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September 20, 2010

Industry : FMCG Industry View :Neutral Company Update

"Stable Business,Attractive Dividend Yield"

Buy

VST Industries Ltd.

S.Ranganathan

[email protected]

+91 22 6635 1270

Disclaimer:The information in this document has been printed on the basis of publicly available information, internal dataand other reliable sources believed to be true and is for general guidance only. While every effort is made toensure the accuracy and completeness of information contained, the company makes no guarantee and

assumes no liability for any errors or omissions of the information. No one can use the information as the basisfor any claim, demand or cause of action. LKP Securities Ltd., and affiliates, including the analyst who haveissued this report, may, on the date of this report, and from time to time, have long or short positions in, andbuy or sell the securities of the companies mentioned herein or engage in any other transaction involving suchsecurities and earn brokerage or compensation or act as advisor or have other potential conflict of interestwith respect to company/ies mentioned herein or inconsistent with any recommendation and related informa-tion and opinions. LKP Securities Ltd., and affiliates may seek to provide or have engaged in providingcorporate finance, investment banking or other advisory services in a merger or specific transaction to thecompanies referred to in this report, as on the date of this report or in the past.

One Year Indexed( % ) 1 Month 3 Months 12 Months

VST Industries 10.2 2.5 35.6

BSE Relative 1.7 (9.0) 18.5

Relative price performance

Stock Data

Current Market Price (`) 573

Target Price (`) 713

Potential upside (%) 25

Reuters VSTI.BO

Bloomberg VST IN

Market Cap (`.bn ) 8.9

52-Week Range (`) 617 / 443

Avg. Daily Trading Volume 9,600

Promoters (%) 32.2

FII Holding (%) 0

DII Holding (%) 9.3

Public & Others Holding (%) 58.5

Key Data

Y/E March FY10 FY11E FY12E FY13E

Net sales 4,721.6 5,178.8 5,795.4 6,488.9

EBITDA (%) 17.5 16.5 16.6 15.9

PAT (%) 13.1 13.9 12.7 11.9

EPS (Rs) 40.2 46.6 47.8 50.0

EPS Growth (%) 0.4 15.9 2.8 4.6

P/E (x) 14.3 12.3 12.0 11.5

P/BV (x) 3.6 3.6 3.7 3.9EV/EBITDA (x) 8.3 7.8 6.8 6.4

ROCE (%) 90.6 62.6 58.6 69.5

ROE (%) 25.1 29.1 30.8 34.1

Dividend yield (%) 5.2 7.0 7.9 8.7

Fiscal Year Ending

VST, with a market share of about 6.9% by volume is a strong player in the low-

price cigarette segment in the eastern and north-eastern markets. The company

has witnessed steady increase in revenues over the years, despite the high

taxes, led by strong performance of its key brands such as Charminar, Charms

and Moments.

Strategic Contracts for Key Raw Material Ensures Timely Supply

VST has ensured uninterrupted and assured supply of tobacco, at the right price,

through tie-ups with tobacco cultivating farmers in Andhra Pradesh and otherareas. This alliance helps VST in sourcing the correct quality of leaf at the most

competitive price, while reducing the overall raw material costs.

Holds Significant Capacity in a Highly Regulated Industry

VST has significant unutilized licensed capacity of about 24,512 million sticks.

Since the government has stopped issuing license for cigarette manufacturing,

there are very few players into manufacturing. VST can unlock value, either by

sub contracting work from larger players or selling off the excess capacity to

other players looking to establish their presence in the market.

Increasing Focus Towards Exports, Compensating for Decline inCigarette Volumes

VST is concentrating on the growing tobacco exports segment and has entered

into long term commitments with overseas tobacco merchants. VST is also

concentrating on the development and marketing of Oriental Tobacco for exports

and has tie-ups with potential customers which are expected to provide steady

export revenues going forward.

Healthy Balance Sheet, Consistent Dividend Payment Record

With its healthy, debt free balance sheet, VST is expected to continue to generate

robust free cash flows and the excess cash, we believe, would be distributed to

the shareholders in form of dividends, expected to be around`30-40 per share.

Valuation

VST though not a growth stock is a value stock with an attractive dividend yield of

5.2%. We believe VST is currently trading at an attractive 12xFY12E earnings

with robust cash generation thereby providing visibility towards a higher dividend

payout and we maintain Buy with a target price of`713.

