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June 04, 2013

Consumer Staples

SECTOR INITIATION


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Summary valuation table
Company
Comptt.
Mapping
Rating
CMP
(Rs)
Mcap
(US$bn)
Target
Price (Rs)
Upside/
Downside
P/E
(FY14E)
P/E
(FY15E)
Implied
P/E (FY14)
EPS CAGR
(FY08-13)
EPS CAGR
(FY13-15)
ROE
(FY13)
GSK CH

SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%
Nestle

SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%
Colgate

SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%
Marico

SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%
HUL

SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%
Dabur

SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%
GCPL

SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%
Median 37.2 32.8 31.6 18% 15%
Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15
Analyst contacts
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel .: +91 22 3043 3246
shariqmerchant@ambitcapital.com

Trade off between defensiveness
v/s valuations for discretionary and
staples
0%
10%
20%
30%
40%
20 30 40
E
P
S

C
A
G
R

(
F
Y
1
3
-
1
5
)
P/E FY14
BATA
TTKPT
APNT
GCPL
TTAN
MRCO
DABUR
BRGR
PIDI
HUVR
CLGT
JUBI
SKB
NEST
ITC

Source: Bloomberg, Ambit Capital research
Note: Bubble size indicates level of defensiveness;

Our competitive advantage framework (see
page 12)
I Capital deployment
(a) Returns on deployment initiatives
followed over the past decade;
(b) Deployment strategy for future

II Product portfolio positioning
(a) Width and depth of portfolio;
(b) Category growth for the portfolio;
(c) Competition displacement capability
(in terms of market share in relevant
product categories)

III Near term raw material cost
benefits


The party is over
The current valuations of FMCG stocks37.2x one-year forward P/E, at
~35% premium to their historical three-year averagesdo not reflect
the likely moderation in earnings growth in the near term (to 15% EPS
CAGR over FY13-15E from 18% EPS CAGR over FY08-13). Whilst we do
not doubt the secular growth trend of the Indian consumption story, the
rising competitive intensity and saturating penetration in few product
categories would adversely affect the earnings growth and valuations
of FMCG firms. Lack of further softening in raw material costs is a near-
term negative catalyst for these companies. We advise investors to SELL
the frontline FMCG stocks (excl ITC, NOT RATED) and invest in
discretionary consumer stories (such as TTK and Asian Paints) owing to
the latters relatively higher EPS growth and cheaper valuations.
Deflating growth rates for staples companies: Penetration levels (at 80-
90%) are approaching saturation levels in product categories such as oral care,
soaps, detergents, skin creams and hair oils. Furthermore, competitive intensity
is rising quickly (owing to new entrants and promotion-led push from
incumbents) in categories such as oral care, chocolates, noodles, premium
edible oils and cosmetics. Thus, revenue growth could moderate (to 15% over
FY13-15 vs 19% over FY08-13) and EBITDA margins could contract, thereby
pulling down the EPS CAGR (by 500bps over FY13-15 vs FY08-13) for the
frontline FMCG stocks covered in this note (HUL, Nestle, Colgate, Marico,
GCPL, Dabur, and GSK Consumer).
HUL and Nestle better placed than the rest: HUL and Nestle are the best
placed in the FMCG sector, given HULs ability to leverage on its size to ride a
wave of consumption evolution across most product categories and Nestles
dominant presence in less-penetrated, rapidly-growing and entry-level
aspirational categories. HULs and Nestles consistent strategy of dividend
payouts/share buybacks alongside consistent reinvestment into the core
business give them a further edge over competition. Colgate, Marico, GCPL,
Dabur and GSK Consumer are intermediately placed.
No more support for punchy valuations: Given punchy valuations, we
initiate coverage with a SELL stance on each of these stocks. Our DCF-based
valuation implies a 10-30% downside for most (as we model near-term
earnings estimates factoring in lower growth and more importantly no more
softening in raw material costs). We believe investors should move their
consumption-focused investments to discretionary consumption stocks in paints,
light electricals and apparel, as the rising disposable incomes in India would
increase the depth and breadth of consumption to newer categories. We
recommend investors to switch into high-quality discretionary names like Asian
Paints, TTK Prestige and Bata.


Consumer Staples
Ambit Capital Pvt Ltd 2


CONTENTS

SECTOR
Investment thesis 3

Industry overview 7

Competitive advantage framework 13

- Capital utilisation strategies 13

- Portfolio positioning across segments 19

- Recent raw material trends 26

Valuations set to decline 31


COMPANIES
Hindustan Unilever (SELL) 39

Nestl (SELL) 58

Godrej Consumer (SELL) 73

Dabur (SELL) 89

GSK Consumer (SELL) 105

Colgate Palmolive (SELL) 120

Marico (SELL) 134





Consumer Staples
Ambit Capital Pvt Ltd 3

Investment thesis
Indias consumption story is structurally sustainable
Indias consumption story is on a robust structural trend owing to: (a) the influence
of working women on disposable income levels and spending patterns; (b)
traditionally backward regions, such as Bihar, Chhattisgarh, Madhya Pradesh and
Orissa, driving the next leg of growth; and (c) high Government spending over the
next 2-3 years. (refer pages 8-12)
HUL and Nestle are best placed amongst the seven FMCG plays
Exhibit 1: Competitiveness framework and the relative standing of peers - HUL and Nestle are ahead of the pack
HUL Colgate Dabur Marico Nestle GSK Consumer GCPL
Portfolio positioning
(diversification and category growth)

Ability to displace competition

Capital allocation and corporate strategy

Near-term raw material cost benefits

Overall rating

Source: Ambit Capital research; Note: indicates superior positioning relative to peers; indicates intermediate positioning relative to peers;
indicates inferior positioning relative to peers
Portfolio positioning: Under this parameter, we rate companies based on:
(a) pace of growth of the relevant categories driven by an increase in
penetration of consumption, increase in frequency of consumption, and the
rate of premiumisation within the relevant categories; and
(b) spread of the product portfolio across premium/economy brands and
across various product categories.
Nestle (market leader in fast-growing categories) and Dabur (diverse
portfolio in moderately growing categories) are best placed on this parameter.
Colgate, GSK Consumer and Marico are poorly placed on this parameter
given their predominant presence in one or two categories, with weak-to-
moderate category growth rates. HUL (diverse portfolio and predominantly
weak growth rate of categories) and GCPL (moderate diversification and
category growth) are placed at the intermediate level. (refer pages 18-25)
Ability to displace competition: The rating on this parameter is based on
our expectations of market share gains/losses for the respective companies.
Marico (hair oils and premium edible oils) is the best placed on this
parameter due to its strong potential to gain market share. Dabur is poorly
placed on this parameter due to the likelihood of market share losses in
categories such as hair care and oral care. GCPL, GSK Consumer, Colgate,
HUL and Nestle are intermediately placed due to a combination of market
share gains in a few categories (such as soaps and shampoos for HUL, coffee
for Nestle, home insecticides for GCPL and auxiliary income from Sensodyne
for GSK) and market share losses in others (such as oral care for Colagte, oral
care and skin creams for HUL, chocolates for Nestle and MFD for GSK).
Capital allocation and corporate strategy: Given the cash-generative
nature of the companies in this sector, capital allocation is a key component of
corporate strategy. We rate HUL, Nestle and Colgate Palmolive as firms
which have historically been the best allocators of surplus capital, with
dividend payouts and capex related to core operations forming over 80% of
cash generated by these companies. GCPL and Marico, on the other hand,
have underperformed vis--vis their peers on this metric because they have
Indias consumption story is on
a robust structural trend
Nestle and Dabur have the
best portfolio positioning
Marico (domestic portfolio) is
best placed to displace
competition
HUL, Nestle and Colgate have
the best capital allocation
strategy


Consumer Staples
Ambit Capital Pvt Ltd 4

invested a large proportion of their capital generated towards a combination
of M&A and international business expansion which have NOT been value
accretive for shareholders over the past five years. (GCPL has invested 125% of
its cash generated over FY03-12 vs 52% for Marico.) GSK Consumer and
Dabur are intermediately placed because: (a) GSK Consumer has
accumulated cash on the balance sheet and no effective means of capital
deployment; and (b) Dabur has made a value-destructive M&A of Namaste in
the US and Africa despite highly value-accretive expansion of its Middle
Eastern business. (refer pages 13-18)
Near-term raw material cost benefits: Input costs for Tea, Milk Food Drinks
(wheat) and HDPE (key ingredient used for packaging of most products) have
significantly increased in YTD CY13 over the previous year. Also, input costs for
soaps (palm oil), rice bran oil and coffee have declined in YTD CY13 over the
previous year. Consequently, in 1HCY13, we expect HUL, GCPL and Marico
to be the key beneficiaries of these trends; whilst GSK Consumer is likely to
be at a disadvantage as compared to its peers. (refer pages 25-30)
However, a derating of the seven stocks under our coverage is
warranted
The table below shows that the FMCG sector (i.e. the seven stocks covered in this
note) has been rerated by 61% over FY09-13. The rerating from FY09 to FY11 was
justified by increase in the growth momentum of Indias consumption story over
this period (volume growth increased by 200bps YoY over FY09-11). However, the
rerating over the past 24 months to current levels of 37.3x one-year forward P/E
multiples is not justified by any fundamental acceleration in volume or earnings
growth prospects of the relevant stocks. Instead, volume growth has moderated by
520bps over the past 24 months (FY11-13) for the sector.
Exhibit 2: Rerating in the FMCG sector vis--vis volume and EPS growth trends
FY09 FY10 FY11 FY12 FY13 Current
Sector P/E average (1-yr fwd) 18.5 21.9 26.7 27.4 29.7 37.2
Volume Growth 12% 13% 14% 10% 8% NA
EPS Growth 17% 27% 16% 15% 20% NA
Source: Company, Ambit Capital research; P/E multiples are simple averages of daily P/E multiples for each
year using Bloomberg consensus forecasts
Over FY13-15, we forecast an EPS CAGR of 15% for the sector, 500bps lower than
that of FY12-13, and around 300bps lower than the EPS CAGR of FY08-13.
Exhibit 3: Rerating in the FMCG sector given declining volume growth trends
15
18
21
24
27
30
33
FY09 FY10 FY11 FY12 FY13
6%
8%
10%
12%
14%
16%
18%
20%
Average P/E (LHS) Average Volume Growth
Penetration FY07 Advt spends FY07
Skin creams 25% GSK Cons. 12.9%
Biscuits 68% HUL 10.2%
Detergents 88% Marico 12.5%
Penetration FY12 Advt spends FY13
Skin creams 62% GSK Cons. 16.3%
Biscuits 89% HUL 12.5%
Detergents 98% Marico 13.6%

Source: Bloomberg, Company, Ambit Capital Research; Average volume growth represents simple average of the annual volume growth reported by
the FMCG companies (excluding GCPL) covered in this note
HUL, GCPL and Marico are
beneficiaries of near term
commodity price movements
Sector has been re-rated to 37x
FY14 P/E despite 600bps
moderation in YoY volume
growth over FY11-13


Consumer Staples
Ambit Capital Pvt Ltd 5

This moderation in EPS CAGR for the sector can be broadly attributed to the
following factors:
High penetration levels of several product categories: The penetration of
categories such as oral care, hair oils, milk/milk products, soaps and
detergents have substantially increased over the past five years. With the
current penetration levels exceeding 80% in these categories, growth rates are
likely to moderate going forward as compared to those achieved in the past.
Exhibit 4: High-price and low-utility items have low penetration (percentages in
bubbles and size of bubbles indicate penetration levels)
5%
11%
25%
17%
15%
15%
5%
47%
40%
90%
74%
88%
83%
90%
99%
-2
7
0 10
P

R

I

C

E
U T I L I T Y
Low utility
High utility
Baby foods
Premium edible oils
Milk food drinks
Insecticides
Oral care
Soaps and detergents
Coffee
Noodles
Milk/milk
products
Skin care
Fruit juices
Shampoos
Biscuits
Tea
Hair oils
H
i
g
h

P
r
i
c
e
L
o
w

P
r
i
c
e

Source: Industry, Ambit Capital research; Size of the bubble = penetration level of the respective category
Increased competitive intensity: Categories such as noodles, premium
biscuits, premium edible oils, oral care and cosmetics, previously had only one
or two large players controlling the market; however, these categories have
seen an influx of new entrants with large balance sheets, such as HUL and ITC
in noodles, ITC in biscuits, P&G and GSK Consumer in toothpastes, and Adani
Wilmar in premium edible oils. This has led to a rise in competitive intensity,
which is also visible in increased advertising spend to sales ratio for these
players over the past five years.
Tailwinds related to raw material cost benefits are fleeting: Over the
past 12 months, although the volume growth of discretionary consumer
categories has moderated, most players in the FMCG sector have been able to
stimulate consumer spending through accelerated promotions. Also, the
companies that have gained market shares from competitors have been well
supported by their ability to increase investment in advertising. This has been
made possible by weak raw material prices, a tailwind which is likely to be
fleeting. Gross margins are not likely to expand as substantially as they did
over the past 12 months, thereby cushioning EBITDA margins from the impact
of rising competitive intensity and saturating the penetration level in FY13.
Penetration levels are
approaching saturation in
several high utility product
categories
Competitive intensity has
increased substantially for
several product categories over
FY08-13
Tailwinds related to raw
material cost benefits are
fleeting


Consumer Staples
Ambit Capital Pvt Ltd 6

Exhibit 5: Gross margin expansion vs EBITDA margin expansion for FY13 (bps)
430
240
170
160
80 80
150
120
-10
-220
60
40
-70
-50
-250
-150
-50
50
150
250
350
450
550
M
a
r
i
c
o
N
e
s
t
l
e
D
a
b
u
r
G
C
P
L
H
U
L
Gross Margin Expansion EBITDA Margin expansion
G
C
P
L
G
S
K

C
o
n
s
u
m
e
r
C
o
l
g
a
t
e

Source: Company, Ambit Capital research
Consequently, based on our DCF valuations on these companies, our implied fair
multiple for the frontline FMCG stocks is ~15% lower than the current multiples
and hence warrants a sector-wide derating over the next 12 months.
Exhibit 6: Summary valuation table
Company
Comptt
Mapping
Rating
CMP
(Rs)
Mcap
(US$ mn)
Target
Price (Rs)
Upside/
Downside
P/E
(FY14E)
P/E
(FY15E)
Implied
P/E (FY14)
EPS CAGR
(FY08-13)
EPS CAGR
(FY13-15)
ROE
(FY13)
GSK CH

SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%
Nestle

SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%
Colgate

SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%
Marico

SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%
HUL

SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%
Dabur

SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%
GCPL

SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%
Median 37.2 32.8 31.6 18% 15%
Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15
Whilst we retain our SELL stance on the FMCG sector, we believe discretionary
consumption stocks like Asian Paints (MCap US$7.9bn, 6% upside) and TTK
Prestige (MCap US$694mn, 23% upside) offer a significantly stronger growth
profile and are available at more attractive valuations.
Level of defensiveness in consumer stocks highlighting valuations and EPS growth
0%
10%
20%
30%
40%
20 25 30 35 40 45
E
P
S

C
A
G
R

(
F
Y
1
3
-
1
5
)
P/E FY14
Bata
TTK Prestige
Asian Paints
GCPL
Titan
Marico
Dabur
Berger
Paints
Pidilite
HUL
Colgate
Jubilant
Foodworks
GSK Consumer
Nestle
ITC

Source: Bloomberg, Ambit Capital research; Note: Size of the bubble highlights the level of defensiveness
determined by the coefficient of variation of revenues over the past 24 quarters.
Discretionary consumption
stocks offer a significantly
stronger growth profile and
more attractive valuations


