgate sensitive, 10%

Dabur Real Juice 15%

GSK Horlicks – Junior, Women, Mothers, Gold 23%

Emami Navratna Oil, Zandu balm 30%

Source: Company data, Credit Suisse estimates,

Who has the best portfolio? Categories which have high headroom for penetration and premiumisation or are gaining from a shift in consumer behaviour would grow ahead of the FMCG market average growth. Taking these three factors into account we map out the top 25 categories in which our coverage companies operate in. The categories which fall in the top right corner of the chart have the highest growth potential.

Figure 37: Categories with higher penetration gap and positive tailwinds of

premiumisation and consumer behaviour change would grow faster

Detergent

Soap

Skin

Shampoo

Hair oil

Oral

Noodles

Malted

Insecticide

Hair colour

CigaretteBalm

BiscuitTea

Coffee Chocolate

Face wash

Deo

Chwayanprash

Edible oil

Baby food

Milk products

6.5

Penetration gap HIGH

Prem

ium

isat

ion/

beha

viuo

r ta

ilwin

d H

IGH

LOW


Mapping out companies looking at their portfolio of brands, we see that GSK, GCPL, Emami and Marico have presence in the most attractive categories.

22 August 2012


Figure 38: GSK, GCPL, Marico and Emami have the best portfolio in terms of growth

headroom

Detergent

Soap

Skin

Shampoo

Value added oil

Coconut oil

Oral

Noodles

Malted

InsecticideHair colour

Cigarette

BalmBiscuit

Tea Coffee

Chocolate

Face wash

Deo

Chwayanprash

Edible oil

Baby food

Milk products

Penetration gap HIGHLOW

Prem

ium

isat

ion/

beha

viuo

r ta

ilwin

d H

IGH


Companies with leading brands in the right categories will grow the fastest

Companies with leadership positions in the categories or price segments we have identified as having tailwinds would grow the fastest. We map out the portfolio of every company in our coverage universe.

Figure 39: HUL’s portfolio footprint Figure 40: GCPL’s portfolio footprint

Mass soaps (15%)

Skin care, Shampoo, Deo, Premium

detergent, Premium soap (48%)

Tea, Coffee, Mass detergents (26%) Oral care, Foods(11%)

HIGH

HIGHLOW

LOW

Category/segment tailwinds

Mar

ket p

ositi

on

Soaps - No1 (25%) Insecticide, home care, others (54%)

Soaps - Cinthol, Hair colour (21%)


Mar

ket p

ositi

on

LOW

HIGH

HIGH

LOW


22 August 2012


Figure 41: Marico’s portfolio footprint Figure 42: GSK’s portfolio footprint

Saffola, Coconut Oil, Hair Gel (70%)

Value added oils, Deos, Others (30%)

HIGH

HIGH

LOW

LOW

Category/segment tailwindsM

arke

t pos

ition

Horlicks, Boost (94%)

Others (4%) Noodles (2%)

HIGH

HIGH

LOW

LOW


Mar

ket p

ositi

on


Figure 43: Colgate’s portfolio footprint Figure 44: Dabur’s portfolio footprint

Mass toothpaste(45%)

Premium toothpaste (35%)

Toothpowder (10%) Others (10%)

LOW

LOW

HIGH

HIGH


Mar

ket p

osit

ion

Amla oil, Chwyanprash,

Digestive (40%)Juices (15%)

Mass toothpaste, Toothpowder (18%)

Shampoo, home care, skin care, glucose,

other oils (27%)

HIGHLOW

LOW

HIGH


Mar

ket p

ositi

on


22 August 2012


Figure 45: Emami’s portfolio footprint Figure 46: Nestle’s portfolio footprint

Balm (23%) Cooling oil, Boro, Men's fairness (52%)

Others (17%) Pain relief, OTC (8%)

HIGH

HIGHLOW

LOW

Category/segment tailwindsM

arke

t pos

ition

Dairy whitener, Coffee (26%)

Pacakged milk products, baby food,

noodles (52%)

Ketchup, Cholocates (22%)

HIGH

LOW

LOW

HIGH


Mar

ket p

ositi

on


GSK, Marico, GCPL best placed in terms of portfolio

Companies which have the maximum share of revenue coming out of leading brands in categories which have high headroom for growth would likely grow faster than the overall FMCG market. Taking both these factors into account we estimate that GSK and Marico are best placed in terms of their portfolio.

Figure 47: GSK, Marico and GCPL have the largest share of revenues from attractive

segments

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

GSKConsumer

Marico GCPL Nestle Emami HUL Colgate Dabur

% domestic revenue share from attractive categories


22 August 2012


Dominant positions key to margin resilience Disruptive competition the key threat to margins We have seen sustained strong volume led growth in the Indian FMCG market over the past six years despite one of the worst monsoon failures in 2009, sustained high food inflation impacting urban expenses and a general slowdown in economic growth. As a result the importance of India in the global scheme of large multi-national consumer companies has seen a significant jump. This can be seen in the increasing reference to India in the strategic roadmap of various consumer MNCs, shift from indirect to direct reporting of Indian managements’ to global leadership and increasing visits by global consumer company CEOs to India.

As a consequence of this growing focus on India, we are seeing a structural change in competitive intensity in many categories with deep pocketed players willing to forgo a few years of profitability to gain respectable market share. This, in our view, poses the key threat to FMCG company margins in India. Looking at the past track record of the managements of consumer companies in India, we see the biggest threat from Procter & Gamble and ITC, both of whom have the resources and have demonstrated the willingness to gain share at the cost of near-term profits.

P&G will continue to be a key threat in some categories

P&G’s aggressive market moves post 2004 have been a story of playing catch up in India. The company did not have a focus on Asian emerging market except China (where it is a market leader) right up to the 2000s. In complete contrast, Unilever has built dominant market leadership positions in India over 75 years of presence, built most of India’s large consumer brands and invested in strong local management. Unilever has similar strong market positions in other Asian emerging markets like Indonesia, Thailand and Malaysia. As a result, emerging markets constitute over 54% of Unilever’s global turnover as compared to 37% for P&G. This has been one of the reasons why P&G’s global growth has lagged that of Unilever, as the gap in growth rates of emerging and developed markets has widened.

Figure 48: P&G is one of the weakest in emerging market contribution

0%

10%

20%

30%

40%

50%

60%

Unilever Colgate Nestle P&G Loreal Reckitt Kraft

% revenue share of emerging markets


India’s strong growth in consumer spending is attracting focus from all global FMCG companies

P&G being a late entrant into India has been highly aggressive to build market share

22 August 2012


P&G’s recent change in strategy to focus on top 10 developing markets

P&G has since 2000 focussed on increasing its share of business from emerging markets as a result of which its emerging market contribution has jumped from 20% in 2000 to 37% now. P&G has recently announced its new strategy which focusses on only the top ten developing markets as against a focus on all developing markets together. While the company has not articulated what the top ten markets are, it is very likely that India is a part of this group. We do not see a let up in P&G’s aggression in the focus emerging market. In the very recent past P&G has further expanded its oral care footprint in emerging markets. The company has also entered seven large African markets with ‘Safeguard’ soap.

P&G has demonstrated its willingness to take major hits to near-term profitability to gain market share in India. P&G’s unlisted company which operates in detergents, shampoos and skin-care made a PAT loss of Rs3.3 bn in FY11. P&G has two listed entities in India — P&G Health & Hygiene and Gillette. These companies operate in feminine hygiene, shaving and male grooming—in which competitive intensity is lower than in home and personal care. But even in the listed companies, P&G’s EBITDA margins have halved in the past two years. The reasons have been a huge surge in ad spend, launch of lower priced products to recruit consumers which led to sharp reduction in gross margin.

Figure 49: P&G Hygiene’s margins have halved Figure 50: Gillette’s margins have more than halved

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

FY07 FY08 FY09 FY10 FY11 9MFY12

P&G Hygiene EBITDA margin (%)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

FY07 FY08 FY09 FY10 FY11 9MFY12

Gillette EBITDA margin (%)


Figure 51: P&G made a loss in India in FY11 Figure 52: P&G’s unlisted entity made a loss in FY11

-4.0%

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P&G India consolidated revenues (Rs bn) PAT margin (%)

-4,000

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0

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3,000


P&G home products (unlisted) PAT (Rs mn)


P&G has launched soaps in seven African markets recently

P&G’s unlisted entity in India incurred a loss of Rs3.3 bn in FY11, while its listed entities have seen a sharp drop in margins

22 August 2012


There is a thought process that since P&G is now a sizable player in categories like detergents and shampoos, it would not be disruptive in these categories. However we do not concur, as P&G is a distant second in these categories and their portfolio even in these categories have very large gaps to fill. For example, P&G does not have a credible product in washing cakes, which is almost half the detergent market in India. Similarly P&G does not have a shampoo in the discount segment. The following table lists the gaps in P&G’s India portfolio in key categories. In skin care, P&G holds just over 4% market share and is clearly looking to ramp this up very strongly. P&G has articulated in its investor release that it hopes to launch toothpastes in India by 2015. Soaps in another category where P&G is a market leader in China and has recently launched in Africa but has no presence in India.

Figure 53: P&G’s market share in many categories trails the market leader by a distance

0%

10%

20%

30%

40%

50%

60%

Shampoo Toothbrush Detergent Skin Care Hair colour Toothpaste

P&G marketshare (%, CY10) Market leader share (%, FY11)


Figure 54: P&G is yet to fill its portfolio in many large categories in India Category Key brands yet to be launched in India Oral Care Oral B (present in Latam), Crest (present in US, Europe) Shampoo Herbal Essence (Premium), Rejoice (mid to lower end) Soap Safeguard (market leader in China, recently launched in Africa)


ITC is also a threat in all large personal-care categories

ITC has demonstrated its ability to take deep losses to build its FMCG business. The company cumulatively suffered losses of Rs25.2 bn over FY01-12 in its FMCG business. In the process the company has revenues of Rs55.4 bn in its FMCG business which would rank it among the top-three domestic FMCG businesses in India, built in just over a decade.

P&G is still a small player in many categories and would look to gain market share

22 August 2012


Figure 55: ITC has built a large FMCG business Figure 56: FMCG losses are coming off sharply

0.0

10.0

20.0

30.0

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50.0

60.0

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

ITC FMCG revenues (Rs bn)

-6.0

-5.0

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-3.0

-2.0

-1.0

0.0

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

ITC FMCG EBIT (Rs bn)


The company’s confidence has in fact increased substantially after the foods business broke even in FY11 and FY12, and is now seeing mid-single digit margins. This has proven its model of share gain as being sustainable. ITC’s strategy has been different from P&G’s in gaining market share. Unlike P&G which starts with premium products and slowly moves down the pyramid, ITC has started at the bottom of the pyramid to build volumes in trade leveraging its strong distribution, and then focussed on premium products backed by very strong advertising support.

Having established a large and now profitable foods business, ITC is in the initial stages of building a personal care business. In the large and highly competitive soaps category, the company has achieved over 6% exit volume market share in FY12, within four years of launch. ITC’s entry into skin care was two years back and the company has c3% market share. Soaps and skin-care are the key categories that are likely to be affected by ITC’s ambitions.

Figure 57: ITC has a long way to go to become a large player

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Biscuit Salty Snacks Soaps Shampoo Skin Care

ITC marketshare (%) Market leader share (%)


ITC’s packaged foods business is now delivering mid single-digit margins as per our estimates

22 August 2012


We prefer the relative safety of dominant brands Only brands with exceptionally high dominance in their categories would have minimal possibility of margin erosion in the face of competition. Thus companies which have the highest proportion of their turnover coming from such brands would likely sustain high earnings growth over the medium term. Such brands face relatively lower threat from irrational competition, have brand equity significantly higher than existing competition levels, would also be able pass on raw material cost inflation without a meaningful impact on volumes and have the scope for margin expansion if raw material costs come down at any stage.

A framework to assess brand dominance

Brand equity is a highly subjective metric and while there are annual consumer surveys on brand equity, they at best give a sense of brand popularity and recall. Also they do not incorporate the category construct (relative positions of various competitors) and the interest levels from disruptive new players which we believe are a key determinant of brand dominance. We have used a four-point framework to estimate brand dominance of brands.

Figure 58: Defining the key matrices of the model Margin resilience Current market

leadership P&G, ITC interest Sizable unbranded

market Growth rate

HIGH >2.0 relative share NO NO >20%

MEDIUM 1.5-2.0 relative share 15-20%

LOW <1.5 relative share YES YES <15%


Dominant brands in categories with minimal competitive risks will have the highest margin resilience

22 August 2012


Figure 59: Brand dominance for companies in various categories/segments

Company Category - Brands% of revenues

(FY12 estimate)

Current market

dominanceP&G, ITC interest

Sizable unbranded presence Growth rate

Margin resilience

ITC Cigarette 80% (of EBIT) HIGH NO NO LOW HIGHHUL Detergents (Premium) 10% MEDIUM YES NO MEDIUM MEDIUM

Detergents (Mid & Discount) 15% MEDIUM YES YES LOW LOWSoaps (Premium) 8% HIGH YES NO MEDIUM MEDIUM

Soaps (Mid & Discount) 12% HIGH YES YES LOW LOWSkin Care 15% HIGH YES NO HIGH HIGH Shampoo 10% MEDIUM YES NO MEDIUM MEDIUMOral care 5% LOW YES NO LOW LOW

Foods 6% HIGH NO YES MEDIUM LOWBeverages 9% HIGH YES NO HIGH MEDIUM

GCPL Insecticides 28% HIGH NO NO MEDIUM HIGHSoaps 21% MEDIUM YES NO MEDIUM LOW

Hair colours 7% MEDIUM YES NO MEDIUM MEDIUMIndonesia 20% MEDIUM NO MEDIUM HIGH HIGH

Africa 8% HIGH NO YES HIGH HIGHLatam 6% MEDIUM YES NO HIGH LOW

UK 4% LOW NO NO LOW LOWDabur Amla Oils 13% HIGH NO YES MEDIUM HIGH

Health Supplements 12% HIGH YES NO HIGH HIGHOral care 10% LOW YES YES MEDIUM LOWShampoo 2% LOW YES NO MEDIUM LOWSkin care 4% LOW YES NO HIGH LOW

Home Care 4% LOW NO YES HIGH LOWDigestives, OTC 11% HIGH NO YES MEDIUM MEDIUM

Juices 10% HIGH NO YES HIGH HIGHInternational 34% LOW NO MEDIUM MEDIUM LOW

GSK Consumer Malted foods 94% HIGH NO YES HIGH HIGHColgate Oral care 95% MEDIUM YES NO MEDIUM MEDIUMBritannia Biscuits 80% LOW YES YES MEDIUM LOWMarico Coconut Oils 38% HIGH NO YES HIGH

Value added oils 18% LOW NO YES MEDIUM MEDIUMSaffola 15% HIGH NO YES HIGH MEDIUM

Bangladesh 15% HIGH NO YES MEDIUM HIGHMiddle East North Africa 5% HIGH NO YES MEDIUM HIGH

Emami Cooling Oils 17% HIGH NO YES HIGHPain Balm 18% HIGH NO YES HIGH HIGH

Men's creams 10% HIGH NO NO HIGH MEDIUMBoro Creams 15% MEDIUM NO NO MEDIUM LOWInternational 15% LOW NO NO HIGH MEDIUM

Nestle Dairy whitener, packaged milk 43% HIGH NO YES MEDIUM MEDIUMBaby food and milk products HIGH NO NO HIGH HIGH

Noodles 20% HIGH YES NO HIGH HIGHKetchup 5% LOW NO YES HIGH MEDIUM

Chocolates 14% LOW NO NO HIGH LOWCoffee 12% LOW NO NO MEDIUM MEDIUM


Dominant brands in packaged foods, hair oils, skin care, insecticides and niche segments

Using our framework for assessing brand dominance we expect resilient margins from leadings brands in packaged foods (Maggi, Horlicks), hair-oils (Parachute, Navratna, Dabur Amla, Bajaj Almond), home insecticides (Good Knight, Hit), skin care (Fair & Lovely) and traditional categories such as pain balms (Zandu) and health supplements (Chwyanprash). On the other hand, even leading brands in categories such as detergents, soaps and biscuits would always have the threat of margin erosion from competitive cycles. In some other categories such as shampoos and toothpastes, escalating competition may well reduce margin resilience from medium to low in the coming years.

22 August 2012


GSK, Emami, Nestle, Godrej Consumer and Marico have the highest share of revenues from dominant brands

After analysing all major brands of FMCG companies in the listed space, we conclude that GSK Consumer, Emami, Marico and Godrej Consumer derive over 60% of their domestic revenues from brands with high margin resilience. Below, we have discussed each of these companies in detail, along with their flagship brands.

Figure 60: GSK, Marico and Emami have the largest share of dominant brands

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Home and personal care gross margins likely to improve for companies with dominant brands Looking at the price trends for key raw materials for companies under our coverage, we see a definite moderation in cost inflation for home and personal care companies. Many crude derivatives which are important inputs for home and personal care products like LAB and liquid paraffin have seen largely stable prices over the past six months and hence the YoY inflation has come down significantly. Among crude derivatives only packaging costs have continued to move up in the past six months. Agri inputs for home and personal care companies like copra and menthe oil have seen sharp correction from the peak levels. In this scenario we expect companies with dominant brands in home and personal care to deliver gross margin improvement. With demand holding up well, companies have continued to take up pricing in most categories.

In packaged foods, however, trends are mixed at this moment. With the monsoons being lower than normal, production growth is likely to be lower than in the past year and there would be upward pressure on prices. Milk prices could also continue to go up if fodder prices move up. We thus do not expect significant gross margin expansion for food companies except GSK Consumer, where the high pricing power would still lead to margin gains.

Raw material costs inflation has come off over the past few months. Companies with dominant brands to see margin expansion

22 August 2012


Figure 61: Key raw material commodity price trends Raw material Category Company

impacted Price trend / Margin outlook

Palm Oil Soaps HUL, Godrej Consumer

Palm oil prices in USD have been come off by 15-20% in recent months though they are largely flat YoY. However, in INR terms, prices are higher 15-20% YoY due to the depreciation of the INR. Steep price hikes of c15% YoY by soap players would mitigate this increase.

LAB Detergents HUL LAB prices have remained flat for the past six months; as a result inflation has come off to 4% YoY versus 27% YoY six months back. As product prices have moved up, we expect YoY margins to improve.

Packaging (HPDE, PP)

Personal products

Dabur, HUL, Emami, Marico, Colgate

HPDE and PP prices have moved up 10-12% in the past six months and hence margins would remain capped despite price hikes

Copra Coconut Oil Marico Copra is seeing a major down cycle, with prices lower 35% YoY and 20% YTD. Marico has not dropped prices in large packs and would see sharp margin expansion.

Light Liquid Paraffin

Value added hair oils

Emami, Dabur, Marico

Prices have remained flat for the past six months; as a result inflation has come off to 1% YoY vs 28% YoY six months back. As product prices have moved up, we expect YoY margins to improve.

Mentha Oil Cooling oil Emami Prices have come off 45% from the peak in March 2012, but are still up 15% YoY. Margin expansion on a weak base should come through in 2HFY13

Boric Acid Boro Cream Emami Prices have been largely stable over the past six months

Milk and Skimmed milk powder

Milk products, malted foods

GSK Consumer, Nestle

Prices have come off in the past few months, but are still up YoY significantly

Edible oils Biscuits, noodles

Britannia, Nestle

Palm oil prices in USD has been largely stable for the past six months, and is lower 10% YoY. However, in INR terms, prices are higher 10% YoY due to the depreciation of the INR.