LKPSince 1948

90

103

116

129

142

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

VST Industries B SE Sensex

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Company Description

VST Industries, a Hyderabad based firm, is engaged in the manufacturing and marketing

of cigarettes. The company is the third largest producer of cigarettes in India, with a

market share of about 6.9% and operates in the lower end of the cigarette market. The

companys well known brands include Charminar and Charms brand of cigarettes. The

company is an affiliate of British American Tobacco (BAT), UK, which holds a 32% stake

in the company, while ITC and Bright Star Investments (BSI) hold 10% and 25% each.

The company has its manufacturing facility in Azamabad in the state of Andhra Pradesh.

As of FY10, the company has a total installed capacity of 23,976 million sticks, including

the 25% extendable capacity. The cigarette output is approximately 624 million per

month, which includes about 18% for contract manufacture.

Most of the companys cigarette brands fall in the mid-price band. The company has

shifted its focus from non-filter to filter segment recently, in line with other industry

players, due to higher tax incidence in the former segment. While the volume of non-filter

brands has been declining over the year, the performance of its filter brands has been

steady, with some brands gaining volumes. The companys Charms Virginia Filter andCharms Smooth Virginia have performed well in volume terms while its brand, Moments,

launched during the last quarter of the year FY07 has gained market acceptance and

continues to display good performance. Some of its other brands include Charminar, XL

Filter and Shaan. The company continues to launch new brands in the value-for-money

segments, which are expected to provide further impetus to its revenues.

While the company derives about ~85% of its revenues through sale of cigarettes, it is

also involved in the business of selling raw and cut tobacco. The demand for

unmanufactured (leaf) tobacco continues to remain strong globally, with high growth

prospects, and the company continues to explore opportunities to successfully tap

these export markets. The companys unmanufactured tobacco segment has graduallyincreased its share in the revenue mix, contributing about 14.4% to the total revenues in

FY10 compared to 11.2% in the previous year.

VST Industries

Cigarette Manufacturing85.3% Share of Revenue

Unmanufactured Tobacco14.4% Share of Revenue

Shaan

Charminar

Charms Virginia Filter

XL Filter

Moments

Light Soil Burley Tobacco

Flue Cured Tobacco

Sun/Air Cured Tobacco

Oriental Tobacco

Uncut Tobacco0.3% Share of Revenue

Currently Focusing onDevelopment & Exports of this

Variety

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Revenue Mix (FY09) Total Sales`````10,047 Mn Revenue Mix (FY10) Total Sales ````` 11,254 Mn

Cigarettes

89%

Cut Tobacco

0%Unmanufactured

Tobacco

11%

Source: Company reports. LKP Research

Cigarettes

86%

Cut Tobacco

0%Unmanufactured

Tobacco

14%

Investment Argument

Strong Position in the Value Segment of the Indian Cigarette Market

VST is amongst the few players with licenses to manufacture cigarettes in India. With itsvarious brands, the company has established itself as a strong player in the low-price

segment in the eastern and north-eastern markets. The company commands a market

share of 6.9% (in volume terms), only behind Indian Tobacco Company (ITC) and Godfrey

Phillips India (GPI), with sales of about 7,511 million sticks in FY10. Keeping in line with

the changing trends, the company has exited the non filter-tipped segment totally, and is

focused on the filter segments. The company has been able to build a substantial base

in the filter segment and during FY10 the overall volume of filter brands stood at 94% of

the branded volumes. The company has recently launched 59mm length cigarettes in

western parts of India to attract volumes from the regular size filters. The company is

also growing as a major player in exporting unmanufactured tobacco, which is reflected

in its revenue mix over the years.

Cigarette Market Share (FY10) VST Cigarette Sales Volume FY10 Total - 7511 Mn Sticks


Golden Tobacco

2%VST

7%Godfrey Phillips

14%

ITC

77% Filter Volumes

94%

Non-Filter Volumes6%

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Strategic Contracts for Raw Material Ensures Timely Supply

Tobacco is the key raw material for manufacturing tobacco related products such as

cigarettes, cut tobacco and unmanufactured tobacco. Since it forms a major proportion

of the overall raw material costs, managing leaf sourcing profile is the key to delivering

the correct quality of leaf at the most competitive price. VST has entered into tie-ups with

tobacco cultivating farmers in Andhra Pradesh and other areas so as to ensure

uninterrupted and assured supply at the right price. Further, the company has alsoestablished special tobaccos for niche markets, which are being produced by the large

farmer base of the company.