Summary Sheet


Ambit Capital Pvt Ltd 7
Exhibit 7: Summary of our investment hypothesis
Rating CMP
Mcap
(US$ bn)
Target
Price
Downside
P/E
FY14
P/E
FY15
Implied
FY14 P/E
Comments on hypothesis
Colgate SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2
Benefit = Oral care leadership; Negative = a) lack of portfolio diversification; b) competitive intensity rising (Oral-
B, GSK); and c) drivers of GM benefits are over
Dabur SELL 158 4.9 136 -14% 31.2 27.0 26.8
Benefit = Juices & home care; Negative = a) 45% revs in mass market positioning, penetrated and intense
competition (oral, hair, skin); b) 23% in niche which doesn't offer premiumisation
GCPL SELL 873 5.3 792 -9% 32.6 27.2 29.6
Benefit = Strong and efficient domestic portfolio; Negative = 60% capital generated deployed towards intl M&A: a)
volatile margins; b) low returns so far; c) economic/infra uncertainties
GSK CH SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5
Benefit = Franchise in S&E + aux revs; Negative = a) mkt sh loss to Complan; b) comptt intensity in premium MFD;
c) capital allocation risks; and d) new aux launch won't offset EPS growth moderation
HUL SELL 592 22.7 503 -15% 37.2 32.8 31.6
Benefit = size/width helps ride consumption waves + efficient capital deployment; Negative = subdued vol
growth:: a) 60% revs from penetrated cat.; b) mkt sh loss and rising A:S in oral, skin, and bevs; and c) rising royalty
rates and tax rates
Marico SELL 234 2.7 198 -16% 33.0 27.1 27.8
Benefit = Strong cat growth of vaule added hair oils; Negative = a) reliance on commodity prices for Parachute &
Suffola; b) capital allocation risks - EM MNC target; and c) comptt from Fortune
Nestle SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6
Benefit = Leadership in strong growth cat.; Negative = comptt intensity rising in chocolates (Fererro & Cadbury's),
premium coffee (HUL), noodles (ITC & HUL) and risk of Danone's and Mead Johnson's expansion in baby foods
Median 37.2 32.8 31.6
Source: Company, Ambit Capital research

Exhibit 8: Summary of our forecasts
Competitive mapping FY08-13 FY13-15

Portfolio
position-
ing
Ability to
displace
competi-
tion
Capital
allocation
strategy
Near
term RM
benefits
Overall
Sales
CAGR
EPS
CAGR
Sales
CAGR
Gross
Margin
change
(bps)
EBITDA
Margin
change
(bps)
EPS
CAGR
ROE
FY13
Comments on forecasts
Colgate

16% 16% 15% 40 (77) 8% 107% Rising A:S given comptt intensity, rising tax rates (150bps each year)
Dabur

21% 18% 14% 20 14 15% 40% Penetration and comptt will constrain revs and margins respectively
GCPL

42% 21% 19% 60 211 28% 23% Margin expansion on low base of FY13; organic growth
GSK CH

19% 22% 15% 50 88 18% 35% 23% CAGR of Aux income, mkt sh loss in MFD portfolio
HUL

13% 13% 13% 110 (27) 9% 103% Rising royalty & A:S given comptt from GCPL, L'Oreal, P&G, Nestle
Marico

19% 17% 10% (10) 150 *24% 23% 14% underlying EBITDA CAGR ex-Kaya; commodity play
Nestle

19% 21% 15% 475 (18) 14% 70% Vol growth moderation even once discretionary spends revive
Median 19% 18% 15% 50 14 15% 40%
Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; inferior positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15


Consumer Staples

Ambit Capital Pvt Ltd 8
Industry overview
Revenues in the Rs1,807bn Indian FMCG market have increased by ~15% YoY in
FY12, with rural revenues accounting for 34% of the overall sector. Whilst until
CY06, urban growth rates were higher than rural growth rates (refer to the exhibit
below), rural growth has outpaced urban growth by ~200bps over CY07-11
(average of 15% growth per annum in rural vs 13% per annum in urban over this
period). The rural and urban markets increased by ~15% YoY in FY12.
Exhibit 9: FMCG industry split across rural and urban
1,566
1,040
526
1,807
1,201
606
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
FMCG Industry
size
Urban Rural
FY11 FY12

Source: Industry, Ambit Capital research
Exhibit 10: Rural growth picked up pace after CY05
(10)
(5)
-
5
10
15
20
CY03 CY05 CY07 CY09 CY11
Urban
(%)
Rural
(%)
Overall
FMCG
(%)

Source: Industry, Ambit Capital research
Revenue growth in rural markets has outpaced those in the urban markets due to
a combination of the following factors:
1. Growth led by traditionally backward regions
The traditionally backward Indian states are now leading the charge in terms of
economic growth rates. Besides this pick up in income growth in traditionally
backward regions, the phenomenal proliferation of three drivers of aspirational
consumption over the past decade is likely to propel this story forward, namely,
Improved penetration of electricity access over the past decade which in turn
will facilitate consumption of electricity-based durables;
Improved levels of household sanitation which are likely to drive the
consumption of personal and home care products; and
Revolution in general awareness levels driven by the jump in penetration of
mobile phones and rising penetration of the internet.
The traditionally backward
Indian states are now leading
the charge in terms of
economic growth rates


Consumer Staples

Ambit Capital Pvt Ltd 9
Exhibit 11: The traditionally backward states in the
late-1990s
6.5%
5.4%
4.9%
4.3%
3.7%
3.4%
0%
1%
2%
3%
4%
5%
6%
7%
I
n
d
i
a
M
P
B
i
h
a
r
O
r
i
s
s
a
U
t
t
a
r
a
n
c
h
a
l
C
h
a
t
t
i
s
g
a
r
h
Avg GDP growth over FY95-99 (YoY, in %)

Source: CSO, Industry, Ambit Capital research
Exhibit 12: are now leading the charge in terms of
economic growth rates
13.7%
11.1%
9.4%
8.4%
8.2%
7.9%
4%
6%
8%
10%
12%
14%
16%
U
t
t
a
r
a
n
c
h
a
l
B
i
h
a
r
M
P
C
h
a
t
t
i
s
g
a
r
h
O
r
i
s
s
a
I
n
d
i
a
Avg GDP growth over FY07-12 (YoY, in %)

Source: CSO, Industry, Ambit Capital research
2. Rise in Governments welfare spends
Rural development spends by the Government have recorded a CAGR of 33% over
FY05-11 and 20% over FY05-13 (see the exhibit below). This has been achieved
through Government schemes such as MGNREGA (a rural employment scheme
which is likely to spend Rs294bn in FY13), Indira Awas Yojana (a rural housing
scheme with an estimated spend of Rs81bn in FY13), and the Pradhan Mantri
Gram Sadak Yojana and Central Road Fund (road development schemes with an
FY13 estimated spend of Rs91bn).
Exhibit 13: Rural development spends have recorded a CAGR of 33% over FY05-11
0
100
200
300
400
500
600
700
800
900
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E
-40%
-20%
0%
20%
40%
60%
80%
100%
Rural Spends (Rs bn) % Growth

Source: Industry, Ambit Capital research
The long-term prospects of structural growth in
consumption remain intact
Besides the benefits related to a high economic growth rate, we expect the
following factors to drive growth of consumption over the longer term in India:
1. Influence of women on disposable income levels
Improving economic opportunities for women, which have been a function of
rising female literacy levels, have helped in the economic empowerment of
women. More women are increasingly employed in the non-farm sector, which is
characterised by higher income levels vis--vis the farm sector. Furthermore,
Rural development spends by
the Government - 20% CAGR
over FY05-13
Household incomes will
continue to rise in India driven
by increased employment of
women in the non-farm sector


Consumer Staples

Ambit Capital Pvt Ltd 10
international experience suggests that as a country develops economically (as
measured by per capita income), the non-farm sector employs most of the women.
For instance, only 35% of Indias working women are currently employed in the
non-farm sector at a point where Indias per capita income is US$3,400 (in PPP
terms). At the other end of the spectrum is the US where 99% of working women
are employed in the non-farm sector, as its per capita income is at US$46,900 (in
PPP terms). Therefore, we expect household incomes to continue to rise in India
driven by increased employment of women in the non-farm sector.
Exhibit 14: Female literacy levels are rising faster than
male literacy levels in India
10%
20%
30%
40%
50%
60%
70%
80%
90%

1
9
8
1

1
9
8
3

1
9
8
5

1
9
8
7

1
9
8
9

1
9
9
1

1
9
9
3

1
9
9
5

1
9
9
7

1
9
9
9

2
0
0
1

2
0
0
3

2
0
0
5
Y
o
u
t
h

L
i
t
e
r
a
c
y

R
a
t
i
o
s

(
i
n

%
)
Males Females Gap

Source: CEIC, IMF, Ambit Capital research
Exhibit 15: The rising employment of women in the
higher-paying non-farm sector
25%
26%
29%
35%
20%
22%
24%
26%
28%
30%
32%
34%
36%
CY94 CY00 CY05 CY10
S
h
a
r
e

o
f

I
n
d
i
a
n

w
o
m
e
n

e
m
p
l
o
y
e
d

i
n

t
h
e

n
o
n
-
f
a
r
m

s
e
c
t
o
r

(
i
n

%
)

Source: World Bank, Ambit Capital research
2. Revival of discretionary spends by the Government
Whilst discretionary spending increased by only 12% in FY13, we expect a 19%
increase in FY14 in these spends based on the Governments FY14 budget. These
benefits given out before the elections are likely to help rural consumers over the
next 12-18 months.
Exhibit 16: Allocation to NREGA by the Government
has declined since FY11
113
120
300
391
401 400
330
-
50
100
150
200
250
300
350
400
450
2006-
07
2007-
08
2008-
09
2009-
10
2010-
11
2011-
12
2012-
13
NREGA Allocation (Rs Bn)

Source: Budget transcripts, Ambit Capital research
Exhibit 17: Discretionary spends by the Government
pick up in the two years before the general elections
3%
6%
12%
22%
25%
19%
0%
5%
10%
15%
20%
25%
30%
Gen Election
2004
Gen Election
2009
Gen Election
2014
Year 1,2 and 3 Year 4 and 5

Source: Ambit Capital research



We expect 19% YoY increase in
discretionary spending by the
Government in FY14


Consumer Staples

Ambit Capital Pvt Ltd 11
3. Evolution of consumption patterns
The factors highlighted above will have a structurally positive impact on household
incomes across most segments of the Indian population and hence will lead to a
large proportion households shifting from illiterate daily wage manual labourers
towards educated salaried/small business controllers.
Exhibit 18: Shift in proportion of Indian consumers across various categories
based on household income and segregation into rural vs urban
50%
24%
6% 6%
8%
2%
4%
28%
30%
6%
13%
10%
5%
8%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
S
t
r
u
g
g
l
e
r
s
S
m
a
l
l

t
o
w
n
n
e
x
t

b
i
l
l
i
o
n
L
a
r
g
e

t
o
w
n
n
e
x
t

b
i
l
l
i
o
n
R
u
r
a
l
A
s
p
i
r
e
r
s
U
r
b
a
n
A
s
p
i
r
e
r
s
T
r
a
d
i
t
i
o
n
a
l
A
f
f
l
u
e
n
t
P
r
o
f
e
s
s
i
o
n
a
l
A
f
f
l
u
e
n
t
2010 2020

Source: The Tiger Roars - Boston Consulting Group & CII; Ambit Capital research
This shift in household profiles is likely to lead to a change in consumption
patterns for various categories of consumption due to:
Spending patterns of the next generation: When consumers who are
currently in the age group of 15-25 years become decision-makers for
consumption, they would significantly change the consumption patterns in
their respective households. They would have observed wealth creation and
the influx of foreign brands first hand. Thus, they are likely to spend
significantly more on consumer products as compared to the previous
generations. Consequently, the definition of fashion/luxury/leisure will
evolve over the next decade.
Migration from rural to urban areas: Urban dwellers have better access to
goods and are exposed to more consumerism. Therefore, a migration to larger
cities tends to increase a households spending on various categories. This is
likely to add more depth to consumption in India and widen the range of SKUs
consumed in a typical household.
Nuclear families: Anecdotal data suggests that nuclear families spend 20-
50% more per capita as compared to traditional joint families in the same
household income group. These higher spends are mostly related to
discretionary consumption categories rather than staples.
This is likely to lead to the evolution of consumption spends across all product
segments along the following lines:
Several product categories within the staples segment as well as others including
light electricals, brown goods, white goods, auto and luxury spending categories
are currently under-penetrated in India. Penetration in these categories is likely to
increase either for the overall product segment or from a shift from the
unorganised product segment into the organised segment.
Professional
Affluent
Income over
US$18,500. Educated,
professionals
Traditional
Affluent
Income over
US$18,500. Less
educated, self-
employed, value
conscious
Urban
Aspirers
Income between
US$7,400-18,500. High
aspirations, live in urban
cities
Rural
Aspirers
Income between
US$7,400-18,500. less
aspirational, live in rural
areas
Large Town
Next Billion
Income between
US$3,300-7,400. Live in
large towns. Basic
education/lifestyle.
Small Town
Next Billion
Income between
US$3,300-7,400.Live in
small towns. Basic
education/ lifestyle.
Strugglers
Income less than
US$3,300. Illiterate,
daily wage earners
Penetration of several
categories (relatively more
discretionary in nature) is likely
to increase going forward


Consumer Staples

Ambit Capital Pvt Ltd 12
The chart below maps FMCG product categories across a price vs utility matrix,
with categories being more discretionary in nature at the top-left of the chart and
the ones that are more staple in nature at the bottom-right of the chart. Alongside
the price and utility, we map category penetration and find categories such as
baby foods and milk food drinks are the least penetrated across the country whilst
those such as soaps, detergents, biscuits and tea are almost completely penetrated
given their higher utility and smaller ticket size.
Exhibit 19: High-price and low-utility items have low penetration (percentages in
bubbles and size of bubbles indicate penetration levels)
5%
11%
25%
17%
15%
15%
5%
47%
40%
90%
74%
88%
83%
90%
99%
-2
7
0 10
P

R

I

C

E
U T I L I T Y
Low utility
High utility
Baby foods
Premium edible oils
Milk food drinks
Insecticides
Oral care
Soaps and detergents
Coffee
Noodles
Milk/milk
products
Skin care
Fruit juices
Shampoos
Biscuits
Tea
Hair oils
H
i
g
h

P
r
i
c
e
L
o
w

P
r
i
c
e

Source: Industry, Ambit Capital research; Size of the bubble indicates penetration level of the respective
category
Premiumisation is likely to be a strong driver of growth in well-penetrated
categories such as soaps, detergents and biscuits, as higher disposable household
incomes will be spent towards lifestyle upgrades for existing consumers of these
products. Also, the frequency of consumption of categories such as noodles, fruit
juices, deodorants and cosmetics are also likely to propel consumption going
forward.