Barley Malted foods GSK Consumer

Barley prices have come off sequentially in the past few quarters which would help expand margins

Wheat Biscuits, malted foods, Noodles

Britannia, Nestle, GSK

Prices have been stable for the past few quarters but have seen a recent run up

Sorbitol Toothpaste Colgate, HUL, Dabur

Prices have been largely stable over the past six months

Source: Bloomberg, Company data, Credit Suisse estimates

Figure 62: Palm oil prices have corrected after rising Figure 63: LAB prices have been stable

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22 August 2012


Figure 64: HPDE prices have moved up recently Figure 65: PP prices have moved up recently

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22 August 2012


Figure 70: Wheat prices have increased recently Figure 71: Sugar prices have also jumped recently

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Figure 72: Barley prices have corrected sharply Figure 73: Groundnut oil prices have moved up

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Ad spends – companies who did not curtail spends in FY12 have higher potential for margin expansion Given the steep commodity inflation of FY12, most companies used a combination of price hikes and cost rationalisation to limit the downside on EBITDA margins. Companies with dominant brands were able to raise prices with minimal impact on volume growth and hence continued to increase investments in advertising. On the other hand, companies with lower pricing power were forced to lower ad spends as a percentage of sales as a lever for margin protection. As commodity costs now stabilise or come off for most companies, we expect companies who cut ad spend ratio to raise them in order to spur volume growth. Hence the scope for EBITDA margin expansion is limited in these companies. We see the highest potential for margin gains from Marico, Godrej Consumer, GSK Consumer and Colgate, as they continued to grow ad spends in FY12 and hence there is no necessity to step up the growth trajectory further from hereon. We are already seeing this trend in 1Q FY13 where Hindustan Unilever and Dabur saw significant increases in ad spends YoY, which would limit EBITDA margin upsides.

Marico, GCPL, GSK and Colgate did not cut ad spends to support margins in FY12

22 August 2012


Figure 74: Marico, GCP, GSK and Colgate did not cut ad spend growth in FY12

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22 August 2012


Positive on managements investing in innovation and execution Profitable innovation the key to stable growth In the FMCG business, consistent and profitable innovation is one of the key drivers for stable earnings growth. Any existing brand needs continuous improvements in product delivery, packaging and communication to keep the consumer excited and prevent him from losing to a competitor brand. Every company also need to consistently identify new consumer trends and needs, and deliver new products to take advantage of these. New categories seldom contribute to profitability initially, but well thought out and executed launches turn profitable within a few years as operating leverage on advertising spends kicks in. This is very essential for maintaining medium-term growth as some existing categories start maturing and hence see a slowdown in growth rate.

ITC’s packaged foods foray has been one of the biggest FMCG success stories

ITC entered the FMCG business in 2001 with the ambition of building a large and diversified portfolio in mainstream categories which would become a substantial contributor in over a long timeframe. This was a daunting task as no company in India has been able to build a large FMCG business in mainstream categories from scratch in the past few decades except multi-national players like P&G and L’Oreal, who had the benefit of bringing in global brands into India which already had consumer recall and premium positioning. Successful Indian consumer companies built in the past two-three decades like Emami and Paras Pharmaceuticals have played in niche segments rather than mainstream categories and hence have relatively small revenues.

Figure 75: ITC’s FMCG business is now very sizable Figure 76: ITC’s FMCG business is now near breakeven

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ITC has succeeded in building a profitable domestic packaged foods business with revenues of Rs37 bn in FY12 which would rank within India’s top five consumer companies in revenues, within the timeframe of just a decade. Including personal care and other segments ITC’s FMCG revenues in FY12 were Rs54 bn. The company has incurred cumulative losses of Rs25 bn in the past ten years, which in present value terms is cRs40 bn. Thus the company has built a near break-even FMCG business with three large brands at less than 0.8x revenues. This compares with 3-6x sales multiples of most FMCG acquisitions in recent times like Reckitt’s purchase of Paras, Marico’s purchase of part of Reckitt’s portfolio and Dabur’s acquisition of Fem Care. While these businesses being profitable would have commanded a premium, ITC’s foods business which is 60% of FMCG revenues is now clearly profitable and growing at over 20%.

ITC’s success in packaged foods in just a decade is unprecedented for a company with new brands

ITC’s FMCG business has been built at 0.8x revenues

22 August 2012


Initially ITC did incur steep losses in the business which questioned their portfolio’s sustainability. However, ITC followed a very clear and consistent strategy in all categories it entered. The company first built volumes with the discount segment in biscuits and branded staples, leveraging its strong distributors who are highly profitable in the cigarette business. The company gave large trade discounts to place their products and spent on visibility. However, the company backed this up with heavy advertising spends for the premium products in the portfolio, which slowly gained traction. The initial period of losses lasted till premium products started contributing significantly to ITC’s revenues. Once the company gained c10% market share in biscuits and market leadership in branded staples, it started driving premium products even more while slowly defocusing on the discount segment by reducing trade promotions. As a result, ITC’s foods business broke even in FY11 and is now delivering mid-single-digit margins as per our estimates. ITC’s overall FMCG business EBIT losses have also come from down 16% in FY08 to less than 3% in 1Q FY13.

GCPL is transforming into an innovation driven organisation

GCPL is one of the oldest consumer companies in India with over 100 years of presence. The company however stayed limited largely to soaps and hair colours over the decades, with their attempts at entering new categories not seeing success. However, GCPL has seen a transformation post the merger of the insecticide business and the acquisitions in Indonesia, Africa and Latin America. The company has clearly seen a step up in innovation activity in FY12 with three-five major product launches every year. The ground work for these launches would have happened in FY11, which is the time when GCPL had started integrating the insecticide and international businesses. This is reflecting in higher growth and market share gains in insecticides. In hair colours, the innovations are yet to make a major impact, though the intent for GCPL is more aggressive than in the past.

Figure 77: GCPL’s pace of innovation has picked up very sharply since 2009 Year Category/Innovation

FY05 Godrej No1 variant launch



FY08 South Africa – Hair colour: Powder hair colours launched

FY09 India – Insecticides: Low smoke coil

FY10 India – Soap: Complete re-launch of Godrej No1 range

FY11 India – Insecticides: Active dual switch vaporizer

FY12 India - Hair colours: Gel based hair colour to upgrade consumers from powders

Indonesia – Insecticides: Magic Paper targeted at lower income and rural consumers

Indonesia – Baby Care: Expanded range to baby products like crème bars

South Africa – Hair colours: Launched Caucasian hair colours

FY13 Africa – Insecticides: Likely launch in 2HFY13 in Nigeria

India soap – Cinthol relaunch with extended range of deos, talcs and shower gels

India – Air fresheners: Launch in 2QFY13

India – Hair Colours: Likely launch of crème sachets


To manage the wide footprint of international business, GCPL has also made a few senior management hires from large multinational companies. They are in the process of further beefing up management in each of the individual companies outside India.

22 August 2012


Figure 78: GCPL has beefed up senior management Name, Role Background

Shashank Sinha, CEO International business Joined in 2010

• Has wide international experience across South East Asia and Latin America with global FMCG companies

• Sara Lee: He has held positions of CEO of Sara Lee South East Asia and CEO of Sara Lee China

• Reckitt: Was Regional Category Director for Reckitt's Latin America region. As product manager at joined Reckitt & Colman in India and launched Mortein insecticides.

Vivek Gambhir, Chief Strategy Officer (Joined in 2009)

• Was a Partner at Bain & Company. He has worked with Bain in Boston, Singapore and New Delhi.

• He is a founding member of Bain’s consulting operations in India. • He led the Consumer Goods and the Technology & Media Practices

in India. He also oversaw the organisational capability area for Bain in India.


GSK: New product pipeline has been expanding

GSK Consumer has seen a dramatic shift in growth trajectory post CY07, when the new management team led by managing director Zubair Ahmed took charge of the company. The company has delivered a revenue CAGR of c20% over CY07-11, as compared to 12% over CY03-07. There are broadly two pillars of strategy that the new management team has put in place out of which one has seen very good success. We see significant scope for this strategy to continue to drive growth in the next 3-5 years.

#1: Make Horlicks a contemporary brand and launch value added premium offers: Horlicks is an over 100-year old brand in India, and for long periods of time there were no changes made to the look and feel of the brand. Post 2007, we have seen a significant change in the packaging and advertising of Horlicks which made it much more contemporary. Post that management re-launched Junior Horlicks and Mothers Horlicks and launched new premium variants Women’s Horlicks and Horlicks Gold. As a result, the share of these premium variants has increased from 16% to 23% in the past four years. Besides having better margins, these products also add on to the nutritional brand equity of the base Horlicks variant by establishing expertise.

#2: Expand into adjacent categories: GSK has attempted to expand its flagship brands Horlicks and Boost into other food categories like noodles, glucose, breakfast oats and biscuits. It has not been smooth going here as the company had to rework its marketing mix in noodles and glucose after the initial launch. GSK also withdrew from nutritional bars. However, in biscuits GSK has seen very strong growth in the past four years, while initial trends for oats is encouraging. In our view, building positions in new categories will be a long haul despite the brand equity of GSK’s flagship brands. However categories like oats could see an inflection point and this is the right time to start building brands in the category.

Figure 79: Share of value added products has risen Figure 80: Non-malted portfolio has also grown

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GSK’s new management has turned around the company post 2007

22 August 2012


HUL: Innovation has seen a step jump in quantity and quality

HUL has seen a significant step up innovation activity in the past three years which has been one of the key drivers for the company to maintain strong volume growth in FY11 and FY12. The pace of innovation has seen a rise with over 60% of HUL’s portfolio being touched by innovation in FY12 itself. Considering the size of HUL’s portfolio which spans over 12 categories and straddles the price pyramid, the intensity of the innovation calendar has been very high.

Also in a change from the past, HUL had expanded its presence in many categories despite those not being fully aligned with the global portfolio. Launches like sandal variant in Lux and a liquid whitener, demonstrates the company’s willingness to cater to local consumer tastes.

The company has also worked on the quality of innovation with blind product wins making a comeback as a key metric of any launch. The company has tripled the number of blind product wins in the past two years. For any new product launch for HUL, blind product wins is one of the key factors for a go ahead.

Emami: Innovation focus has transformed it into a diversified FMCG play

In FY06, over 65% of Emami’s domestic turnover came from just two brands – Navratna Oil and Boro Plus. The company has successfully built niche brands in niche segments over the years, focusing on new consumer insights and steadfastly avoiding mainstream categories which raw competition from large MNCs. As a result, the top two brands contribute to only 42% of Emami’s turnover now. There are over six categories – cooling oil, boro creams, pain balms, talcum powder, OTC and men’s fairness creams that contribute more than 5% of Emami’s consolidated revenues, as against only three categories five years back. The company has consistently followed a policy of spending a fixed amount of new launches; as a result of which ad spends for the company over FY09-12 was 18-20% of sales, one of the highest in the industry.

Figure 81: Over 45% of Emami’s revenues come from brands built post 2005 Year Product launched & Insight Contribution to

FY12 revenue 2006 Fair & Handsome: Consumer studies showed that over 30% of users of

female fairness creams are men. F&H launched with top Indian movie actor Shah Rukh Khan as brand ambassador

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• Boro Plus lotion: Consumers upgrading from cold creams to body lotions due to ease of usage

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2009 Navratna Cool Talc: Cooling talcum powder was a need gap, launched with Shah Rukh Khan as brand ambassador

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• Vasocare: A natural ingredient based petroleum jelly

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• Zandu Phancharishta launched with MS Dhoni has brand ambassador • Boro Plus Suncreen: Focussed on the rural market

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Over 60% of HUL’s large portfolio was touched by innovation in FY12

Emami has six categories contribution to over 5% of revenues now as compared to three-five years back

22 August 2012


Execution capabilities getting sharper for some HUL: Widening the distribution edge gap with competition

HUL has always had a significant leadership in direct distribution as compared to its competitors by virtue of significantly larger scale which enabled it to penetrate deeper into rural India. However, in the past four-five years, some of HUL’s competitors like P&G, Godrej Consumer, Dabur and Marico have also seen revenues become sizable and given the critical mass they have expanded rural direct distribution. In this context, HUL’s management has taken a step jump in the quantity and quality of distribution to widen the distribution edge that it has held for many decades now.

HUL has expanded its rural direct coverage by three times in a matter of just two years though a very targeted programme. HUL overall direct reach has expanded to over 2 mn outlets, up from around 1.5 mn outlets a couple of years back. This has widened the gap in direct distribution reach between HUL and other FMCG players.

Figure 82: HUL has widened its distribution gap over competitors

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HUL’s management also implemented project IQ, which equipped front end salesmen with handheld terminals that had capability of analytics based output of key tasks to do at any of the 2 mn outlets that HUL directly covers. The company aims to increase the width of stock keeping unit it sells to each outlet and also uniquely serve each outlets based on its consumer profile and competitive presence. While it would take some time to definitively understand the impact of IQ on market share, it clearly raises the bar for HUL’s competitors.

Emami: Getting ready for the big league

Emami is transitioning from a small company with a couple brands to a larger and more diversified player in the Indian FMCG market. In FY06, Emami had a turnover of just over Rs3 bn with two brands – Boro Plus and Navratna oil contributing to the bulk of revenues. As a consequence the company relied on very basic systems and processes to run its business. However, as the company started gaining scale organically and through acquisitions, management started investing in infrastructure that would help it transition into a larger company. Emami implemented an ERP system in 2002 and has implemented SAP in 2006. The company used Ernst & Young to restructure supply chain in FY12 which led to reduction in inventory days from 36 days in FY11 to 28 days in FY12.

On distribution too, the company is significantly expanding rural distribution through a program named Project Swadesh. Under this project Emami is expanded its rural

HUL’s rural distribution reach tripled in just FY12

Emami has implemented SAP way back in 2006 and is expanding distribution in rural areas now

22 August 2012


distribution from 430,000 outlets in FY11 to 500,000 outlets for FY12 and is now looking to increase it to 600,000 outlets in FY13.

GSK: Distribution expansion a big ticket opportunity

GSK has by far the lowest direct distribution width in India. One of the reasons has been the absence of small packs priced at Rs20 and below, which is critical for any product to reach smaller towns and rural areas. Post 2009, management has put special emphasis on smaller packs as well as expanding direct distribution. As a result, the share of small packs has moved up from less than 2% in CY09 to over 4.5% in 1H CY12. Direct distribution has moved up from 500,000 outlets in CY09 to over 700,000 outlets in CY11.

Figure 83: GSK upping distribution reach Figure 84: Share of small packs increasing


Valuations The FMCG sector has consistently outperformed the Indian equity markets for the past two years, which has raised concerns on valuations. The sector has always traded at a premium to the overall market due to the high free cash flow generating business models which commands very high ROEs and high standards of corporate governance demonstrated by managements of most companies in the sector. We do not see a case for de-rating of the Indian FMCG stocks from their current valuations. We expect earnings growth trajectory to be maintained, ROE to improve further from current high levels, balance sheet leverage to further come down and high levels of corporate governance to continue. There could be earnings upsides if commodity costs stabilise from hereon after the sharp increases in the past two years.

Indian FMCG stocks also trade at a premium to their peers in emerging Asia and to a much larger premium to developed market peers. Despite the significant outperformance of the sector within India in the past one year, the valuation premium for the companies under our coverage as a whole has been stable vis-a-vis emerging Asian consumer peers at 17-18% and the premium over developed market consumer companies has in fact dropped from 82% to 78%.

There are of course variations across companies, with HUL, ITC and GCPL seeing a significant valuation expansion and Nestle, Emami, Marico and GSK seeing a contraction in one-year forward P/E. However, these relative movements have clear reasons like earnings upgrades, improving outlook for FY13, balance sheet deleveraging and management-specific issues.

GSK is focusing of rural distribution expansion and increasing share of small packs

We do not see a case for de-rating of Indian FMCG stocks

Indian FMCG stocks’ premium over emerging Asian staples stocks and developed market staples stocks had not widened

22 August 2012


Figure 85: Indian FMCG stocks have not expanded their

premium over Asian or developed market FMCG stocks

Figure 86: HUL and GCPL has seen substantial multiple

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Most Indian FMCG companies have similar business models which helps them achieve high free cash flow generation and sustain high ROEs. A few companies like GCPL have lower ROEs at this point in time due to a bunching up of acquisitions in the past two years. Nevertheless, GCPL’s core operational ROEs continue to be very high at over 40%. As we plot the P/E ratio of companies versus the EPS growth projections for the next three years, we view GCPL, Marico, GSK and ITC has falling in the most attractive growth-valuation quadrant.

Figure 87: Stock returns vs earnings growth Figure 88: PEG for Indian FMCG stocks

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22 August 2012


Asia Pacific / IndiaTobacco

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ITC Ltd (ITC.BO / ITC IN)

INITIATION

Resilient earnings growth ■ Initiate coverage with OUTPERFORM. We initiate coverage on ITC with an

OUTPERFORM rating and an SOTP-based one-year target price of Rs300.

■ Cigarette EBIT growth is exceptionally resilient. In nine of the past 10 years, ITC’s cigarette EBIT has grown in a tight band of 15%-20% annually despite wide variation in tax increases over the years. The near-absolute pricing power of ITC in cigarettes enables it to pass on price hikes without a risk of market share loss. In years of very adverse tax increases such as FY08, FY09 and FY11, the company prioritised EBIT growth while taking a decline in volumes. We expect this stability in cigarette EBIT growth to continue and drive consistent earnings growth for ITC.

■ FMCG business on the verge of breakeven. ITC has built one of India’s top five FMCG businesses in revenue terms in just over a decade. The EBIT loss margin for the business has come down sharply, from 16% in FY09 to less than 3% in the past two quarters. Within FMCG, the packaged foods business (60% of FMCG revenues) is now profitable, delivering mid-single-digit margins, which should improve further. The personal care business is gaining in scale, which could bring down losses going forward. We expect the FMCG business to break even in FY14 and improve in profitability from thereon.

■ VAT uncertainty to persist; packaging changes not a risk. In the past three years, there has been an additional element of uncertainty with state governments hiking value added tax (VAT) on cigarettes. Average VAT on cigarettes has moved up from 12.5% in FY09 to 18% in FY13. We expect this uncertainly to remain until GST comes into force, which would fix the VAT rate nationally. The recent introduction of plain packaging for cigarettes in Australia has raised concerns. We see very low probability of this move in India. Even if plain packaging were to come through, the impact on ITC would be minimal given that over 70% volumes are sold in loose sticks.

Share price performance

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0100200300400

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Price (LHS) Rebased Rel (RHS)

The price relative chart measures performance against the BSE SENSEX IDX which closed at 17885.26 on 21/08/12 On 21/08/12 the spot exchange rate was Rs55.3/US$1

Performance Over 1M 3M 12M Absolute (%) 4.6 11.8 28.8 Relative (%) -1.3 1.6 20.4

Financial and valuation metrics

Year 3/12A 3/13E 3/14E 3/15ERevenue (Rs mn) 247,984.3 286,108.2 328,764.0 378,791.9EBITDA (Rs mn) 84,732.2 100,845.3 119,876.3 141,948.6EBIT (Rs mn) 77,747.1 92,983.2 110,976.0 132,010.0Net profit (Rs mn) 61,623.6 73,255.8 87,576.3 104,376.5EPS (CS adj.) (Rs) 7.88 9.37 11.20 13.35Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 9.3 10.9 12.6EPS growth (%) 22.3 18.9 19.5 19.2P/E (x) 33.1 27.9 23.3 19.6Dividend yield (%) 1.7 2.2 2.6 3.1EV/EBITDA (x) 23.9 19.9 16.6 13.8P/B (x) 10.9 9.7 8.7 7.6ROE (%) 35.5 36.8 39.3 41.5Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, Credit Suisse estimates.

*Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months.

Research Analysts Arnab Mitra

91 22 6777 3806 [email protected]


[email protected]

Rating OUTPERFORM* Price (21 Aug 12, Rs) 261.10 Target price (Rs) 300.00¹ Upside/downside (%) 14.9 Mkt cap (Rs mn) 2,048,803 (US$

37 049)Enterprise value (Rs mn) 2,010,011 Number of shares (mn) 7,846.81 Free float (%) 100.0 52-week price range 267.8 - 189.4 ADTO - 6M (US$ mn) 29.8

22 August 2012


Company snapshot Figure 89: Revenue mix Figure 90: EBIT mix

Cigarette57%

Paper11%

Hotels3%

Agri15%

FMCG14%

ITC Revenue mix (FY12)


Cigarette EBIT growth is exceptionally resilient ITC’s cigarette EBIT growth annually has been exceptionally stable in a tight band of 15%-20% over FY03-12, with the exception of FY04. However, in the same period, we have seen significant variation in tax increases by the government for cigarettes in the annual budgets. The increase in excise duty equivalent taxation has ranged 0%-28% over this period.

Figure 91: ITC’s cigarette EBIT growth has been resilient to taxation changes

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FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12ii FY13ii

Cigarette taxation increase (% YOY)* Cigarette EBIT growth (% YoY)


What imparts this exceptional stability in profit growth of the cigarette business is ITC’s near-absolute pricing power in the category. With foreign direct investment (FDI) banned in new cigarette manufacturing, ITC’s dominance in the category will remain unchallenged. ITC controls over 70% volume share in cigarettes with competition presence largely limited to lower-priced cigarette segments where ITC has not been active.

Cigarette volumes have also seen an increasing resilience to price hikes in the past five-six years. During the period of FY2000-05, ITC posted a 1.1% CAGR in cigarette volumes with a 6.4% CAGR in cigarette prices. The trend improved substantially over FY05-12, when cigarette volumes have seen a higher CAGR of 3.2% despite pricing witnessing a higher CAGR of 8.8%. This clearly demonstrates the increasing resilience of cigarette volumes to price increases.

ITC’s cigarette volume and earnings have strong resilience to price hikes

22 August 2012


Figure 92: Cigarette volumes did not significantly dip in

FY11, FY09 and FY10 despite steep price hikes

Figure 93: Cigarette volume resilience to price hikes has

increased

(10)

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FY00-05 FY05-12

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ITC’s cigarette dominance to remain unchallenged

ITC’s scale in the cigarette business towers over its competitors such as Godfrey Phillips India and VST Industries. ITC’s profit for FY12 was 34 times higher than its nearest competitor Godfrey Phillips India. This sizeable difference in scale allows ITC to service over 700,000 outlets at a frequency of once a day, which makes ITC’s distribution intensity way above any other FMCG player in India across categories. The only serious challenge for ITC could have come from Phillip Morris, which holds a minority stake of 25% in Godfrey Phillips India. However, after the ban on FDI in cigarette manufacturing in 2010, Phillip Morris cannot make further investments in Godfrey Phillips India. The company still has an avenue of participating in the cigarette market in India via wholesale trading of cigarettes, which is open to FDI. However, there is a move to ban FDI even in this area. Also, Phillip Morris’s brand Marlboro has had good presence in India over the past five-years years, but has failed to make a dent into ITC’s competing brands such as Classic and Gold Flake Kings. We do not see any risk to ITC’s dominance in the Indian cigarette market in the medium term.

Management likely to focus on profitability over volumes in adverse years

ITC’s management has focussed on delivering EBIT growth in the cigarette business over volumes in years of very adverse taxation changes. In FY08, FY09 and FY11, years which saw very steep increases in cigarette taxation, ITC took up prices well beyond what was needed to pass on the tax increase and expanded margins, while giving up volumes marginally. We expect management to continue with this strategy in the years to come, and hence this imparts higher visibility of earnings growth for the company.

FDI ban on cigarette manufacturing has further minimized competitive risk, FDI ban on cigarette trading would completely close out MNCs

22 August 2012


Figure 94: ITC’s management has focussed on cigarette EBIT growth over volumes

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FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Cigarette volume growth (% YoY) (LHS) Cigarette EBIT margin (% of gross sales) (RHS)


Other FMCG business likely to break even ITC’s FMCG business has seen a very strong run in the past six quarters with revenue growth sustaining at over 20% YoY while losses have come off sharply. In the past two quarters, the other FMCG EBIT loss margin has been below 3%, compared with 16% in FY09. We expect the business to break even in FY14 and see continuous improvement in margins from thereon.

Figure 95: ITC’s FMCG revenues have grown strongly Figure 96: FMCG losses are now below 3% of revenues

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The driver for the improving profitability has been the packaged foods business (60% of FMCG revenues), which turned profitable in FY11 and is now delivering mid-single-digit margins by our estimates. Sunfeast and Ashirwad have become over Rs10 bn brands and the share of premium variants within these brands has been growing. In case of Sunfeast, its premium variant Dark Fantasy has seen very strong growth in the past two years. As a result, the share of glucose biscuits in ITC’s biscuit portfolio has come down from over 50% five years back to less than 25% now. Bingo (salted snacks) has also seen a breakeven in a highly competitive category. ITC’s noodles launch has also been very well received with the company gaining double-digit market share nationally within two years of launch.

In the personal care business, ITC continues to incur losses due to the high advertising spend as a percentage of revenue. However, the company has notched up respectable market share in soaps at 6% and is ramping up in skin care. In soaps, ITC is also seeing an improvement in mix towards its premium brands Vivel and Fiama. We expect this part

Improving scale and profitability of the packaged foods business will drive FMCG breakeven

22 August 2012


of the FMCG business to continue to make losses over the next three years, although the quantum of losses will likely come off due to operating leverage on ad spends.

Uncertainly on VAT to persist; packaging changes not a risk In the past three years, there has been an additional element of uncertainty for ITC which has been the changes in value added tax; VAT can be reset every year by different state governments. The blended average value added tax on cigarettes has gone up from 12.5% in FY09 to 19% in FY13. This uncertainty will persist until the goods and services tax (GST) comes into being—GST would set the rate nationally and hence remove uncertainty. However, as the states act independently, ITC has seen a gradual increase in blended VAT with some states hiking the rates every year rather than everyone doing it together.

Figure 97: States have continuously hiked cigarette value added tax (VAT) State Cigarette VAT

(FY10) Cigarette VAT



(FY13) Maharashtra, Haryana, Delhi 20.0% 20.0% 20.0% 20.0%

Andhra Pradesh, Chhattisgarh 12.5% 14.5% 20.0% 20.0%

Karnataka 12.5% 15.0% 15.0% 17.0%

Gujarat 12.5% 20.0% 25.0% 25.0%

Rajasthan 12.5% 20.0% 40.0% 40.0%

Kerala 12.5% 12.5% 12.5% 15.0%

Tamil Nadu 12.5% 12.5% 20.0% 20.0%

West Bengal 12.5% 12.5% 20.0% 20.0%

Bihar 12.5% 13.5% 13.5% 20.0%

MP 12.5% 13.5% 13.5% 13.5%

UP 12.5% 12.5% 12.5% 50.0%

All other states 12.5% 12.5% 13.0% 13.5%

Blended All India 13.7% 14.6% 17.7% 19.3%

Source: Company data

The recent judgement in Australia mandating plain packaging for cigarettes has raised concerns about a global move towards the same. We do not see a strong likelihood of the same happening in India. Even India’s pictorial warnings are less intense than in many other countries. Even if plain packaging were to happen in India, we see no meaningful impact. Over 70% of cigarette volumes are sold in loose sticks and hence the consumer never comes in contact with the packaging. For even the remaining consumers, we believe plain packaging will be beneficial to the market leader as it should further increase entry barriers for new players—like the ban on media advertisements had done more than a decade back.

Valuation We value ITC using an SOTP-based approach. We value ITC’s cigarette business at par with the average one-year forward P/E of our FMCG coverage universe. Given the very high visibility of 15%-20% earnings growth in the cigarette business, minimal risks to margins and high ROCE, we believe the business deserves to trade at these multiples. We value the FMCG business at a revenue multiple of 2x, as the business is clearly on the path to breakeven. We value the agri and hotels businesses at par with competitors, while we value its paper business at a 30% premium to competitors given the value-added nature of the business. Our SOTP-based one-year target price for ITC is Rs300. We initiate coverage on ITC with an OUTPERFORM rating.

We do not see a significant impact of packaging changes if they are implemented in India

22 August 2012


Figure 98: ITC—SOTP-based target price breakdown Business Valuation method Value/share (Rs)

Cigarettes P/E 239

Other FMCG Mcap/sales 20

Hotels P/E 5

Agri P/E 9

Paper P/E 16

Cash 10

Total 300

Source: Credit Suisse estimates

Figure 99: ITC’s P/E has been re-rated due to consistency

in earnings growth

Figure 100: ITC’s earnings have not seen much upward

revisions in the past six months

5.0

10.0

15.0

20.0

25.0

30.0

1-Jan-01 1-Jan-03 1-Jan-05 1-Jan-07 1-Jan-09 1-Jan-11

P/E (12m forward consensus)

8.0

10.0

12.0

1-Jan-10 1-Jun-10 1-Nov-10 1-Apr-11 1-Sep-11 1-Feb-12 1-Jul-12

2013 consensus earnings 2014 consensus earnings

Source: Company data, I/B/E/S Datastream Source: Company data, I/B/E/S Datastream

Key risks The key risks to our call on ITC are as follows

• Disruptive change in cigarette taxation structure which could impact volumes and margins adversely.

• Adverse change in government regulations on selling or consuming cigarettes

• A significant slowdown in consumer income growth which increases the elasticity of cigarette volumes to prices hikes

22 August 2012


Financial summary Figure 101: Income statement Y/e 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E

Revenues 181,532 211,676 247,984 286,108 328,764 378,792

EBITDA 60,741 71,213 84,732 100,845 119,876 141,949

Depreciation -6,087 -6,560 -6,985 -7,862 -8,900 -9,939

EBIT 54,654 64,653 77,747 92,983 110,976 132,010

Non-operating income 6,147 8,712 12,007 13,808 16,570 19,884

Financial expense -648 -683 -779 -624 -624 -624

PBT 60,154 72,682 88,975 106,168 126,922 151,270

Tax expense -19,543 -22,806 -27,352 -32,912 -39,346 -46,894

Reported PAT 40,610 49,877 61,624 73,256 87,576 104,376


Figure 102: Balance sheet Y/e 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E

Cash & cash equivalents 10,829 21,789 27,378 39,683 58,412 83,799

Inventories 45,491 52,692 56,378 65,046 74,743 86,117

Receivables 8,588 8,851 9,860 11,376 13,072 15,061

Other current assets 15,929 18,032 18,311 24,481 27,927 31,968

Creditors 34,983 44,524 47,861 55,159 63,322 72,888

Other current liabilities 45,499 41,063 44,111 54,968 65,375 77,559

Net current assets 788 16,420 20,767 30,458 45,456 66,499

Fixed assets 91,514 96,785 113,759 125,897 136,997 147,058

Investments 57,269 55,547 63,166 63,166 63,166 63,166

Total assets 149,571 168,752 197,692 219,521 245,619 276,723

Borrowings 1,077 992 891 891 891 891

Other long-term liabilities 7,850 8,227 8,882 8,882 8,882 8,882

Shareholders equity 140,644 159,533 187,919 209,749 235,847 266,951

Total liabilities 149,571 168,751 197,692 219,523 245,620 276,724


Figure 103: Cash flow statement Y/e 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E

PBT 60,153 72,682 88,975 106,168 126,922 151,270 Tax paid (19,900) (21,957) (23,180) (32,912) (39,346) (46,894) Depreciation 6,087 6,560 6,985 7,862 8,900 9,939 Net working capital change 2,914 52 (4,868) 1,802 3,731 4,345 Operating cash flow 49,254 57,336 67,913 82,920 100,208 118,660 Capital expenditure (12,386) (13,439) (23,678) (20,000) (20,000) (20,000) Long-term investments (27,385) 3,795 (2,839) - - - Others 1,173 (1,371) (3,343) (0) - 0 Free cash flow 10,656 46,322 38,053 62,920 80,208 98,660 Equity raising 7,207 9,038 7,650 - - - Borrowings (638) 121 (99) - - - Dividend (16,333) (44,517) (40,015) (51,426) (61,479) (73,272) Net chg in cash and equivalents

892 10,963 5,589 11,494 18,729 25,387


22 August 2012


Asia Pacific / IndiaPersonal Products

-

Hindustan Unilever Ltd (HLL.BO / HUVR IN)

INITIATION

Turnaround story playing out ■ Initiate coverage with OUTPERFORM. We initiate coverage on HUL with a

one-year target price of Rs564, based on 30x June 2014 earnings.

■ Management has delivered a strong and sustainable turnaround. HUL’s strong investments in innovation starting from FY10 have imparted volume growth momentum to the business. In a departure from the company’s strategy over the 2000s on rationalising brand portfolio and aligning to the parent’s global objectives, HUL has become more focussed on the local market, improved agility in responding to competition and is churning out a significantly larger number of innovations. Over 60% of HUL’s large portfolio was touched by innovation in FY12, with a clear focus on premiumisation in established categories and growth in new categories such as deodorants and face washes.

■ Moderate scope for margin expansion post 1H FY13. Key raw materials for HUL such as LAB, palm oil and packaging while not seeing an absolute decline in prices, have seen a moderation in YoY inflation. Given the volume growth momentum, HUL continues to gradually increase prices which should help inch up gross margins in FY13. Also, the strong revenue growth is imparting operating leverage to the business. However, post 1H FY13, HUL will not have the benefit of a weak base; this could limit margin expansion.

■ A slowdown in soaps and detergents the key risk. HUL’s revenue growth in soaps and detergents in FY12 is almost twice the historical growth rates for the categories. While HUL has likely gained share from unorganised and local players who form 20%-30% of the market, these gains should peak at some stage, leading to a moderation in growth rates. Also, soaps and detergents by virtue of being the largest FMCG categories are susceptible to down-trading by consumers, which impacts HUL adversely as it has a larger share in the premium segments.


80

130

180

200300400500600




Performance Over 1M 3M 12M Absolute (%) 16.0 20.9 61.9 Relative (%) 10.2 10.9 53.7


Year 3/12A 3/13E 3/14E 3/15ERevenue (Rs mn) 217,356.0 257,228.1 299,651.1 349,129.1EBITDA (Rs mn) 32,913.5 40,364.5 47,622.3 56,144.4EBIT (Rs mn) 30,731.0 38,115.1 45,269.2 53,687.5Net profit (Rs mn) 26,914.1 32,553.5 38,202.4 45,171.4EPS (CS adj.) (Rs) 12.45 15.06 17.67 20.90Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 14.5 16.6 19.0EPS growth (%) 17.7 21.0 17.4 18.2P/E (x) 41.2 34.1 29.1 24.6Dividend yield (%) 1.7 2.1 2.4 2.8EV/EBITDA (x) 33.2 26.9 22.6 19.0P/B (x) 31.6 27.1 23.2 19.8ROE (%) 87.2 85.5 85.9 86.8Net debt/equity (%) net cash net cash net cash net cash






[email protected]

Rating OUTPERFORM* Price (21 Aug 12, Rs) 513.50 Target price (Rs) 564.00¹ Upside/downside (%) 9.8 Mkt cap (Rs mn) 1,110,129 (US$

19 999)Enterprise value (Rs mn) 1,087,126 Number of shares (mn) 2,161.89 Free float (%) 49.0 52-week price range 513.5 - 317.3 ADTO - 6M (US$ mn) 18.2

22 August 2012


Company snapshot Figure 104: Revenue mix Figure 105: EBIT mix

Soaps20%

Detergents25%

Personal products

30%

Foods6%

Beverages 9%

Others10%

HUL Revenue mix (FY12)

Soaps & Detergents

36%

Personal products

52%

Foods1%

Beverages11%

HUL EBIT mix (FY12)


Sustainable turnaround in business momentum HUL’s management has turned around the business in the past two years through a focus on volume growth, cost rationalisation and faster innovation. From a situation where the company was growing below market average and losing market share in 2009, HUL has consistently delivered near-double-digit volume growth for nine quarters. This has come despite the company raising blended prices by c.10% YoY to pass on raw material cost inflation.

Figure 106: HUL has sustained double-digit volume

growth

Figure 107: Revenue growth has accelerated due to price hikes

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This change in growth trajectory has come about through a combination of organisation changes effected by HUL’s management:

(1) Significant jump in quantity and quality of innovations: HUL has significantly increased the number of innovations/renovations in the home and personal care categories. The company revamped 60% of its large and diverse portfolio just in FY12, which shows the intensity of innovation. The company has been able to seize opportunities in very fast-growing new categories such as face washes and deodorants by a large number of new product launches. HUL also entered categories such as fabric whiteners and

22 August 2012


low-end utensil cleaners, which would have in previous years fallen out of focus for the company due to its attempts to align with the parent’s portfolio.

(2) Playing the full portfolio in all categories: In the period of 2000-08, HUL had actually curtailed its portfolio of brands in categories such as soaps, detergents and tea, de-focusing on ‘local brands’ while increasing investments into global brand platforms. However, given the local nature of competition in these three categories, this led to market share losses in many states where HUL de-focussed on regionally strong brands. This is changed now, with management focusing on every part of the portfolio. Thus, local brands such as Sunlight, Hamam, Breeze, Ruby and Lakme have also seen innovation activity in the past two years.

(3) Increased agility in responding to competition: As an organisation, HUL has become more agile in responding to competitive moves and volatility in input costs, which is needed to remain competitive in the market.

(4) Expansion in rural distribution by three times: HUL has always enjoyed a large gap in distribution reach vis-a-vis its competitors. However, in FY12, the company took a step jump in its rural distribution (which was already the best in the industry) by expanding its coverage by three times. With this, HUL’s total direct retail coverage is over 2 mn outlets, compared with 0.5-1.1 mn for its key competitors.

Another positive for HUL is that the high-margin personal products business has seen very stable growth in the range of 15%-20% over the past nine quarters, driven by strong double-digit volume growth.

Figure 108: Personal products has had consistent growth Figure 109: S&D growth has spiked due to price hikes

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Margin expansion potential limited post 1H FY13 HUL’s EBITDA margins are seeing expansion in 1H FY13 on a very low base of soap and detergent segment margins. These margins had bottomed in 1Q FY12 at 7.5% and then sharply moved up to c.13% in 2H FY12. We do not see HUL’s soap and detergent margins moving significantly beyond those levels. While commodity costs such as palm oil and LAB have stabilised, other costs like packaging materials have continued to move up, thus denying the company a favourable cost environment even now. Competitive intensity has also shown signs of an increase after remaining benign for several quarters, as reflected by a rise in industry GRPs, which could also be adverse to any significant gain in margins. Ad spend as a lever for margin growth is also unlikely to sustain as the high base of ad spend has run out. The only room for margin expansion will likely come from overheads as a percentage of sales, as HUL is in the midst of one of its best years in terms of revenue growth, which brings in operating leverage to fixed overhead costs. We expect HUL’s EBITDA margin to expand by 60 bp YoY in FY13 and remain largely stable from thereon.

