December 17, 2013

RETAIL RESEARCH Scrip Code LIBSHOEQNR

Price Chart
1-LIBERTSHOE.LIBERTY SHOES LTD.NSE - 16/12/13 Trend7 135 130 125 120 115 110 105 100 95 90 85 80 75 70 65 60 55 50 45 40 35

LIBERTY SHOES LTD (LSL)

Industry Footwear CMP Rs. 95 Recommendation Buy at CMP and add on dips to Rs. 8387

MANAGEMENT INTERACTION NOTE Target Rs. 125 Time Horizon 12 quarters

LSL is engaged in manufacturing & selling leather & nonleather footwear. It is the only Indian company which is amongst the worlds top 5 manufacturers of leather footwear, producing over 50,000 pairs of footwear a day (in peak season). Its products are marketed across the globe through ~150 distributors, ~425 exclusive showrooms & over 6000 multibrand outlets. LSLs consolidated net sales & PAT could grow at a CAGR of 21.9% & 59.3% over FY1315. Growth is likely to be driven by distribution expansion, penetration into low presence / untapped markets, new launches, incremental revenues from new stores & robust industry outlook. OPM is likely to improve due to stability in raw material prices and cost rationalisation. Low footwear consumption in India, increasing household income, change in consumption habits provide immense growth opportunities for the industry. Being an established player, LSL is likely to benefit immensely from the robust industry outlook. Over next 23 years, LSL has plans to open up ~50 stores per year across the cities. While maintaining focus on its key markets (north & south), LSL also plans to expand its reach to low presence / untapped regions. Timely ramp up could enable LSL to expand its reach & boost its revenues & profits. Implementation of TOC program over last few years has helped LSL to attract new channel partners (ensuring higher ROI) & expand its reach. In future, LSL could continue to benefit from this approach. Minority shareholder friendly restructuring of financial arrangements with group companies, if proposed could result in value unlocking, add value to brand, valuation rerating and boost profits. It would enable LSL to rope in a PE investor to fund its expansion plans. Consolidation of retail operations would result in operational efficiencies. Shareholder friendly initiatives & sustained growth in turnover & profits could narrow LSLs discount in valuations to its peers Bata India & Relaxo. We feel investors could buy this stock at current levels and average it on dips in the price band of Rs. 8387 for a price target of Rs. 125 (15xFY15E EPS) over the next one to two quarters. Any news on the progress on restructuring of group companies could result in substantial rerating (if it benefits the minority shareholders).
Particulars (Rs. in Mn) Net Sales % Growth y-o-y Operating Profit % Growth y-o-y PAT (Adjusted) % Growth y-o-y EPS (Fully Diluted) PE FY11 3099.0 15.5 242.0 7.4 61.8 32.4 3.6 26.2 FY12 3563.9 15.0 308.3 27.4 42.1 -31.9 2.5 38.4 FY13 3628.6 1.8 301.1 -2.3 53.9 27.9 3.2 30.0 FY14E 4492.8 23.8 382.2 26.9 105.0 94.8 6.2 15.4 FY15E 5285.1 17.6 460.5 20.5 141.7 35.0 8.3 11.4

J09

F10

F11

M12

J13

Weekly

Stock Details
BSE Code NSE Code Bloomberg Price (Rs) on Dec 16, 2013 Equity Capital (Rs Mn) Face Value (Rs) Eq. Shares O/s (mn) Market Cap (Rs Mn.) Book Value (Rs) Avg. Volume (52 Week) 52 wk H/L (Rs) 526596 LIBERTSHOE LBS IN 95 170.4 10.0 17.0 1,629 80.2 18,367 110.5 / 67.8 % Holding 65.4 0.0 0.0 34.6 100.0

Shareholding Pattern
(As on Sept 30, 2013) Promoters FII Institutions Others (incl. body corporate) Total

Mehernosh K. Panthaki Research Analyst FMCG, IT, Midcaps mehernosh.panthaki@hdfcsec.com RETAIL RESEARCH

(Source: Company, HDFC sec Research)

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Company Overview
LSL was incorporated in September 1986 and is engaged in the business of manufacturing and selling leather and nonleather footwear. The companys business operations are run by three promoter families (2 Gupta Families & 1 Bansal Family). The promoters have been in this business for almost 60 years. While they initially used to cater to only export markets, the company has been catering to the Indian markets since 1980s. The other firms in the Liberty group are Liberty Enterprise (LE), Liberty Group Marketing Division (LGMD), and Liberty Footwear Company (LFC), all 100% held by promoters of LSL. All the firms were earlier engaged in the manufacturing/marketing of shoes. At present, LSL has a franchise agreement with LE and LGMD for 2 years (w.e.f from April 01, 2013) under which, the facilities for manufacturing of footwear of these two firms along with access to their export and domestic network and use of trademarks owned by them is available exclusively to LSL on franchise basis against payment of the annual franchise fees (Rs. 67.4 mn paid to LE, Rs. 78.7 mn paid to LGMD in FY13). LSL also has a financial arrangement with LFC, wherein it has a right to use trademark Liberty and other marks and logos on exclusive basis for a period of 15 years (w.e.f. April 01, 2013) against a payment of minimum guaranteed obligation (Rs. 53.1 mn License Fee paid to LFC in FY13). LSL is the only Indian company which is amongst the top 5 manufacturers of leather footwear in the World. The company is producing more than 50,000 pairs of footwear a day (during peak season) covering virtually every age group and income category. Its products are marketed across the globe through ~150 distributors, ~425 exclusive showrooms (added 25 stores in H1FY14) and over 6000 multibrand outlets, and sold in more than 25 countries including fashiondriven, qualityobsessed nations like France, Italy, and Germany. Under its Mother Brand Liberty, LSL has developed a spectrum of 10 exclusive sub brands (coolers, fortune, warrior, gliders, force10, senorita, Windsor, prefect, tiptopp and footfun), each of which has been specially designed to cater to a specific target group. Warriors, Fortune & Coolers generate maximum sales. LSL has products available at price points ranging from Rs. 100 6,000. The company has been focusing on increasing its retail presence for a decade now. The company has around 87 stores that are owned and managed by its wholly owned subsidiary Liberty Retail Revolution Ltd (balance are franchise stores).