Staples growth in well
penetrated categories will be
driven by premiumisation and
frequency of consumption


Consumer Staples

Ambit Capital Pvt Ltd 13
Competitive advantage framework
Our framework analyses the following competitive advantages of the
seven companies covered in this report:
1. Capital utilisation strategies: Given the high cash generation in this
sector, this section compares the efficiency of capital utilisation
strategies adopted by the respective companies over the past decade
and the intended strategy for the next 3-5 years.
2. Portfolio positioning: This section analyses the drivers of growth of key
product categories in the FMCG universe and identifies the winners
and losers within each of these product categories for FY13-15.
3. Raw material cost benefits: This section looks at the short-term gains
or losses that are likely at a gross margin level for various companies
from the changes in commodity prices over the past three months.
I - Capital utilisation strategies in a sector with
strong cash generation
As shown in the table below, cash generation in the FMCG sector has remained
strong for most companies over the past decade.
Exhibit 20: High asset turns and pre-tax CFO/EBITDA indicate strong cash
conversion

Average Asset
Turnover
Average PAT
Margin
Average
ROCE
Average Pre-tax
CFO/EBITDA
Colgate 5.8 14.4% 84% 126%
Nestle 6.4 12.3% 82% 118%
HUL 5.3 12.8% 66% 114%
GCPL 3.9 14.0% 62% 96%
Dabur 2.6 11.5% 34% 100%
ITC 1.1 23.2% 27% 114%
Marico 3.2 7.7% 24% 75%
GSK Consumer 2 11.5% 23% 137%
Source: Company, Ambit Capital research; Note: Average =ten-year period over FY03-12
In this section we analyse the various modes of capital deployment adopted by
large listed FMCG companies over the past decade, the consequent impact felt on
their return ratios, and the corporate strategy over the next 3-5 years.
Capital deployed over the past ten years
Modes of surplus capital deployment have varied across the sector and can be
classified into the following categories (see the exhibit below):
Dividend paid to shareholders through a combination of normal dividend,
special dividend and buybacks;
Core investments to expand the core product portfolio i.e. manufacturing
capacity, R&D facilities and distribution network;
Investments in non-core activities i.e. expanding presence in geographies
outside India or M&A around product categories which are not directly related
to the core business;
Surplus capital accumulation in the absence of appropriate avenues for
capital deployment;
Strong cash generation in the
FMCG sector over the past
decade
calls for a need to choose
from amongst various capital
deployment initiatives


Consumer Staples

Ambit Capital Pvt Ltd 14
Accumulation of unutilised cash which neither has been returned to
shareholders nor has been invested in core/non-core activities.
Exhibit 21: Avenues of capital deployment for various companies over FY03-12
-20%
0%
20%
40%
60%
80%
100%
H
U
L
N
e
s
t
l
e
C
o
l
g
a
t
e
G
S
K
C
o
n
s
u
m
e
r
D
a
b
u
r
M
a
r
i
c
o
G
C
P
L
Investment in core Dividend Paid Non core Inv./Intl. M&A Change in cash Others

Source: Company, Ambit Capital research; Note: height of the bar for each company refers to the sum of
operating cash flows, new equity raised and increase in gross debt.
Segregation of companies into three buckets
HUL, Nestle and Colgate repatriation to shareholders: These
companies are best placed with over 80% of the cash generated deployed
towards either investments in the core business or share buybacks/dividend
payouts to shareholders. Moreover, across these ten years, the payout ratio
has reduced for these firms only during years where deployment opportunities
in the core business have been exploited (e.g. Nestles payout below 70% only
over the past three years due to the capex towards doubling manufacturing
capacities in its core business). As a result, these three companies have
consistently had high RoEs and RoCEs over the past ten years.
GSK Consumer attempted to expand core business, but has ended up
accumulating unutilised cash: Whilst GSK Consumers working capital
management and cash generation is amongst the best in the sector, the
companys dividend payout ratio has been between 35% and 50% over the
past ten years, leaving ~50% of the cash generated over the past ten years
(after capex) unutilised. Attempts to leverage on the Horlicks brand to enter
into categories like biscuits, noodles, energy drinks and health bars have not
been successful. Consequently, GSK Consumers RoEs have been consistently
at 20-30% over the past ten years, several notches below that of its peers.
Dabur, Marico and GCPL substantial non-core investments/
International M&A: These firms have ventured into new
geographies/product categories through M&A which has been funded by a
combination of reduction in the dividend payout ratio (see chart below) and
new capital raised in the form of equity and debt. An analysis on the returns
generated through these non-core capital deployment initiatives (provided in
the next section of this note) suggests that the incremental returns generated
on these non-core investments/International M&A have been either at or
below par as compared to the cost of equity of the corresponding capital
employed.
Capital deployment strategies
have varied substantially across
the sector


Consumer Staples

Ambit Capital Pvt Ltd 15
Exhibit 22: Dividend payout trends over the past decade
0%
20%
40%
60%
80%
100%
120%
F
Y
0
3
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
GCPL
Marico
Dabur
Colgate
HUL
GSK
Consumer
Nestle

Source: Company, Ambit Capital research
Exhibit 23: Acquisitions made by FMCG companies since FY08
CY GCPL Marico Dabur
2007 NA
Enaleni Pharma (South
Africa)
NA
2008 Kinky
NA NA
2009 NA
NA NA
2010
Tura, Megasari, Issue,
Argencos
Code 10 (Malaysia)
Namaste Labs, Hobi
Kozmetik
2011 Darling (On going)
International Consumer
Products (Vietnam)
30 Plus
2012 Cosmetica Nacional Paras (Personal Care) NA
Total increase in Debt over
FY08-12 (Rs mn)
10,925 552 6,033
Total dividend retained over
FY08-12 (Rs mn)
11,500 9,553 14,212
Total equity diluted over
FY08-12 (Rs mn)
18,263 NA NA
Source: Company, Ambit Capital research
Analysis of investments in non-core M&A by Dabur, Marico and
GCPL
Whilst the RoAs (see chart below) have significantly declined for all three
companies, an RoA-based analysis is not the best way to compare capital
deployment of these companies because: (1) Goodwill paid for acquisitions is a
drag on the RoA; and (2) since FMCG businesses are capital-light in nature, any
small reduction in the dividend payout ratio leads to a significant increase in the
asset base, irrespective of the capital deployment initiative (eg: cash held on the
books of HUL is higher than its equity).

International M&A has NOT
generated substantial
shareholder returns so far


Consumer Staples

Ambit Capital Pvt Ltd 16
Exhibit 24: RoA trends as reported
-10%
10%
30%
50%
70%
90%
110%
130%
150%
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
Dabur
Marico
GCPL

Source: Company, Ambit Capital research
Exhibit 25: RoA trends after adjusting for goodwill
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
Dabur
Marico
GCPL

Source: Company, Ambit Capital research

To analyse the returns generated on capital deployed, we have compared
the incremental EPS generated by the three firms on incremental capital
deployed towards M&A or international growth.
The underlying assumptions for this approach are: (a) the current gap between the
standalone and consolidated accounts almost fully reflects growth of international
entities over FY08-12; and (b) capital deployed towards non-core acquisitions
relates to a combination of retained earnings (which otherwise would have been
paid out as dividends to shareholders) and new equity/debt issuance. Also, we
have assumed a 13% cost of equity on this capital deployed over this period. The
conclusions from our analysis are:
Exhibit 26: Analysis of value created by the M&A strategy of Indian FMCG companies

Sum of standalone
EPS (FY08-12)
Retained
earnings/ share
(FY08-12)
Equity
diluted/share
13% Cost of
Equity
Standalone EPS +
Return on Equity
Sum of
consolidated EPS
(FY8-12)
% Gain
Dabur 11.85 8.16 0 1.06 12.91 14.06 9%
Marico 19.17 15.54 0 2.02 21.19 19.52 -8%
GCPL 53.40 33.79 53.67 11.69 65.09 63.66 -2%
Source: Company, Ambit Capital research; Note: EPS is bonus adjusted and retained earnings/share is based on shares outstanding as on 31 March
2012.
Marico as well as GCPL have generated incremental earnings from non-core
businesses, lower than the cost of equity deployed over FY08-12. Dabur,
on the other hand, has generated incremental value for shareholders
higher than the cost of equity.
GCPL and Marico both had a debt:equity of 0.67x in FY12. Since this does
not form a part of the deployed capital considered in our analysis above, the
total return on incremental capital deployed is further dragged down beyond
what is highlighted in the analysis above.
Dabur appears to be unleveraged, with an FY12 net debt of only Rs730mn on
a consolidated basis. However, the company holds Rs10.7bn of gross debt,
largely in foreign currency at a subsidiary level, and holds Rs10bn of cash on
the standalone balance sheet in FY12. This is driven by the companys strategy
of NOT deploying capital from the parents balance sheet to fund expansion of
the subsidiary entity. Therefore, note the incremental debt capital is used to
fund the return generated from non-core investments.


Consumer Staples

Ambit Capital Pvt Ltd 17
FY13 acquisitions NOT taken into account: Our analysis does NOT take
into account either Maricos acquisition of Paras or the phase-2 integration of
GCPLs Darling business in Africa. These two transactions were executed in
FY13, the annual report for which is not yet available to us. Whilst our analysis
on GCPLs historical capital allocation is unlikely to change after the
integration of the Darling Groups phase-2 acquisition, we expect further
deterioration of Maricos performance relative to its peers once the Paras
acquisition is factored into our analysis. The acquired portfolio of Paras will
bring revenues of ~Rs1.5bn, and for this, the consideration paid by Marico
was Rs7.4bn. Consequently, even if the acquired entity generates PAT margins
of 10%, the corresponding annual return on capital deployed towards the
acquisition is only ~2-3%.
Future growth prospects of businesses acquired in the past: Our analysis
above is based on historical data. With each of these three businesses
planning to become an emerging market MNC, there is a possibility of
deriving growth from the acquired entities which has not been part of the
historical performance. However, whilst there have been examples of
successful integration over the past five years, such as GCPLs Megasari
acquisition in Indonesia and Daburs Middle East business, there have also
been examples of headwinds related to political/economic turmoil, business
disruptions due to labour strikes/transporters strikes, and execution-related
issues in a new geography.
Capital deployment strategy going forward
HUL, Colgate and Nestle: Based on their historical approach towards capital
allocation, we see limited risk of these companies deploying their surplus capital
towards value-destructive non-core investments.
GSK Consumer: Over the past three years, the company has highlighted
prospective M&A as a mode of surplus capital deployment. Moreover, over the
past four years, GSK Consumer has tried to leverage on the brand recall of
Horlicks and Boost to enter into new product categories including biscuits, cookies,
and nutribars and has also tried to launch new brands/products including Foodles
(noodles). Most of these initiatives are yet to gather momentum materially for GSK
Consumer. At the same time, the company has seen a consistent moderation in
volume growth of its Milk Food Drinks categories over the past four quarters,
which is on account of increased competition from Complan in non-south
geographies and high penetration of Horlicks in south India. Based on a
combination of these factors/initiatives/comments made by the company, we
believe that: (a) GSK Consumer is NOT likely to repatriate/distribute a significant
proportion of surplus capital; and (b) the risk of making a non-core acquisition
remains high in the future and until then surplus capital will remain a drag on
return ratios.
Godrej Consumer: Our recent discussions with GCPLs management team
suggest that the company is likely to focus on subsequent phases of integration of
the Darling acquisition in Africa rather than seeking new M&A opportunities over
the next 12-18 months. The surplus cash generated from its existing businesses in
the near future is likely to be used for consolidation of Darling in Africa, debt
repayment, and growth of the acquired businesses.
Dabur: Based on our discussions with Daburs management team, although the
company is holding a large amount of cash on the standalone balance sheet, this
will not be used to repay debt on the subsidiary balance sheets. Instead, the
company is looking at M&A opportunities within India for standalone surplus
capital deployment going forward. Until such M&A opportunity is explored, the
management is comfortable with the treasury income being generated on the
balance sheet surplus capital. Consequently, we see Dabur also running the risk of
diversifying into non-core areas - both domestic as well as international.


Consumer Staples

Ambit Capital Pvt Ltd 18
Marico: Our discussion with Maricos management team suggests that the
immediate goal of the company is to bring its core operations in India to a
consistent double-digit YoY volume growth rate. Once this goal is achieved, the
company intends to explore M&A opportunities in Indonesia and Africa, with the
intention of evolving into an emerging market MNC firm. However, with an
unattractive track record of capital deployment through M&A over the past five
years, we consider this strategy to be a key risk to shareholder returns.
Overall conclusion on capital deployment
We rate HUL, Nestle and Colgate Palmolive as the best allocators of surplus
capital, with dividend payouts and capex related to core operations likely to
continue forming over 80% of cash generated by these companies. GCPL and
Marico, on the other hand, have underperformed vis--vis their peers on this
metric with their capital deployment initiatives NOT been value accretive for
shareholders over the past five years. GSK Consumer and Dabur are
intermediately placed.
Exhibit 27: Summary of ratings around capital deployment
Company
Historical capital
deployment
Deployment
strategy in future
Overall
rating
Comments
HUL

High dividend payout ratio historically (ten-year average of
92%); high RoEs (103%); strategy unlikely to change going
forward
Nestle

High (ten-year average of 80%) dividend payout ratio
historically; high RoEs (70%); strategy unlikely to change going
forward
Colgate

Around Rs4.5bn cash on books; going by historical trends,
surplus likely to be repatriated through special dividends
GSK Consumer

Average ten-year dividend payout ratio of 46% in the past; no
additional capital deployment initiatives followed so far;
management highlights M&A as a likely option in the future
Dabur

M&A has been value accretive in the past; acquisition of entities
like Namaste have not been successful; management intends to
deploy over Rs10bn of surplus towards M&A in India
Marico

M&A historically has NOT been value accretive; strategy going
forward focuses on acquisitions in Indonesia and Africa
GCPL

M&A historically has NOT been value accretive for
shareholders; strategy going forward includes integration of
Darlings businesses in Africa and debt repayment
Source: Company, Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning









HUL, Nestle and Colgate
Palmolive are the best
allocators of surplus capital


Consumer Staples

Ambit Capital Pvt Ltd 19
II - Portfolio positioning across segments
We have categorised the growth drivers of each product segment into
Penetration, Premiumisation, and Frequency of consumption, which is our PPF
framework, which have been defined as follows:
Rate of increase in penetration: This relates to an increase in the number of
consumers within the relevant population size for that product category.
Premiumisation: This relates to an up-trading of consumers towards more
premium products and hence leads to a growth in realisation rates per product
for the FMCG players.
Frequency of consumption: This relates to an increase in the frequency of
the consumption of products within the penetrated population of consumers.
We have divided the FMCG universe into four broad categories: Packaged
Foods, Personal Products, Beverages and Home care. These four categories
are further divided into 25 product-based sub-categories. The framework then
analyses, for each sub-category, the following:
Sustainability of the three PPF growth drivers;
Extent of and the change in competitive intensity for each of the product
categories based on both the aggression from existing players as well as from
the aggressive entry of new players; and
Market share gainers and losers amongst key players prevalent in the
respective product category.
The outcome of this portfolio analysis for each category as well as for each
company is used in our company specific forecasts highlighted later in this note.
Overall conclusion: Nestle has the best portfolio positioning
Whilst each of the seven companies mentioned in the table below are market
leaders in at least one of the product categories, we rate the companies on the
basis of overall diversification, macro growth in the categories of presence and
ability to win market share from competitors. On this basis, we find Nestle to be
the best placed whilst GSK Consumer is the worst placed vs peers.
Exhibit 28: Overall rating of companies on portfolio positioning

Diversification
of portfolio
Category
growth
Competition
displacement
ability
Overall
portfolio
positioning
Comments
HUL

Diverse portfolio (presence in over 12 categories) + market
share gains in soaps & shampoos; losses in oral, skin care.
Nestle

Present in four categories, market leader in three;
competitive intensity and focus on margins will restrict
share gains
Colgate

Present in only oral care; strong brand and dentist tie-ups.
Competition from GSK and P&G.
Marico

Own the strongest brands in the hair and edible oils;
innovation and marketing to drive gains in hair oils
Dabur

Diversified portfolio; present in few growth categories like
juices; share gains restricted due to mass focus
GCPL

Hair colours, insecticides and soaps only; gains likely in
domestic business; modest positioning in Africa and LatAm
GSKCH

Over 90% = MFD portfolio; Will face challenges from more
premium positioned competitors
Source: Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning


Nestle has the best portfolio
positioning across the sector


Consumer Staples

Ambit Capital Pvt Ltd 20
Packaged foods: Penetration-led 15-20% CAGR; moderate but
rising competitive intensity
Exhibit 29: Packaged foods market key players and growth drivers
Key players (mkt share) Key segment growth drivers Comments
Product
category
Market
Size (Rs
bn)(+)
Rank 1 Rank 2 Rank 3
Expected
segment
FY13-15
CAGR#
Freq. of
consumption
Penetr-
ation
Premium-
isation

Biscuits 140
Parle
(34%)
Britannia
(32%)
ITC
(8%)
12%

Fully penetrated (90%);
Premiumisation - glucose to
creams/cookies
Chocolates 55
Cadbury
(67%)
Nestle
(21%)
Ferrero
(6%)
15%

Increased frequency, penetration
increasing in urban and rural
(urban - 5% in 07 to 16% in 12)
Noodles
(excl
pastas)
20
Nestle
(75%)
ITC (10%)
HUL
(3%)
20%

Penetration (19% urban, 3% rural),
migration to healthier variants
(premium of 20-50%)
Ice Cream 18
Amul
(41%)
HUL
(18%)
Vadilal
(18%)
15%

Distribution growth - investment in
cold chains, shift from unbranded
to branded
Baby
Foods
15
Nestle
(88%)
Farex
(7%)
15-20%

Penetration increasing in urban
population
Premium
Edible Oils
10
Marico
(58%)
Agro
Tech
(42%)
15%

Rising spends on health based
products, shift from base to
premium edible oils
Sauces 8
Nestle
(29%)
HUL
(25%)
GD
Foods
(15%)
26%

Penetration (15% in urban;
negligible in rural), shift from
unorganised to branded
Overall 266 15-20%