Source: Company reports, LKP Research

Proportion of Raw Materials Consumed (FY10) Total 2,634 Mn

Cigarette Paper

1%

Foil

1%

Filter Rods

5%

Hinge Lid Packs

5%

Others

12%

Board

3%

Unmanufactured

Tobacco

73%

Holds Significant Capacity in a Highly Licensed Industry

The total licensed capacity of the four largest players is about 2,23,308 million sticks

annually, of which about more than 50%, about 1,38,646 is unutilized. Larger players

such as ITC, dominate the cigarette market, while other players have sub contractedwork from larger players in a bid to generate revenues. VST is active in the lower segment

of the cigarette market and envisages to seek a place in the profitable king size segment,

where ITC has a very formidable presence. Also, with the progressive implementation of

the Cigarettes and other Tobacco Products Act, leading to a ban on advertising and

promotion in virtually every form, the introduction of new brands and similarly

communicating to customer the relative merits of a new brand has become a daunting

task. Hence, VST, in a bid to unlock value, can either sub contract work from larger

players or sell off the excess capacity to other players looking to establish their presence

in the market. Currently, of the total production, about 18% of the cigarette output is from

contract manufacture.


Idle Capacity (Mn p.a.)

0

25,000

50,000

75,000

100,000

ITC VST Godfrey Phillips Golden Tobacco

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Stable Revenues, Despite Onerous Tax Structure

The company has witnessed consistent increase in revenues despite the punitive

measures taken by the government, which has affected all the players in the industry.

VST has however been able to recover substantial volumes in the filter category after

experiencing declines in the FY09 due to steep increase in excise duties. It has been

able to capture market share in new geographies, enough to compensate to a large

extent for the drop in volumes in the affected regular and micro cigarette category. Thecompanys revenue registered a healthy CAGR of 15.8% from FY07 to FY10. Though

cigarette volumes have recorded a decline, value realizations were higher at`.1.28 per

stick in FY10, up from`.0.77 in FY07. In the first quarter of the current fiscal, the company

recorded a volume growth of about 6-7% though the industry reported a drop of 3-4%.

Further, the company has launched 59mm length cigarettes in western parts of India to

attract volumes from the regular size filters. We expect these initiatives to help VST post

a 1516% top line growth this fiscal.

Revenue (````` Mn) Cigarette Volume

-

2,000

4,000

6,000

8,000

10,000

12,000

FY07 FY08 FY09 FY10

0

5

10

15

20

25

30

35

40

Cigarettes (LHS)

Unmanufactured Tobacco (LHS)

Cut Tobacco (LHS)

Excise Duty as % of sales (RHS)


0

100

200

300

400

500

600

700

800

900

1000

FY07 FY08 FY09 FY10

0

0.2

0.4

0.6

0.8

1

1.2

1.4

Cigarettes (Mn) (LHS)

Unit Realization (Rs) (RHS)(`) (RHS)

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Increasing Focus Towards Exports, Compensating For Decline In CigaretteVolumes

Un-manufactured tobacco or leaf tobacco, as it is popularly known, has a substantial

demand in the export markets. India is one of the large global manufacturers of leaf

tobacco. VST which procures leaf tobacco from its large farmer base is increasingly

concentrating on the growing tobacco exports segment, where its performance has

been very encouraging. The company has entered into long term commitments withoverseas tobacco merchants for exports of its regular Air Cured Burley and Fire Cured

tobacco exports, which contains the lowest pesticide residues. In addition to this, the

company has also established markets with premium customers for Air Cured Burley in

new areas, which is expected to provide steady export growth in the years to come. The

company continues to retain the premier status in Sun/Air/Fire cured tobacco exports.

With higher demand and better realizations in the years ahead, this segment is expected

to continue contributing an increasing portion to the revenues. The company is now

concentrating on the development and marketing of Oriental Tobacco and has entered

into long term (10 years) tie-ups with potential customers for the same.