LSLs promoters have been in the footwear business for 60 years

Products marketed through ~150 distributors, ~425 showrooms & 6000 multibrand outlets

10 exclusive subbrands under the mother brand Liberty; warrior fortune & coolers major subbrands

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Strong presence in North & South (3/4 of the revenues); marginal presence in East

LSLs domestic sales account for around 89% of total sales. In the domestic market, ~50% of its revenue comes from retail, ~25% from distribution and the balance ~20% from institution. To categorize it further, the mens category constitutes 50%, women 30% and kids 20%. The company has a strong presence in North & South, which account for ~75% of the total sales. West accounts for ~20%, while East contributes the balance. LSL also has a good presence in overseas markets (11% of the total sales) like West Asia, Singapore, Sri Lanka & Bhutan and in a small way in Europe, United States, and Russia. Geographical Revenue Breakup FY13 H1FY14

LSL generates 89% of its sales from domestic market

6 manufacturing facilities with total capacity of 1.1 cr footwear pairs p.a.

The manufacturing facilities at LSL are called Humantech Centres, where technology works in perfect tandem with human creativity. The company is equipped with Humantech centres at six locations in Haryana (3 in Karnal; 1 owned and 2 leased plants belonging to its group companies LE & LGMD), Uttarakhand (1 in Roorkee & 1 in Dehradun) & Himachal Pradesh (in Poanta Sahib). The plants have a total capacity of 1.1 cr pairs of footwear p.a. Subsidiaries LSL has two wholly owned subsidiaries (1 Indian and 1 overseas) viz; Liberty Retail Revolutions (LRR), which is retail subsidiary in India [stake increased from 93.86% to 100% in FY13] and Liberty Foot Fashion Middle East FZE (LFF), Dubai, which is a largely marketing subsidiary. LRRs turnover grew marginally by 3.3% in FY13, while net loss reduced by 49.4% to Rs. 16.5 mn over FY12. In H1FY14, the subsidiaries turnover declined by 3.4%, while net loss increased from Rs. 1.5 mn to Rs. 3.1 mn.

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The details of each of them are given in the table below: Subsidiary Liberty Retail Revolutions (LRR), India Business The subsidiary is into retail business, having a chain of high end showrooms across the country. It owns and manages 85 stores. Its a marketing subsidiary set up to expand the Middle East business. However, currently it is dormant. FY13 Turnover (Rs, in Mn) 597.6 FY13 PAT (Rs. in Mn) 16.5

Liberty Foot Fashion Middle East FZE (LFF)

1.0

Investment Rationale
An established branded player in underpenetrated and fast growing footwear market in India
India is 2nd largest producer of footwear and leather garments in the world. India is a second largest producer of footwear & the leather garments in the world, but contributing just 3% (approx.) in the global leather trade. Export of different categories of footwear alone holds a major share of 41.14% in India's total Leather & Leather Products. This entire sector over the years is consistently earning valuable foreign exchange for the Country and for this very reason holds a prominent place in the Indian economy. Footwear Industry, besides its export earnings, has also got tremendous potential in the domestic market due to change in the consumption habits and fast growing market for footwear and leather articles. In addition to the managerial capabilities and competence of the entrepreneurs, the following inherent strengths available to the footwear industry also help in augmenting its pivotal position in Indian economy: Industrys potential has further increased due to investor friendly policies and efforts from GOI Abundance and easy availability of raw material Strong and ecocompliant tanning base Sufficient modernized manufacturing capacities Availability of skilled manpower at competitive wage levels Dedicated support from allied industry Presence in major overseas markets and growing domestic market for footwear and leather articles

The economic liberalization, the dereservation process of the leather industry implemented in phases, the enactment of Micro, Small and Medium Enterprises Development Act, major policy initiatives announced in the Foreign Trade Policy 2010 14, allowing 100% FDI through automatic route, and Indian Leather Development Programme (ILDP), have all played a crucial role in the development of the leather Industry. Due to above industry friendly policies and proactive efforts of the Government of India, the potential of the industry has further increased not only for sourcing but also for foreign investments.