Source: Company, Ambit Capital research; Note: #Based on Ambits estimates; / / indicates strong/moderate/weak driver of growth
respectively
Exhibit 30: Packaged foods market competitive positioning of various players
Market share changes
Product
category
Competitive
intensity
Comments
Gainers Losers
No
Change
Comments
Biscuits
Medium and
flat
New players: Cadbury's;
80bps increase in A:S for
BRIT over FY09-12
Britannia,
ITC
Parle
Britannia = wide portfolio, first mover in health
biscuits; ITC = advertising muscle, strong balance
sheet; Parle = portfolio offers limited
premiumisation
Chocolates
Medium and
rising
New entrants: Ferrero and
Kraft
Cadburys,
Ferrero
Nestle
Cadburys = wide portfolio, A&P up 300bps over
five years, strong brand recall; Ferrero = strong
premium offering; Nestle = focus on margins, price
increases
Noodles
(excl
pastas)
Medium and
rising
New entrants: GSKCH,
Ching's; Increased
aggression from HUL
ITC Nestle
HUL,
GSKCH
ITC = marketing, distribution, differentiated
offering; Nestle= low media spends
Ice Cream
Medium and
rising
HUL Vadilal Amul
HUL = strong distribution, advertising, new
launches; Amul = strong distribution, brand recall,
leadership in economy segment
Baby
Foods
Low and flat
Restrictions around adverts
curb competitive intensity

Nestle,
Farex
Nestle = strong brand recall, good quality; high
entry barriers for competition
Prem.
Edible Oils
Medium and
rising
New entrant: Adani Wilmar Marico
Agro
Tech
Foods

New entrants, disruptive adverts; Marico = stronger
brand recall for Saffola vs Sundrop, higher A&P
Sauces
Medium and
flat
Media spends and price
discounting frequent
Nestle HUL
Nestle = strong brand recall for Maggi, superior
product quality
Overall
Medium &
rising
Mainly aggression from
new entrants

Source: Ambit Capital research, Company
Overall summary: The Packaged foods market in India is akin to an aspirational
consumption segment with the following key characteristics:
Biscuits, the largest product category within packaged foods, has seen
saturation in penetration rates, with penetration level of ~65% in 2007
rising to ~90% in 2012. Consequently, as shown in the table below,
premiumisation is the largest driver of growth for biscuits.
Packaged foods market in
India is akin to an aspirational
consumption segment


Consumer Staples

Ambit Capital Pvt Ltd 21
Exhibit 31: Biscuits face premiumisation from glucose to cookies/creams (share of
category within biscuits in percentage)
Apr-Sep 2012 Apr-Sep 2011 Apr-Sep 2010 % Change (FY10-12)
Glucose 19.3 21.8 26.7 -28%
Sweet/cookies 26.2 26.9 23.8 10%
Cream 22.2 18.7 16.6 34%
Marie 10.7 10.9 11.1 -4%
Non-salt cracker 9.3 9.7 9.7 -4%
Salt cracker 6.0 6.2 6.5 -8%
Milk 4.3 4.1 4.1 5%
Arrowroot 0.8 0.6 0.6 33%
Wafer cream 0.9 0.8 0.5 80%
Other biscuits 0.1 - 0.1 0%
Assorted biscuits 0.2 0.2 0.2 0%
Cereal bars - - 0.1 -100%
Source: Industry, Ambit Capital research
Excluding biscuits, most other product categories are small in size, with strong
revenue growth rates (15-25% CAGR over FY13-15).
Excluding biscuits, revenue growth is predominantly led by increased
penetration, with average current penetration levels of 15-20% for most
product categories.
Competitive intensity is medium and rising in most categories due to: (a)
entry of new players like Cadburys in biscuits, Adani Wilmar in edible oils,
Ferrero in chocolates and Chings in noodles; and (b) increased competitive
intensity through advertising spends by incumbents like Britannia (80bps
increase in advertising spends to sales ratio over FY09-12) and Cadburys
(250bps increase in A:S over FY05-11 see the table below).
Exhibit 32: Cadbury - financial summary (Rs mn)
CY05 CY06 CY07 CY08 CY09 CY10 CY11
Net Sales 8,798 10,582 12,935 15,886 19,344 25,032 33,595
YoY Sales Growth (%) NA 20.3% 22.2% 22.8% 21.8% 29.4% 34.2%
EBITDA Margin (%) 13.3% 14.0% 13.9% 15.3% 14.5% 12.5% 13.4%
PAT Margin (%) 5.2% 6.5% 9.1% 10.4% 9.8% 8.3% 8.8%
Adv/Net Sales (%) 10.9% 11.5% 12.2% 11.8% 12.3% 13.3% 13.4%
Source: Ambit Capital research









Packaged foods = Penetration
led 15-20% CAGR; medium but
rising competitive intensity


Consumer Staples

Ambit Capital Pvt Ltd 22
Beverages: ~15% revenue CAGR over FY13-15; high and rising
competitive intensity
Exhibit 33: Beverages market key players and growth drivers
Key players (market
shares)
Key segment growth drivers Comments
Product
category
Market
Size (Rs
bn)(+) Rank 1 Rank 2 Rank 3
Expected
segment
FY13-15
CAGR
Freq. of
consumption
Penetr-
ation
Premium-
isation

Milk/Milk
Products
250+ Amul Nestle NA

Shift to branded and value-
added products; organised
penetration only 15%
Tea
79
Tata
Tea
(22%)
HUL
(22%)
Wagh
Bakri
(8%)
10%

Slow rate of premiumisation; shift
from loose to packaged tea;
volume growth of 1-3%
Milk Food
Drinks
40
GSKCH
(63%)
Heinz
(20%)
Cadbur
y (13%)
15%

Penetration especially in rural
areas; premiumisation to value-
added variants
Coffee
25
HUL
(50%)*
Nestle
(49%)
10-12%

Shift from loose to branded;
premiumisation to 100% coffee;
changing tastes
Fruit Juices
15
Dabur
(52%)
PepsiCo
(38%)
15-20%

Penetration; increasing
consumption with meals, shift
from nectar to 100% juice
Overall
409 15%

Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively
Exhibit 34: Beverages market competitive positioning of various players
Market share changes
Product
category
Competitive
intensity
Comments
Gainers Losers
No
Change
Comments
Milk/Milk
Products
Low and
rising
Private Equity backed
new entrants Nestle Amul
Nestle = Aggressive marketing; brand
strength and premium positioning
Tea
Medium and
flat Tata Tea
Wagh
Bakri HUL
Playing out of benefits from Tata Global's
'Jaago re' marketing campaign
Milk Food
Drinks High and flat
MNC fight for market
share to keep A&P
elevated Heinz GSKCH Cadbury
Heinz to benefit from presence in lower-
penetrated north and west markets and
premium positioning
Coffee
Medium and
rising
Nestles increased
aggression recently Nestle HUL
Nestle to gain from stronger brand
especially in the 100% coffee segment
Fruit
Juices
Medium and
rising
High growth category
attracting new entrants
New
entrants Pepsico Dabur
Dabur to gain from strong brand and
frequent innovation; new entrants include
Del monte, Parle, Godrej , Cavin care, KDD
Overall
Medium and
rising
Select high-growth segments facing aggression from
MNCs
Source: Ambit Capital research, Company
Overall summary: The market for beverages in India can be divided into two
segments: (a) tea and coffee; and (b) milk, milk food drinks and fruit juices. The
characteristics of these two segments are exactly opposite to each other.
Whilst tea and coffee are highly-penetrated slow-growing categories
(~10% CAGR over FY13-15) driven predominantly by premiumisation, other
beverage categories have low penetration rates with relatively higher
revenue growth of over 15% YoY.
Competitive intensity is either high or rising across all beverages
categories. This includes a strong distribution and advertising push from Heinz
(27% sales CAGR and 30% EPS CAGR over CY06-11) for Complan in north
and west India, and a large number of new entrants in packaged milk and
milk products (Danone) and fruit juices (Parle, Coca Cola and KDD).


Beverages = ~15% revenue
CAGR over FY13-15; high and
rising competitive intensity


Consumer Staples

Ambit Capital Pvt Ltd 23
Personal products: Saturating penetration; premiumisation-led
growth; high and rising competitive intensity
Exhibit 35: Personal products market key players and growth drivers
Key players (market
shares)
Key segment growth drivers
Comments
Product
category
Mkt
Size
(Rs bn) Rank 1
Rank
2
Rank
3
Expected
segment
FY13-15
CAGR
Freq. of
consumption
Penetr-
ation
Premium
-isation
Soaps
100
HUL
(45%)
GCPL
(12%)
Reckitt
Benck.
(9%)
8-10%

Premiumisation only driver;
fully penetrated segment
Tooth
paste
52
Colgate
(53%)
HUL
(29%)
Dabur
(12%)
12-13%

Overall penetration 83%;
conversion from toothpowder to
toothpaste; premiumisation
Tooth
brushes
14
Colgate
(39%)
Oral B
(20%)
15%

Conversion from toothpowder
to toothpaste; premiumisation;
lower replacement cycles of
toothbrushes
Tooth
powder
6
Colgate
(42%)
Dabur
(32%)
-5%

Declining market due to the
shift to toothpaste
Shampoos
40
HUL
(43%)
P&G
(29%)
Cavin
Care
(9%)
16%

Penetration (urban 57%, rural
37%) and frequency drivers;
strong premiumisation trends
Skin
creams
40
HUL
(58%)
L'Oreal
(13%)
P&G
(10%)
15%

Premiumisation led; Penetration
up substantially over five years
(fairness creams fully
penetrated)
Hair Oils
40
Marico
(43%)
Dabur
(14%)
Bajaj
(12%)
10-15%

Shift to value-added hair oils;
75-80% current penetration;
Cosmetics
11
HUL
(29%)
L'Oreal
(13%)
Revlon
(18%)
20%

Low penetration;
premiumisation; entry of
several new global players
Deodora
nts
6
HUL
(42%)
McNR
OE
(16%)
Maric
o
(15%)
25-30%

Currently low penetration; shift
from grey market to organised;
increasing frequency
Overall
305 15%

Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively
Exhibit 36: Personal products market competitive positioning of various players
Market share changes
Product
category
Competitive
intensity
Comments
Gainers Losers
No
Change
Comments
Soaps
High and
rising
Low commodity prices
providing additional
surplus for A&P
HUL,
GCPL,
Reckitt
Wipro, ITC
HUL = strong portfolio, weak premium
portfolio from competitors; GCPL =
gains from the rejuvenated Cinthol
portfolio
Tooth paste
High and
flat
MNCs control 80% share,
fighting for share
GSK
HUL,
Dabur
Colgate
Colgate = better association with
dentists; HUL = weaker product
portfolio
Tooth
brushes
Medium
and rising
Commoditised, fight for
portfolio premiumisation
Colgate,
P&G
Local
organised
HUL
Colgate: Launch of new variants,
brand, wider range, strong distribution
Tooth
powder
Low and
declining
Declining segment, lower
focus
Regional
players
Colgate Dabur
Colgate: reducing focus on category
Shampoos
High and
rising
MNC fight for share in the
premium space
HUL,
LOreal
P&G,
Cavin-
Care,
Dabur

HUL: strong portfolio across segments
and innovation; L'Oreal: high spenders
(A:S 35%); Dabur: lacks premium
portfolio
Skin
creams and
lotions
High and
rising
Besides premium, slowing
mass-end segment
witnessing push
LOreal HUL
LOreal: significantly aggressive and
strong innovation; HUL: overhang from
Fair & Lovely
Hair Oils
High and
rising
Strong competition in
inflexion point- value
added segment
Marico
Dabur,
Bajaj
Emami
Marico: strong brand, value-added
portfolio; Dabur: slowest growing
category (amla);
Cosmetics
High and
rising
New entrants in MNC-
dominated category
LOreal Revlon
Oriflame,
HUL
Aggressive investments from LOreal;
weaker innovation and marketing from
Revlon
Deodorants
Medium
and rising
New entrants in fast-
growing category
New
entrants
HUL Marico
New entrants - backed by heavy
marketing spends; eats into HULs
share
Overall
High and
rising
Innovation and fight for
premium portfolio
Source: Ambit Capital research, Company


Consumer Staples

Ambit Capital Pvt Ltd 24
The Personal products market has rapidly progressed towards high
penetration over the past five years, with categories such as soaps, oral care,
skin care and hair care having over 83% penetration currently.
Premiumisation is the biggest driver of growth in personal product
categories.
Competitive intensity has remained exceptionally high and continues to
rise further with: (a) entry of new players like Sensodyne in oral care, and
others like Marico, Bodyshop and several international brands; and (b)
significant investments behind advertising and new product launches by
players such as P&G and LOreal, as highlighted below.
Aggression from P&G: P&G Home Products (with a presence in detergents,
shampoos, skincare and diapers) has seen its A&P spends increase at a CAGR of
52% from 12.3% of sales in FY06 to 28.9% of sales in FY11. The parent company
recently infused more equity (Rs15.4bn) into the company, adding to its advertising
firepower. We expect the increasing competitive intensity to have the largest
impact on HUL (whose A&P has increased from 8.8% of sales in CY05 to 14% in
FY11). P&G Home Products has reported revenue CAGR of 28% over FY06-11.
Exhibit 37: P&G Home Products - financial summary (Rs mn)
FY07 FY08 FY09 FY10 FY11 FY12
Net Sales 9,937 13,037 16,991 21,042 28,329 39,304
Sales growth (%) 22.4% 31.2% 30.3% 23.8% 34.6% 38.7%
EBITDA Margin 9.9% 10.5% 1.5% 14.5% -9.2% -6.2%
PAT Margin 4.6% 6.0% -0.9% 9.1% -11.8% -9.0%
Adv/Net Sales 12.0% 13.5% 21.7% 21.3% 28.9% 16.5%
Source: Company
Increased aggression from LOreal (Not listed): LOreal has seen 26%
revenue CAGR over CY06-11 and 31% CAGR over CY08-11, with advertising
spends as a percentage of sales of around 35% (compared with 12-18% for most
FMCG companies). With new launches at aggressive price points (especially
shampoos), we do not expect any reduction in advertising spends and expect
competitive intensity to remain high in the segment, putting pressure on market
leaders like HUL. LOreal maintains EBITDA margins of around 6%. We expect
LOreals strong brands and aggressive marketing to help it gain share in the
cosmetics, haircare and skincare space.
Exhibit 38: LOreal - financial summary (Rs mn)
CY06 CY07 CY08 CY09 CY10 CY11
Gross Sales 4,590 6,190 6,383 9,112 12,033 14,396
Sales growth (%) NA 34.9% 3.1% 42.8% 32.1% 19.6%
EBITDA Margin 7.7% 8.8% -0.5% 5.5% 5.9% 6.4%
PAT Margin 4.9% 4.8% -5.6% 1.9% 3.6% 4.1%
Source: Company





Personal products = Saturated
penetration; premiumisation-
led growth; high and rising
competitive intensity
LOreal and P&G have been
substantially aggressive more
recently


Consumer Staples

Ambit Capital Pvt Ltd 25
Home care: 10-12% revenue CAGR; moderate but rising competitive
intensity
Exhibit 39: Home care market key players and growth drivers
Key players (market
shares)
Key segment growth drivers Comments
Product
category
Market
Size (Rs
bn)(+)
Rank
1
Rank 2 Rank 3
Expected
segment
FY13-15
CAGR
Freq. of
consumption
Penetr-
ation
Premium-
isation

Detergents 130
HUL
(38%)
Ghari
(17%)
P&G
(15%)
10%

Fully penetrated segment;
growth driven by
premiumisation
Insecticides 30
GCPL
(42%)
Reckitt
Benckiser
(17%)
SC
Johnson
(17%)
12-14%

Penetration (60% urban, 18%
rural); rising incomes and focus
on sanitation driving frequency
Dishwashing
Products
10
HUL
(60%)
Jyothy
(20%)
20%

Penetration and shift to
organised segment
Surface
Cleaners
3
Reckitt
(74%)
HUL
(13%)
30%

Penetration and shift to
organised segment
Overall 173 12%


Source: Ambit Capital research; / / indicates strong/moderate/weak driver of growth respectively
Exhibit 40: Home care products market competitive positioning of various players
Market share changes
Product
category
Competitive
intensity
Comments
Gainers Losers No Change Comments
Detergents Medium and rising
Only premium segment
growing; MNC market
share fight
Ghari
P&G,
Nirma
HUL
Ghari: distribution expansion led gains;
HUL: gains in premium to make up
losses in the mass segment
Insecticides Medium and rising
Increasing aggression
from GCPL
GCPL
Reckitt, SC
Johnson