With the benefit of weak base for soap & detergent margins running out, margin expansion potential is limited post 1HFY13

22 August 2012


Figure 110: Ad spends have started inching up Figure 111: S&D EBIT margin has stabilised

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Soaps & detergent EBIT margin


Slowdown in soaps and detergents a key risk HUL’s soaps and detergents (S&D) segment has led revenue and earnings growth for HUL in the past few quarters. In the past three quarters, S&D revenue growth is holding well above 20% and the segment delivered 70% of the incremental profit for HUL. Soaps and detergent revenue growth was above 28% in 1Q FY13, the highest quarterly growth for HUL in 10 years for this segment. Along with the revenue growth, HUL’s margins in this segment have bounced back to double digits from a bottom of 7.5% in just over three quarters—a result of price hikes which have been comfortably taken given the robust demand environment. This combination of revenue growth and margin expansion has led to HUL delivering soap and detergent EBIT growth in the range of 60%-110% YoY in the past three quarters.

Figure 112: S&D has had very volatile growth Figure 113: S&D EBIT growth has been very high on a

weak base

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CY01 CY03 CY05 CY07 FY10 FY12

Soaps & detergent growth (YoY)

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HUL’s S&D revenue growth over the past few quarters has been well above the average growth seen by HUL and by these categories, which are mature categories. While drivers like premiumisation should continue to drive a 10%-15% sustainable growth in these categories, most listed companies are reporting growth well in excess of these levels. One of the reasons is that unbranded products or local brands in these categories are losing share as they become uncompetitive in a high input cost environment. Also, the high cost of capital and the volatility in currency could be impacting small businesses much more

Soaps & detergents has contributed 70% to incremental profits in the past 3 quarters

22 August 2012


than larger companies. However, the share gain of the branded players should stem at some stage, leading to moderation in revenue growth.

Soaps and detergents continue to be an important part of HUL’s profits. For FY12, the segment constituted 47% of revenue and 36% of operating profit. Thus, any moderation in growth here could be a key risk for HUL. These categories, being the two largest FMCG categories, are also highly susceptible to down-trading by consumers as they form large parts of the consumer wallet within FMCG.

Valuation HUL has traded at an average one-year forward P/E of 24.3x over the past 10 years, which includes the period of eight years between CY03 and FY11 when the company delivered less than 3% earnings CAGR, significantly below its listed peers. Even during the peak of the price war with P&G from 2004 to 2006, the stock traded at an average one-year forward P/E of 24.2x. Hence, HUL should trade at a premium to its valuation during these periods given the high visibility of mid-teens earnings CAGR over the next three years. The turnaround affected by management over the past two years was based on investments made in innovation and distribution, which could reap benefits over the next two-three years. Hence, we value the stock at 30x one-year forward earnings, which is a 20% premium to the stock’s 10-year trading average.

Figure 114: HUL’s P/E has re-rated in the past 12 months Figure 115: Upward earnings estimate revision

momentum could continue

10.0

15.0

20.0

25.0

30.0

35.0

40.0

1-Jan-01 1-Jan-03 1-Jan-05 1-Jan-07 1-Jan-09 1-Jan-11


10.0

12.0

14.0

16.0

18.0

20.0

22.0



Source: Company data I/B/E/S Datastream Source: Company data, I/B/E/S Datastream

Key risks The key risks to our call on Hindustan Unilever are as follows:

■ Significant slowdown in consumer income growth which impacts consumption. This could induce down trading in soaps and detergents and impact HUL which has a larger share in premium segments in these categories.

■ A major increase in competitive intensity from deep-pocketed players like P&G.

■ A sharp price in raw material costs could adversely impact margins.

Soaps & detergents are susceptible to down trading by consumers in a slowdown

22 August 2012


Financial summary Figure 116: Income statement Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E

Revenue 175,238 193,810 217,356 257,228 299,651 349,129

EBITDA 27,905 26,784 32,914 40,364 47,622 56,144

EBIT 26,065 24,576 30,731 38,115 45,269 53,687

Net Interest expense 70 2 12 12 12 12

Others 1,076 2,729 2,783 4,175 5,010 5,761

Profit before tax 27,071 27,302 33,502 42,277 50,266 59,436

Taxes 6,044 5,769 7,420 9,724 12,064 14,265

Exceptional items 994 1,527 832 0 0 0

Net profit 22,020 23,060 26,914 32,554 38,202 45,171


Figure 117: Balance sheet Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E

Cash & equivalents 9,065 2,282 9,229 13,932 23,848 35,537

Other balances 9,857 14,003 9,071 9,071 9,071 9,071

Sundry debtors 6,716 9,432 6,790 6,790 6,790 6,790

Inventories - trade 21,799 28,108 25,167 25,167 25,167 25,167


Fixed assets 24,361 24,579 23,629 23,180 22,627 21,970

Other term assets 15,129 14,703 26,525 26,525 26,525 26,525

Total assets 93,167 101,627 109,583 113,837 123,200 134,232

Sundry creditors 43,737 38,904 37,826 37,826 37,826 37,826

Other current liabs 23,595 36,128 36,627 34,989 37,438 40,294

Long-term debt/CBs 0 0 0 0 0 0

Net worth 25,835 26,595 35,129 41,021 47,936 56,112

Total liabs & equity 93,167 101,626 109,583 113,837 123,200 134,232


Figure 118: Cash flow statement Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E


Depr. & amortisation 1,840 2,208 2,183 2,249 2,353 2,457

Tax paid -6,617 -6,524 -6,568 -9,724 -12,064 -14,265

Working capital ∆ 14,376 -1,607 2,036 -1,639 2,449 2,856

Operating cash flow 35,626 20,748 30,004 33,164 43,004 50,484

Capital expenditure -5,568 -3,113 -2,450 -1,800 -1,800 -1,800

Free cash flow 30,058 17,635 27,554 31,364 41,204 48,684

Equity raised 313 -6,188 336 0 0 0

Investments -7,176 -1,691 -3,395 0 0 0

Debt financing/disposal -4,220 0 0 0 0 0

Dividends paid -17,827 -16,539 -17,546 -26,661 -31,288 -36,995

Net change in cash 1,149 -6,783 6,948 4,702 9,916 11,689


22 August 2012


Asia Pacific / India Household Products

-

Godrej Consumer Products Ltd (GOCP.BO / GCPL IN)

INITIATION

In a new Avatar ■ Initiate coverage with OUTPERFORM. We initiate coverage on Godrej

Consumer (GCPL) with a SOTP based target price of Rs790.

■ India business has transformed into a stronger entity; innovation focus has significantly improved. GCPL’s India business has more than doubled in the past two years after the merger of the household insecticides (HI) business in FY10. The share of the slow-growing soaps business has come down to 36% in FY12 from 68% in FY09. GCPL’s focus on innovation has sharply increased with the launch calendar looking significantly more packed than in the past. GCPL’s market share in HI (45% of the India business) has moved from 30% to over 40% in the past three years, driven by innovation and distribution expansion. GCPL should continue to drive benefits of synergies from the merger of the insecticide business over the next two-three years.

■ International business a high quality franchise; cross-pollination a key driver. We like GCPL’s international business, as it largely comprises market-leading positions in emerging markets in categories that face limited competitive intensity. There are big-ticket opportunities for cross-pollination of products across various geographies, e.g. insecticides in Africa and Latin America and hair colours in Indonesia, which will be realised over the next three years. We are most positive on its Indonesia and Africa businesses where brands have market leadership, and GCPL’s innovation pipeline arising out of opportunities of cross-pollination is significant.

■ Balance sheet deleveraging to continue; ROEs to improve gradually. GCPL’s debt:equity ratio has come off from 1x in March 2011 to 0.5x in March 2012, helped by strong earnings growth and working capital reduction. We see further scope of reducing working capital in the international business and expect free cash flows to deleverage the balance sheet further despite the upcoming payments for further stake acquisition in Darling Holdings. While GCPL’s consolidated ROE is depressed due to the recent spate of acquisitions, we expect ROE to gradually recover as the acquired businesses do not need further investments and are highly cash generating.


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Performance Over 1M 3M 12M Absolute (%) 13.8 19.7 55.4 Relative (%) 7.8 9.5 47.0


Year 3/12A 3/13E 3/14E 3/15E Revenue (Rs mn) 48,661.6 63,411.9 79,609.3 92,569.5 EBITDA (Rs mn) 8,554.0 11,579.1 14,744.3 17,503.4 EBIT (Rs mn) 7,909.6 10,716.9 13,746.9 16,494.1 Net profit (Rs mn) 7,267.1 7,843.5 9,762.0 11,909.3 EPS (CS adj.) (Rs) 17.3 21.97 27.34 33.36 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 22.6 27.8 33.6 EPS growth (%) 14.8 27.5 24.5 22.0 P/E (x) 31.1 30.2 24.3 19.9 Dividend yield (%) 0.7 1.3 1.6 2.0 EV/EBITDA (x) 27.9 20.1 15.6 12.8 P/B (x) 8.0 6.1 5.3 4.7 ROE (%) 32.0 23.3 23.3 25.0 Net debt/equity (%) 42.6 15.6 8.4 net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]

Rating OUTPERFORM* Price (21 Aug 12, Rs) 664.60 Target price (Rs) 790.00¹ Upside/downside (%) 18.9 Mkt cap (Rs mn) 226,181 (US$ 4,090) Enterprise value (Rs mn) 232,413 Number of shares (mn) 340.33 Free float (%) 37.0 52-week price range 664.6 - 374.2 ADTO - 6M (US$ mn) 3.9

22 August 2012


Company snapshot Figure 119: Revenue mix Figure 120: International business mix

Insecticides28%

Hair care7%

Personal wash21%

Others5%

International 39%

Godrej Consumer Revenue mix (FY12)

Indonesia50%

Latam15%

Africa24%

Europe11%

Godrej Consumer International business mix (FY12)


Domestic business has transformed into a stronger entity GCPL’s domestic business has transformed into a much stronger entity post the merger of the erstwhile Godrej Sara Lee business (home insecticides) into the company. Prior to the merger, GCPL’s revenue mix was dominated by soaps, which formed 68% of revenue in FY09. Soaps is one of the most mature categories in India with penetration levels well in excess of 90%; as a result, growth potential for the category is relatively low. After the merger of the business, the domestic revenue mix has completely transformed for the better, with home insecticides now forming 45% of domestic revenue.

Figure 121: FY09 domestic revenue mix was dominated

by soaps

Figure 122: FY12 domestic revenue mix is led by

insecticides

Soaps68%

Hair Colour32%

Soaps36%

Hair Colour19%

Insecticide45%


22 August 2012


Domestic business reaping benefits of a step jump in scale

GCPL’s domestic revenue has more than doubled in the past two years as a consequence of the merger of the home insecticides business. This step jump in scale has obvious benefits for the company in terms of costs and revenues. On the cost side, GCPL is looking to generate synergies from merger of operations such as sales and distribution, supply chain, media buying and central overheads. On the revenue side, GCPL’s distribution network will now be able to push deeper into rural India with much greater scale. The home insecticide business has been the biggest beneficiary as its rural reach has substantially moved up, riding on GCPL’s rural distribution. The company is also ploughing back savings into higher media spends, which enable greater intensity of innovation from the company.

Figure 123: GCPL’s India business doubled over FY10-12 Figure 124: Insecticide growth has been very strong

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Home insecticides an attractive category; GCPL consistently gaining share

Insecticides is an attractive category with a relatively low penetration of c.35%. The category is also seeing premiumisation with higher value segments such as aerosols and electrics growing well ahead of the low-end coils. The headroom for premiumisation is still very large, with over 45% revenue still coming from the coils segment.

GCPL has grown its insecticide category at 20%-40% YoY for all but one of the past nine quarters. This consistent growth is well ahead of the market growth and has resulted in GCPL’s market share moving up from 30% in FY10 to over 40% in FY12, a sizeable gain of 1,000 bp. GCPL’s portfolio mix is well positioned for further share gain, as its shares in the faster-growing premium segments such as aerosols and electrics are much higher than the slower growing coils. GCPL has also had very successful innovations in the category, e.g., the low smoke coil and dual switch electric. We expect further innovations such as paper-based insecticide (which GCPL has successfully launched in Indonesia and is under the approval process in India) to drive market share gains.

GCPL’s domestic revenues have more than doubled in the past 2 years as a consequence of the merger of the home insecticides business

GCPL’s market share has moved up 1000 bp in the past two years to over 40%

22 August 2012


Figure 125: GCPL has high share in premium segments Figure 126: Premium segments growing faster in insecticides

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Soaps to get a boost from Cinthol re-launch; hair colour will likely take time to gain traction

GCPL’s soaps business has seen very strong volume-led growth in the past six quarters, driven by the successful re-launch of Godrej No 1 variants. The company has now undertaken a major re-launch of its Cinthol brand, which should help sustain strong growth. However, we do expect the soaps growth to moderate from the exceptionally high levels that we have seen in the past few quarters, although it could remain above market growth.

GCPL’s hair colour brands have, however, seen muted growth despite a major re-launch of the Godrej Expert brand in FY12. The company is still losing market share to L’Oreal as consumers prefer to shift to the premium crème hair colours segment. We do not expect the growth momentum in hair colours to return very quickly. The key trigger could be the launch of crème sachets, the technology for which GCPL has gained post its acquisition of an Argentinean hair colour company in 2010. This product should be a serious differentiation that GCPL can bring to the category.

Figure 127: Soaps growth has been very strong Figure 128: Hair colour growth has been muted

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22 August 2012


International business a high quality franchise; cross-pollination a key driver

We like GCPL’s international business as it is a high-quality franchise of market-leading brands. The company has market leadership in Indonesia in all three operating categories—non-coil insecticides, air fresheners and baby wipes. GCPL is also the market leader for hair colours in South Africa, hair extensions in Africa and hair colours in Argentina and Chile. We expect GCPL’s international business to deliver stable earnings growth similar to a strong India business.

There are a number of big-ticket opportunities for cross-pollination of products within GCPL’s different geographies. The company has already initiated some of these opportunities such as the launch of paper insecticide in Indonesia, Caucasian hair colour in South Africa and air care range in India. The launch of the paper insecticide in Indonesia has been a major success with the company gaining c.10% market share in rural Indonesia. Similarly, the Caucasian hair colour product has gained 20% volume market share within a year of launch.

Figure 129: Big-ticket cross-pollination opportunities across geographies Geography Category Launch year Opportunity/status

Indonesia Insecticide FY12 Initially, GCPL had no presence in the coils segment, now ramping up with the Hit magic paper which has made inroads into coil consumers

Hair colour NA Evaluating various formats including powder and crème

Baby care FY13 Expanding the Mitu range to other baby care products outside wet wipes

Africa Insecticide FY14 Applied for product registration in Nigeria, pan Africa launch also planned

Hair colour FY12 Launched Caucasian hair colours from the Latin American business, gained 20% volume share in South Africa

Hair colour FY13 Already a 90% market share in ethnic hair colour in South Africa, product will be introduced pan Africa using the Darling distribution network

Latin America Insecticide FY14 Conducting market study

India Hair colour FY13 Crème sachet technology from Latin American business can help GCPL have a differentiated proposition for the premium hair colour market in India

Insecticide FY14 GCPL looking to launch the successful paper based insecticide in India to gain share

Air care FY13 Recently launched a range of air care products.


Balance sheet deleveraging to continue; ROEs to improve gradually

GCPL’s net debt:equity ratio has come off sharply from 1x on March 2011 to 0.5x on March 2012. We expect the company to become net cash by FY15. The company currently carries US$300 mn of foreign currency debt on its books, and would need another US$100-125 mn of investments over the next two years to complete the remaining tranches of acquisition of the Darling Group. GCPL is likely to generate very strong free cash flows of Rs21 bn over the next three years, which should bring down the net debt despite the further payments coming up.

GCPL’s consolidated ROE has also dipped in the past two years from over 35% to just below 20% due to the bunching up of five acquisitions where investments have been deployed. However, the businesses bought are classic FMCG businesses which are asset-light, high cash flow-generating and do not require further investments from GCPL to grow revenues and profits. These businesses are delivering strong 15%-25% earnings growth. As a result, GCPL’s ROE should improve gradually over the coming years. We expect ROE to move up from 18% in FY12 to 24% in FY15.

GCPL’s international business comprises of market leading brands

GCPL is likely to become net cash by FY15

22 August 2012


Figure 130: GCPL will likely become net cash by FY15E Figure 131: GCPL’s ROE will gradually improve

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Valuation We value GCPL’s businesses in different geographies using an EV/EBITDA multiple. We value the India and Indonesia business with the highest multiples within GCPL due to market-leading positions in high growth categories. We value these businesses in line with the average EV/EBITDA multiples for Indian FMCG companies at 20x. We value the UK and Latin American business at 10x EV/EBITDA, while the Africa business at a 25% discount to India given the lower visibility of the business. We initiate coverage on GCPL with an OUTPERFORM rating and a one-year target price of Rs790.

Figure 132: GCPL’s P/E has re-rated due to consistent

earnings growth in domestic and international operations

Figure 133: Upward earnings estimate revisions should

be led by the international business

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Key risks The key risks to our call on GCPL are as follows:

■ A major economic slowdown in any of the international markets that GCPL operates in can impact consumption growth.

■ Competitors in insecticides taking price cuts to gain back market share lost to GCPL in the past 2 years.

■ Any sharp devaluation in currencies that GCPL’s international business operates in will impact earnings translation.

22 August 2012


Financial Summary Figure 134: Income Statement Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E

Revenue 20,412 36,936 48,662 63,412 79,609 92,570

EBITDA 4,073 6,531 8,554 11,579 14,744 17,503

EBIT 3,837 6,032 7,910 10,717 13,747 16,494

Net Interest expense -111 -436 -658 -564 -417 -329

Other Income 473 522 520 624 749 899


Taxes -803 -1,382 -2,261 -2,155 -2,816 -3,413

Minority interest 0 0 -245 -778 -1,501 -1,742

Exceptional items 0 411 2,002 0 0 0

Net profit 3,396 5,147 7,267 7,843 9,762 11,909


Figure 135: Balance Sheet Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E


Sundry debtors 1,153 3,840 4,725 5,786 6,734 7,846



Fixed assets 2,626 15,527 16,494 15,882 15,134 14,375

Other term assets 3,789 15,404 21,454 24,854 26,654 26,654

Total assets 15,510 44,900 60,167 67,961 72,007 78,600

Short-term debt 0 3,170 2,671 1,671 1,171 1,171


Other current liabs 203 351 743 851 990 1,154

Long-term debt/CBs 369 16,838 16,098 12,057 9,057 6,557

Other long-term liabs 66 14 877 877 877 877

Net worth 9,546 17,252 28,152 39,196 44,420 50,793



Figure 136: Cash flow statement Y/e 31 Mar FY10A FY11A FY12A FY13E FY14E FY15E

Profit before tax 4,199 6,118 7,771 9,999 12,578 15,322 Depr. & amortisation 236 499 644 862 997 1,009 Tax paid -803 -1,259 -2,101 -2,155 -2,816 -3,413 Working capital ∆ -270 -3,558 2,241 -2,119 -1,752 -1,034 Other operating items 24 130 -2,914 0 0 0 Operating cash flow 3,386 1,931 5,642 6,587 9,007 11,884 Capital expenditure -565 -13,400 -1,565 -3,650 -2,050 -250 Free cash flow 2,821 -11,469 4,077 2,937 6,957 11,634 Equity raised 1,925 4,525 6,847 6,847 0 0 Investments -1,582 -11,615 -1,714 0 0 0 Debt financing/disposal -2,407 19,639 -5,164 -5,041 -3,500 -2,500 Dividends paid -1,490 -1,966 -1,697 -3,646 -4,538 -5,537 Net change in cash -732 -887 2,349 1,097 -1,081 3,598


22 August 2012


Asia Pacific / India

Nestle India (NEST.BO / NEST IN)

INITIATION

Near term headwinds ■ Initiate coverage with NUTRAL. We initiate coverage on Nestle India with a

NEUTRAL rating and a target price of Rs4590, based on 30x June 2014 earnings.