Sales Segmentation (````` Mn)

-

2,000

4,000

6,000

8,000

10,000

12,000

FY07 FY08 FY09 FY10

Sales within India Sales outside India

Strong and Healthy Balance Sheet Position, Consistently Paying Dividend

The company has a very healthy balance sheet which is debt free and has ample

amount of cash at hand. Considering the equity capital of`154 million and market cap

of`8.9bn, the company has cash holdings exceeding`1,903 million which is 21% of

the current market cap. The company has also produced consistent profits in difficult

market conditions and has paid consistent dividends over the years. The company is

expected to continue to generate robust free cash flows and the excess cash, we believe,

would be distributed to the shareholders in form of dividends, which is expected to be

around`30-40 per share( a dividend payout ratio of 75%-85%)


Rising Profits and Dividends

480

520

560

600

640

FY07 FY08 FY09 FY10

0%

25%

50%

75%

100%

PAT (Rs Mn) Dividend as a % of PAT(`) (Mn)

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Quarterly Performance

Q1-FY11 Financial Performance

600

780

960

1,140

1,320

1QFY09 1QFY10 1QFY11

0%

6%

12%

18%

24%

Net Sales (Rs Mn) (LHS) EBITDA Margin (%) (RHS)

PAT Margin (%) (RHS)

For Q1 FY11, VST Industries Limited reported a marginal rise in net revenues to `1278.5 million from`1261.2 million in the same quarter previous year, on the back of

recovery in volumes in some of its key brands. However, the net profit of the company

declined 25.23% to `180.2 million from`241.0 million, due to rising marketing costs

and following fresh levy of taxes in some states such as Chhattisgarh.

The quarter saw a decline in unmanufactured tobacco sales as some sales got

postponed to the next quarter. EBITDA margins declined by 670 basis points to 15.8%

mainly due to higher advertisement and selling expenditure of`127.1 million. However,

raw material consumption was lower during the quarter, as the leaf tobacco sales were

less than expected.

The companys operating margins have remained at healthy levels of over 20% for the

past couple of years, which reflects the companys strong financial performance. However,

the continuous increase in taxation, an unprecedented rise in tobacco prices and

increase in sales and advertising expense have dented margins during in FY09 and

FY10.

Net Profit Margins EBITDA Margins


480

520

560

600

640

FY07 FY08 FY09 FY10

0%

5%

10%

15%

20%

PAT (Rs Mn) (LHS)

PAT Margin (%) (RHS)

800

811

822

833

844

FY07 FY08 FY09 FY10

0%

8%

16%

24%

32%

EBITDA (Rs Mn) (LHS)

EBITDA Margin (%) (RHS)

(`) (Mn) (LHS)

(`) (Mn) (LHS) (`) (Mn) (LHS)

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Indian Tobacco Industry

India ranks amongst the largest producers of Tobacco

Tobacco is an important commercial crop grown in India and plays a significant role in

the Indian economy as it contributes substantially in terms of employment generation,

government tax collections and exports. India is the third largest producer of tobacco in

the world, after China and Brazil, producing about 520 thousand tonnes of tobacco in

2008. Of the different types grown, flue-cured tobacco, country tobacco, burley, bidi,

rustica and chewing tobacco are considered important. Andhra Pradesh and Karnataka

are the two biggest tobacco producing states in India where cigarette tobacco is cultivated,

while chewing tobacco is grown in mainly in Tamil Nadu, Gujarat, Bihar, West Bengal

and U.P. Out of the total tobacco produced in India, only one-third is flue-cured tobacco

suitable for cigarette manufacturing. Most of the tobacco produce is suitable for the

manufacture of chewing tobacco, bidis and other cheap tobacco products, which have

no demand outside the country.

During FY10, Indias tobacco exports surged 29% to `43,730 million, following higher

demand from Europe and the US, as against `33,880 million in the same period last

year. The rise in exports was also due to higher average price realization for Indian

tobacco which was around $3 a kg in FY10 as against $2.50 a kg in the previous

financial year. However, exports registered a decline of 7.0% to `9,710 million during

April-June of FY11, against`10,420 million in the corresponding period, previous year,

mainly due to poor global demand.

Source: FAOSTAT

Global Tobacco Production

0

1200

2400

3600

4800

2003 2004 2005 2006 2007 2008

(thousand

tonnes)

China Brazil India EU-16 Turkey

However Consumption of Cigarettes Has Remained Low

India ranks fourth in the total tobacco consumption in the world. However in contrast to

most other countries, Indias tobacco consumption pattern is predominantly of non-

cigarette tobacco, primarily in the form of bidis, chewing tobacco and paan preparations.

Of the total amount of tobacco produced in the country, around 35% is in the form of

chewing tobacco, 50% as bidis, and only 15% as cigarettes. Thus, bidis, snuff and

chewing tobacco (such as gutka, khaini and zarda) form the bulk (85%) of Indias total

tobacco production. In the rest of the world, production of cigarettes is 90% of total

production of tobacco related products. Despite the lower consumption, the contribution

of tax revenues from cigarettes forms about 85% of the taxation revenues from the

tobacco industry, due to prolonged punitive taxation by the government in form of higher

excise, and other value added taxes by different states.