GCPL: frequent innovation, distribution
expansion, marketing investments
Dishwashing
Products
Medium and rising HUL Jyothy
HUL: gain backed by strong brand and
marketing
Surface
Cleaners
Low and rising Reckitt, HUL No material changes expected
Overall Medium and rising
Source: Ambit Capital research, Company
Detergents form the bulk of the homecare market, with high penetration,
weak volume growth and increasing competition for especially from players
such as Rohit Surfactants (Ghadi) at the mass end and HUL at the premium
end (highlighted below).
Insecticides is the other decently sized, underpenetrated and fast-growth
category in this market dominated by GCPL.
Ghadis aggression likely to accelerate further: Rohit Surfactants Ghadi
detergent recently displaced HULs Wheel to become the largest detergent brand
in India. The company targets only the mass end of the market, and recorded
revenue CAGR of 21% over FY07-11 and has maintained an average EBITDA
margin of 11% over the same period (broadly in line with HULs soaps and
detergent margins). We expect Ghadi to continue its competitive intensity at the
mass-end and gain further share as it expands its distribution across India.
Exhibit 41: Rohit Surfactants - financial summary (Rs mn)
Rohit
Surfactants
FY07 FY08 FY09 FY10 FY11 FY12
Net Sales 9,169 10,846 14,158 18,003 19,366 25,588
Sales Growth (%) NA 18.3% 30.5% 27.2% 7.6% 32.1%
EBITDA Margin 6.5% 9.3% 16.4% 15.6% 9.3% 10.2%
PAT Margin 3.1% 4.5% 9.4% 9.9% 5.4% 6.7%
Adv/Net Sales 4.1% 4.4% 4.9% 4.7% 4.7% 3.4%
Source: Company
Reckitt looking for new growth avenues: With more than 50% of revenues
coming from the highly penetrated soaps business, Reckitt has still managed to
record revenue CAGR of 20% over CY06-11. With healthy EBITDA and PAT
Competitive intensity from
Ghadi and Reckitt is likely to
accelerate further going
forward


Consumer Staples

Ambit Capital Pvt Ltd 26
margins (averaging at least 200bps above industry average), the company still
maintains aggression, with advertising spends averaging 15% of sales over CY06-
11. Its recent acquisition of Paras Pharmaceuticals is indicative of the companys
aggression. We expect Reckitt to gain share in the soaps space, as it benefits from
faster than market growth in the germicidal category. However, we expect it to
lose share to GCPL in the insecticides space, as GCPL will benefit from its
distribution expansion and aggressive promotions.
Exhibit 42: Reckitt Benckiser - financial summary (Rs mn)
Reckitt Benckiser CY06 CY07 CY08 CY09 CY10 FY12
Net Sales 11,019 13,131 15,296 17,901 21,658 27,947
Sales Growth (%) NA 19.2% 16.5% 17.0% 21.0% 29.0%
EBITDA Margin 18.6% 22.5% 21.8% 19.9% 20.6% 20.5%
PAT Margin 14.2% 19.2% 18.3% 16.3% 15.6% 15.4%
Adv/Net Sales 16.7% 15.8% 15.6% 16.6% 14.1% 10.9%
Source: Ambit Capital research. Note: FY12 figures are adjusted for a 12M year ending

III - Recent raw material trends
CY13 YTD has seen the following key input cost trends:
Significant increase in input costs for tea, milk food drinks (wheat) and HDPE
(key ingredient used for packaging of most products) over the previous year;
and
Significant decline in input costs for soaps (palm oil), rice bran oil and coffee
over the previous year.
However, the prices of tea, safflower oil and Palm Fatty Acid Distillate (PFAD) have
declined by over 10% decline.
Manufacturing for most product segments (excluding tea, coffee, coconut hair oils
and soaps) includes an average holding period of 30-40 days. Therefore, near-
term gross margins for most FMCG categories will be driven by input cost trends
over the past two months. Given that the raw material holding period for tea,
coconut oils and soaps, on average, is 2-3 months, we expect soaps and coffee to
report a continued gain in gross margins in early FY14 due to weak raw material
costs (palm oil and coffee respectively) in 4QFY13. We see no major commodity
price increases in 4QFY13.
The historical price trends of key raw materials used in manufacturing FMCG
products by listed companies are highlighted on pages 28-30. Based on the
contribution of each of these raw material inputs towards CoGS for various
companies, the key trends affecting the FMCG companies are:
Gross margin benefit over in FY13: As highlighted in the exhibit below,
gross margins for most companies in the sector have increased by a median of
160bps YoY in FY13. This gross margin gain has been predominantly led by
raw material cost declines for these companies.


Consumer Staples

Ambit Capital Pvt Ltd 27
Exhibit 43: Gross margin expansion YoY recorded in
FY13 (bps)
430
240
170
160
80 80
-50
-100
0
100
200
300
400
500
M
a
r
i
c
o
N
e
s
t
l
e
D
a
b
u
r
G
C
P
L
H
U
L
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
e

Source: Company, Ambit Capital research
Exhibit 44: Increase in advertisement to sales ratio in
FY13 (bps)
180
145
120
95
60
20
0
40
80
120
160
200
M
a
r
i
c
o
C
o
l
g
a
t
e
D
a
b
u
r
G
C
P
L
H
U
L
G
S
K
C
o
n
s
u
m
e
r

Source: Company, Ambit Capital research
A&P spends over the FY13: As highlighted in the exhibit above, the
expansion in gross margins in FY13 so far has been ploughed back into
advertising and promotions for most of the FMCG companies, thereby
supporting category volume growth (through promotions) and market share
gains (through investments in advertising).
Conclusions
Based on these observations, we expect the following sector-wide and stock
specific implications:
Impact on the sector: Whilst most players have seen the benefit of low input
costs over the past three quarters, the pace of gross margin expansion is likely
to recede in the near term, as (1) some commodities (especially copra, tea,
wheat and packaging materials) have displayed inflationary trends in 4QFY13;
and (2) FY13 forms a high base for gross margins for the sector.
Impact on Marico: Whist Marico benefitted from lower copra prices through
FY13, the past two quarters have seen a strong escalation in prices of copra
(14% from October 2012 to March 2013), the key raw material for its coconut
oil portfolio. With favourable copra prices seen throughout FY13, it will be
difficult for Marico to sustain the pace of margin expansion in FY14, assuming
no changes to commodity prices from current levels.
Impact on HUL and GCPL: A high inventory situation in Malaysia and strong
soybean crop in the West has led to palm oil prices correcting by 20% from
September 2012 to April 2013 (30% over the past one year). This is a key raw
material for soaps, and the price correction is likely to positively impact HUL
and GCPL, both of which derive ~20% of their consolidated revenues from
their soaps business.
Impact on GSK Consumer: Given the price increase of ~25% YoY in wheat
in 4QFY13, we expect GSK Consumers gross margin to contract as it enters
FY14.


Consumer Staples

Ambit Capital Pvt Ltd 28
Exhibit 45: Impact of recent raw material price trends on various players in the industry
Source: Ambit Capital research; indicates superior positioning; indicates intermediate positioning; indicates inferior positioning


HUL Nestle Dabur Marico GCPL
GSK
Cons
Colgate
Recent
price
trends
Recent raw material movements
Copra

Whilst copra prices sharply trended
downwards until Oct12, they saw a 25%
increase over Oct12-Jan13. However, copra
prices have eased 7% over February-April
2013.
Sugar

Whilst sugar prices have shown signs of
moderation over the past quarter, they still
remain higher by 10% YoY. Reduction in sugar
prices augurs well for GSK and Nestle.
Milk

Milk prices have remained relatively stable on
a QoQ basis, helping GSK and Nestle contain
cost inflation.
Tea

HUL and Tata Global will see impact of tea
prices inching up from 2HFY13 onwards due
to production shortages (note that prices are
currently 25% higher YoY)
Coffee

With coffee prices having eased by around
30% YoY until April 2013, Nestle and HUL will
be key beneficiaries.
Wheat

GSK will be the most impacted by the 20-30%
YoY increase in wheat prices, whilst HUL and
Nestle will also see a small impact.
LAB (Linear
Alkyl Benzene)

LAB prices have remained fairly stable with
prices increasing by about 6% YoY in April.
Polyethylene
(PE)

With a 10-15% YoY increase in 4QFY13, PE
prices have led to packaging cost pressures
but prices have moderated slightly in 1QFY14.
Safflower Oil

The sharp rise of around 50% in safflower oil
prices in FY13 will negatively impact Marico.
However, there has been a sharp correction in
Safflower prices in March.
Rice Bran Oil

Prices of Rice bran oil, an input for the Saffola
portfolio, has been on declining trend over
Feb-April 2013, a 13% decline from January
2013 prices (April 2013 prices are down 21%
YoY).
Liquid Paraffin

Liquid paraffin prices have been fairly stable
this year and they are down 10% YoY.
HDPE

Prices of a key component of plastic
packaging, HDPE, have risen around 14% YoY
over the previous quarter.
Calcium
Carbonate

Prices of a key raw material for toothpastes,
Calcium Carbonate, have been flat YoY.
Palm Oil

Both palm oil and PFAD prices have seen a
decline of 30-40% YoY, which will benefit all
soap manufacturers.
Caustic Soda &
Soda Ash

Caustic soda prices have risen around 10-15%
YoY, with prices strengthening from
September onwards.
Barley

Whilst October-January saw sharp increases in
Barley prices (30% YoY), February-April saw
sharp cooling in prices (down 13% YoY in
April).
Net RM impact



Contributes more than 20% of Raw materials

Contributes up to 20% of Raw materials

Contributes up to 10% of Raw materials

Contributes 0% of Raw materials



Consumer Staples

Ambit Capital Pvt Ltd 29
Exhibit 46: Copra (Rs/100Kg)
2,000
3,000
4,000
5,000
6,000
7,000
8,000
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research
Exhibit 47: Sugar M-grade (Rs/tn)
2,000
2,500
3,000
3,500
4,000
4,500
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3
Source: NCDEX, Ambit Capital research
Exhibit 48: Milk WPI (Indexed)
120
140
160
180
200
220
A
p
r
-
0
9
S
e
p
-
0
9
M
a
r
-
1
0
A
u
g
-
1
0
J
a
n
-
1
1
J
u
l
-
1
1
D
e
c
-
1
1
J
u
n
-
1
2
N
o
v
-
1
2
A
p
r
-
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 49: Tea (Rs/Kg)

60
70
80
90
100
110
120
130
140
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Tea Board, Ambit Capital research
Exhibit 50: Coffee (US$/lb)

100
150
200
250
300
J
a
n
/
1
0
J
u
n
/
1
0
D
e
c
/
1
0
J
u
n
/
1
1
N
o
v
/
1
1
M
a
y
/
1
2
O
c
t
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 51: Wheat New Delhi
(Rs/quintal)
1,000
1,100
1,200
1,300
1,400
1,500
1,600
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: NCDEX, Ambit Capital research
Exhibit 52: Coconut oil (Rs/100Kg)
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
M
a
y
/
0
9
O
c
t
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
F
e
b
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
M
a
y
/
1
2
O
c
t
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research
Exhibit 53: LAB (Rs/Kg)
60
70
80
90
100
110
120
130
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Reliance Industries, Ambit Capital
research
Exhibit 54: Polyethylene (Rs/Kg)
60
65
70
75
80
85
90
95
100
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Reliance Industries, Ambit Capital
research
Exhibit 55: Sunflower oil (Rs/10Kg)
300
400
500
600
700
800
900
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research

Exhibit 56: Kardi oil (Rs/10Kg)
400
600
800
1,000
1,200
1,400
1,600
1,800
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research



Exhibit 57: Rice bran oil (Rs/10Kg)
200
300
400
500
600
700
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research


Consumer Staples

Ambit Capital Pvt Ltd 30
Exhibit 58: Liquid paraffin (Rs/lt)

20
30
40
50
60
70
80
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research
Exhibit 59: HDPE* (Rs/Kg)

60
65
70
75
80
85
90
95
100
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Marico, Ambit Capital research. *
stands for High density polyethylene
Exhibit 60: Calcium Carbonate
(Indexed)
115
120
125
130
135
140
145
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 61: India RBD Palmolein
(Rs/tonne)
600
700
800
900
1,000
1,100
1,200
1,300
1,400
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 62: Caustic Soda/ Soda Ash
(Indexed)
100
120
140
160
180
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 63: Palm Fatty Acid
Distillate (Rs/tonne)
400
500
600
700
800
900
1,000
1,100
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research
Exhibit 64: Barley India UP
(Rs/quintal)
700
800
900
1,000
1,100
1,200
1,300
1,400
1,500
A
p
r
/
0
9
S
e
p
/
0
9
M
a
r
/
1
0
A
u
g
/
1
0
J
a
n
/
1
1
J
u
l
/
1
1
D
e
c
/
1
1
J
u
n
/
1
2
N
o
v
/
1
2
A
p
r
/
1
3

Source: Bloomberg, Ambit Capital research




Consumer Staples

Ambit Capital Pvt Ltd 31
Valuations set to decline
We adopt a DCF-based approach to value the FMCG sector because it
appropriately captures: (a) the varied capital reinvestment/allocation strategies
likely to be adopted in the future; (b) earnings growth moderation attached to
rising competitive intensity and penetration saturation; and (c) the relative
defensive/ predictable nature of the respective businesses. Thus, we initiate
coverage on the sector with a SELL stance on the seven stocks, as shown in the
tables below.
On one-year forward P/E multiples, the sector has rerated by over 70% since
FY08. Whilst two-thirds of this re-rating is backed by an improved fundamental
performance of the respective stocks, the balance we believe is not justified given
the moderation in volume growth related to an increase in competitive intensity
and saturating penetration in several large product categories over the past five
years.
Also, a comparison with other listed emerging market plays in countries, such as
Indonesia, Brazil and China, suggests that the Indian FMCG sector currently trades
at a 40% premium to these international peers despite having generated 300bps
lower revenue CAGR and 500bps lower EPS CAGR over FY08-13 with 100bps
lower revenue and 500bps lower EPS forecasts over the next 24 months.
Finally, we briefly compare the valuation gap between large-cap discretionary
consumer stocks and the seven FMCG stocks covered in this report. We conclude
that the seven FMCG stocks compare unfavourably against major FMCG
companies such as ITC as well as discretionary names such as Asian Paints, Berger
Paints, Titan and TTK Prestige
Our DCF-based valuation suggests ~15% derating of valuations
Exhibit 65: Summary valuation table
Company
Comptt
Mapping
Rating
CMP
(Rs)
Mcap
(US$ mn)
Target
Price (Rs)
Upside/
Downside
P/E
(FY14E)
P/E
(FY15E)
Implied
P/E (FY14)
EPS CAGR
(FY08-13)
EPS CAGR
(FY13-15)
ROE
(FY13)
GSK CH

SELL 5,515 4.1 3,945 -29% 45.5 38.0 32.5 22% 18% 35%
Nestle

SELL 5,306 9.1 4,389 -17% 43.0 36.7 35.6 21% 14% 70%
Colgate

SELL 1,451 3.5 1,227 -15% 38.1 33.8 32.2 16% 8% 107%
Marico

SELL 234 2.7 198 -16% 33.0 27.1 27.8 17% *24% 23%
HUL

SELL 592 22.7 503 -15% 37.2 32.8 31.6 13% 9% 103%
Dabur

SELL 158 4.9 136 -14% 31.2 27.0 26.8 18% 15% 40%
GCPL

SELL 873 5.3 792 -9% 32.6 27.2 29.6 21% 28% 23%
Median 37.2 32.8 31.6 18% 15%
Source: Bloomberg, Ambit Capital; superior positioning; intermediate positioning; *one-off impact of Kaya in FY14, 21% YoY growth in FY15
We prefer DCF since it captures cash generation,
utilisation and growth moderation
Since the Indian consumer story is constantly evolving both in terms of the pace of
growth (width and depth of consumption) as well as in terms of the competitive
intensity, we prefer a DCF-based approach which factors in the implication of this
evolution at a firm specific level. Also, our DCF captures: (a) the varied capital
deployment strategies likely to be adopted by these companies through capex and
working capital investments; and (b) the relative defensive (or lack thereof) nature
of these businesses as compared to each other. Mentioned below is a summary of
our assumptions around these factors:
Capital deployment: Given that working capital and capex are strong drivers of
cash flows, the divergence in working capital efficiency is clearly visible in the chart
We adopt a DCF-based
approach to value the FMCG
sector
Comparison with listed
emerging market plays
suggests 40% premium rating
of Indian FMCG sector
FMCG stocks compare
unfavourably against ITC and
discretionary consumer names