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Low footwear consumption in India, increasing household income and change in consumer habits provides good growth opportunity for organised footwear industry Organized footwear market is 1/3 of total market & is growing at 15% p.a. The current Indian footwear industry is worth Rs. 22,000 cr which holds immense business opportunities and is divided between organised and unorganised segments. The organised segment caters to about onethird of the market while the remaining market is serviced by smaller unorganised players. The market is further segmented into men, women and kids footwear range. The organised footwear market in India is growing at a rate of 15% p.a. The increase in household income, change in consumption habits, rapid urbanization, accessibility and availability of leading international brands, organized retailing and emergence of on line market provides plenty of opportunities for the organised footwear industry. Further, it should be noted that the average footwear consumption in India is as low as one or two pairs while that in the US is about six to eight pairs. This provides significant growth potential for the industry and the companies under this business. The recent policies of Government of India opening FDI in retail would also create opportunities for the development and growth of Footwear industry. We expect the industry to grow at a robust rate over the next few years. Being an established player with strong domestic presence, LSL could benefit immensely from the robust industry outlook LSL is an established branded player in the Indian footwear industry since years. It is the only Indian company which is amongst the top 5 manufacturers of leather footwear in the World. The company is producing more than 50,000 pairs of footwear a day (during peak season) covering virtually every age group and income category. Under the mother brand Liberty, the company has developed a spectrum of 10 exclusive subbrands (coolers, fortune, warriors, gliders, force10, senorita, Windsor, prefect, tiptopp and footfun) each of which has been specially designed to cater to a specific target group. The company is constantly working on new designs so that it can always provide fashionable and comfortable products to its customers. Its DNA of innovation, technology and advancement (technologies like Oxygen Power Motion Propeller, Acu Massager, Feather Walk, LTX Zone, Tetra, Wave Massager, Flexotech and Techno Walk) has enabled the company to stay abreast of all that is new in the domain of fashion and quality. Today, the company has products available at price points ranging from Rs. 100 6,000. Its products are marketed across the globe through ~150 distributors, ~425 exclusive showrooms and over 6000 multibrand outlets. The company has a strong domestic presence (89% of the total sales) with a good grip in north & south, from where the company generates 75% of its sales. The company has prominent retail presence in the cities of Delhi, Mumbai, Chennai, Gurgaon, Noida, Gwalior, Lucknow, Raipur, Indore, Ludhiana, Hyderabad etc. The company has low presence in the West (20% of sales) and East (5% of sales). While it would continue to focus and expand its reach in North & South, it also has plans to penetrate into areas / cities (Tier II & Tier III cities) which are untapped or where it has less presence (like in the West & East). The company has plans to set up new stores (own and franchisee) over the next two to three years. This would enable the company to expand its reach, leverage its strength and exploit the available opportunities in the Indian footwear industry.

Low footwear consumption in India, increase in household income, provide immense growth potential

Well placed to capitalise on available opportunities with strong domestic presence & big expansion plans

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Strong brand perception would enable LSL to strengthen its penetration further in the growing footwear market and more and more consumers would find LSL to their level of satisfaction.

Restructuring of financial arrangements with group companies and subsidiary could result in value unlocking, add value to brand, better credit rating, valuation rerating and boost profits
At present, LSL has a franchise agreement with LE and LGMD for 2 years (w.e.f from April 01, 2013) under which, the facilities for manufacturing of footwear of these two firms along with access to their export and domestic network and use of trademarks owned by them is available exclusively to LSL on franchise basis against payment of the annual franchise fees (Rs. 67.4 mn paid to LE, Rs. 78.7 mn paid to LGMD in FY13). LSL also has a financial arrangement with LFC, wherein it has a right to use trademark Liberty and other marks and logos on exclusive basis for a period of 15 years (w.e.f. April 01, 2013) against a payment of minimum guaranteed obligation (Rs. 53.1 mn License Fee paid to LFC in FY13). LSL has entered into this agreement to pool the resources of the group companies to avail of economies of scale and to rationalize its resource utilization The table below provides details of the present financial arrangements of LSL with its group companies: Group Companies Liberty Enterprise Liberty Group Marketing Division Liberty Footwear Company Financial Arrangement Agreement for use of footwear manufacturing facilities at Karnal and export sales network for a period of 2 two years w.e.f. April 01, 2013 Agreement for use of services of fixed assets for manufacturing at Karnal, registered trademarks and domestic sales network for sale of footwear for a period of 2 years w.e.f. April 01, 2013 Agreement for use of Trademark Liberty and other trademarks on exclusive basis for a period of fifteen years w.e.f. April 01, 2013 Franchise / License Fees paid in FY13 Rs. 67.4 mn Rs. 78.7 mn

Financial arrangement with LE, LGMD & FFC; total franchise/license fee paid in FY13 Rs. 199.2 mn

Rs. 53.1 mn

Over the next two years, LSL has plans to restructure these arrangements with an emphasis to unlock shareholders value. While the company has not clarified in what form the restructuring could happen, we feel merger of some or all group companies with LSL is one of possibilities. The extension period of agreements referred to above provides some hint. Early restructuring could result in huge rerating in the stock price; it could help LSL to rope in a PE partner Current financial arrangement with group companies can be looked upon as antiminority shareholders so far. Restructuring of financial arrangements with group companies could result in value unlocking, add value to LSLs brand, better credit rating, valuation rerating and boost profits. LSL would be able to rope in a PE partner to fund its expansion plans (which would be difficult without restructuring). Restructuring could ensure that the company will own the brand/subbrands and the facilities and hence it would not require to pay the licence / franchise fees, which would boost the net profits significantly. However, for better valuations, it is essential that the restructuring, in whichever form it happens, benefits minority shareholders (for instance, in the event of merger, the swap ratio should be in favour of minority shareholders). Page | 6