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Consumption Pattern of tobacco Products Contribution to Exchequer through Tobacco products

Source: Various Sources, LKP Research

Indias per capita cigarette consumption is amongst the lowest in the word at about 85,

compared to the global average of 844. The low per capita consumption cigarettes inIndia compared to international standards is due to the high usage of alternate forms of

tobacco, that are manufactured locally and are cheaply available. Consumers have

been reluctant to shift to cigarettes from beedis, due to the high price differentiation

between the entry level cigarette brands and beedis, as well as due to the taste

preferences. Most beedis manufactured in India are currently out of the tax net, either

because of exemptions or tax evasion. Cigarettes have been taxed heavily and trends

indicate that smokers affected by rising cigarette prices migrate to the other cheaper

options such as beedis and Gutkas. Chewing tobacco is largely unregulated and more

than 70% of the production comes from unregistered factories. In spite of low consumption

of cigarettes on a per capita basis, the market potential in India is considered. The

growth of cigarette industry both in the domestic and international market represents abig revenue opportunity for the economy.

Source: ITC presentation, March 2010

Per Capita Cigarette Consumption in India (Sticks)

0

800

1600

2400

3200

Japan

USA

China

Pakistan

Nepal

SriLanka

Bangladesh

India

World

Average

ChewableTobacco

35%-38%

Beedis

50%-53%

Cigarettes

14%-15%

ChewableTobacco

10%-15%

Cigarettes

85%-90%

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Source: ITC presentation, March 2010

Per Capita Consumption of Tobacco in India (Gms per year)

0

350

700

1050

1400

China US Pakistan Nepal India World

Top Four Players Account For 90% of the Industry Production

The Indian tobacco and cigarette industry is controlled by government regulations and

current norms do not permit international tobacco companies to set up shop in India,

either directly or indirectly. Government has stopped issuing new cigarette manufacturing

licenses since last decade and does not allow any manufacturing capacity enhancement

in the tobacco industry either through grant of industrial license or through FDI. Further,

existing licensed capacities are blocked by the large and dominant players, so ensuring

difficulties for new competitors entering the markets.

The industry is dominated by four large players, which account for about 90% of the total

market. There are a couple of smaller-sized cigarette companies with manufacturing

facilities, but they lack the necessary marketing infrastructure, and hence they produce

cigarettes for the large cigarette companies on a sub-contract basis. Cigarette production

in India increased from 87,568 million sticks in FY02 to 125,017 million sticks in FY07,an increase of 42%. However, the past two years have seen a slight decline in output. In

financial year FY10, cigarette production dropped to 117,480 million sticks. The decline

was mostly on account of increased excise duty on non-filter cigarettes. Cigarette sale

volumes have recovered to 111,102 million sticks in FY10, after declining to 103,286

million sticks in FY09.

Cigarette Volumes (Mn sticks) Cigarette Sales (Rs Mn)

Source: Company Reports

Note: Considering top players in the industry, as they account for about 90% of the revenues

0

25,000

50,000

75,000

100,000

125,000

FY07 FY08 FY09 FY10

VST ITC GPI GTC

0

50,000

100,000

150,000

200,000

250,000

FY07 FY08 FY09 FY10

VST ITC GPI GTC

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The potential of the Indian tobacco market coupled with the countrys resilience during

the economic downturn has attracted a number of international cigarette majors. Some

of the international tobacco players have invested in Indian companies and are trying to

capture a large share of the growing Indian market by collaborating with them. These

international players are trying to establish a strong foothold in the Indian cigarette

market by incorporating majority-owned entities to carry on the business through

sourcing, selling, distribution and marketing of cigarettes as well as other tobaccoproducts.

Company Foreign Partner Cigarette Brands

ITC BAT Insignia, India Kings, Classic, Gold Flake, Silk Cut, Navy Cut,

Scissors, Capstan, Berkeley, Bristol and Flake

GPI Philip Morris Four Square, Red and White, Jaisalmer, Cavanders and

Tipper, Jaisalmer, I.gen, North Pole

GTC None Panama, Flair, Chancellor, Gold Flake, Just Black, Lips,

Esquire, and Legend, CHL (Chancellor Harward Luxury), Ms

Special Filter (for women)

VST BAT Charminar, Moments, Shaan, Special Extra Smooth

RDB None Regent, No 10, Cool (7 brands including different variants)

BBM Bommidala None Bright, Deal, Lucky Gold, Miles, Pride, Rolon, Ruby and Smart,

Group

Japan Tobacco Japan Tobacco Camel, Winston

Source: LKP Research

Industry Suffers From High Punitive Tax Rates

Tobacco excise has become a particularly important source of revenue for the national

budget. Over the years, the government has been more and more predictable in itspolicy towards the tobacco sector. Every year, the government has been increasing taxes

in form of excise duties, which are then passed on by the manufacturers to the consumers.