Consumer Staples

Ambit Capital Pvt Ltd 32
below. MNCs operate on a negative working capital cycle whilst the Indian
companies still have a long way to go to reach that level of efficiency.
Exhibit 66: Working capital as a percentage of sales for
various FMCG companies over FY15-26E
-2.2%
-1.8%
-1.8%
-1.5%
0.0%
0.8%
1.3%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
G
S
K
C
o
n
s
u
m
e
r
H
U
L
N
e
s
t
l
e
C
o
l
g
a
t
e
G
C
P
L
D
a
b
u
r
M
a
r
i
c
o

Source: Company, Ambit Capital research; Note: Numbers based on our
DCF forecasts over FY15-26
Exhibit 67: Capex as a percentage of sales for various
FMCG companies over FY15-26E
0.5%
0.8%
1.3%
1.4%
1.5%
1.6%
1.7%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
H
U
L
G
C
P
L
G
S
K
C
o
n
s
u
m
e
r
N
e
s
t
l
e
M
a
r
i
c
o
D
a
b
u
r
C
o
l
g
a
t
e

Source: Company, Ambit Capital research; Note: Numbers based on our
DCF forecasts over FY15-26
Factoring in the evolution of the consumption story: Whilst we believe in the
sustainability of Indias consumption story for the next decade, our three-stage
DCF model uses the following approach:
Stage 1 (first five years): Explicit forecasts for the next five years are based
on the expectations of category growth rates and sustainability of competitive
advantages of these companies.
Stage 2 (next eight years): Cash flow growth moderation from 15% on
average in Stage 1 (FY14-FY18) to 10% average in Stage 2 (FY18-26) is based
on the assumption that: (a) increase in competitive intensity and increase in
penetration of categories will result in moderation in revenue growth after
FY18 for all these companies; (b) EBITDA margins will be broadly steady in this
stage as margin benefits from premiumisation of product portfolios will be fully
offset by increased advertising spends to counter rising competitive intensity;
and (c) it would be unfair to expect a mid- to high-teen growth rate for the
companies even after 13 years given the need to evolve with the consumption
trends through changes in long-term strategies of these companies.
Stage 3 (FY26 onwards): Terminal growth of 5% after 13 years.
Exhibit 68: Stage 1 and stage 2 free cash flow CAGR
0%
5%
10%
15%
20%
25%
30%
35%
H
U
L
N
e
s
t
l
e
G
C
P
L
D
a
b
u
r
M
a
r
i
c
o
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
e
Stage 1 (FY13-18) Stage 2 (FY18-26)

Source: Company, Ambit Capital research; For Marico, Stage 1 has been calculated from FY14-18 as our
FY13 forecast suggest negative free cash flow to firm


Consumer Staples

Ambit Capital Pvt Ltd 33
Cost of equity assumed: Based on an assumption of a risk-free rate of 8.5%,
equity risk premium of 7% and a beta range of 0.5-0.55, our cost of equity
assumed for the FMCG stocks ranges from 12% to 12.5%.
Sector P/E multiples rerating vs fundamentals:
Disconnect has emerged over the past 24 months
Exhibit 69: Rerating in the FMCG sector given declining volume growth
15
18
21
24
27
30
33
FY09 FY10 FY11 FY12 FY13
6%
8%
10%
12%
14%
16%
18%
20%
Average P/E (LHS) Average Volume Growth
Penetration FY07 Advt spends FY07
Skin creams 25% GSK Cons. 12.9%
Biscuits 68% HUL 10.2%
Detergents 88% Marico 12.5%
Penetration FY12 Advt spends FY13
Skin creams 62% GSK Cons. 16.3%
Biscuits 89% HUL 12.5%
Detergents 98% Marico 13.6%

Source: Bloomberg, Company
The 61% rerating of the sector on one-year forward P/E multiples (see the exhibit
above) is partly justified by improved fundamentals and partly by the defensive
nature of the sector in a weak economic environment. This rerating can be divided
into two parts:
Rerating over FY08-11 - emergence of Indias consumption story: Due
to a combination of macro-economic and demographic factors such as
increased government spends, women empowerment, media penetration,
urbanisation, and growth of economies which have been laggards in the past,
fundamental volume growth of the FMCG companies accelerated over FY08-
11. Since these structural drivers of improved fundamentals of Indias
consumption story are here to stay over the next five years, we expect the
rerating of the sector on P/E multiples from 18.5x in FY09 to 26.7x in FY11 to
be sustainable going forward.
Rerating achieved over FY11-13 despite moderating volume growth:
The 16% rerating over the past 24 months to current levels of 37.2x one-year
forward P/E multiples is not justified by any fundamental improvements.
Instead, volume growth of companies covered in this report moderated by
300-400bps over FY11-13 (except for Dabur where the portfolio of juices and
home care has offset moderation in volume growth of other categories over
this period).
Exhibit 70: Volume growth trends over the past 9 quarters (YoY)
4QFY11 1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13
HUL 13% 8% 10% 9% 10% 9% 7% 5% 6%
Dabur 10% 9% 5% 11% 12% 12% 9% 10% 12%
Marico 12% 14% 14% 13% 13% 14% 14% 11% 8%
Nestle 10% 8% 8% 5% 3% 3% -5% 1% 0%
Colgate 9% 12% 13% 15% 12% 11% 10% 7% 12%
GSK Consumer 4% 16% 10% 11% 7% 7% 6% 8% 8%
Source: Ambit Capital research;
FY08-11 re-rating reflects
emergence of Indias
consumption story
FY11-13 re-rating despite
moderating volume growth


Consumer Staples

Ambit Capital Pvt Ltd 34
Over FY13-15, we forecast an EPS CAGR of 17% for the sector, 300bps lower than
the performance over FY12-13, and around 200bps lower than the EPS CAGR of
19% reported over FY08-13. This moderation in EPS CAGR for the sector can be
broadly attributed to the following factors:
High penetration levels of several product categories: Penetration of
categories such as oral care, hair oils, milk/milk products, soaps and
detergents have substantially increased over the past five years. With the
current penetration levels exceeding 80% in these categories, growth rates are
likely to moderate going forward as compared to those achieved in the past.
Exhibit 71: Increase in penetration levels over 2007-2012 for a few categories
2012 2007
Rural Urban Rural Urban
Food & Beverages
Biscuits 83% 94% 55% 80%
Soaps 99% 100% 89% 97%
Toothpaste 67% 91% 38% 75%
Skin creams 57% 67% 18% 32%
Washing powder/liquid 97% 99% 84% 91%
Mosquito repellents 18% 59% 27% (avg)
Toilet/Bathroom cleaners 3% 30% 9% (avg)
Floor cleaners 4% 26% 2% 22%
Source: Industry, Ambit Capital research
Increased competitive intensity: Categories such as noodles, premium
biscuits, premium edible oils and cosmetics, which were previously controlled
by only one or two large players, have seen an influx of new entrants including
MNCs with large balance sheets. This has led to a rise in competitive intensity
in these categories. Consequently, we expect a combination of moderation in
revenue growth potential and increased advertising spend to sales ratios for
some of the incumbents in these categories.
Exhibit 72: Rise in new entrants indicates an increase in competitive intensity
Category Key players five years ago Formidable new entrants since then
Biscuits Britannia, Parle, ITC United Biscuits, Cadbury, Unibic
Chocolates Cadbury, Nestle Ferrero, Kraft
Noodles Maggi, ITC
Smith and Jones, Chings Secret, GSK
Consumer
Premium Edible Oils Agro Tech, Marico Adani Wilmar
Fruit juices Dabur, PepsiCo KDD, Parle, Coca Cola
Toothpaste Colgate, HUL, Dabur GSK Consumer, P&G (expected)
Skincare/Cosmetics
HUL, L'Oreal, P&G, Revlon,
Beiersdorf
Marico, Bodyshop, Shiseido, Clinique, Faces
Source: Company, Ambit Capital research
Tailwinds related to raw material cost benefits are fleeting: Despite the
volume growth moderation over FY11-13, PAT growth in the sector has
remained robust over this period. This support to PAT growth is derived from a
substantial gross margin expansion due to softening commodity prices (see the
table below). Assuming that commodity prices remain unchanged from the
current levels, we do not expect this margin support to continue for the sector,
especially given the high price elasticity of demand currently and hence the
less likelihood of substantial price increases going forward.
Moderation in earnings growth
will continue over FY13-15


Consumer Staples

Ambit Capital Pvt Ltd 35
Exhibit 73: Gross margin expansion vs EBITDA margin expansion for FY13
430
240
170
160
80 80
150
120
-10
-220
60
40
-70
-50
-250
-150
-50
50
150
250
350
450
550
M
a
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H
U
L
Gross Margin Expansion EBITDA Margin expansion
G
C
P
L
G
S
K

C
o
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s
u
m
e
r
C
o
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g
a
t
e

Source: Company, Ambit Capital research
Moderation in revenues and EPS growth over FY13-15: Based on a
bottom-up approach related to our category framework analysis, we forecast a
median moderation of 600bps in revenue CAGR (15% CAGR over FY13-15 as
against 21% CAGR over FY08-13) and 200bps in EPS CAGR (17% CAGR over
FY13-15 as against 19% CAGR over FY08-12) for the stocks covered in this
note (refer to the table below). This applies particularly to stocks such as
Dabur, GSK Consumer, Marico and Nestle, where we expect the FY13-15
EPS CAGR to be lower than that achieved over FY08-13 (see the tables below).
Exhibit 74: Relative valuation multiples for the Indian FMCG sector
P/E EV/EBITDA EV/SALES
Co Name
CMP
(Rs)
Mcap
($mn)
Implied
P/E (FY14)
FY14E FY15E
PEG
(FY14)
FY14E FY15E
P/CFO
(FY14)
FY14E FY15E
Dividend
yield (%)
(FY14)
Indian Consumer
GSK Consumer
5,515 4,112 32.5 45.5 38.0 1.4 38.4 32.3 36.4 6.0 5.2 1.1
Nestle
5,306 9,036 35.6 43.0 36.7 3.0 25.2 21.8 31.0 5.4 4.7 1.4
Colgate
1,451 3,492 32.2 38.1 33.8 4.5 27.0 23.1 33.5 5.3 4.6 2.1
HUL
592 22,660 31.6 37.2 32.8 3.7 28.5 25.0 32.3 4.3 3.8 1.9
Marico
234 2,647 27.8 33.0 27.1 1.0 21.0 17.9 25.1 3.2 2.7 0.5
Dabur
158 4,891 26.8 31.2 27.0 2.0 23.5 20.3 29.2 3.9 3.4 1.1
Godrej Consumer
873 5,263 29.6 32.6 27.2 1.2 22.5 18.7 27.6 3.8 3.3 0.9
Mean
30.9 37.2 31.8 2.4 26.6 22.7 30.7 4.6 4.0 1.3
Median
31.6 37.2 32.8 2.0 25.2 21.8 31.0 4.3 3.8 1.1
Source: Ambit Capital research, Bloomberg; All forward looking numbers are based on our forecasts


Consumer Staples

Ambit Capital Pvt Ltd 36
Exhibit 75: Return profiles of the Indian FMCG sector
Company Name
EPS CAGR
FY08-13
EPS CAGR
FY13-15
EBITDA CAGR
FY08-13
EBITDA CAGR
FY13-15
Sales CAGR
FY08-13
Sales CAGR
FY13-15
ROE
(FY13)
ROCE
(FY13)
ITC 18% 19% 20% 19% 16% 17% 36% 36%
HUL 13% 10% 14% 12% 13% 13% 103% 104%
Dabur 18% 15% 20% 14% 21% 14% 40% 27%
Colgate 16% 8% 18% 13% 16% 15% 107% 112%
Godrej Consumer 21% 28% 34% 27% 42% 19% 23% 15%
Marico 17% 24% 20% 16% 19% 10% 23% 17%
Britannia 8% 15% 11% 13% 17% 15% 54% 30%
Emami 23% 21% 36% 8% 24% 18% 42% 37%
GSK Consumer 22% 18% 16% 19% 19% 15% 35% 36%
Nestle 21% 14% 21% 14% 19% 15% 70% 41%
Median 18% 17% 20% 14% 19% 15% 41% 36%
Source: Ambit Capital research, Company, Bloomberg; Forecasts for ITC, Emami and Britannia are based on Bloomberg consensus
MNC share buybacks do they change the fundamentals?
One of the recent catalysts for share price re-rating (especially for players like
HUL, GSK Consumer, Nestle and Colgate Palmolive) has been the buybacks
announced by the parent companies of GSK Consumer and HUL to increase their
stake in the listed entity through an open offer priced at 20-25% premium to the
then prevailing share price. Whilst Unilever announced an increase in ownership
in HUL from 52.5% to 75% through the open offer, GSK Consumer announced an
increase from 43% to 75%.
The rationale behind the MNC parents decision to make these open offers can be
one of the following: (a) Intention to help improve the Indian operations
incrementally; or (b) Leveraging on low cost of capital to invest in high growth
economy. Based on our analysis and discussions with market participants, we
believe that the rationale behind these open offers is likely to be a reflection of the
parents confidence in the Indian subsidiarys long term leadership position in
Indias fast growth consumption story and hence more of an investment
opportunity given:
Indias consumption story: is one of the strongest and most sustainable in
the parents portfolio of emerging markets, especially given weakening growth
prospects in the developed world.
Cost of capital: for the MNC parent is substantially low in the current
environment and hence deployment in growth profiles such as that offered by
their subsidiaries in India is an attractive investment opportunity.
Limited prospects of new brand introductions from non-India portfolio:
Unilever currently has 33 brands in action globally, of which 22 are present
in India. Of the rest, as highlighted in HULs stock specific section, only 3-4
brands currently have a good potential for a launch in India over the short to
medium term. Also, for GSK Consumer, given a history of launches that have
not met with success (Lucozade, Nutribars, Foodles, Aquafresh, Horlicks
Chilled Doodh, etc), we believe it is pre-mature to expect a new launch to lead
to a revenue growth that is as strong as that reported by Sensodyne over
CY10-12.
Existing collaboration with the parent: The existing royalty structure takes
into account the support provided by the parent to the Indian subsidiary on an
ongoing basis.