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Merger to LRR with LSL to result in operational efficiency; savings in service tax & CST to boost the profits

While the restructuring of group companies is yet to be finalised, the company has already started the restructuring process of its retail subsidiary Liberty Retail Revolutions (LRR). The Board of Directors has approved the Scheme of Amalgamation of M/s Liberty Retail Revolutions Ltd. (LRRL) with the Company to be effective from 1st April, 2013 subject to sanction from the respective Hon'ble High Court(s) and approval from the Members of the Company. The necessary formalities as required to effect the above said amalgamation have already been initiated. Once the merger is complete, it would result in operational efficiencies. LSLs standalone sales growth would improve as the sales realisation would be higher improve. Further, there would be substantial savings towards service tax and CST. This would boost the operating & net profits & the respective margins of both standalone & consolidated business of LSL.

Aggressive expansion plans to set up new own and franchisee stores likely to boost the sales & profits
Plans to open 50 stores p.a. year across Tier 1, Tier 2 & Tier 3 cities. LSL is pacing up its strategy of expanding its retail stores and has added ~25 new stores in H1FY14 to its existing kitty of over 400 exclusive showrooms and also strengthened its multibrand outlets across India. These stores are spread across metros, tier 1 and tier 2 cities. Over the next two to three years, the company has aggressive plans to open up ~50 stores per year (own as well as franchise) across the Tier 1, Tier 2 and Tier 3 cities. With equal focus on its key markets, which are north & south, LSL also plans to expand its reach to regions which are untapped or where it has low presence. As per the management, per store CAPEX is estimated to be Rs. 25 lacs to Rs. 40 lacs. The expansion is expected to be funded through a mix of internal accruals, borrowings and the institutional placement (if it happens; depending upon how early the restructuring of group companies takes place). Timely ramp up of the new stores could enable LSL to expand its reach and boost its revenues & profits going forward. Further, LSL has reduced opening up stores in malls (where costs are high mainly due to higher rentals and payback period is longer) and has started opening standalone stores in high streets. This could result in cost savings on the back of lower lease rentals.

Looking to expand reach in untapped / low present markets; reducing opening up stores in malls

Implementation of TOC program over last few years could lead to continuing benefit going forward
Theory of Constraints Approach and its benefits The Theory of Constraints (TOC) approach exploits the fact that the cumulative forecast at the plant level is more accurate than at individual links. Using heuristic models, replenishment and emergency inventory levels at strategic supply chain links are determined. It is a powerful tool, but relatively difficult to implement. It first requires that each supply chain link undergo a paradigm shift in processes and thinking. An effective supply chain solution must ensure that each link in the chain, from raw materials supplier to consumer, recognizes its state of ideal performance. For distributors and showrooms, this state is to keep inventory levels low but maintain high availability, to buy less of each item, but with more variety and quick resupply of popular items. For this to occur, replenishment lead times must drop dramatically, boosting sales without raising fixed cost. With higher inventory turns, distributors and showrooms achieve RETAIL RESEARCH Page | 7

significantly greater return on investment. With higher returns on investments, its easier to attract new distributors. The company can capitalize on these advantages, further broadening its reach and range. Meanwhile, the consumer finds the perfect shoe. Every supply chain link benefits from the decisive competitive edge. The approach has enabled LSL to attract more channel partners and expand its reach and range With guidance from the Vector Consulting Group, LSL implemented a TOC initiative a few years back with the aim of raising sales and, more importantly, profitability. It is a unique business tool, which was implemented for the first time globally in a fashion industry. The implementation took the form of the following six discrete steps viz; i) Establish a central warehouse; ii) Implement a production priority system; iii) Ensure retail availability; iv) Decouple production and raw materials lead times; v) Identify fashion winners and losers quickly and vi) Increase the number of new products. All these steps have benefited LSL to a large extent. Post implementation of the TOC distribution and replenishment system, replenishment frequency for each item at each stocking point has become greater. The forecasting horizon has reduced significantly, which has prevented retail stores from getting stuck with slow movers and has enabled continuous reordering of winning items. The companys channel partners have been able to increase their inventory turns, which has resulted in significantly higher return on investment. With higher returns on investments, fast replenishment and efficient supply chain management LSL has been able to attract new channel partners and expand its reach. This has translated into faster growth in sales & profitability. Going forward, LSL could continue to benefit in terms of expanding its distribution reach and range, which would translate into higher sales & profit growth going forward.

TOC has / could continue to benefit LSL in adding new channel partners (by ensuring higher ROI to them) and expanding its reach & range

Strengthening the export business by expanding into new geographies

Besides having a strong domestic presence, LSL also has a good presence in the overseas markets (11% of the total sales) like West Asia (Middle East, Gulf), Singapore, Sri Lanka & Bhutan. It also exports to other markets like Europe, United States, and Russia. The company currently supplies shoes to over 25 countries. The company plans to strengthen its overseas presence by entering into new geographies as well. Its wholly owned marketing subsidiary Liberty Foot Fashion Middle East FZE (LFF), which was set up to expand the Middle East business, is currently dormant. However, the as per the management, the company is set to start its operations from next year. To cater to the need of the fashiondriven and qualityseeking customers in overseas market, LSL is also exploring options for setting up overseas trading/representative offices. All this is likely to boost the export sales going forward. After declining by 20% in FY13, the export business has improved in H1FY14, growing by 17.1% in H1FY14. With all the initiatives, the company expects the exports to grow at a robust rate growing forward.