The government expects that increasing the price of cigarettes would lead to a reduction

in smoking by discouraging youths and young adults from initiating smoking and reducing

the total cigarette consumption among the addicted smokers.

The tobacco industry in India is subject to a range of taxes imposed by the Central and

State Governments. The Union Government raises revenue from the sales of all types of

tobacco products through the imposition of excise duty calculated on an ex-factory basis.

Cigarettes are taxed based on their length and according to their category, namely filter

and non-filter category. In addition, state governments impose tax on tobacco productsthrough imposition of value-added-taxes (VAT) which differs from state to state and may

range from 12.5% to 25%.

The extraordinary increase in the rates of excise duty on non-filter cigarettes in the 2008

Union budget, led the organized cigarette industry to exit the non-filter category, virtually

wiping it out. This has resulted in some section of consumers migrating to smuggled

and tax-evaded cigarettes resulting in a sharp decline in volumes for the legitimate

cigarette sector, and leading to an estimated trebling of illegal cigarette volumes. These

low priced tax-evaded illegal cigarettes are a growing threat to Government revenue, the

social objective of regulating tobacco and will also affect the earnings of thousands of

tobacco farmers, who gain the maximum realization from cultivating cigarette type

tobaccos

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Source: Central Excise Tariff

Excise Duty on Cigarette (Rs/1000 Sticks)

125

509415 441

1068

620 659 659

1005 1068

13401424 1424 1424

162416451748 1748 1748

1948

659

133

659

1218

1068

659659

12181068

1068

0.0

550.0

1,100.0

1,650.0

2,200.0

FY07 FY08 FY09 FY10 FY11

length 60 mm (Non-f iltered) length 60-70 mm (Non-filtered)length 70 mm (Filtered) length 70-75 mm (Filtered)length 75-85 mm (Filtered) length >85 mm (Filtered)

However, despite the higher taxes, the players have witnessed an increase in average

realization per cigarette, considering the fact that the higher tax has been passed on to

the consumers through price hikes. While FY10 saw good growth in cigarette volumes,the government in the Budget 2010-11, has again increased the excise duty on cigarettes.

Source: Company Reports

Realizations Rs/Cigarette

0.0

0.6

1.2

1.8

2.4

FY07 FY08 FY09 FY10

VST ITC GPI GTC

Recent Ban on FDI to Jeopardize Plans of International Players

In April 2010, the Cabinet Committee on Economic Affairs (CCEA) approved the proposal

from the department of industrial policy and promotion (DIPP) to ban FDI in the tobacco

sector. FDI will be prohibited in the manufacture of cigarettes, whether it is for domestic

consumption or for exports. It will also cover SEZs. At present, three major global players

British American Tobacco (BAT), Japan Tobacco and the Altria Group have large

investments in India. The ban has affected plans of Japan tobacco which had envisaged

increasing its stake in Indian venture from 50% to 75%, with an investment of $100

million. Further BAT had also planned to increase its stake in ITC from 31.8% to 51%.

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Industry Overview

As of 31st March 2010 VST GPI GTC ITC

Registered/Licenced (p.a.) 25,600.0 15,937.5 14,500.0 123,547.0

25% extendable capacity 6,400.0 2,812.5 3,625.0 30,886.8

Installed (p.a.) 23,976.0 5,160.0 18,012.0 134,383.0

Self Production 6,106.0 6,536.0 1,782.0 68,857.0

Contract Manufacture 1,382.0 9,060.0 - 11,069.0

Idle Capacity 24,512.0 12,214.0 16,343.0 85,576.8

Source: Company Report, LKP Research

Competitive Landscape in Indian Tobacco Industry

Rivalry Among Existing C ompetitors

(LOW)Bargaining power of Suppliers(tobacco leaf farmers and oth er rawmaterial suppliers)(MODERATE) Farmers lack power in the supply

chain

There are l imited alternative raw

materials in this market, so players

are u nlikely to switch supplier,

which i ncreases supplier p ower.