■ Most diversified play on packaged foods in India. Nestle holds market leadership in a number of food categories in India with strong brands. Most of these categories have high growth potential as penetration levels are below 20%. Rising incomes, growing number of nuclear families, larger proportion of working women and a higher acceptance of western cuisines are structural drivers for these categories.

■ We expect volume growth to revive. Nestle has seen a significant slowdown in volume growth across categories post CY10. Blended volume growth for the company in CY11 was only 5%, a sharp deceleration over the 15% volume growth of CY10 and an average of 12% over CY06-10. Growth slowdown in some of Nestlé’s categories that are relatively more discretionary within consumer staples, capacity constraints and portfolio rationalisation are some of the reasons for the slowdown. With the capacity expansion plan completed and the portfolio rationalisation largely over, we expect a revival in volume growth, although it is unlikely to be as strong as in the CY06-10 period.

■ Margin expansion unlikely ahead; depreciation, interest costs to drag near-term earnings. With the slowdown in volume growth, management is likely to be more careful in hiking prices to take up margins further. Nestle has executed a capex programme of Rs20 bn in the past 18-24 months. With most of the new manufacturing facilities commissioning, depreciation and interest charge to the P&L will likely increase sharply. At the same time, a slowdown in volume growth means capacity utilisation should remain low in the near term. They could be drags on earnings growth over the next two-three years.


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Performance Over 1M 3M 12M Absolute (%) 2.8 1.0 7.6 Relative (%) -3.2 -9.3 -0.8


Year 12/11A 12/12E 12/13E 12/14E Revenue (Rs mn) 74,908.2 86,353.6 103,323.3 123,636.8 EBITDA (Rs mn) 15,527.6 18,945.3 22,808.6 27,443.0 EBIT (Rs mn) 13,994.3 16,216.1 19,311.9 23,786.3 Net profit (Rs mn) 9,615.6 10,737.9 12,989.0 16,515.2 EPS (CS adj.) (Rs) 99.73 111.37 134.72 171.29 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 119 144 175 EPS growth (%) 17.5 11.7 21.0 27.1 P/E (x) 46.0 41.2 34.1 26.8 Dividend yield (%) 1.1 1.2 2.2 3.0 EV/EBITDA (x) 29.0 23.5 19.3 15.8 P/B (x) 34.7 25.7 23.6 22.3 ROE (%) 90.3 71.7 72.2 85.5 Net debt/equity (%) 58.4 17.7 net cash net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]

Rating NEUTRAL* Price (21 Aug 12, Rs) 4,590.95 Target price (Rs) 4,590.00¹ Upside/downside (%) -0.0 Mkt cap (Rs mn) 442,640 (US$ 8,004) Enterprise value (Rs mn) 445,676 Number of shares (mn) 96.42 Free float (%) 38.0 52-week price range 4,977.1 - 3,942.5 ADTO - 6M (US$ mn) 3.0

22 August 2012


Company Snapshot Figure 137: Revenue Mix

Milk & nutrition44%

Prepared dishes28%

Beverages14%

Chocolates14%

Nestle Revenue mix (CY11)

Source: Company data, Credit Suisse

Most diversified play on packaged foods Nestle operates in over 10 packaged food categories which makes it by far the most diversified play on packaged foods in India. The company has well entrenched brands which are market leaders or the No 2 player in most categories.

Figure 138: Nestle is the leader or strong second in most categories Business Segment Category Brands Market position based on

market share Milk Products & Nutrition

Baby Food Cerelac 1

Infant Formula Lactogen 2

Condensed Milk Milkmaid 1

Milk Powder EveryDay 2

Prepared Dishes & Cooking Aids

Instant Noodles Maggi 1

Ketchups Maggi 1

Instant Pasta Maggi 1

Cooking aids Maggi 1

Soups Maggi 2

Beverages Instant Coffee Nescafe 1

Chocolate and confectionery

Chocolate Kit Kat, Bar One 2

Wafers & White Chocolate Munch 1

Eclairs Eclairs 1


Packaged foods likely to be one of the fastest growing categories in India

Packaged foods is one of the most attractive categories in India with high growth potential. The penetration for most categories in packaged foods are less than 20%, which gives a significant headroom for growth. Many of the categories have minimal presence in rural markets, which is again an opportunity for future growth. There are many structural drivers for these categories in India: (1) growing consciousness of health and nutrition, (2) rising number of working women, (3) increasing number of nuclear families and (4) growing acceptance of western cuisines. We expect the category to be one of the fastest-growing FMCG categories in India in the medium term.

22 August 2012


Nestlé’s innovation track record is strong; India getting increasing support from the parent

Over a third of Nestlé’s revenue in India comes from innovations/renovations in the past three years. The company has consistently churned out innovations across its segments which have been well received by consumers. Nestle India has risen in relative importance for the parent over the past few years, being one of the fastest growing market for the company. Nestle is opening its first R&D centre in India in Manesar, which would be the 30th R&D centre for Nestle globally. This centre should further enhance the innovation support that Nestle India gets from its parent company. In the past too, a number of products launched in India have been developed in overseas R&D centres of Nestle.

Volume slowdown a concern, but we expect a recovery Nestle has seen a very sharp slowdown in volume growth in CY11 and 1H CY12 after delivering consistently high volume growth in the prior three-year period. The slowdown is also broad based across Nestlé’s four segments, which is a major concern.

Figure 139: Nestlé’s volume growth has come off across categories

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We believe there are three main reasons for this volume slowdown:

(1) Discretionary consumption impacted due to the economic slowdown: The overall slowdown in economic growth has impacted consumer spending in discretionary consumption in many products categories. A part of Nestlé’s portfolio is relatively discretionary to other staples categories. Baby food, ketchups, cooking aids, soups, premium packaged milk, premium chocolates and instant coffee have high unit prices and hence are the relatively more discretionary part of Nestlé’s portfolio.

(2) Portfolio rationalisation by Nestle: Nestle has consciously rationalised its product and channel mix in the past few quarters which has impacted volume growth. The company discontinued supplies to the Army’s canteen stores division due to increasing receivables. Similarly, Nestle has de-focussed on low unit packs in chocolates and confectionary as the company finds the margins not sustainable.

(3) Capacity constraints in many categories: Nestlé’s management has stated that the company is constrained for capacity given the c.14% volume CAGR over CY07-10, which was one of the reasons for the bunching up of capex for the company in the

Nestle is in the process of opening its first R&D centre in India

22 August 2012


past 18 months. The company has recently completed its Rs20 bn capex programme, which more than doubled gross block in 18 months.

We expect recovery for volume growth, although it would not be as robust as the CY07-10 period due to the overall weakness in consumer discretionary demand. The commissioning of most new capacities has happened for Nestle, which should take out any capacity constraint that the company may have had. Management has also stated its intention to increase innovation by launching a number of products from its global stable of brands post the capacity coming on stream. The portfolio rationalisation which has continued over the past four-five quarters should also conclude and not be a drag on volume growth.

Margin expansion unlikely post CY12; depreciation and interest cost to be drags Nestle has been able to expand gross margins by 160 bp YoY in 1H CY12 despite continued inflation in commodities such as milk, skimmed milk powder and edible oils. Price hikes taken by the company and mix improvement from discontinued low-margin products helped the company expand margins. However, we do not expect these levers to play out beyond CY12. The slowdown in volume growth in the time of such high capacity addition will likely dissuade management from taking substantial further price hikes. We also do not expect further rationalisation of portfolio that would improve mix. Raw material cost inflation continues to be high, although it is low YoY compared with CY11.

Nestle has added over Rs22 bn to its gross block between CY09 and CY11 as part of its large capex programme. As the facilities commissioned recently, the depreciation and interest costs were largely capitalised in CY11. These costs will likely hit the P&L from CY12 onwards, dragging earnings in the near term as capacity ramp-up will take time.

Figure 140: Nestle’ gross block has doubled in two years Figure 141: Depreciation costs rising for Nestle

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Valuation Nestlé’s one-year forward P/E significantly re-rated from an average of 25x in 2006 to an average of 35x in 2011. The valuation for the stock has since come off to 32x one-year forward earnings. We expect Nestlé’s P/E ratio to de-rate from the current level due to the low earnings growth likely over the next three years compared with the past three years. The slowdown in volume growth will also likely be an overhang on the stock. We value Nestle at 30x one-year forward P/E, in line with its five-year average one-year P/E ratio. We initiate coverage with a NEUTRAL rating and a target price of Rs 4,590.

We expect a partial volume growth recovery as new capacities come on stream

Slowdown in volume at the time when capacities have been added will likely deter the management from seeking price hikes

22 August 2012


Figure 142: Nestlé’s valuation has come off from peak

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Figure 143: Nestlé’s earnings estimates have come off

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Key risks The key risks to our call on Nestle are as follows:

■ Slowdown in packaged foods intensifies as consumers cut down on relatively more discretionary items in their FMCG basket

■ Prices of key raw materials like milk, sugar, edible oils and wheat move up sharply

■ ITC becomes a strong No. 2 in the noodles category and impacts Nestlé’s dominance

22 August 2012


Financial summary Figure 144: Income statement Year end 31 Dec (Rs mn) CY09 CY10 CY11 CY12E CY13E CY14E

Revenues 51,294 62,547 74,908 86,354 103,323 123,637

EBITDA 10,345 12,497 15,528 18,945 22,809 27,443

Depreciation -1,113 -1,278 -1,533 -2,729 -3,497 -3,657

EBIT 9,232 11,219 13,994 16,216 19,312 23,786

Non-operating income 378 427 509 662 827 1,034


PBT 9,596 11,635 14,452 16,125 19,364 24,438

Reported PBT 9,493 11,635 14,348 16,125 19,364 24,438

Tax expense -2,620 -3,265 -4,264 -4,918 -5,906 -7,454

PAT 6,873 8,370 10,085 11,207 13,458 16,984

Exceptional -323 -184 -469 -469 -469 -469

Reported PAT 6,550 8,187 9,616 10,738 12,989 16,515


Figure 145: Balance sheet Year end 31 Dec (Rs mn) CY09 CY10 CY11 CY12E CY13E CY14E


Inventories 4,987 5,760 7,340 8,462 10,125 12,115

Receivables 642 633 1,154 1,656 1,982 2,371


Creditors 5,817 7,454 9,979 11,503 13,764 16,470


Net current assets -3,626 -4,730 -7,061 -1,883 -1,294 -3,079

Fixed assets 9,758 13,616 29,944 31,215 29,718 28,061

Total net assets 6,133 8,887 22,883 29,332 28,424 24,982

Borrowings 0 0 9,709 11,700 9,200 4,700

Other long-term liabilities 320 333 435 435 435 435

Shareholders’ equity 5,813 8,554 12,739 17,196 18,788 19,847



Figure 146: Cash flow statement Year end 31 Dec (Rs mn) CY09 CY10 CY11 CY12E CY13E CY14E

EBIT 9,232 11,219 13,994 16,216 19,312 23,786 Tax paid (2,693) (3,207) (3,640) (4,918) (5,906) (7,454) Depreciation 1,113 1,278 1,533 2,729 3,497 3,657 Net working capital change 1,544 756 (163) 1,214 2,328 2,787 Other operating items (295) (105) (356) (469) (469) (469) Financial expense (14) (11) (13) (753) (775) (382) Non-operating income 378 427 509 662 827 1,034 Operating cash flow 9,265 10,357 11,863 14,681 18,814 22,959 Capital expenditure (2,552) (4,459) (15,552) (4,000) (2,000) (2,000) Free cash flow 6,713 5,902 (3,689) 10,681 16,814 20,959 Borrowings - - 8,652 1,992 (2,500) (4,500) Dividend (5,410) (5,430) (5,407) (6,281) (11,397) (15,457) Net chg in cash 1,302 471 (444) 6,392 2,917 1,002


22 August 2012


Asia Pacific / IndiaPersonal Products

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Marico Ltd (MRCO.BO / MRCO IN)

INITIATION

Consistently delivering results ■ Initiate coverage with OVERWEIGHT. We initiate coverage on Marico with

a target price of Rs228, based on 25x June 2014 earnings.

■ India business delivering market share gain-led growth. Marico’s domestic business has delivered best in industry volume growth of 14-16% over the past four quarters. The broad-based nature of growth across all parts of the portfolio is a result of management’s consistency in strategy. Parachute coconut oil continues to gain from loose and unbranded coconut oils. Marico has had very good success in value added hair oils with market share gains across amla and light hair oils. Saffola continues to see secular growth as consumers uptrade to healthier edible oils. The most positive aspect of the growth is that it is led by gains in market share across all categories that Marico operates in.

■ International business likely to recover in 2H FY13. Marico’s international business has seen headwinds in Bangladesh and Egypt. However the company is seeing normalisation in trends in both these geographies and should see a recovery in 2H FY13. International business margins have also come off largely on account of a front-loading of new launches and advertising spends in FY13. Management expects margin improvement to play out in 2H FY13.

■ Pricing power demonstrated again; margin tailwinds to last through FY13E. Copra prices are lower 35% YoY, which has given a major boost to gross margins. However, we are more positive on the fact that the company was again able to take steep price hikes in coconut oils when copra prices rose in 2011 without sacrificing volume growth, and is now able to sustain volume growth despite not taking down prices. We also expect Marico’s margins in value added oils to move up as the business has gained substantial scale. Margin tailwinds for the company should last through FY13.


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Year 3/12A 3/13E 3/14E 3/15ERevenue (Rs mn) 40,082.8 47,694.2 55,366.5 64,337.6EBITDA (Rs mn) 4,844.0 6,762.7 7,894.6 9,221.6EBIT (Rs mn) 4,118.8 5,948.9 7,048.3 8,342.9Net profit (Rs mn) 3,188.6 4,594.9 5,571.0 6,764.8EPS (CS adj.) (Rs) 5.19 7.13 8.65 10.50Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 6.7 8.2 10.0EPS growth (%) 25.4 37.5 21.2 21.4P/E (x) 37.0 26.9 22.2 18.3Dividend yield (%) 0.42 0.47 0.52 0.52EV/EBITDA (x) 26.8 19.3 16.0 13.2P/B (x) 10.3 6.1 4.9 4.0ROE (%) 31.0 28.9 24.5 24.0Net debt/equity (%) 54.8 35.2 11.7 net cash






[email protected]


22 August 2012


Company Snapshot Figure 147:

Coconut oil38%

Value added oil15%

Saffola13%

Others4%

International26%

Kaya4%

Marico Revenue mix (FY12)


India business delivering market share gain-led growth We believe Marico’s management has been exceptionally consistent in its strategy for each of the categories it operates in. In coconut oils, the focus has been entirely to migrate loose oil users to branded oils, while in value added oils the company has adopted a very aggressive pricing strategy to gain market share being a small player. Saffola edible oil is consistently building credentials as a heart health brand and gaining from other edible oils. As a result, domestic volume growth has been very strong at 10%-16% over the past 10 quarters despite very sharp price hikes in 2011.

Figure 148: Domestic revenue growth has been strong Figure 149: Volume growth has been high and consistent

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22 August 2012


Figure 150: Parachute volume growth has accelerated Figure 151: Value added volume growth has been strong

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Marico has gained market share in every category it operates in the past couple of years. In coconut oils, the gain in shares has come from other local brands while in value added oils, the company has gained from both national and regional players. Saffola has also gained share from its key competitor and unbranded edible oils. We see Marico continuing to gain market share, as competitors are struggling to come up with a clear response. Marico’s portfolio has also got a new dimension with the acquisition of youth-focused brands in categories such as deodorants, hair gels and hair levons. The initial success of Parachute body lotion also opens up Marico’s participation in the fast-growing skin care category. We expect Marico’s India business to deliver 18% revenue CAGR over FY12-15.

Figure 152: Market share in coconut oils has increased Figure 153: Value added oils share has increased

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Marico has gained market share is every category it operates in the past couple of years

22 August 2012


Figure 154: Market share for Saffola has increased Figure 155: Marico has mixed shares in its new categories

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International business likely to recover in 2H FY13 Marico’s international business has seen a slowdown in growth and lowering of EBITDA margins in the past few quarters arising from a number of local issues in Bangladesh and Egypt related to the broader economy in those countries. However, Marico is seeing a growth recovery and we expect strong growth to return in 2H FY13 as the base becomes favourable. In Egypt, the normalisation in the political situation and economic activity is helping Marico’s business come back on track. In Bangladesh, a number of initiatives of management like building new categories such as hair dyes, perfumed oils and Saffola are yielding results. Our confidence in Marico’s international business also stems from the fact that the company has leading market positions in most countries it operates in. In Bangladesh, the company holds 80% market share in coconut oils and the brand Parachute has been consistently rated as one of the top brands across all consumer categories in the Nielsen brand equity survey.

We expect a growth recovery for Marico in Bangladesh and Egypt

22 August 2012


Figure 156: Marico has high market share in international

markets

Figure 157: International business growth has been weak

in 1QFY13

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Pricing power demonstrated again; margin tailwinds to last through FY13

Marico has demonstrated pricing power in its flagship brands Parachute over the past seven years. During this period through various cycles of the key input Cora, Marico’s EBITDA margin has structurally moved up from 8.8% in FY05 to 14.2% in FY13 (our estimates). This has come about as the company has taken up prices in every up-cycle in copra, but not brought down prices in the down-cycles. This has demonstrated the company’s pricing power in the category. As we are in the midst of another copra down-cycle, Marico will likely see a jump in margins as we do not expect Marico to cut prices for most of its coconut oil SKUs. The weighted average cut in prices for coconut oil has been just 3% as against a 35% YoY fall in the key input cost copra.

Figure 158: Copra prices have corrected sharply Figure 159: Marico has not cut prices for large packs in

Parachute over the past 10 years

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Valuation Marico is trading at close to its peak one-year forward P/E at over 25x one-year forward as compared to its five-year average P/E of 21.6x. This re-rating is based on the company’s exceptionally consistent growth in volumes and earnings despite going through a couple of

22 August 2012


commodity cycles. We do not see any reason for the stock to de-rate given the stability in management strategy, high pricing power and tailwinds on margins. We value the stock at 25x one-year forward earnings. We initiate coverage with an OUTPERFORM rating and a target price of Rs228.

Figure 160: Marico’s P/E has re-rated due to its consistent

high earnings and volume growth

Figure 161: Earnings estimates are likely to see upward

revision due to margin expansion

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Key risks The key risks to our call on Marico are as follows

■ A major economic slowdown in any of the international markets that Marico operates in.

■ Weakening consumer sentiment in India which induces consumers down trade to loose coconut oil from Marico’s brand Parachute and to loose edible oil from Marico’s brand Saffola.