Strengthening export presence by entering in new geographies; business has done well in H1FY14

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Consolidated Net Sales to grow at a CAGR of 21.9% over FY1315; margins to improve on the back of stability in the raw material cost and cost rationalisation
LSLs consolidated net sales grew by 10.6% on a CAGR basis over FY1013. The growth was impacted due to poor performance in FY13, wherein the net sales grew marginally by 1.8% on the back of global slowdown and sluggishness in the Indian economy, which impacted the spending power of consumers and put pressure on the pricing. The company sold 85.34 lacs pairs of shoes, an increase of 9.2% over FY12. However, realisation per pair degrew by 6.5%. However, there has been a turnaround in H1FY14, wherein the standalone net sales grew by 43%. The company sold 57 lacs pairs of shoes in H1FY14, an increase of 67.8% over H1FY13, while the realisation degrew by 16%. The decline in realisation and substantial jump in sales volumes was due to low value large institutional order executed in H1FY14. While we expect the volume growth to reduce on sequential basis in Q3, the sales realisations are likely to improve. Thus overall sales value growth in FY14 is likely to be robust, which would be driven by a mix of robust volume growth & improvement in realisation. On a CAGR basis, we expect LSLs net sales to grow by 21.9% over FY1315, which is likely to be driven by distribution expansion, penetration into low presence / untapped markets, new launches, incremental revenues from new stores and robust industry outlook (as economic growth is expected to improve in H2FY14 and in FY15, which would improve the spending power and increase the demand for LSLs products).
Net Sales (Rs. in Mn) LHS 6000 5000 4000 3000 2000 1000 0 FY11 FY12 FY13 Year End 1.8 FY14E FY15E 15.5 3099.0 4492.8 3563.9 15.0 3628.6 23.8 17.6 % growth rate RHS 5285.1 30 25 20 15 10 5 0

Distribution expansion, penetration in untapped markets, new launches, ramp up of new stores & robust industry outlook to boost the sales

Stability in the input prices (which are crude based) & lower marketing cost to aid in margin improvement

We expect LSLs operating profit to grow by 24.4% on CAGR basis over FY1315, while OPM is estimated to improve gradually from 8.3% in FY13 to 8.5% in FY14 & further to 8.7% in FY15 on the back of stability in the raw material prices and cost rationalisation. LSLs inputs are largely crude based and we expect crude oil prices to fall in near term and remain stable in the medium term. Further, one major round of celebrity led marketing push is over and over the next few quarters we expect LSL Page | 9

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to incur lower marketing expenses. Consolidation of retail operations could also aid in margin expansion (in the form of lower service tax & CST).
500 450 400 350 300 250 200 150 100 50 0 Operating Profit (Rs. in Mn) LHS 8.6 8.3 308.3 242.0 7.8 301.1 % of sales RHS 460.5 382.2 8.5 8.7 9 9 8 8 8 8 8 7 7 FY11 FY12 FY13 Year End FY14E FY15E

We expect PAT to grow at a faster rate by 59.3% on CAGR basis, while PAT margins are likely to improve from 1.6% in FY13 to 2.3% in FY14 and further to 2.7% in FY15 on the back of relatively lower growth in the depreciation and interest cost and NIL tax (due to MAT credit entitlement).
PAT (Rs. in Mn) LHS % of sales RHS 2.3 1.6 57.9 104.4 141.7 2.7 3 3 2 2 1 1 0 FY11 FY12 FY13 Year End FY14E FY15E

Lower growth in depreciation & interest cost & NIL tax to boost PAT

160 140 120 100 80 60 40 20 0

2.2 2.0 79.4 61.8

Going forward, once the restructuring plans materialize, we expect LSL to achieve much higher levels of operating & PAT margins.

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Competitive Profile
In the organised footwear market, LSL faces competition from established listed footwear players like Bata India & Relaxo Footwear. At CMP, LSL is trading at 15.2x TTM EPS, which is at a discount of 56% to Bata India & 28% discount to Relaxo Footwear. The company also faces competition from the unorganised players from India and global players. The discount to its peers could be largely due to its lower scale of business and lower profit margins compared to Bata & Relaxo and due to its current financial arrangements with its group companies, which can be looked upon as antiminority shareholders. Further, Bata India & Relaxo are both regular dividend payers, while LSL has not paid dividend to its shareholders over the last 7 years. However, LSLs recent restructuring proposal and expansion plans could mark a turnaround in its business operations over the next 23 years. Early restructuring of financial arrangements with group companies could result in value unlocking, better brand value, better credit rating, valuation rerating and higher profits. LSL has already taken steps to consolidate its retail operations by amalgamating its retail subsidiary (LRR), which is likely to result in operational efficiencies going forward. Further, the company has aggressive expansion plans to open up more own and franchisee stores over the next two to three years and also expand its distribution network through multi brand outlets. The company plans to increase its penetration in areas / cities, where it has lower presence or which are untapped like in the East & West. This is likely to improve its revenue visibility going forward. With improved size, growth and profits, there is a possibility of company starting to reward its shareholders with dividend payments after a couple of years. Years of management experience in the footwear industry, strong distribution reach across the country, aggressive plans to set up owned retail stores, established position in the midprice segment of footwear industry and fiscal benefits available to LSLs production facilities in Roorkee and Ponta Sahib enhances its competitiveness over the unorganised segment. If the company is able to achieve success in the above mentioned plans and becomes more investor friendly, then it would definitely get better valuations and its discount to its peers (in the organised industry) would narrow down significantly going forward. Company Name OPM (%) 15.0 11.5 7.9 NPM (%) 9.4 4.8 2.7 EPS (Rs.) 29.4 8.8 6.3 TTM (Oct 2012Sept 2013) PE Net Sales Mkt. Cap / Sales (x) (Rs. in Mn) (x) 34.2 20188.2 3.2 21.1 10901.6 1.0 15.1 3997.0 0.4