Bargaining Power o f Buyers(retailers are considered as buyers)(MODERATE) Concentration of retail outlets is

relatively fragmented in the

tobacco market.

Custom ers are likely to be loyal

towards certain brands

Threat of New Entrants Stringentregulations

(WEAK) Stringent legislation and government

regulation with regards to smoking

Governments new set of rules to rein in

surrogate advertising of tobacco

products

Banning of Foreign Direct Investment in

cigarette manufacturing in India

Probability of new brand off-take limited

due to existing brand loyalty

Threat of Substitute Products (Various

substitutes available)(LOW) Indian tobacco market highly Inter-segmental substitutes apparent

within this market, a lternatives to

cigarettes and fi ne cut tobacco

products include smokeless tobaccos,

cigars and pipe tobacco. However,

inter-segmental s ubstitution still

involves essenti ally the same product

Substituting tobacco products for

products such as nicotine gum, or

patches

Threat of Substitute Products (Various

substitutes such as nicotine gum, or

patches)

Indian tobacco market highly

concentrated

Brand driven mark et ensures market

stability

Rivalry in the market is boosted by the

lack of product differentiation and the

pressure p laced on market players by

the illicit cigarette trade.

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VST Industries Ltd.

14LKP Research

Key Risks

The cigarette industry is regulated by high excise duties and multiple state taxes

accompanied with a ban and restriction on promotions and consumption of ciga-

rettes, limiting the growth of the industry. VST, along with other cigarette manufactur-

ers are vulnerable to these regulatory changes.

Cigarette industry is highly competitive, with players vying to increase market share.Larger players like ITC have large number of brands, very strong distribution network

and national presence. VST, with its relatively limited brands is particularly focused in

only northern regions.

Outlook & Valuation

VST, a strong player in the low-price cigarette segment in the eastern and north-eastern

markets, is attractively placed in the cigarette industry with its stable business and high

dividend yields. The company has been able to generate robust revenue streams over

the years, despite onerous tax structure, primarily due to the uninterrupted and assured

supply of tobacco, at the right price, through tie-ups with tobacco cultivating farmers inAndhra Pradesh and other areas. The companys exports are anticipated to grow in the

future thereby providing a steady stream of revenue. Further, we expect new launches

within the regular and micro segments to help the company post a topline growth of

around 15% during the current fiscal.VST is expected to continue rewarding its

shareholders in form of dividends, which is expected to be around`30-40 per share in

the coming years.

We had initiated coverage on VST Industries during February 2009 (stock price `210)

and updated it in September 2009 (stock price `420) with the positioning as a value

stock and not as a growth stock. We re-iterate the value proposition even now with the

stock trading at 12xFY12E earnings. BUY with a target price of`713.

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VST Industries Ltd.

15LKP Research

Financial Summary

Income statement Balance sheet

YE Mar (`````million) FY10 FY11E FY12E FY13E

Gross Sales 11,254.2 12,947.1 14,488.6 16,222.3

Excise Duty 6,532.5 7,768.2 8,693.1 9,733.4

Net Sales 4,721.6 5,178.8 5,795.4 6,488.9Raw Materials & Pur. 2,618.4 2,710.0 3,104.5 3,649.5

Mfg. & SGA. 1,277.6 1,616.0 1,726.6 1,809.4

EBITDA 825.6 852.8 964.3 1,030.1

EBITDA Margin (%) 17.5 16.5 16.6 15.9

Depreciation 178.7 191.8 215.2 238.7

EBIT 646.9 661.0 749.0 791.4

EBIT Margin (%) 13.7 12.8 12.9 12.2

Other Income 332.6 323.9 263.1 267.3

Exceptional Item (124.1) - - -

PBT 855.4 984.9 1,012.1 1,058.7

PBT Margin (%) 18.1 19.0 17.5 16.3

Tax 234.9 265.9 273.3 285.9

PAT 620.5 718.9 738.9 772.9

PAT Margin (%) 13.1 13.9 12.7 11.9

YE Mar (`````million) FY10 FY11E FY12E FY13E

SOURCES OF FUNDS

Equity Share Capital 154.4 154.4 154.4 154.4

Reserves & Surplus 2,319.4 2,315.6 2,241.5 2,111.0Total Networth 2,473.8 2,470.1 2,395.9 2,265.4