Consumer Staples

Ambit Capital Pvt Ltd 37
Comparison with other emerging market FMCG
companies
Exhibit 76: Relative valuation multiples for global consumer companies

CY12
Revenues
(US$ mn)
Mcap
(USD bn)
CY07-12
Rev CAGR
CY07-12
EPS CAGR
FY14 P/E
CY12-14
Rev CAGR
CY12-14
EPS CAGR
Emerging market consumer companies
Unilever Indonesia TBK Pt 2,912 22.6 17% 20% 37.4 16% 11%
Unilever Nigeria Plc 350 1.6 10% 40% 54.9 15% 20%
Tingyi (Cayman Isln) (Taiwan) 9,212 14.5 23% 18% 35.6 16% 15%
BRF SA 14,656 20.3 34% 2% 22.3 11% 72%
M Dias Branco SA (Brazil) 1,822 5.0 19% 43% 18.2 9% 15%
Hengan Intl (China) 2,388 13.2 27% 25% 22.8 20% 18%
Mayora Indah Pt (Indonesia) 1,121 2.7 30% 39% 27.9 19% 21%
Want Want China Holdings Ltd 3,359 19.3 25% 25% 37.5 20% 20%
Nestle Nigeria Plc 735 5.0 22% 29% 6.9 20% 22%
Gudang Garam Tbk Pt (Indonesia) 5,229 10.4 12% 23% 18.5 11% 22%
Median 22% 25% 25.4 16% 20%
Source: Bloomberg, Ambit Capital research; Note: The non-India emerging market companies have been shortlisted based on their product portfolio
A quick comparison with large listed FMCG companies in countries like China,
Indonesia and Brazil suggests that:
Indian companies have expanded at a lower rate: Indian players have
reported 500bps lower EPS CAGR as compared to their international peers
over CY07-12.
Indian companies are likely to expand slower: Indian players are likely to
report 300bps lower EPS CAGR as compared to their international peers over
CY12-14.
Indian companies are trading at a premium: Indian players currently
trade at a ~20% premium as compared to their international counterparts on
one-year forward P/E multiples.
This valuation disconnect, we believe, is not justified, because countries like China,
Indonesia and Brazil broadly share similar long-term demographic and macro-
economic growth drivers.
Aspirational consumer vs Staples consumer
trade-off between defensiveness and valuations
Whilst we retain our SELL stance on the FMCG sector, we believe stocks like Asian
Paints (MCap US$7.9bn, 6% upside) and TTK Prestige (MCap US$694mn, 23%
upside) offer a significantly stronger growth profile and are available at more
attractive valuations.
We have used the coefficient of variation of quarterly revenue growth over the past
six years to determine the defensiveness of a stock. The matrix ranks Colgate as
the most defensive stock and Berger as the least in the consumer space. Whilst
there is a clear correlation between the level of defensiveness and the multiple at
which the company is trading, the growth profiles of these companies vary
significantly. We highlight the dichotomy between the growth profiles and
valuations, with HUL, Colgate and Nestle (average EPS CAGR of 11% over FY13-
15) enjoying premium multiples, and TTK and Bata (average EPS CAGR of 26%
over FY13-15) trading at a 24% discount to the sector average.
Trade-off between FMCGs
defensiveness and discretionary
plays growth and valuations


Consumer Staples

Ambit Capital Pvt Ltd 38
Exhibit 77: Level of defensiveness in consumer stocks highlighting valuations and
EPS growth
0%
10%
20%
30%
40%
20 25 30 35 40 45
E
P
S

C
A
G
R

(
F
Y
1
3
-
1
5
)
P/E FY14
Bata
TTK Prestige
Asian Paints
GCPL
Titan
Marico
Dabur
Berger
Paints
Pidilite
HUL
Colgate
Jubilant
Foodworks
GSK Consumer
Nestle
ITC

Source: Bloomberg, Ambit Capital research; Note: Size of the bubble highlights the level of defensiveness
determined by the coefficient of variation of revenues over the past 24 quarters.
We havent included light electrical players such as Bajaj Electricals and Havells in
the chart above since their non-core businesses like E&P for Bajaj and Sylvania
for Havells restrict a fair comparison on all parameters including consolidated EPS
CAGR, P/E multiples as well as historical volatility in reported revenues. However,
we believe strongly in the tailwinds for their product categories in the consumer
vertical such as kitchen electrical appliances and other brown goods.



Consumer Goods June 04, 2013
Hindustan Unilever
Bloomberg: HUVR IN EQUITY
Reuters: HLL.NS
Accounting: GREEN
Predictability: AMBER
Earnings momentum: RED


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income (` mn) 197,355 221,164 258,102 292,085 330,137
EBITDA(` mn) 26,784 32,913 40,038 44,509 50,307
EBITDA Margin (%) 13.6% 14.9% 15.5% 15.2% 15.2%
Adjusted PAT(` mn) 20,953 26,565 32,206 34,437 39,080
Adjusted EPS (`) 9.7 12.3 14.9 15.9 18.1
RoE (%) 80.2% 83.1% 103.1% 108.2% 95.2%
P/E (x) 61.1 48.0 39.7 37.2 32.8
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `592
Target Price (Mar14): `503
Previous TP: NA
Downside (%) 15%
EPS (FY14E): `15.9
Change from previous (%) NA
Variance from consensus (%) -5%
Stock Information
Mkt cap: `1,280bn/US$22.7bn
52-wk H/L: `598/400
3M ADV: `1,486mn/US$26.3mn
Beta: 0.53x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
3 31 43 13
Rel. to Sensex
3 27 20 12
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Oct-12 J an-13 May-13
400
500
600
Sensex Hind. Unilever

1-year forward P/E bancdchart
180
230
280
330
380
430
480
530
580
A
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24x
27x
33x
30x
36x

Source: Bloomberg, Ambit Capital research
What goes up,
Hindustan Unilevers (HUL) volume growth has gradually moderated
from a steady run rate of 12-13% until FY11 to 6-8% over FY12-13.
With a product portfolio that is skewed towards fully penetrated
categories and with intense competition from MNC peers like Colgate,
LOreal and Nestle, we expect an average volume growth of only 7%
over FY13-15. Also, EBITDA margins are likely to decline by 50bps over
FY13-15 due to rising competitive intensity, leading to increased
advertising spends and an increase in royalty rates (as announced by
the parent). With the stock currently trading at a 35% premium to its
historical three-year and five-year P/E multiples, we initiate coverage
with a SELL stance.
Competitive position: STRONG Change to this position: STABLE
Due to the size and width of its product portfolio, HUL is able to ride the wave
of evolving consumption in most product categories either by creating such a
wave or by becoming the second entrant and yet a key beneficiary. However,
we expect structural headwinds from the following:
Volume growth moderation: HULs overall volume growth could remain
subdued at ~7% CAGR over FY13-15. HUL derives ~60% of its revenue from
soaps & detergents (S&D) and teathree fully penetrated categories with likely
volume growth of only 2-5% per annum. Also, HUL is likely to lose market
share in oral care (due to Colgates strong competitive advantages), skin care
(high penetration in the mass market and intense competition from LOreal in
the premium market) and beverages (weak brand recall of 100% coffee,
competition between HULs Bru Gold and Nescafe Classic).
EBITDA margin compression: Whilst we expect gross margin expansion of
40bps per annum over FY13-15 (related to portfolio premiumisation), we
expect EBITDA margins to decline by 50bps over FY13-15, due to: (a) 50bps
increase in advertising spend to sales ratio in response to strong competition
from GCPL (S&D), LOreal (cosmetics, hair care and skin care), P&G
(detergents, shampoos, skin care, oral care) and Nestle (beverages); and (b) a
140bps gradual increase in royalty rates over FY13-18 and a 4 percentage
point increase in tax rates over the next two years.
Valuation: HULs one-year forward P/E multiple of 37.2x is at a ~35%
premium to its three-year and five-year historical average of 27.0-28.0x.
However, given the ongoing and forthcoming drag on EBITDA margins and
volume growth, the extent of this premium rating is not justified. Unilevers
open offer indicates the parent companys confidence in HULs long-term
leadership positioning in Indias fast growth consumption story. However, we
do not expect revenue and EPS CAGR to incrementally benefit from the
parents increased ownership. Our DCF-based valuation generates a TP of
`503/share (15% downside), an implied FY14 P/E multiple of 31.6x.


Hindustan Unilever
Ambit Capital Pvt Ltd 40

Company Financial Snapshot
Profit and Loss (` mn)
FY13 FY14E FY15E
Net sales 258,102 292,085 330,137
Optg. Exp(Adj for OI.) 218,065 247,576 279,829
EBIDTA 40,038 44,509 50,307
Depreciation 2,360 2,318 2,339
Interest Expense 251 30 30
PBT 43,495 46,162 53,182
Tax 11,612 12,925 15,423
Adj. PAT 32,206 34,437 39,080
Profit and Loss Ratios

EBIDTA Margin % 15.5% 15.2% 15.2%
Adj Net Margin % 12.4% 11.4% 11.4%
P/E (X) 39.7 37.2 32.8
EV/EBIDTA (X) 31.5 28.5 25.0
Dividend Yield (%) 3.1% 1.9% 2.0%
Company Background
HUL, a 52% subsidiary of Unilever, is Indias largest FMCG
company, with a presence in Home and Personal Care
Products and Food and Beverages.
The company has more than 35 brands spanning 20
categories such as soaps, detergents, shampoos, skin care,
toothpastes, deodorants, cosmetics, tea, coffee, packaged
foods, ice cream, and water purifiers. Also, the company has
more than 16,000 employees.
Its key brands include Lux, Lifebuoy, Surf Excel, Rin, Wheel,
Fair & Lovely, Ponds, Vaseline, Lakm, Dove, etc.
Balance Sheet (` mn)
FY13 FY14E FY15E
Total Assets 113,077 133,469 156,543
Net Fixed Assets 25,085 25,267 25,428
Current Assets 64,685 69,895 84,808
Other Assets 23,307 38,307 46,307
Total Liabilities 113,077 133,469 156,543
Networth 26,740 34,688 44,626
Debt - - -
Current Liabilities 88,385 100,829 113,965
Deferred Tax (2,048) (2,048) (2,048)
Balance Sheet Ratios
ROE % 103.1% 108.2% 95.2%
ROCE % 103.7% 108.3% 95.3%
Net Debt/Equity (1.4) (1.5) (1.5)
Equity/Total Assets 1.0 1.0 1.0
P/BV (X) 47.9 36.9 28.7
Cash Flow (` mn)

FY13 FY14E FY15E
PBT 43,495 46,162 53,182
Depreciation 2,360 2,318 2,339
Tax (11,612) (12,925) (15,423)
Change in Wkg Cap 7,454 4,034 5,838
Others 95 (0) 0
CF from Operations 41,792 39,589 45,936
Capex (3,816) (2,500) (2,500)
Investments 1,076 (15,000) (8,000)
CF from Investing (2,741) (17,500) (10,500)
Change in Equity - - -
Debt - - -
Dividends (46,834) (27,847) (30,379)
Others 6,562 2,558 2,558
CF from Financing (40,272) (25,289) (27,821)
Change in Cash (1,222) (3,200) 7,615
Best-in-class distribution (mn outlets)
HULs working capital cycle has been led by its
management of creditors (days, FY12/CY11)
0
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2
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Direct reach Total reach

(60)
(40)
(20)
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Other current liabilities Working capital days

Source: Company, Ambit Capital research


Hindustan Unilever
Ambit Capital Pvt Ltd 41

Company Background
Exhibit 1: HULs portfolio mix
Category Key brands Key Competitors
Market share
rank
% of
turnover
Estimated FY12
Growth
Soaps
Lifebuoy, Lux, Dove, Pears, Hamam,
Liril, Breeze, Rexona
Godrej Consumer, Reckitt
Benckiser, Wipro
1
20% 9%
Detergents
Surf Excel, Rin, Wheel, Comfort, Vim,
Domex, Cif
P&G, Rohit Surfactants,
Nirma
1
28% 29%
Oral care Pepsodent, Close-up Colgate, Dabur
2
5% 17%
Skin care
Fair & Lovely, Vaseline, Dove, Ponds,
Lakme, Aviance
L'Oreal, Marico, Beiersdorf,
Emami
1
11% 18%
Hair care
Clear, Clinic Plus, Tresemme, Dove,
Sunsilk
P&G, CavinCare, Dabur,
L'Oreal
1
8% 16%
Tea
3 Roses, Red Label, Taj Mahal, Taaza,
Lipton
Tata Tea, Wagh Bakri
2
9% 9%
Coffee Bru Nestle
1
3% 18%
Ice Creams Kwality Walls Amul, Vadilal, Mother Dairy
2
2% 30%
Branded Staples Annapurna Aashirvaad
2
2% 11%
Culinary Products Knorr, Kissan Maggie
NA
3% 11%
Source: Ambit Capital research
HUL is the largest and the most-diversified listed FMCG company in India. As of
FY12, HUL derived around 48% of its revenues from soaps and detergents, 31%,
from personal care, 12% from beverages and 9% from food and others. The soaps
and detergents segment contributed to 37% of EBIT in FY12 vs 52% for personal
care, and 11% from beverages (the food and others segments did not contribute to
EBIT).
HUL has a market-leading portfolio and the company is the #1 player in soaps,
detergents, skin care, hair care, culinary products and coffee and the #2 player in
oral care, tea and ice creams.
Historical track record
HUL has reported revenue CAGR of 7% with EBIT CAGR of 6% over CY01-FY12. As
shown in the charts below, over the past decade, revenue growth of the soaps and
detergents (S&D) and personal products categories has outpaced the revenues of
the beverages, food and other categories. Consequently, the proportion of
revenues from S&D and personal product categories has increased from under
50% in CY01 to ~80% in FY12. However, a consistent decline in S&D EBIT margins
from 22.8% in CY01 to 11.6% in FY12 has reduced the contribution of S&D to PBIT
from 51% in CY01 to 37% in FY12.
Exhibit 2: Revenue contribution of soaps and detergents
has risen from 43% in CY02 to 49% in FY13
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
C
Y
0
2
C
Y
0
4
C
Y
0
6
F
Y
0
9
F
Y
1
1
F
Y
1
3
Exports/
Others/Foods
Beverages
Personal
products
Soap and
Detergents

Source: Company, Ambit Capital research.
Exhibit 3: However, personal products share of PBIT
has been increasing versus soaps and detergents
-20%
0%
20%
40%
60%
80%
100%
C
Y
0
2
C
Y
0
4
C
Y
0
6
F
Y
0
9
F
Y
1
1
F
Y
1
3
Exports/
Others/Foods
Beverages
Personal
products
Soap and
Detergents

Source: Company, Ambit Capital research


Hindustan Unilever
Ambit Capital Pvt Ltd 42

Distribution
HUL derives around 15% of its revenues from modern trade as against a 5-6%
contribution of modern trade in overall FMCG consumption in India. Also, this has
been the fastest-growing distribution channel for the company over the past
decade. The current distribution reach for HUL stands at ~7mn outlets including a
direct reach of ~2mn outlets (up from a direct reach of ~1mn in FY10). The
company is currently focusing on building its direct reach rather than focusing on
the overall reach.

SWOT analysis
Exhibit 4: SWOT analysis for HUL
Strengths Weaknesses
Heavy marketing efforts across brands have led to the creation
of strong brands that are market leaders in most of the
categories in which they have a presence in. (Advertisement
spends are up from 7.2% in CY03 to 12.5% in FY13E.)
It has a portfolio that straddles all segments (from mass to
premium) and in most categories, it has an established premium
portfolio (market shares of over 50% in personal products and
S&D), enabling HUL to be one of the largest beneficiaries of
premiumisation.
Strict control over inventory (inventory days - 42 in FY12) and
creditors (other current liabilities days - 91 in FY12) helps HUL
have amongst the best working capital cycles (WC cycle of -55
days in FY12) in its peer group.
Amongst the best talent (one of the first FMCG companies to
start recruiting from the IIMs) and distribution reach in India,
reaching out to more than 7mn outlets.

Portfolio is skewed towards lower growth categories like
soaps and detergents (48% of FY12 turnover) and
beverages (11% of FY12 turnover) which are almost fully
penetrated.
Whilst the skin care portfolio is a market leader in the
mass market (Fair & Lovely), it faces tremendous
competition in the premium market (Ponds faces strong
competition from LOreal).

Opportunities Threats
HUL is building its portfolio in high-growth categories like
premium skin care (over 20%), hair care (18%) and deodorants
(30%) and is entering into emerging categories like hand wash
and face wash (>25%).
Investing aggressively in the rural market, which is a segment
that has been growing faster than urban areas since CY07.
Strong balance sheet with support from the parent company as
well as access to its global brands and technology can lead to
new product launches in India.