Shareholder friendly initiatives like successful restructuring of group companies, dividend payouts could improve the valuations

Bata India Relaxo Footwear LSL

P / BV (x) 8.0 4.4 1.0

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Risks & Concerns

Company has not paid dividends to its shareholders over the last 7 years. For better valuations, it is essential that the company resorts to investor friendly measures and starts rewarding its shareholders with healthy dividend payments. Majority of LSLs inputs (like PVC Compound, PU Chemicals, EVA Resin etc) are crude based. Hence any substantial rise in the crude oil prices could increase the overall material cost and impact the companys margins if it fails to pass on such cost increase to its consumers. Increasing competition from the unorganised and organised Indian and Global players could put pressure on the pricing and impact the sales & profit growth LSLs Working Capital Cycle (WCC) is high at 124 days (in FY13) on the back of higher inventory and debtor days (121 days & 80 days respectively in FY13). High debtor days are partly a function of institutional orders. Despite the TOC implementation, little improvement has been witnessed in the WCC. LSL should take steps to improve its WCC efficiency, or else it will have to resort to incremental borrowings to meet its working capital requirements, which would increase the interest cost and impact the net profits. Current financial arrangement with group companies can be looked upon as antiminority shareholders so far. Hence early and comprehensive restructuring is warranted for improvement in valuation. Further, the company will have to rope in a PE partner for funding its expansion plans. Delay in the financial restructuring or partial restructuring could result in lower re rating. LSLs business is run by three promoter families (2 Gupta families and 1 bansal family). Any dispute arising in future (though it has not happened in the past) could impact the growth prospects of the company. Prolonged slowdown in the Indian economy could impact the consumer spending and result in downtrading, impacting the sales & profit growth. Adverse government policies could hamper the prospects of footwear industry and the companies in that business. Currently the company pays only MAT on the back of tax benefits available at its plants at Dehradun, Ponta Sahib & Roorkee. As a result of MAT credit entitlement, its effective tax rate on PBT is NIL. The tax benefits are expected to stay till Dec 2016. Post that, the company will have to pay higher taxes, which could impact the growth in bottomline & margins. LSL acquired balance 6.14% stake in Liberty Retail Revolutions from the promoter group for Rs. 98 mn, valuing the subsidiary company at Rs. 1598 mn. This is quite high considering the entire valuation of LSL, which is Rs. 1738 mn, and considering the recent financial performance of this retail subsidiary. Bulk order from institutions could impact the realisations per pair & margins in particular quarter, thus increasing volatility on QoQ basis. LSLs operating profit & PAT margins are lower compared to its peers like Bata India and Relaxo Footwear, though it is making attempts to improve the same. Its return ratios are also lower due to very low PAT margins.

Delay in the restructuring exercise, sharp rise in input cost, increasing competition, higher inventory & debtor days key risks

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Conclusion
We expect LSLs consolidated net sales & PAT to grow by 21.9% & 59.3% on a CAGR basis over FY1315. Sales growth is likely to be driven by distribution expansion, penetration into low presence / untapped markets, new launches, incremental revenues from new stores and robust industry outlook. We expect the organised footwear market to grow at a robust pace over the next two years, as economic growth is expected to improve in H2FY14 and in FY15, which would improve the spending power and increase the demand for LSLs products. Low per capita consumption of footwear in India provides immense growth opportunity going forward. Being an established player with strong domestic presence, LSL is likely to benefit immensely. Timely ramp up of the new stores could enable LSL to expand its reach and boost its revenues & profits going forward. TOC approach would continue to help LSL to attract more channel partners and expand its reach and range in its key markets as well as in areas which are untapped or where it has low presence. LSL also expects its export business to do well going forward, which would further boost the growth. LSLs OPM is likely to improve over next two years on the back of stability in the input prices (as majority inputs are crude based and crude oil prices are expected to fall or remain stable) and cost rationalisation (lower marketing expenses). Consolidation of retail operations could also aid in margin improvement (in the form of lower service tax & CST). Higher OPM, relatively lower growth in depreciation & interest cost & NIL tax would boost the PAT & PAT margins over the next two years Minority shareholder friendly restructuring of financial arrangements with group companies and subsidiary (if proposed and extensive) could result in value unlocking, add value to brand, better credit rating, valuation rerating and boost profits. Timely implementation could enable LSL to rope in a PE investor to fund its expansion plans. Restructuring would ensure that the company will own the brand/subbrands and the facilities and hence it would not require to pay the licence / franchise fees (Rs. 199.2 mn in FY13), which would boost the net profits significantly. At CMP, LSL is trading at 15.2x TTM EPS, which is at a discount of 56% to Bata India & 28% discount to Relaxo Footwear. The discount could be largely due to its lower business size and lower profit margins compared to Bata & Relaxo, absence of any dividend payments (unlike its peers, which are regular dividend payers) and due to its current financial arrangements with its group companies, which can be looked upon as antiminority shareholders. However, shareholder friendly initiatives (like successful and comprehensive restructuring, dividend payments) and sustained growth in turnover & profits could narrow down this discount in valuation. As regards the unorganised competition, years of management experience in the footwear industry, strong distribution reach across the country, established position in the midprice segment and tax benefits available at its plants enhances its competitiveness over the unorganised segment. We feel LSL is capable of trading at atleast 15xFY15E EPS, which gives a price target of Rs. 125. Hence we feel investors could buy this stock at current levels and average it on dips in the price band of Rs. 8387 (1010.5xFY15E EPS) for our price target over the next one to two quarters. Any news on the progress on comprehensive restructuring of group companies could result RETAIL RESEARCH Page | 13

