Motilal Oswal retains buy on Emami with 18% upside, sees healthy earnings growth
Motilal Oswal Financial Services has retained a buy rating on Emami with 18 percent upside and sees healthy long-term earnings growth prospects.
The research firm believes that Emami has the right portfolio with low penetration and focused spending which brightens the growth potential comprising 80 percent of high-demand problem-solving products, and the remaining 20 perceny of discretionary products. This insulates the company from volumes risk in an adverse consumer environment.
Motilal Oswal feels that penetration is low in many categories and it is the dominant player in its leading categories, which puts it at the forefront to drive category growth. While Zandu is already strong with its balms and Chyawanprash products, it can also emerge as a strong Ayurvedic products brand. Management believes that the company’s strength lies in its ability to validate product efficacy on the basis of data derived from systematic scientific research at NABL and Ministry of AYUSH accredited laboratories.
Emami spends more on R&D than most FMCG companies in India; it incurred Rs 23.1 crore or 0.99 percent of sales in FY'17. Despite demonetization, absolute A&P spend grew from Rs 430 crore in FY'16 to Rs 443 crore in FY'17. In terms of A&P as a percentage of sales, the company stands among the top in the FMCG space, it added.
Motilal Sowal reasons that with Emami having increased its direct reach to 7.3 lakh outlets from 6.4 lakh in FY'16, with a target to reach 8 lakh in FY'18, for a company with a pan-India reach of 43 lakh outlets at end-FY'17, the direct reach is well below that of peers and also weak in terms of proportion of total outlets.
However, the company has initiated 'Project Race' in FY'17 to expand its direct reach in urban towns and has engaged AC Nielsen to conduct a study in the top 30 towns to understand the best way to take the expansion plan forward. Emami also initiated ‘Project Dhanush’ to enhance its rural direct reach via van operations (which were introduced in 1,500 routes covering 6,000 towns with a population of below 5,000). The target is to double its rural reach in two years.
The research house feels that operating leverage potential is huge as the product reaches only 3 percent of households in India. Apart from increasing distribution, management is planning targeted communication, leading to product trials and believes that while growth of Kesh King is likely to be muted in Q1/Q2 FY'18 due to its high wholesale dependence, the brand will be a source of strong revenue and profitability growth (gross margins of over 70 percent) in the medium-to-long term.
Strong summer and abundant rainfall enabled 15 percent YoY domestic business sales growth in H1FY17 for Emami, along with 29 percent EBITDA growth. However, H2FY17 was impacted by demonetisation, and thus, sales declined 2 percent YoY with flattish EBITDA. While profit growth was unimpressive, net operating cash flows increased to Rs 730 crore in FY17 from Rs 560 crore in FY16, led by lower other assets. Debentures of Rs 300 crore are scheduled to be redeemed in three tranches in FY18. Also, Emami's management reiterated its target to become debt-free by end-FY'18," it said.
Despite significant near-term challenges due to likely higher sales disruption following GST implementation Emami remains a credible long-term play due to expected healthy growth in the existing product categories, where it has dominant market share and demonstrated ability to leverage on its innovative ability, customer understanding and distribution reach to turnaround acquisitions, best-of-breed R&D and A&P spend, innovative products, ability to back-up innovation with strong marketing and efforts toward improving its direct distribution reach, Motilal Oswal said.With valuations at 31.6x FY'19E EPS which are inexpensive relative to peers Emami has a healthy long-term earnings growth prospects and return ratios in the mid-30s, it added.