■ The newly acquired brands of the Paras stable are unable to grow due to high competitive intensity

22 August 2012


Financial summary Figure 162: Income statement Y/E 31 Mar (Rs mn) FY10 FY11 FY12 FY13E FY14E FY15E

Revenue 26,608 31,350 40,083 47,694 55,366 64,338

EBITDA 3,752 4,181 4,844 6,763 7,895 9,222

EBIT 3,151 3,473 4,119 5,949 7,048 8,343

Net Interest expense -257 -410 -424 -424 -244 -64

Other Income 183 212 326 363 422 490


Taxes -677 -684 -783 -1,237 -1,590 -1,929

Exceptional items -65 323 -18 0 0 0

Minorities and other -19 -50 -50 -57 -65 -75

Net profit 2,317 2,864 3,171 4,595 5,571 6,765


Figure 163: Balance sheet Y/E 31 Mar FY10 FY11 FY12 FY13E FY14E FY15E


Sundry debtors 1,507 1,779 1,816 2,160 2,508 2,914



Fixed assets 3,997 4,578 5,018 5,605 5,158 4,680

Intangible assets 1,467 5,261 5,412 5,412 5,412 5,412

Other term assets 827 889 2,957 10,357 10,357 10,357

Total assets 15,260 22,331 26,170 35,858 38,723 42,950

Short-term debt 3,317 4,198 4,083 3,583 3,083 2,583


Other current liabs 768 1,213 1,197 1,322 1,461 1,618

Long-term debt/CBs 1,142 3,544 3,765 4,765 2,265 -235

Minorities/other equity 125 219 249 249 249 249

Net worth 6,540 9,155 11,430 20,320 25,141 31,156



Figure 164: Cash flow statement Y/E 31 Mar FY10 FY11 FY12 FY13E FY14E FY15E


Depr. & amortisation 601 708 725 814 846 879

Tax paid -677 -684 -783 -1,237 -1,590 -1,929

Working capital ∆ -1,080 -411 -240 -1,794 -1,064 -1,252

Other operating items -83 273 -67 -57 -65 -75

Operating cash flow 1,838 3,161 3,656 3,615 5,353 6,392

Capital expenditure -1,486 -1,289 -1,166 -1,400 -400 -400

Free cash flow 352 1,872 2,490 2,215 4,953 5,992

Equity raised 0 5 0 0 0 0

Investments -681 -3,908 -2,349 -7,400 0 0

Debt financing/disposal 709 3,283 107 500 -3,000 -3,000

Dividends paid -470 -472 -500 -675 -750 -750

Other items 283 311 -366 4,971 0 0

Net change in cash 193 1,091 -618 -390 1,203 2,242


22 August 2012


Asia Pacific / India Packaged Foods

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Dabur India (DABU.BO / DABUR IN)

INITIATION

Strategy in transition ■ Initiate coverage with UNDERPERFORM. We initiate coverage on Dabur

with a target price of Rs117, based on 22x June 2014 earnings.

■ A substantial part of the domestic and international portfolio is weak relative to competition. Dabur’s oral care, shampoo, skin care and home care portfolios are weakly positioned with the company not being a market leader or a strong second in these highly competitive categories. These categories contribute c.40% of Dabur’s domestic revenue and adds weakness and volatility to revenue growth and margins. Dabur’s innovation activity in these categories has also been significantly below other large MNCs such as HUL, P&G and Colgate. We expect Dabur’s domestic business to deliver a revenue CAGR of 15% over FY12-15.

■ Underinvestment in hair oils and other herbal categories hurting. Dabur’s umbrella brand is one of the oldest and most trusted in the herbal and Ayurvedic space. However, the company failed to leverage this brand in categories such as value added hair oils outside of Amla oils. While the company is now trying to enter light hair oil, incumbents have become stronger and competitive intensity has risen in the past three years; this makes its task very difficult. Dabur has also not tried to enter other traditional categories where the Dabur brand has high relevance.

■ Margins likely to expand in 2H FY13 over a weak base. Dabur saw the largest decline in margins in 2H FY12 among its FMCG peers. On this weak base, we expect an expansion in 2H FY13, although the company will unlikely be able to regain its FY11 margins. Raw material cost inflation, the key driver for margin expansion, has fallen YoY. However, the company will have to increase ad spends which it had aggressively cut last year to maintain volume growth. This should offset part of the expansion in gross margins.


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Year 3/12A 3/13E 3/14E 3/15E Revenue (Rs mn) 53,054.2 61,432.2 70,169.0 80,201.2 EBITDA (Rs mn) 8,901.7 10,334.0 11,939.3 13,829.2 EBIT (Rs mn) 7,869.2 9,245.0 10,809.4 12,670.2 Net profit (Rs mn) 6,448.8 7,474.6 8,904.2 10,462.4 EPS (CS adj.) (Rs) 3.70 4.29 5.11 6.01 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 4.38 5.22 6.12 EPS growth (%) 13.9 15.9 19.1 17.5 P/E (x) 32.2 27.8 23.3 19.8 Dividend yield (%) 1.1 1.5 2.0 2.8 EV/EBITDA (x) 24.1 20.0 17.0 14.2 P/B (x) 12.1 9.9 8.3 7.2 ROE (%) 41.5 39.1 38.6 38.7 Net debt/equity (%) 39.2 net cash net cash net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]

Rating UNDERPERFORM* Price (21 Aug 12, Rs) 119.15 Target price (Rs) 117.00¹ Upside/downside (%) -1.8 Mkt cap (Rs mn) 207,669 (US$ 3,755) Enterprise value (Rs mn) 206,397 Number of shares (mn) 1,742.92 Free float (%) 70.0 52-week price range 123.1 - 92.9 ADTO - 6M (US$ mn) 2.4

22 August 2012


Company snapshot Figure 165: Revenue mix Figure 166: International revenue mix

Hair oil15%

Shampoo2%

Juices10%

Health Supplements

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Digestives5%Skin care

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International31%

Oral care10%

Dabur Revenue mix (FY12)

US26%

Africa22%

Asia16%

Middle East30%

Others6%

Dabur International revenue mix (FY12)


A substantial part of the domestic and international portfolio is weak relative to competition Dabur’s domestic business comprises a large number of categories such as hair oils, health supplements, fruit juices, shampoos, toothpaste, digestives, home care, skin care and OTC medicines. While this adds diversity to the portfolio, the company is not a leading player or a strong second in categories contributing to over 40% of the domestic business. Dabur is a weak player in highly competitive categories with large MNC presence—shampoos, toothpaste, skin care and home care, which contribute to c.40% of the India business.

This weakness has led to a lot of volatility in growth for Dabur in these categories and an overall slowdown in volume growth. Dabur’s domestic volume growth came off to mid-single digits in some of the recent quarters which was the lowest among the FMCG peer group. Growth in categories such as toothpaste, shampoos and skin care has also come off relative to competitors. We expect Dabur’s domestic revenue growth to lag its FMCG peers in India as a turnaround could take many years of effort in these categories.

Figure 167: Dabur’s domestic growth has been volatile Figure 168: Domestic volume growth slipped into mid-

single digits in a few quarters

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Over 40% of Dabur’s domestic portfolio is weakly positioned relative to competition

22 August 2012


Figure 169: Toothpaste growth has been sluggish Figure 170: Shampoos went through steep declines

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Figure 171: Skin care growth has also been muted Figure 172: Foods has been a consistent performer

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The same weakness in portfolio is seen in a substantial part of Dabur’s international business, where the company has small market shares in a large number if geographies. Dabur international business contributes 30% to consolidated revenue. Almost 25% of the international business comes from the US, where sustaining high growth rates is tough. Among the emerging markets, Dabur does not have market-leading positions except in Turkey and some categories in South Asia and the Middle East. Dabur’s market positions in Africa, the Levant and the Middle East are relatively weak compared to competition. This has again resulted in a lot of volatility in margins and growth in the international business. We do not see this changing and the international business growth and margins should continue to be volatile.

Underinvestment in hair oils and other herbal categories hurting

The Dabur umbrella brand has very high relevance in traditional and herbal categories by virtue of it being a 100-year old brand. However, the company invested heavily in personal care categories such as shampoos, toothpaste and skin care, in the past few years, where after initial success there was a slowdown due to intensifying competition from large MNCs such as HUL, P&G and L’Oreal. The company did not invest in expanding its hair oil portfolio beyond the Amla category where Dabur is a dominant market leader. Dabur entered light hair oils only recently which is late, in our view. Similarly, the company has also not come up with big-ticket new products in the herbal/ayurvedic healthcare space.

Dabur’s international business does not have market leading positions in most markets

22 August 2012


The only major success has been the continued thrust on fruit juices, where the company has delivered high growth rates in the past three years.

Figure 173: Hair oils growth has also been volatile Figure 174: Health supplements has seen stable growth

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EBITDA margin expansion likely on a weak base in 2H FY13, but will unlikely recover fully Dabur saw the maximum fall in EBITDA margins among the Indian FMCG coverage universe in FY12, a sign of the weak market positions in many categories; this imparts limited pricing power to the company. The company cut ad spends aggressively in FY12 to limit the impact on EBITDA margins, which could now be increased to improve revenue growth and protect market share. As a result, while on a weak base we expect margin improvement for Dabur, the company is unlikely to go back to the margins it commanded in FY11.

Figure 175: Ad spends will likely rise over a weak base Figure 176: Gross margin should expand on a weak base

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22 August 2012


Valuation Our target price of Rs117 is based on 22x Jun-14 earnings (10% discount to historical multiples).

Figure 177: Dabur has de-rated due to volatility in

earnings growth

Figure 178: Downward revisions in earnings are likely to

end

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Key risks The key risks to our call on Dabur are as follows:

■ A swift turnaround in oral care, shampoos and skin care categories where Dabur is currently facing intense competition from MNCs.

■ Very strong success in the newly launched almond oil

■ A sharp deflation in input costs like packaging and liquid paraffin could give upsides to margins.

22 August 2012


Financial summary Figure 179: Income statement Y/e 31 Mar, Consolidated FY10 FY11 FY12E FY13E FY14E FY15E

Revenues 33,914 41,045 53,054 61,432 70,169 80,201

EBITDA 6,300 8,001 8,902 10,334 11,939 13,829

Depreciation -562 -952 -1,033 -1,089 -1,130 -1,159

EBIT 5,738 7,049 7,869 9,245 10,809 12,670

Non-operating income 394 322 574 689 792 911


PBT 6,009 7,079 7,905 9,334 11,261 13,403

Tax expense -1,005 -1,390 -1,464 -1,867 -2,365 -2,949

Reported PAT 5,032 5,686 6,449 7,475 8,888 10,462


Figure 180: Balance sheet Y/E 31 Mar, Consolidated FY10 FY11 FY12E FY13E FY14E FY15E


Inventories 4,262 7,085 8,239 9,563 10,925 12,489

Receivables 1,198 3,555 4,617 5,359 6,122 6,998


Creditors 4,669 7,394 9,298 16,271 18,491 21,040


Net current assets 1,855 4,134 6,487 5,892 5,543 8,785

Fixed assets 6,767 15,311 16,680 17,127 17,534 17,211

Investments 2,641 4,197 4,825 4,825 4,825 4,825

Other long-term assets 27 1,010 719 719 719 719

Total net assets 11,291 24,651 28,711 28,564 28,621 31,540

Borrowings 1,793 10,510 11,235 7,235 3,235 2,235





Figure 181: Cash flow statement Y/E 31 Mar, Consolidated FY10 FY11 FY12E FY13E FY14E FY15E

PBT 6,009 7,079 7,905 9,334 11,261 13,403 Tax paid (968) (1,307) (1,379) (1,867) (2,365) (2,949) Depreciation 562 952 1,033 1,089 1,130 1,159 Net working capital change 39 (796) (485) 4,617 65 197 Other operating items 79 (1,584) 103 8 (9) 8 Operating cash flow 5,721 4,344 7,176 13,180 10,083 11,818 Capital expenditure (1,738) (9,496) (2,402) (1,536) (1,536) (836) Long-term investments 829 (1,556) (629) - - - Free cash flow 4,812 (6,707) 4,146 11,644 8,547 10,982 Equity raising (1,836) 1,199 (191) (31) 17 - Borrowings (507) 8,717 725 (4,000) (4,000) (1,000) Dividend (2,031) (2,328) (3,000) (3,590) (4,847) (6,543) Net chg in cash 439 882 1,680 4,022 (284) 3,439


22 August 2012


Asia Pacific / India Personal Products

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Emami (EMAM.BO / HMN IN)

INITIATION

Unique portfolio ■ Initiate coverage with OUTPERFORM. We initiate coverage on Emami with

an OUTPERFORM rating and a target price of Rs619, which translates into 24x June 2014 earnings.

■ Unique portfolio of leading brands in niche categories. Emami operates with leading market shares in niche categories such as cooling oils, pain balms and men’s fairness creams. As these categories are relatively small in market size and in many cases are ayurvedic/herbal, there is minimal presence of deep-pocketed MNCs; this makes the competitive intensity benign and imparts pricing power to Emami’s leading brands, Navratna and Zandu. These categories also have high growth potential as they have low penetration and address very clear consumer needs.

■ Management has strong innovation track record. Emami’s management has consistently seeded in new products, which have successfully grown to become profitable and meaningful contributors to growth. Over 30% of Emami’s current turnover comes from products launched post FY05. Management has built from scratch categories like cooling oils, cooling talcum powders and men’s fairness creams. The philosophy has been to pilot a number of products every year and strongly back a couple of new products with national advertising using celebrities.

■ Margin expansion likely in 2H FY13; international business could also revive on a weak base. Emami has faced unprecedented cost inflation in the past 24 months as one of its key inputs, menthol, saw a 400% rise in price in this period. However, menthol has corrected 45% from the peak levels, although it is still up 20% YoY. We expect Emami to see gross margin expansion in 2H FY13 as the product price continues to be gradually raised in the absence of any increase in competitive intensity. Emami’s international business is also likely to revive on a weak base with additional drivers such as the commissioning of new facilities in Bangladesh and Egypt.


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Performance Over 1M 3M 12M Absolute (%) -2.3 -0.8 3.2 Relative (%) -8.3 -11.1 -5.2


Year 3/12A 3/13E 3/14E 3/15E Revenue (Rs mn) 14,535.1 17,291.3 20,537.1 24,446.3 EBITDA (Rs mn) 2,967.6 3,341.6 4,170.4 5,181.1 EBIT (Rs mn) 2,779.8 3,124.9 3,927.2 4,911.5 Net profit (Rs mn) 2,588.0 3,108.0 3,711.6 4,468.0 EPS (CS adj.) (Rs) 17.10 20.54 24.53 29.53 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 20.3 24.0 28.5 EPS growth (%) 13.2 20.1 19.4 20.4 P/E (x) 27.8 23.1 19.4 16.1 Dividend yield (%) 1.7 1.7 2.1 2.5 EV/EBITDA (x) 23.8 20.9 16.3 12.8 P/B (x) 10.2 8.2 6.7 5.5 ROE (%) 37.1 39.3 38.2 37.5 Net debt/equity (%) net cash net cash net cash net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]


22 August 2012


Company snapshot Figure 182: Revenue mix

Cooling oil22%

Boro15%

Balm20%

Fairness cream

9%

Talc5%

OTC4%

Others11%

International14%

Emami Revenue mix (FY12)


Unique portfolio of leading brands in niche categories Emami has a portfolio of leading brands most of which operate in niche categories. Emami’s leading brands Navratna cooling oil, Zandu balm and Mentho Plus balm, Fair & Handsome and Boro Plus hold 54%-74% market share in small but fast growing categories. Emami’s portfolio is also well diversified with no single product contributing to over 25% of Emami’s consolidated revenues.

Figure 183: Emami is the market leader in niche

categories

Figure 184: Emami has a unique diversified mix of niche

categories

54%

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Cooling oils Boro creams Men's fairness Pain balm

Emami's marketshare (%)

Cooling oils22%

Boro creams

13%

Pain balms19%

Talc5%

Mens fairness

10%

International

14%

Others17%


Emami’s categories have high growth potential as their current consumer adoption is low despite the strong growth seen in the past three years. Cooling oils penetration is below 20% while the category has seen a CAGR of 18% over the past four years. The size of men’s fairness creams market is less than 10% of the female fairness cream market where a significant part of consumption still comes from male consumers. Skin care is one

22 August 2012


of the fastest-growing categories in India and variants of Boro Plus operating in lotions, face wash and sun screen should grow well in the category.

Figure 185: Cooling oils market has seen strong growth Figure 186: Fair & Handsome has been a big success

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Emami’s management has strategically chosen to stay out of mainstream categories that face competition from deep-pocketed MNCs. The company directly faces MNCs in products contributing less than a fourth of its turnover. Emami’s competitors are largely regional players in other categories, and in most cases Emami’s brands are the only ones in their category with television advertising support. This imparts a lot of pricing power to Emami as its brands are way above their competitors in brand equity and scale. The company has been able to limit margin declines in periods of very high inflation in its input costs as was seen in FY12.

Figure 187: Emami faces local competitors except in skin care Category Key competitors

Cooling oil Hemgange (Uttar Pradesh, Bihar), Himtaj (North India), Banfool (North India), Marico (in prototype stage in South India), Bajaj Corp (in prototype stage in North India)

Pain balms Amrutanjan (South and West India)

Antiseptic creams Boroline (East India), Borosoft (South India)

Men's fairness cream HUL, L’Oreal

OTC range Local players in Ayurvedic medicines, Dabur, Baidyanath

Cooling talcs Reckitt Benkiser, Heinz


Management has strong innovation track record Emami’s core philosophy has been to drive revenue growth through innovations, which address niche opportunities. The company has launched a number of products in the past five-six years; they have become sizeable in revenue contribution and are also profitable.

Emami’s management has strategically chosen to stay out of mainstream categories which face competition from deep-pocketed MNC players

Over 40% of Emami’s revenues come from brands that were not present prior to 2006

22 August 2012


Figure 188: Emami’s track record of product launches is very strong Year Products launched and insights Contribution to

FY12 revenue 2006 Fair & Handsome: Consumer studies showed that over 30% of users of

female fairness creams are men. F&H launched with top Indian movie actor Shah Rukh Khan as brand ambassador

10%

2007 Emami Malai Kesar Cream: Natural ingredient based moisturising cream was missing in the market

5%

2008 • Zandu re-launch: Changed packaging after 30 years, launched a Rs2 SKU, advertised with the Mumbai Indian’s team including Indian cricket star Sachin Tendulkar

16%

• Boro Plus lotion: Consumers upgrading from cold creams to body lotions due to ease of usage

3%

2009 Navratna Cool Talc: Cooling talcum powder was a need gap, launched with Shah Rukh Khan as brand ambassador

3%

2010 • Extra Thanda: Consumers in UP and Bihar used a local cooling oil competitor due to higher menthol content

• Vasocare: A natural ingredient based petroleum jelly

3%

2011 • Boro Plus face wash: Face wash market has hit an inflection point and Boro has strong healthcare equity

• Zandu Phancharishta launched with MS Dhoni has brand ambassador • Boro Plus Suncreen: Focussed on the rural market

1%

2012 Fast Relief: Relaunch with top Indian sports stars from the Olympics 1%

Total proportion of turnover from brands that did not exist pre-2006 41%


The company’s business model has been to pilot 5-10 new products every year, out of which management selects those which meet action standards for a national launch. The company backs new launches with big-budget celebrity endorsements. The top movie actors of the Hindi film industry and Southern regional film industry and many sports champions are brand ambassadors for Emami’s brands. A recent example is the pain relief brand “Fast Relief” which has been re-launched with a media campaign featuring the top Indian sportsmen who participated in the Olympics. In 2011, the company re-launched “Zandu Pancharishta” with Indian cricket captain MS Dhoni as brand ambassador. These launches have significantly diversified Emami’s revenue streams, with over six products contributing to over 5% of domestic revenues, compared with three back in FY05.