in substantial rerating (if it benefits the minority shareholders). LSLs average one year forward PE for the last 5 years stands at 25x. Even if we apply 20% discount to that, the stock has the potential to touch Rs. 166 in the next one year, if there is any positive announcement on restructuring and the company continues to impress the street with robust numbers.

Quarterly Financials (Standalone)

Particulars (Rs. in Million) Gross Sales Excise Duty Net Sales Other Operating Income Total Income Total Expenditure Raw Material Consumed Stock Adjustment Purchase of Finished Goods Employee Expenses Other Expenses Operating Profit Other Income PBIDT Interest PBDT Depreciation PBT Tax (including DT & FBT) Reported Profit After Tax Extraordinary Items Adjusted PAT EPS (Rs.) Equity FV OPM (%) PATM (%) Q2FY14 1083.9 39.7 1044.2 4.0 1048.2 962.3 506.5 94.3 157.9 126.8 265.5 85.9 0.1 85.9 35.6 50.4 21.0 29.4 1.0 30.4 0.5 29.9 1.8 170.4 10 8.2 2.9 Q2FY13 741.2 38.2 703.0 0.1 702.9 648.3 406.6 66.5 19.9 92.6 195.7 54.6 0.3 54.9 34.0 20.9 19.6 1.3 0.5 0.8 0.0 0.8 0.0 170.4 10 7.8 0.1 VAR [%] 46.2 4.0 48.5 49.1 48.4 24.6 693.3 36.9 35.7 57.2 71.7 56.5 4.7 140.9 6.9 2191.0 291.6 3828.8 3764.2 3764.2 0.0 0.0 5.8 2501.5 Q1FY14 1077.5 41.1 1036.3 3.2 1039.5 960.4 458.5 30.3 140.3 127.9 264.0 79.1 0.8 79.9 33.9 46.0 19.5 26.5 0.6 25.9 0.1 25.8 1.5 170.4 10 7.6 2.5 VAR [%] 0.6 3.4 0.8 24.9 0.8 0.2 10.5 12.5 0.8 0.5 8.5 90.0 7.6 4.8 9.6 7.8 10.9 264.8 17.2 400.0 15.7 15.7 0.0 0.0 7.7 14.9 Q4FY13 1061.0 41.2 1019.9 7.7 1027.6 945.4 551.9 90.2 37.0 112.1 334.7 82.2 0.4 81.8 31.9 49.9 21.9 27.9 3.8 31.7 2.2 33.9 2.0 170.4 10 8.1 3.3 Q3FY13 931.7 35.1 896.6 4.5 901.0 834.0 278.2 72.4 125.3 100.1 258.0 67.0 0.5 67.5 27.6 39.9 20.7 19.3 1.5 17.8 0.0 17.8 1.0 170.4 10 7.5 2.0

(Source: Company, HDFC Sec)

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Financial Estimates (Consolidated) Profit & Loss A/c

YE March (Rs. Million) Net Sales Other Operating Income Total Operating Income Material Cost Employee Benefits Expense Other Expenditure Total Operating Expenses Operating Profit Other Income EBITDA Interest Depreciation PBT Tax (including FBT & DT) PAT Minority Int.; Profit / Loss from Associates Reported PAT Extraord Items Adjusted PAT FY11 3099.0 12.0 3111.0 1491.9 417.8 959.4 2869.0 242.0 0.2 242.2 95.7 85.9 60.6 0.0 60.6 1.2 61.8 0.0 61.8 FY12 3563.9 10.1 3574.0 1715.7 437.4 1112.7 3265.8 308.3 35.7 272.6 137.7 96.8 38.1 4.0 42.1 0.0 42.1 37.3 79.4 FY13 3628.6 17.4 3646.0 1716.8 460.2 1167.9 3344.9 301.1 1.6 299.4 142.8 104.0 52.7 1.2 53.9 0.0 53.9 4.0 57.9 FY14E 4492.8 18.3 4511.1 2309.3 566.1 1253.5 4128.9 382.2 1.0 383.2 163.6 115.4 104.2 0.8 105.0 0.0 105.0 0.6 104.4 FY15E 5285.1 19.2 5304.3 2711.3 665.9 1466.6 4843.8 460.5 1.1 461.6 186.2 133.6 141.7 0.0 141.7 0.0 141.7 0.0 141.7