Total Debt 0 0 0 0

Total Liabilities 2,473.8 2,470.1 2,395.9 2,265.4

APPLICATION OF FUNDS

Net block 1,325.9 1,434.1 1,618.9 1,680.2

Capital WIP 68.1 68.1 68.1 68.1

Investments 1,903.1 1,500.0 1,500.0 1,500.0

Deferred Tax (Net) 125.3 125.3 125.3 125.3

Current Assets 2,146.7 2,605.9 2,735.6 2,980.8

Cash and Bank 63.7 730.5 795.6 808.6

Inventories 1,790.8 1,560.7 1,587.8 1,777.8

Sundry Debtors 145.1 141.9 158.8 177.8

Loan,& Advances 145.5 170.3 190.5 213.3

Other Current Assets 1.6 2.6 2.9 3.2

Current Liab & Prov 3,095.2 3,263.4 3,651.9 4,088.9

Current liabilities 2,555.0 2,695.8 3,016.8 3,377.8

Provisions 540.2 567.5 635.1 711.1

Net Current Assets (948.6) (657.4) (916.3) (1,108.1)

Total Assets 2,473.8 2,470.1 2,395.9 2,265.4

Cash Flow

YE Mar (`````million) FY11E FY12E FY13E

PAT 718.9 738.9 772.9

Depreciation 191.8 215.2 238.7

Chng in working capital 375.6 324.0 204.9

CF from operations (a) 1,286.4 1,278.1 1,216.4

Capital expenditure (300.0) (400.0) (300.0)

Chng in investments 403.1 - -

CF from investing (b) 103.1 (400.0) (300.0)

Long term borrowings - - -

Dividend & dividend Tax (722.7) (813.0) (903.4)

Proceeds from fresh equity - - -

CF from financing (c) (722.7) (813.0) (903.4)

Net chng in cash (a+b+c) 666.8 65.1 13.1

Closing cash 730.5 795.6 808.6

Key Ratios

YE Mar FY10 FY11E FY12E FY13E

Per Share Data (`````)

EPS 40.2 46.6 47.8 50.0

CEPS 51.8 59.0 61.8 65.5

BVPS 160.2 160.0 155.2 146.7

DPS 30.0 40.0 45.0 50.0

Growth Ratios (%)

Total revenues 12.0 15.0 11.9 12.0

EBITDA -0.1 3.3 13.1 6.8

PAT 0.4 15.9 2.8 4.6

EPS Growth 0.4 15.9 2.8 4.6

Valuation Ratios (X)

PE 14.3 12.3 12.0 11.5

P/CEPS 11.1 9.7 9.3 8.7

P/BV 3.6 3.6 3.7 3.9

EV/Sales 1.5 1.3 1.1 1.0

EV/EBITDA 8.3 7.8 6.8 6.4

Operating Ratios

Inventory days 121.1 110.0 100.0 100.0

Receivable days 11.2 10.0 10.0 10.0

Net Debt/Equity (x) - - - -

Profitability Ratios (%)

ROCE 90.6 62.6 58.6 69.5

ROE 25.1 29.1 30.8 34.1

Dividend payout 74.7 85.9 94.0 99.9

Dividend yield 5.2 7.0 7.9 8.7

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LKPLKPLKPLKPLKP

LKP Securites Ltd,10th floor, Nariman Bhavan, Nariman Point, Mumbai-400 021. Tel -91-22 - 66351234 Fax- 91-22-66351249 www.lkpshares.com

Research Team

S. Ranganathan Head of Research Pharmaceuticals , Agriculture 6635 1270 [email protected]

Ashwin Patil Research Analyst Automobiles & Telecom 6635 1271 [email protected]

Anisha Makani Research Analyst Infrastructure,Capital Goods,Engineering 6635 1273 [email protected]

Ami Shah Research Analyst Cement & Sugar 6635 1247 [email protected]

Chaitra Bhat Research Analyst Banking & Financial Services 6635 1211 [email protected]

Deepak Darisi Research Analyst Energy 6635 1220 [email protected]

Institutional Equities

Pratik Doshi Director 98210 47676 - [email protected]

Hardik Mehta Sales 93203 08811 6635 1246 [email protected]

Varsha Jhaveri Sales 93241 47566 6635 1296 [email protected]

Hitesh Doshi Dealing 93222 45130 6635 1281 [email protected]

Dhruman Mehta Dealing 93207 63218 6635 1293 [email protected]

Rachit Shah Dealing 93250 07714 6635 1310 [email protected]

Kalpesh Vakharia Dealing 98193 08082 6635 1267 [email protected]

VSTINDUS_20100920

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