Among the recent launches by the company, we are excited about the re-launch of Fast Relief which is operating in a category with high growth potential. We also see potential in the ramp up of Boro Plus variants over the next two-three years.

Any new product failures do not impact Emami’s P&L on a YoY basis as new launch budgets are a regular part of their annual advertising costs, which are the highest in the industry at c.18% of revenues. The company has seen many product failures as a routine part of its innovation process like a range of baby care products, shampoo, glucose and coconut based cooling oil.

Margin expansion likely in 2H FY13, international business also likely to see a revival Emami’s key input cost menthol saw a significant spike of 400% in prices between March 2010 and March 2012, which exerted downward pressure on gross margins. However, the company was able to limit the gross margin drop in FY12 to 150 bp YoY due to the high pricing power it enjoys in all its products given the lack of national competition. Menthol prices have corrected 45% from the peak levels of March 2012, although they are still up 20 YoY. Another input, liquid paraffin, has seen YoY inflation come off from 28% six months ago to 1% YoY now. Emami has continued to increase prices which help the company expand gross margins in 2H FY13 if commodity costs remain stable from hereon.

Stability in menthol prices would help Emami expand gross margins in 2HFY13

22 August 2012


Figure 189: Raw material costs are stabilising after steep run up Raw material % of raw material Remarks/outlook

Menthol 25% Prices moved up 400% over the past 24 months before correcting 45% from the peak. Prices are still up 20% YoY. Local production has jumped 50% in FY13 due to the high prices, and should prevent further increases.

Packaging material 25% Consists mainly of crude derivatives like polypropylene, polyethylene and HDPE. Prices are up 15-20% YoY.

Light liquid paraffin 10% Prices are up 1% YoY as against 28% YoY 6 months back

Others 40% Consists of a large variety of items like boric acid (used in Boro Plus cream), soft stone powder (used in talcum powder), til and castor oil, used in Navratna Oil. Prices of most of these raw materials are stable.


Figure 190: Mentha oil has corrected from peak levels Figure 191: Liquid paraffin prices have been stable

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International business likely to revive on a weak base; Bangladesh and Egypt capacity commissioning a key trigger

Emami’s international business (14% of consolidated revenue) has seen revenue decline in the past three quarters due to a combination of issues—discontinuation of a low margin product range in Africa and an issue of counterfeit in the CIS market. These issues are a result of Emami not having a strong operating presence in these geographies and the weak market position of their brands. However, we expect the base to become favourable in 2H FY13 which should lead to revenue growth coming back on track. There are two other triggers for the international business that we expect to come through in the next six-nine months. Emami has completed the construction of its manufacturing facility in Bangladesh, which is awaiting government licenses to commence operations. The commissioning of the plant should help Emami bring down prices as it would avoid import duties and hence spur volumes. Management expects revenues from Bangladesh to triple over a three-five year period once the plant comes on stream. Emami is also in the process of building its first manufacturing unit in Egypt, which is expected to commission by 4Q FY13. This plant should help cut import duties and service the Middle East and North Africa markets much better.

Valuation We value Emami at 24x one-year forward P/E (in line with historical multiples). We initiate coverage with an OUTPERFORM rating and a target price of Rs619.

International business likely to recover over a weak base in 2HFY13

22 August 2012


Figure 192: Emami’s P/E has come off due to the steep

cost inflation in input costs

Figure 193: Earnings downgrade would likely stop

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Key risks The key risks to our call on Emami are as follows:

■ Significant increase in competitive intensity in skin care segments where Emami operates from large MNC players

■ Spike in prices of key raw materials like menthol.

22 August 2012


Financial summary Figure 194: Income statement Y/E 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E

Revenues 10,217 12,590 14,535 17,291 20,537 24,446

EBITDA 2,465 2,534 2,968 3,342 4,170 5,181

Depreciation -154 -140 -188 -217 -243 -270

EBIT 2,310 2,395 2,780 3,125 3,927 4,911

Non-operating income 70 185 541 677 744 819

Financial expense -210 112 -152 -145 -145 -145

PBT 2,171 2,691 3,169 3,656 4,526 5,585

Exceptionals -119 -3 -179 0 0 0

Reported PBT 2,052 2,689 2,989 3,656 4,526 5,585

Tax expense -354 -402 -401 -548 -815 -1,117

PAT 1,697 2,287 2,588 3,108 3,712 4,468


Figure 195: Balance sheet Y/E 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E


Inventories 826 1,234 1,122 1,326 1,575 1,875

Receivables 755 1,089 1,007 1,198 1,422 1,693


Creditors 890 883 1,288 1,421 1,688 2,009

Other current liabilities 731 767 1,661 1,697 1,978 2,329

Net current assets 3,189 4,347 3,911 5,293 7,025 9,188

Fixed assets 5,673 4,909 4,803 5,087 5,344 5,574

Intangibles 0 8 42 42 42 42

Investments 66 66 68 68 68 68

Other long-term assets -14 0 0 0 0 0

Total net assets 8,914 9,330 8,824 10,489 12,478 14,872

Borrowings 2,591 2,294 1,611 1,611 1,611 1,611





Figure 196: Cash flow statement Y/E 31 Mar, Consolidated FY10 FY11 FY12 FY13E FY14E FY15E

EBIT 2,310 2,395 2,780 3,125 3,927 4,911 Tax paid (314) (326) (267) (548) (815) (1,117) Depreciation 154 140 188 217 243 270 Net working capital change (596) (1,236) 700 (411) (194) (219) Other operating items (93) 171 29 531 599 674 Operating cash flow 946 962 3,278 2,914 3,761 4,518 Capital expenditure (331) (419) (1,131) (500) (500) (500) Free cash flow 840 782 2,687 2,414 3,261 4,018 Equity raising 3,100 - - - - - Borrowings (1,846) (311) (682) - - - Dividend (398) (531) (615) (1,443) (1,723) (2,074) Net chg in cash 1,696 (59) 1,390 971 1,538 1,944


22 August 2012



Glaxo Smithkline Consumer Healthcare (GLSM.BO / SKB IN)

INITIATION

Malted bastion ■ Initiate coverage with OUTPERFORM. We initiate coverage on Glaxo

Smithkline Consumer Healthcare (GSK) with an OUTPERFORM rating and a target price of Rs3,428, based on 25x June 2014 earnings.

■ Multiple growth drivers for GSK’s malted foods brands. The malted foods category has substantial headroom for growth with overall household penetration of 20% and rural penetration being even lower at 11%. GSK is actively looking to capture this potential by expanding its currently lagging distribution reach to smaller towns and rural areas and focussing on price point packs to bring in new consumers into the category. The company is also looking to expand its footprint in Northern and Western India which have been traditionally brown drinks markets by a number of variants. GSK is also premiumising the portfolio with value added products such as Junior, Mothers, Women’s and Gold Horlicks.

■ Dominance on malted category imparts very high pricing power. GSK holds a 65% market share nationally in malted foods, while its shares in South and East India are above 75%. This gives the company very high pricing power as a result of which it has been able to maintain gross margins in a highly inflationary raw material cost environment over CY09-11, while sustaining volume growth in high single digits. Consumer loyalty for GSK’s brands is very high as a result of which credible players such as Nestle, Unilever and Dabur have failed to build inroads into the category despite many serious attempts.

■ Margins likely to expand as ad spends have peaked. GSK launched a number of products outside the malted foods category such as noodles and nutritional bars in the past three years, leveraging the nutritional equity of the Horlicks. To support these launches ad spends moved up from 13% in CY08 to 16% in CY11. However, some of these products have been withdrawn and in others the ramp-up has been scaled down. As a consequence, we believe ad spends have peaked in CY11 and should gradually come off over the next two-three years, aiding an improvement in EBITDA margins.


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Performance Over 1M 3M 12M Absolute (%) 5.7 6.8 20.0 Relative (%) -0.3 -3.4 11.6


Year 12/11A 12/12E 12/13E 12/14E Revenue (Rs mn) 26,855.1 31,584.9 37,320.0 44,110.7 EBITDA (Rs mn) 4,214.9 5,025.2 6,093.8 7,256.5 EBIT (Rs mn) 3,755.1 4,495.6 5,482.4 6,593.0 Net profit (Rs mn) 3,552.1 4,305.5 5,231.8 6,301.6 EPS (CS adj.) (Rs) 84.46 102.38 124.40 149.84 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 104 123 149 EPS growth (%) 18.3 21.2 21.5 20.4 P/E (x) 33.3 27.5 22.6 18.8 Dividend yield (%) 1.2 1.5 1.8 2.2 EV/EBITDA (x) 25.5 21.1 16.8 13.6 P/B (x) 10.3 8.6 7.2 6.0 ROE (%) 33.8 34.3 34.7 34.7 Net debt/equity (%) net cash net cash net cash net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]

Rating OUTPERFORM* Price (21 Aug 12, Rs) 2,811.70 Target price (Rs) 3,428.00¹ Upside/downside (%) 21.9 Mkt cap (Rs mn) 118,248 (US$ 2,138) Enterprise value (Rs mn) 105,783 Number of shares (mn) 42.06 Free float (%) 28.0 52-week price range 2,880.0 - 2,264.3 ADTO - 6M (US$ mn) 1.3

22 August 2012


Multiple growth drivers for the malted foods portfolio Malted foods has high headroom for growth

Malted foods is still a low penetrated category with national penetration of c.20%. Rural penetration for the category is low at 11%, while urban penetration at 40% also has headroom for growth. The category is nutritional in nature and is aimed at growing children for their physical and mental development. There is increasing awareness and desire among parents to give nutritional supplements to their growing children. As incomes rise and affordability of the product improves, we see the category increase in penetration and per capita consumption.

Distribution expansion and low unit packs a low hanging fruit for GSK

GSK has one of the weakest distribution reaches in India among FMCG companies both for direct coverage and overall product presence. The company’s direct distribution reach at 0.7 mn outlets trails other similar-sized companies such as Marico and Dabur by a wide margin. Among food companies too, GSK’s distribution is far weaker. Overall distribution (including indirect reach) for GSK’s products is 1.1 mn as compared to Nestlé’s 4.2 mn.

Figure 197: GSK has one of the lowest distribution

reaches in India

Figure 198: GSK is well below it packaged foods peers in

overall reach

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This gap in distribution is a low hanging fruit for the company to deliver on. Management has already started pushing direct reach which has grown from 500,000 outlets in CY09 to 700,000 outlets in CY11, a commendable increase of 40%. Going hand in hand with distribution expansion is the focus on driving price point packs to bring in new consumers and reach rural markets. Malted foods has the lowest contribution of price point packs in the Indian FMCG space, which is an impediment to expanding consumer base. GSK has now focussed on the Rs5 and Rs25 price points, the share of which has gone up from 1.5% in CY08 to 4.5% now.

Malted foods penetration is 20% which gives it growth head room

22 August 2012


Figure 199: GSK is expanding direct distribution reach Figure 200: Share of small packs is going up

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Value added products will increase in share, new categories an option value

GSK has over the past four years aggressively marketed value added products which command a significant price premium over the base Horlicks. These products have better claims and target specific needs of consumers. Junior Horlicks, Mother Horlicks, Women’s Horlicks, Horlicks Gold and Horlicks taste variants have grown in revenue contribution from 16% in CY07 to 23% in CY11. We see these products further increasing in share going forward.

GSK has also attempted to expand its brands like Horlicks and Boost to other food categories, riding on the nutritional equity of the Horlicks and energy equity of Boost. Some of the new launches such as Nutribar and Sports Drink have not been successful and the company had to withdraw the innovations from the market. Some others such as instant noodles had to be re-launched as the products were not gaining enough traction. GSK’s new launches in biscuits have, however, done well and the category has grown at over 30% CAGR over the past three years for the company. The recent launch of Oats has also been well received. We do not see meaningful upside from these new launches in the next two-three years as these will take time to ramp up and contribute to profitability.

Figure 201: GSK has premiumised its malted portfolio Figure 202: Share of non-malted segments has increased

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GSK’s attempts to extend its brands into non-malted foods has not been very successful

22 August 2012


Category dominance imparts very high pricing power GSK completely dominates the malted foods market in Southern and Eastern India with over 75% market share. The product has very high consumer loyalty as it has been viewed by generations in these geographies as a substitute for milk and as a brand with very high nutritional equity. GSK draws 83% of its revenues from Southern and Eastern India. This dominance gives GSK very high pricing which has enabled it to pass on cost inflation and yet maintain stable volume growth.

Figure 203: GSK dominates the malted category Figure 204: GSK’s shares are very high in South and East

GSK66%

Cadbury16%

Hienz9%

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GSK has also been able to maintain its dominance in the category despite many attempts by major FMCG companies to enter the category. This demonstrates the brand loyalty commanded by the company and gives us comfort on the ability of the company to defend market share and margins.

Figure 205: Credible FMCG companies have failed to make a dent into the category Year Brand Impact

1997 Milo (Nestle) • Milo is a strong brand in the category in South East Asia • Nestlé’s distribution platform and marketing capability in foods made this the

most credible threat to GSK till date • Nestle launched it at a premium to Horlicks in 1997, then repositioned it as an

instant drink and in 2008 repriced it at a 30% discount to Horlicks • Exited the Indian market in 2009 after 12 years with a 3% marketshare

2007 Amaze (HUL) • Developed by Unilever’s global foods R&D with a differentiated positioning of

brain food for growing children • Product was test marketed in 3 states for 2 years and then withdrawn

2009 Chwayan Junior (Dabur)

• Riding on the ayurvedic brand equity of Chwayanprash • Product was withdrawn after 12 months

2011 Kissan NutriSmart (HUL)

• Similar to Amaze in proposition but launched under an established brand Kissan at a 25% premium to Horlicks.

• Was withdrawn after test markets in 2 states


Margins expansion possible as ad spends have peaked GSK’s ad spends saw a step jump from c.13% in CY08 to 16% in CY10 and CY11 as the company attempted to expand into new categories such as noodles, nutritional bars and oats. We believe the initial burst of advertising for these brands is over and some of them have been withdrawn or repositioned for the long haul. We expect ad spends to gradually

GSK draws 83% revenues from South and East India where it has 75% market share

22 August 2012


come down as a proportion of revenues over the next three years. GSK’s raw material index inflation has also come off from c.13% YoY in 4Q CY11 to 6.5% YoY now. The key driver has been lowering of inflation on malted barley and skimmed milk powder. The company has started delivering gross margin expansion as price growth now exceeds raw material cost inflation.

Figure 206: Ad spends jumped to support new category

launches for GSK

Figure 207: Raw material inflation is coming off

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Figure 208: Milk powder inflation have come off Figure 209: Barley inflation have come off

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Valuation GSK Consumer’s valuation has significantly re-rated in the past three years as the company has delivered strong and consistent earnings growth and improved its ROIC by reducing working capital. Given the company’s very high pricing power, we expect it to sustain margins while delivering strong revenue growth; hence, we see no reason for the stock to de-rate from here. We value the stock at 25x one-year forward earnings and initiate coverage with an OUTPERFORM rating and a one-year target price of Rs3,428.

22 August 2012


Figure 210: GSK has re-rated due to earnings surprises

and improvements in capital efficiency

Figure 211: GSK’s earnings have not seen many upgrades

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Key risks The key risks to our call on GSK Consumer are as follows:

■ Slowdown in packaged foods intensifies as consumers cut down on relatively more discretionary items in their FMCG basket

■ Prices of key raw materials like milk, sugar, edible oils and wheat move up sharply.

22 August 2012


Financial summary Figure 212: Income statement Y/E 31 Dec (Rs mn) CY07 CY08 CY09 CY10 CY11 CY12E CY13E CY14E

Revenues 12,778 15,418 19,215 23,061 26,855 31,585 37,320 44,111

EBITDA 2,244 2,375 3,108 3,767 4,215 5,025 6,094 7,257

Depreciation -435 -419 -420 -393 -460 -530 -611 -664

EBIT 1,809 1,956 2,688 3,374 3,755 4,496 5,482 6,593

Non-operating income 688 955 893 1,174 1,648 1,931 2,326 2,812

PBT 2,451 2,857 3,539 4,522 5,403 6,426 7,809 9,405

Tax expense -824 -974 -1,211 -1,520 -1,851 -2,121 -2,577 -3,104

PAT 1,627 1,883 2,328 3,002 3,552 4,305 5,232 6,302


Figure 213: Balance sheet Y/E 31 Dec (Rs mn) CY07 CY08 CY09 CY10 CY11 CY12E CY13E CY14E

Cash & cash equivalents 3,915 4,710 8,198 9,761 10,797 12,464 15,748 19,772

Inventories 1,948 2,772 2,660 3,120 3,700 4,351 5,141 6,077

Receivables 274 433 314 505 992 1,167 1,378 1,629

Other current assets 561 620 557 845 1,213 1,211 1,431 1,692

Creditors 1,453 1,725 2,906 3,569 5,010 5,893 6,963 8,230

Other current liabilities 1,042 1,399 2,204 4,435 4,365 4,693 5,449 6,344

Net current assets 4,203 5,409 6,618 6,227 7,325 8,607 11,287 14,596

Fixed assets 2,433 2,266 2,323 3,106 3,718 4,688 4,777 4,813

Total net assets 6,636 7,675 8,941 9,333 11,043 13,295 16,064 19,409

Other long-term liabilities 173 66 -110 -267 -399 -399 -399 -399

Shareholders equity 6,463 7,609 9,051 9,600 11,442 13,694 16,463 19,808

Total liabilities 6,636 7,675 8,941 9,333 11,043 13,295 16,064 19,409


Figure 214: Cash flow statement Y/E 31 Dec (Rs Mn) CY07 CY08 CY09 CY10 CY11 CY12E CY13E CY14E

EBIT 1,809 1,956 2,688 3,374 3,755 4,496 5,482 6,593 Tax paid (824) (974) (1,211) (1,520) (1,851) (2,121) (2,577) (3,104) Depreciation 435 419 420 393 460 530 611 664 Net working capital change 125 (412) 2,279 1,954 (62) 385 604 715 Other operating items (68) (107) (176) (157) (132) - - - Non-operating income 688 955 893 1,174 1,648 1,931 2,326 2,812 Operating cash flow 2,119 1,785 4,851 5,192 3,818 5,221 6,447 7,680 Capital expenditure (289) (252) (477) (1,176) (1,072) (1,500) (700) (700) Free cash flow 1,830 1,533 4,374 4,016 2,746 3,721 5,747 6,980 Equity raising (0) (0) 0 (1) 0 - - - Dividend (590) (738) (886) (2,452) (1,711) (2,053) (2,463) (2,956) Net chg in cash 1,239 795 3,488 1,563 1,036 1,668 3,284 4,024


22 August 2012



Colgate-Palmolive India (COLG.BO / CLGT IN)

INITIATION

Stable growth but high competitive risks ■ Initiate coverage with UNDERPERFORM. We initiate coverage on Colgate

with an UNDERPERFORM rating and a target price of Rs1,147, based on 25x June 2014.

■ Stronghold on the toothpaste market to be sustained. Colgate’s marketshare in toothpaste has grown by over 500 bp since 2008 to 54.5% now. The brand Colgate has been among the top two brands in the Nielsen brand equity survey for the past five years. We expect Colgate to continue gaining shares on the back of sustained long-term investments made in building oral health credentials of the brand through on-ground activities such as school programmes and dentist contact programmes.