(Source: Company, HDFC Sec Estimates)

Balance Sheet
YE March (Rs. Million) Equity & Liabilities Shareholders Funds Share Capital Reserves & Surplus Share application money pending allotment NonCurrent Liabilities Minority Interest RETAIL RESEARCH FY11 1269.7 170.4 1099.3 55.0 195.4 1.7 FY12 1317.8 170.4 1147.4 0.0 176.3 0.0 FY13 1367.4 170.4 1197.0 0.0 203.5 0.0 FY14E 1471.8 170.4 1301.4 0.0 231.7 0.0 FY15E 1613.5 170.4 1443.1 0.0 264.6 0.0 Page | 15

Long Term borrowings Deferred Tax Liabilities (Net) Other Long Term Liabilities Long Term Provisions Current Liabilities Short Term Borrowings Trade Payables Other Current Liabilities Short Term Provisions Total Equity & Liabilities Assets NonCurrent Assets Fixed Assets Gross Block Depreciation Net Block (Tangible Assets) Intangible Assets Capital WorkinProgress Goodwill On Consolidation Long term Loans and Advances Other NonCurrent Assets Current Assets Current Investments Inventories Trade Receivables Cash & Cash Equivalents Short Term Loans & Advances Total Assets

103.3 55.4 33.5 1.4 1769.3 937.5 674.7 142.2 14.8 3289.4

78.8 50.5 44.8 2.2 1826.9 935.0 674.6 197.9 19.4 3321.0

104.6 51.0 45.9 1.9 1944.7 998.6 704.9 226.4 14.9 3515.5

130.8 50.0 49.4 1.5 2398.7 1148.3 969.2 264.9 16.4 4102.2

156.9 49.5 56.8 1.3 2820.3 1320.6 1182.4 298.0 19.3 4698.3

1306.1 1027.3 1660.0 646.2 1013.8 3.0 10.5 0.0 259.9 18.8 1983.3 0.0 1012.0 620.1 179.3 171.9 3289.4

1322.1 1027.9 1756.8 737.6 1019.2 8.1 0.5 0.0 272.1 22.1 1999.0 0.0 1028.0 715.8 100.5 154.7 3321.0

1284.1 1106.0 1835.6 834.3 1001.3 10.8 2.3 91.5 155.3 22.8 2231.4 0.0 1112.2 792.1 123.9 203.2 3515.5

1340.1 1113.9 1955.6 949.7 1005.9 13.0 3.5 91.5 186.4 39.9 2762.0 0.0 1345.8 1013.9 138.3 264.1 4102.2

1456.7 1189.7 2155.6 1083.3 1072.3 15.6 10.4 91.5 219.9 47.0 3241.6 0.0 1574.6 1206.5 156.8 303.7 4698.3

(Source: Company, HDFC Sec Estimates)

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Key Ratios
YE March FD EPS (Rs.) PE (x) Book Value (Rs.) P/BV (x) OPM (%) PBT (%) NPM (%) ROCE (%) RONW (%) DebtEquity (x) Current Ratio (x) Mkt. Cap / Sales (x) EV/EBITDA (x) FY11 3.6 26.2 74.5 1.3 7.8 2.0 2.0 6.8 4.9 0.8 1.1 0.5 10.2 FY12 2.5 38.4 77.3 1.2 8.6 1.1 1.2 7.5 6.0 0.8 1.1 0.5 9.3 FY13 3.2 30.0 80.2 1.2 8.3 1.5 1.5 7.9 4.2 0.8 1.1 0.4 8.7 FY14E 6.2 15.4 86.4 1.1 8.5 2.3 2.3 9.7 7.1 0.9 1.2 0.4 7.2 FY15E 8.3 11.4 94.7 1.0 8.7 2.7 2.7 10.6 8.8 1.0 1.1 0.3 6.4

(Source: Company, HDFC Sec Estimates)

Cash Flow
YE March (Rs. in Million) Profit Before Tax Net Opt Cash Flow Net Cash from Investing Activities Net Cash from Financing Activities Cash & Cash Equivalents Net Inc/(Dec) in Cash FY11 60.6 76.0 185.3 85.7 179.3 23.6 FY12 38.1 209.8 95.0 194.9 100.5 80.1 FY13 52.7 299.2 182.0 98.0 123.9 19.2 FY14E 104.2 170.4 171.4 15.4 138.3 14.3 FY15E 141.7 249.3 250.2 19.4 156.8 18.6

(Source: Company, HDFC Sec Estimates)

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LSLs one year forward PE price chart

250.00 200.00 150.00 100.00 50.00 0.00

RETAIL RESEARCH Tel: (022) 3075 3400 Fax: (022) 2496 5066 Corporate Office
HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 3075 3400 Fax: (022) 2496 5066 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non-Institutional Clients

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Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13
Close -Unit Curr 10.0 X 15.0 X 20.0 X 25.0 X 30.0 X

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