■ Premiumisation focus a long-term positive. Colgate is leading efforts to build larger contributions from value added products in the toothpaste category. The company has aggressively marketed products such as Colgate Sensitive, Colgate Pro-Relief and Colgate Total where prices are 2-5x that of the base Colgate Dental Cream. While these steps will unlikely lead to any margin upsides in the near term as advertising spends are initially very high, this is a long-term positive as it will improve margin as these products gain scale. It also raises the bar for new entrants by building specialist credentials.

■ P&G’s possible entry will continue to be an overhang. P&G has highlighted its plans to fill up white spaces like India for oral care by 2015 in its presentations. While the actual impact of such a launch should completely depend on the mix that P&G brings to India, it should continue to be an overhang on the stock. P&G’s determined efforts to gain share in toothbrushes has yielded results and the company has moved up market share by over 600 bp over the past two years, some of which has come at the cost of Colgate which has dropped shares by 300 bp in the same period.


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Performance Over 1M 3M 12M Absolute (%) 0.1 -3.2 23.0 Relative (%) -5.7 -13.3 14.8


Year 3/12A 3/13E 3/14E 3/15E Revenue (Rs mn) 26,238.5 30,321.5 35,040.2 40,493.5 EBITDA (Rs mn) 5,091.5 5,992.7 7,007.7 8,189.9 EBIT (Rs mn) 4,698.4 5,582.0 6,583.8 7,752.8 Net profit (Rs mn) 4,464.7 5,208.6 5,999.8 6,950.0 EPS (CS adj.) (Rs) 32.83 38.30 44.12 51.11 Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a. 37.8 43.5 51.1 EPS growth (%) 10.9 16.7 15.2 15.8 P/E (x) 35.6 30.5 26.5 22.9 Dividend yield (%) 2.1 2.7 3.0 3.4 EV/EBITDA (x) 30.6 26.0 22.3 19.0 P/B (x) 36.5 34.3 30.9 27.8 ROE (%) 109.0 115.9 122.8 127.9 Net debt/equity (%) net cash net cash net cash net cash



Research Analysts

Arnab Mitra 91 22 6777 3806

[email protected]


[email protected]

Rating UNDERPERFORM* Price (21 Aug 12, Rs) 1,169.20 Target price (Rs) 1,147.00¹ Upside/downside (%) -1.9 Mkt cap (Rs mn) 159,003 (US$ 2,864) Enterprise value (Rs mn) 155,976 Number of shares (mn) 135.99 Free float (%) 38.0 52-week price range 1,229.5 - 929.6 ADTO - 6M (US$ mn) 1.7

22 August 2012


Stronghold on the toothpaste market to sustain Colgate has consistently gained market share in the toothpaste category over the past seven years moving up from 49% in 2008 to 54.5% in 2012. We expect the company to continue to gain shares as its marketing spends have been focused on building long-term credentials on oral health. Besides television advertising, the company has over the past 10 years consistently done on-group programmes such as school contact and oral health month (a dentist contact programme) at an increasing scale. The company contacts over 20 mn children a year in schools, educating them on oral health and providing free samples. Similarly, the oral health month covers over 25,000 dentists in India and over 1,000 towns. This number has gone up from 175 towns and 8,300 dentists in 2007, a remarkable expansion in long-term brand building activity.

Figure 215: Toothpaste penetration has increased sharply Figure 216: Consumption gaps are still large

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Figure 217: Colgate’s market share has expanded

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Figure 218: Colgate has sustained double digit volume

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Premiumisation focus a long term positive Colgate is in the process of building a premium segment in toothpastes which has specialist credentials and focused on specific problems such as sensitively and whitening.

Colgate’s on ground programs like school contact and dentist contact have enhanced oral health credentials

22 August 2012


The company has aggressively marketed products like Colgate Sensitive, Colgate Pro-Relief and Colgate Total where prices are 2-5x that of the base Colgate Dental Cream. These value added products contribute 10% to Colgate’s revenues already. We expect the share of these products to go up further. While the products are initially not major contributors to profitably as advertising spends are initially very high, this is a long term positive as it will improve margin as these products gain scale. It also raises the bar for new entrants by building specialist credentials.

Figure 219: Colgate has launched a number of value added toothpastes in the past 2

years Colgate product launches in the last two years

Remarks

Colgate Sensitive Pro-Relief Gives instant relief from sensitivity besides long term reduction in pain. As per company estimates, 17-28% of Indian’s have a sensitivity problem

Colgate Sensitive Daily usage would reduce the sensitivity problem for consumers

Colgate Sensitive tooth-brush Compliments the sensitivity toothpaste for consumers with a sensitivity problem

Colgate Kids Toothpaste Fun toothpaste for kids with exciting colours, flavours and light foaming action

Colgate Active Salt First toothpaste with active salt content for stronger gums

Colgate Total Premium toothpaste for 12-hour germ fighting protection

Colgate MaxWhite Strong whitening proposition


P&G risk will continue to be an overhang P&G has clearly articulated in its presentations its intention of filling the white space for toothpaste in India by 2015. P&G entered the Latin American market in 2009 which was also a white space for the company. While Colgate’s brand equity is very high and we do not expect the company to lose market share as P&G will likely gain from other players in the category, there could be a need to raise advertising spends to counter the new threat. Also, Colgate’s secular trend of market share gain could be halted.

We take P&G’s threat seriously as the company has demonstrated its resolve in the much smaller tooth brush category. P&G has gained over 600 bp market share in the category over the past two years, some of which has come at the cost of Colgate which has dropped shares by 300 bp in the same period. P&G’s oral care profitability has dropped from c.25% in FY07 to a loss in FY11, due to aggressive marketing spends and pricing strategy.

Figure 220: P&G gained market share from Colgate in

brushes

Figure 221: P&G has incurred losses to build its brushes

business

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22 August 2012


Valuation Colgate is trading at 30x one-year forward earnings. While the company is likely to see stable earnings growth, the PEG ratio is the highest at 1.69x. We believe that the event risk of an oral care launch from P&G should be factored in the valuations of the company. We value Colgate at 27x one-year forward earnings and initiate coverage with a NEUTRAL and target price of Rs1,147.

Figure 222: Colgate is trading at near its peak P/E multiple Figure 223: Earnings estimates have been stable for

Colgate

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Key risks The key risks to our call on Colgate are as follows:

■ Very quick premiumisation in oral care which helps faster revenue growth

■ Competitive intensity from HUL drops and P&G makes no moves in the category

22 August 2012


Financial summary Figure 224: Income statement Y/e 31 Mar, Rs mn FY10 FY11 FY12 FY13ii FY14ii FY15ii

Revenues 19,625 22,206 26,239 30,322 35,040 40,494

EBITDA 4,254 4,491 5,092 5,993 7,008 8,190

Depreciation -375 -342 -393 -411 -424 -437

Ebit 3,879 4,148 4,698 5,582 6,584 7,753

Non-operating income 981 1,068 1,201 1,425 1,650 1,915


PBT 4,845 5,200 5,884 6,991 8,219 9,653

Exceptionals 0 0 0 0 0 0

Reported PBT 4,845 5,200 5,884 6,991 8,219 9,653

Tax expense -615 -1,174 -1,419 -1,783 -2,219 -2,703

PAT 4,230 4,026 4,465 5,209 6,000 6,950


Figure 225: Balance sheet Y/e 31 Mar, Rs mn FY10 FY11 FY12 FY13ii FY14ii FY15ii


Inventories 1,106 1,537 2,177 2,725 3,149 3,639

Receivables 98 753 873 1,092 1,262 1,458

Other current assets 1,228 906 1,315 1,771 2,037 2,344

Creditors 3,740 4,214 4,136 5,317 6,144 7,100


Net current assets 582 1,040 995 724 611 560

Fixed assets 2,531 2,633 3,238 3,849 4,473 5,110

Other long-term assets 179 168 121 121 121 121

Total net assets 3,307 3,841 4,354 4,693 5,204 5,791

Borrowings 46 1 1 63 63 63




Figure 226: Cash flow statement Y/e 31 Mar, Rs mn FY10 FY11 FY12 FY13ii FY14ii FY15ii

EBIT 3,879 4,148 4,698 5,582 6,584 7,753 Tax paid (765) (1,042) (1,419) (1,783) (2,219) (2,703) Depreciation 375 342 393 411 424 437 Net working capital change (135) (322) (726) 259 155 239 Other operating items 620 727 47 - (0) 0 Non-operating income 261 282 1,201 1,425 1,650 1,915 Operating cash flow 4,220 4,120 4,179 5,879 6,579 7,626 Capital expenditure (310) (409) (999) (1,021) (1,048) (1,074) Long-term investments 261 173 - - - - Free cash flow 4,171 3,886 3,181 4,857 5,531 6,552 Equity raising - - - - - - Borrowings (1) (45) - 63 - - Dividend (3,359) (3,168) (3,951) (4,932) (5,489) (6,364) Net chg in cash 811 672 (771) (12) 42 188


22 August 2012


Companies mentioned (Price as of 21-Aug-12) Figure 227: Companies mentioned Company Ticker Currency CMP Rating Target Price

Altria Group, Inc. MO USD 34 NOT RATED NOT RATED

Amorepacific Corp 090430.KS KRW 1,070,000 NEUTRAL 1,200,000

Beiersdorf BEIG.DE EUR 57 NEUTRAL 52

Britannia BRIT.BO INR 474 NOT RATED NOT RATED

British American Tobacco BATS.L GBP 33 OUTPERFORM 34

Charoen Pokphand Foods Public CPF.BK THB 34 OUTPERFORM 47

Colgate-Palmolive CL USD 106 NEUTRAL 90

Colgate-Palmolive India COLG.BO INR 1,169 UNDERPERFORM 1,147

Dabur India DABU.BO INR 119 UNDERPERFORM 117

Danone DANO.PA EUR 51 UNDERPERFORM 48

Emami Ltd EMAM.BO INR 475 OUTPERFORM 619

Gillette India GILE.NS INR 2,339 NOT RATED NOT RATED

GlaxoSmithkline Consumer Healthcare GLSM.BO INR 2,812 OUTPERFORM 3,428

Godfrey Phillips GDFR.NS INR 3,252 NOT RATED NOT RATED

Godrej Consumer Products Ltd GOCP.BO INR 665 OUTPERFORM 790

Gudang Garam GGRM.JK IDR 51,600 UNDERPERFORM 50,000

H.J. Heinz Company HNZ USD 55 NEUTRAL 54

Hengan International 1044.HK HKD 75 OUTPERFORM 82

Henkel HNKG_p.F EUR 60 NEUTRAL 58

Hindustan Unilever Ltd HLL.BO INR 514 OUTPERFORM 564

Imperial Tobacco IMT.L GBP 25 OUTPERFORM 27

Indofood CBP ICBP.JK IDR 6,650 OUTPERFORM 7,350

ITC Ltd ITC.BO INR 261 OUTPERFORM 300

Japan Tobacco 2914.T JPY 2,415 OUTPERFORM 2,700

Kalbe Farma KLBF.JK IDR 3,925 NEUTRAL 3,100

Kellogg Company K USD 51 NEUTRAL 54

Kimberly-Clark Corporation KMB USD 84 NOT RATED NOT RATED

Kraft Foods, Inc. KFT USD 41 OUTPERFORM 45

KT&G Corp 033780.KS KRW 86,100 OUTPERFORM 91,000

LG Household & Healthcare 051900.KS KRW 607,000 OUTPERFORM 680,000

L'Oreal OREP.PA EUR 102 NEUTRAL 96

Lorillard Inc. LO USD 128 NOT RATED NOT RATED

Marico Ltd MRCO.BO INR 192 OUTPERFORM 228

Mead Johnson Nutrition Co. MJN USD 71 OUTPERFORM 84

Nestle NESN.VX CHF 60 NEUTRAL 62

Nestle India NEST.BO INR 4,591 NEUTRAL 4,590

Orion 001800.KS KRW 850,000 NOT RATED NOT RATED

Philip Morris International PM USD 92 NEUTRAL 90

Procter & Gamble Co. PG USD 67 OUTPERFORM 70

Reckitt Benckiser RB.L GBP 36 NEUTRAL 35

Reynolds American Inc. RAI.N USD 46 NOT RATED NOT RATED

Shanghai Jahwa 600315.SS CNY 48 NOT RATED NOT RATED

Shiseido 4911 JPY 1,165 NEUTRAL 1,300

Thai Union Frozen Products PCL TUF.BK THB 71 OUTPERFORM 84

The Hershey Company HSY USD 72 OUTPERFORM 78

Unilever ULVR.L GBP 23 UNDERPERFORM 24

Unilever Indonesia UNVR.JK IDR 25,550 UNDERPERFORM 14,250

Uni-President Enterprises 1216.TW TWD 51 OUTPERFORM 44

VST Industries VSTI.BO INR 1,703 NOT RATED NOT RATED

Want Want China Holdings Ltd. 0151.HK HKD 9.6 NEUTRAL 10.0


22 August 2012


Companies Mentioned (Price as of 21 Aug 12) Colgate-Palmolive India (COLG.BO, Rs1,169.20, UNDERPERFORM, TP Rs1147) Dabur India (DABU.BO, Rs119.15, UNDERPERFORM, TP Rs117) Emami (EMAM.BO, Rs474.75, OUTPERFORM, TP Rs619) Glaxo Smithkline Consumer Healthcare (GLSM.BO, Rs2,811.70, OUTPERFORM, TP Rs3428) Godrej Consumer Products Ltd. (GOCP.BO, Rs664.60, OUTPERFORM, TP Rs790) Hindustan Unilever Ltd. (HLL.BO, Rs513.50, OUTPERFORM, TP Rs564) ITC Ltd. (ITC.BO, Rs261.10, OUTPERFORM, TP Rs300) Marico Ltd. (MRCO.BO, Rs191.80, OUTPERFORM, TP Rs228) Nestle India (NEST.BO, Rs4,590.95, NEUTRAL, TP Rs4590)

Disclosure Appendix Important Global Disclosures Arnab Mitra & Akshay Saxena each certify, with respect to the companies or securities that he or she analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

See the Companies Mentioned section for full company names. 3-Year Price, Target Price and Rating Change History Chart for COLG.BO COLG.BO Closing

Price Target

Price

Initiation/ Date (Rs) (Rs) Rating Assumption 2-Jul-10 841 883.607 N 29-Oct-10 875 883.61 1-Feb-11 805.9 825.533 18-Oct-11 998.5 NC 884 884

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O=Outperform; N=Neutral; U=Underperform; R=Restricted; NR=Not Rated; NC=Not Covered

3-Year Price, Target Price and Rating Change History Chart for DABU.BO DABU.BO Closing

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22 August 2012


3-Year Price, Target Price and Rating Change History Chart for EMAM.BO EMAM.BO Closing

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22 August 2012


3-Year Price, Target Price and Rating Change History Chart for HLL.BO HLL.BO Closing

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3-Year Price, Target Price and Rating Change History Chart for MRCO.BO MRCO.BO Closing

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22 August 2012


3-Year Price, Target Price and Rating Change History Chart for ITC.BO ITC.BO Closing

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Initiation/ Date (Rs) (Rs) Rating Assumption 26-Oct-09 132.25 149.763 O 1-Mar-10 116.025 127.944 25-May-10 130.4 150.162 23-Jul-10 150.35 170.681 1-Nov-10 171.85 200.359 7-Jul-11 203.05 225.903 X 18-Oct-11 204.3 NC

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The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities. Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months. Credit Suisse’s distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Outperform/Buy* 46% (58% banking clients) Neutral/Hold* 42% (55% banking clients) Underperform/Sell* 10% (48% banking clients) Restricted 2%

*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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22 August 2012


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See the Companies Mentioned section for full company names. Price Target: (12 months) for (COLG.BO) Method: We value Colgate India at Rs 1147 based on 25x Jun-14 earnings in line with historical multiples. Risks: Key risks to our UNDERPERFORM rating and Rs 1147 target price for Colgate are quick premiumisation in oral care and drop in competitive intensity from P&G or HUL Price Target: (12 months) for (DABU.BO) Method: We value Dabur at Rs 117 based on 22x Jun-14 earnings (10% discount to historical multiples). Risks: Key risks to our UNDERPERFORM rating and Rs 117 target price for Dabur are swift turnaround in oral care, shampoos or if Dabur's newly launched almond oil becomes big success Price Target: (12 months) for (EMAM.BO) Method: We value Emami at Rs 619 based on 24x Jun-14 earnings in line with historical multiples. Risks: Key risks to our OUTPERFORM rating and Rs 619 target price for Emami is significant increase in competitive intensity in skin care segments where Emami operates or spike in raw material prices like menthol Price Target: (12 months) for (GLSM.BO) Method: We value Glaxo Consumer at Rs 3428 based on 25x Jun-14 earnings in line with historical multiples. Risks: Key risks to our OUTPERFORM rating and Rs 3428 target price for Glaxo Consumer is slowdown in packaged foods segment or increase in key raw material prices like milk, sugar Price Target: (12 months) for (GOCP.BO) Method: We value Godrej consumer at Rs 790 based on SOTP. We value both India and Indonesian business at 20x EV/EBITDA Jun-14 in line with historical multiples. Risks: Key risks to our OUTPERFORM rating and Rs 790 target price for Godrej consumer is slowdown in international markets where it operates or if its competitors in insecticides take price cuts to gain market share Price Target: (12 months) for (HLL.BO) Method: We value HUL at Rs 564 based on 30x Jun-14 earnings (20% premium to historical multpiles). Risks: Key risks to our OUTPERFORM rating and Rs 564 target price for HUL is significant slowdown in consumer income growth which will lead to down trading in HUL's key categories Price Target: (12 months) for (MRCO.BO) Method: We value Marico at Rs 228 based on 25x Jun-14 earnings in line with historical multiples. Risks: Key risks to our OUTPERFORM rating and Rs 228 target price for Marico are slowdown in international markets where Marico operates or consumers down trading to coconut oil from Marico's brand Parachute Price Target: (12 months) for (NEST.BO) Method: We value Nestle India at Rs 4590 based on 30x Jun-14 earnings (10% discount to historical multiples). Risks: Key risks to our NEUTRAL rating and Rs 4590 target price for Nestle are slowdown in packaged foods industry in India or if ITC starts becoming prominent in noodles category which will impact Nestle's dominance. Price Target: (12 months) for (ITC.BO) Method: We value ITC at Rs300 based on SOTP. We value cigarettes business at 27x Jun-14 earnings (in line with historical multiples) and FMCG business at 2x sales Risks: Key risks to our OUTPERFORM rating and Rs 300 target price for ITC is abrupt change in taxation structure or government regulations which will hurt cigarettes sakes Please refer to the firm's disclosure website at www.credit-suisse.com/researchdisclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names. The subject company (DABU.BO, EMAM.BO, GLSM.BO, HLL.BO, NEST.BO) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (DABU.BO, EMAM.BO, HLL.BO, NEST.BO) within the past 12 months. Credit Suisse provided non-investment banking services, which may include Sales and Trading services, to the subject company (GLSM.BO) within the past 12 months. Credit Suisse has managed or co-managed a public offering of securities for the subject company (NEST.BO) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (HLL.BO, NEST.BO) within the past 12 months. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (COLG.BO, DABU.BO, EMAM.BO, HLL.BO, NEST.BO) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (GLSM.BO) within the past 12 months. Important Regional Disclosures Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report.

22 August 2012


The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (COLG.BO, DABU.BO, EMAM.BO, GLSM.BO, GOCP.BO, HLL.BO, MRCO.BO, NEST.BO) within the past 12 months.

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22 August 2012 Asia Pacific / India Equity Research

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India Consumer Sector - Credit Suisse

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