Increasing competitive intensity across categories
(especially LOreal, Nestle and P&G) has led to market
share losses and the company will likely see elevated
advertisement spends going forward.
HUL has struggled to pass on price increases (especially in
the mass skin care segment and the personal care
segment). Raw material inflation can put pressure on
margins especially as its competitors are MNCs with
strong balance sheets.
Source: Company, Ambit Capital research, Industry


Hindustan Unilever
Ambit Capital Pvt Ltd 43

Benefits from premiumisation, operational
efficiencies and efficient capital allocation
Width and depth of the product portfolio
As shown in the table below, HULs portfolio of products includes strong brands
across economy, mid-tier as well premium products across most product
categories. Currently, HUL derives around 15-20% of its overall revenues from
premium brands (in bold font in the table below).
Exhibit 5: HULs product portfolio has a fair mix of mass, mid and premium brands
Category Key brands
Market
position
Contribution of
premium brand (%)
Contribution of
segment (%)
Soaps
Dove, Lux, Pears, Lifebuoy, Hamam,
Liril
No.1 20%
20%
Detergents Wheel, Rin, Surf No.1 15% 25%
Skin care Fair & Lovely, Lakme, Vaseline, Ponds No.1 10% 18%
Hair care
Dove, Clinic Plus, Sunsilk, Clear,
Tresemme
No.1 20%
8%
Oral care Pepsodent, Closeup No.2 15% 5%
Tea
Red Label, Taj Mahal, 3 Roses,
Lipton, Taaza
No.1 15%
9%
Coffee Bru No.2 5% 3%
Foods
Kissan, Knorr, Modern, Annapurna,
Kwality Walls
No.2 25%
6%
Others Axe, Vim, Domex No.1 NA 6%
Source: Company, Ambit Capital research. Note: Premium brands highlighted in bold
Such a diverse range of products is beneficial to the company for multiple reasons:
Riding the wave of evolution of consumption: The width and size of the
product portfolio allows HUL to test launch new products and variants on a
frequent basis despite having a low rate of success in these launches. Hence,
HUL is able to either create new waves of consumption in several categories or
ride the wave created by a competitor by being the #2 player in such a
category.
Customer acquisition benefits: Many competitors (such as Rohit Surfactants
Ghadi, Nirma, Wipro, and Reckitt Benckiser), in the S&D category, do not have
products across the economy to premium segments. Moreover, with high
penetration levels in categories such as S&D and tea, premiumisation is a
major component of category growth. Consequently, players like HUL benefit
disproportionately as against some of its peers through the acquisition of
customers who premiumise away from competitor brands.
Premiumisation trends within HULs brands: Other players including P&G,
LOreal and Colgate offer premium products across categories that are
relevant to HUL; however, the company benefits from being able to offer
premium products along with the promotions of the economy products within
its portfolio of brands. This has helped the company premiumise customers
from, for example, Fair & Lovely to Ponds and from Wheel to Rin.
Gross margin benefit: Due to a sharp differential in pricing between the
mass and premium categories, especially in the soap and detergents segment,
the incremental gross margin benefit is significant. Our calculations suggest
that a differential of more than 40% on gross profits exists in detergents with
gross margins of ~25%, ~40% and ~70% for Wheel, Rin and Surf
respectively, as consumers straddle up the pyramid of brands. Also, the
expansion of new high-margin categories like face washes, fabric conditioners,
hair conditioners and tea bags is likely to provide a further impetus to gross
margins. Consequently, as shown in the chart below, we forecast a gross
margin expansion of 40bps per annum over FY13-15 for HUL.


Hindustan Unilever
Ambit Capital Pvt Ltd 44

Exhibit 6: We factor in premiumisation-driven gross margin improvements of
40bps in FY14 and FY15 each (%)
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
CY06 CY07 FY09 FY10 FY11 FY12 FY13 FY14E FY15E
44%
45%
46%
47%
48%
49%
50%
51%
Change in gross margin (LHS) Gross margin

Source: Company, Ambit Capital research

Distribution network and working capital cycle
The total distribution reach for HUL was 7mn outlets as on FY12 of which direct
reach accounts for around 2mn outlets (as compared to 1mn outlets in FY10). With
one of the largest overall distribution networks, HUL is now focussed on expanding
its direct reach rather than the overall reach. Also, some of the distribution
initiatives taken by the company in the past include:
Use of advanced analytics for its sales and distribution called Project IQ. This
was developed over the past two years and has helped the company track
stock information from its direct reach. These analytics enable the company to
define a product assortment for each outlet and to assist in promoting the
portfolio (especially premium and new launches) more efficiently to maximise
sales based on the consumer profile.
By 2008, HUL had consolidated its distributors, which were previously
segregated according to product categories. The total number of distributors
was brought down from around 6,000 to less than 3,000. Whilst the company
has not changed distributor margins, the supply chain is now efficient enough
to ensure that distributors do not hold unsold stock for more than 1-2 days for
the company.
Exhibit 7: HUL enjoys the highest distribution reach in the sector (mn outlets)
0
1
2
3
4
5
6
7
H
U
L
D
a
b
u
r
C
o
l
g
a
t
e
G
C
P
L
M
a
r
i
c
o
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
Total reach
Direct reach

Source: Company, Ambit Capital research
HUL also has one of the best working capital cycles in the industry due to its strong
focus on working capital management (refer to the charts below). We believe this
is due to:


Hindustan Unilever
Ambit Capital Pvt Ltd 45

1. Working capital management being a component of the top managements
compensation structure at HUL
2. Globally negotiated vendor contracts that provide favourable payment terms
3. Scale benefits that help negotiate favourable contracts with vendors in India
4. Taking measures to improve its inventory management by shifting away from
legacy systems to SAPs ERP and effecting changes in its ordering patterns from
annual budgeted to monthly planning cycles for raw material procurement.
Through these measures, the company has further improved its working capital
cycle from -39 days in CY04 to -55 days in FY12.
Exhibit 8: Working capital improved by reducing loans
& advances and increasing current liabilities (days)
-
5
10
15
20
25
30
C
Y
0
1
C
Y
0
2
C
Y
0
3
C
Y
0
4
C
Y
0
5
C
Y
0
6
C
Y
0
7
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
75
80
85
90
95
100
105
110
115
Loans and advances Current liabilities

Source: Company, Ambit Capital research
Exhibit 9: HULs working capital cycle has been led by
its management of creditors (days, FY13/CY12)
(60)
(40)
(20)
-
20
40
60
80
100
H
U
L
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
e
G
C
P
L
D
a
b
u
r
M
a
r
i
c
o
Other current liabilities Working capital days

Source: Company, Ambit Capital research
Efficient capital utilisation strategy
HUL ranks amongst the best allocators of capital on our competitive mapping, with
over 80% of the cash generated over the past decade being deployed towards
investments in the core business or share buybacks/dividend payouts to
shareholders (see the exhibit below). As a result, HUL has consistently had high
RoEs and RoCEs over the past ten years.
Exhibit 10: Avenues of capital deployment for various companies over FY03-12
-20%
0%
20%
40%
60%
80%
100%
H
U
L
N
e
s
t
l
e
C
o
l
g
a
t
e
G
S
K
C
H
D
a
b
u
r
M
a
r
i
c
o
G
C
P
L
Investment in core Dividend Paid Non core investments
Change in cash Others

Source: Company, Ambit Capital research


Hindustan Unilever
Ambit Capital Pvt Ltd 46

Structural headwinds against growth
in revenues and margins
Volume growth moderation to 7% over FY13-15
HUL has seen an average volume growth of 10% over the past 12 quarters (refer
to the table below). Whilst personal products have continued to expand
consistently at ~16% YoY (we estimate volume growth of around 14%) during this
period, S&Ds volume growth of ~7% YoY and beverages volume growth of ~6%
YoY have been the biggest drivers of moderation in HULs overall volume growth.
Exhibit 11: Competitive intensity to lead to mid-to-high single-digit volume growth
0%
3%
6%
9%
12%
15%
4
Q
F
Y
1
0
1
Q
F
Y
1
1
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
1
2
3
Q
F
Y
1
2
4
Q
F
Y
1
2
1
Q
F
Y
1
3
2
Q
F
Y
1
3
3
Q
F
Y
1
3
4
Q
F
Y
1
3
3%
5%
7%
9%
11%
13%
15%
17%
19%
Volume growth (LHS) Revenue growth

Source: Company, Ambit Capital research
We expect HULs overall volume growth rates to remain subdued at ~7% CAGR
over FY13-15 due to the following factors:
Product mix skewed towards well-penetrated categories
HUL derives ~60% of its revenue from soaps, detergents and teathree fully
penetrated categories with limited potential for an increase in frequency of
consumption. Consequently, volume growth in these three categories are likely to
be in the low-to-mid single digits (refer to the table below).
Therefore, even with a category volume growth of ~10% for personal products in
HULs portfolio, we expect the companys overall volume growth rates to moderate
to 7% CAGR over FY13-15.
Exhibit 12: HUL's portfolio spread across high and low growth categories
Category
% of total
revenues
Estimated volume
growth for HUL (FY13-15)*
Estimated value growth
for HUL (FY13-15)*
Tea 9% 2% 12%
Coffee 3% 4% 10%
Soaps 22% 5% 11%
Detergents 27% 5% 10%
Branded Staples 2% 5% 12%
Oral care 4% 8% 13%
Skin care 9% 8% 15%
Culinary Products 3% 12% 18%
Ice Creams 2% 12% 20%
Hair care 8% 12% 20%
Source: Company, Ambit Capital research, Industry; * Estimates based on anecdotal data for category
growth and our expectations of market share gains/losses for HUL within respective categories


Hindustan Unilever
Ambit Capital Pvt Ltd 47

Rising competitive intensity in personal products and beverages
As shown in the table below, amongst all product categories where HUL has a
presence, we expect the company to lose market share in oral care, skin care and
coffee, because of the following factors:
Oral care: We believe that HUL has lost market share of ~250bps to Colgate
over the past four years, due to Colgates aggressive rural initiatives (Bright
Smiles Bright Future campaign where it imparts information on dental hygiene
to children and Oral Health Month where it provides free oral care health
check ups) and push-based demand built through exceptionally strong
relationships with doctors in India. With such continued aggression from
Colgate, we expect further market share loss of 60bps for HUL in its oral care
portfolio over FY12-15. Competitive intensity is likely to rise further in this
category, with P&Gs parent recently announcing the prospective launch of its
Oral-B branded toothpaste over the next few months in India.
Skin care: HULs Fair & Lovely brand contributes to 60-70% of its skin care
revenues (excluding cosmetics) and ~6% of overall revenues. Due to high price
elasticity of demand (price increase of `7-8 taken on sachets in 2QFY13) in
personal products, the company has reported value growth of ~10% YoY in
CY11 and a volume decline YoY in 9MFY13. Whilst we expect the volume
decline to abate by 1QFY14, as the effect of the price increase is fully
absorbed, we expect volume growth to be in low single digits going forward,
owing to a high penetration (more than 70%) of the fairness cream sub-
segment in India. Moreover, with aggressive competition at the premium
segment, LOreals marketing campaigns and strong product portfolio is likely
to keep HULs growth below the category growth. We estimate a market share
loss of 360bps over FY12-15.
Beverages: We expect market share loss for HUL in the coffee segment (after
having gained more than 100bps share in FY13). Whilst HULs Bru coffee has
a strong brand recall in the mass segment as against Nestles Sunrise, the
company is likely to lose share of premiumisation due to a weaker brand recall
of Bru Gold against Nescafe Classic (100% coffees).
These market share losses are likely to offset premiumisation gains for HUL in its
soaps and ice creams categories due to a better-quality premium portfolio.
Exhibit 13: Category growth projections
Category
Market Share
(FY12)
Estimated Market
Share (FY15)*
CAGR
FY12-15*
Soaps 45% 47% 15%
Detergents 38% 38% 13%
Oral care 23% 22% 13%
Skin care 58% 57% 13%
Hair care 43% 43% 19%
Tea 29% 29% 12%
Coffee 51% 50% 11%
Ice Creams 12% 14% 20%
Branded Staples NA NA 10%
Culinary Products NA NA 16%
Source: Ambit Capital research. * Estimates based on anecdotal data for category growth and our
expectations of market share gains/losses for HUL within respective categories


Hindustan Unilever
Ambit Capital Pvt Ltd 48

Rising pressure on PAT margins
Whist we expect gross margin expansion of 40bps per annum over FY13-15
related to premiumisation of customers across a wide range of brands in its
portfolio, we expect EBITDA margins for HUL to decline by 50bps over FY13-15, as
shown in the chart below.
Exhibit 14: Gross and EBITDA margins trends and forecasts
46.5%
47.0%
47.5%
48.0%
48.5%
49.0%
49.5%
50.0%
FY10 FY11 FY12 FY13 FY14E FY15E
13.5%
14.0%
14.5%
15.0%
15.5%
16.0%
Gross Margins (%) (LHS) EBITDA Margins (%) (RHS)

Source: Company, Ambit Capital research
This margin compression is likely due to the factors explained below:
Rising A&P spends
HULs A&P spend to sales ratio has been increasing consistently from 7.2% in
CY03 to 11.9% in FY12 (refer to the chart below). The recent increase of 90bps in
this ratio in 9MFY13 has been predominantly driven by a reduction in input costs
for the soaps & detergents segment. Hence, the benefits to gross margins are
invested in A&P. Going forward, even without any such input cost benefit, we
expect HULs advertisement/sales ratio to increase by 110bps over FY12-15.
S&D: This segment has seen increased competitive intensity in Soaps and
Detergents, with a renewed focus from GCPL (Cinthols premium rebranding in
2QFY13) and Wipro (entering the premium segment through brand Yardley).
Given the high-penetration-led low volume growth for the segment, we expect
a rise in A&P spends on HULs S&D portfolio.
P&G: As highlighted previously in the note, P&G Home Products (the entity
with a presence in detergents, shampoos, skincare and diapers) has seen its
A&P spends increase at a CAGR of 52% - from 12.3% of sales in FY06 to
28.9% of sales in FY11. With its recent equity infusion of `15.bn in 3QFY13,
the company is likely to have a strong war chest to keep its A&P spends at
elevated levels.
LOreal: As highlighted previously in the note, LOreal has seen revenue
growth of 31% over CY08-11, with advertising spends as a percentage of sales
of around 35%. With new launches at aggressive price points (especially
shampoos), we do not expect any reduction in advertising spends and expect
the competitive intensity to remain high in the segment. We expect LOreals
strong brands and aggressive marketing to help it gain share in the cosmetics,
hair care and skin care space.
Beverages: The tea segment is facing aggression from Tata Tea (which has
been gaining market share recently). Tata Tea is now the volume market
leader with a market share of 25%. With Nestle having identified the Nescafe
coffee portfolio as one of its key areas of focus in the coming months, Nestle is
increasingly focusing on supply chain and branding of Nescafe from FY13
onwards to gain market share from HUL.


Hindustan Unilever
Ambit Capital Pvt Ltd 49

Consequently, we expect HULs A&P spends to remain at elevated levels whilst
trying to prevent market share loss in response to heightened competitive intensity
(refer to the chart below).
Exhibit 15: Rising A&P trends for HUL
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
C
Y
0
4
C
Y
0
5
C
Y
0
6
C
Y
0
7
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
Advertising spends As % of sale (%)

Source: Ambit Capital research
Increase in royalty and taxes
HUL recently announced an increase in royalty payments to its parent from 1.40%
currently to 3.15% by FY18 (including 50bps in FY14). Ceteris paribus, this is likely
to have an impact of 3% on FY14 EPS and a 11% cumulative impact on FY18 EPS.
Moreover, the parents support to the company will not have any incremental
benefits, other than what we have already factored into our forecasts. This is
because our forecasts take into account an increase in market share for HUL in
categories like S&D and ice creams (partly from the strong product portfolio,
innovation across categories and leverage on the parents R&D). Also, one of the
rationales behind an increase in royalty payment from HUL to the parent relates to
the innovation and R&D success that HUL has had over the past five years through
the parents support.
Exhibit 16: Royalty paid by FMCG MNCs in FY12
5.2%
4.9%
4.0%
3.5%
1.3%
1.0% 1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
C
o
l
g
a
t
e
P
&
G
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
H
U
L
G
i
l
l
e
t
t
e
B
a
t
a

Source: Company, Ambit Capital research. Note: For companies with a
calendar year-end, data pertains to CY11
Exhibit 17: Royalty paid by Unilever companies globally
1.3%
3.6%
3.3%
2.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
HUL Unilever
Pakistan
Unilever
Indonesia
Unilever
Nigeria

Source: Company, Ambit Capital research. Note: For companies with a
calendar year-end, data pertains to CY11
HUL currently enjoys a tax holiday shelter in some of its manufacturing plants
based in Himachal Pradesh. As these plants move out of the tax holiday over the
next two years, HUL is likely to see its effective tax rates increase by ~200bps in
FY14 to 27% and another 300bps in FY15 to ~30%


Hindustan Unilever
Ambit Capital Pvt Ltd 50

Unilevers open offer investment in HULs
leadership in Indias high-growth FMCG sector
Unilever recently announced an open offer at `600/share to increase its
ownership in HUL from 52.5% to 75%. Unilevers open offer indicates the parent
companys confidence in HULs long-term leadership positioning in Indias fast
growth consumption story. However, we do not expect revenue and EPS CAGR to
see any incremental benefits through the parents increased ownership, owing to:
Existing collaboration with the parent: The existing royalty structure takes
into account the support provided by Unilever to HUL on an ongoing basis.
Prospects of new brand introductions from Unilevers non-India
portfolio: Unilever currently has 33 brands in action globally, of which 22
are present in India. Of the rest, as shown in the table below, only 3-4 brands
currently have a good potential for a launch in India over the short to medium
term.
Exhibit 18: Potential for launch of Unilever's 'Brands in action' not already present in India
Brand DES
Potential in
India
Comments
Flora
Cholesterol friendly
spreads
Strong Niche market but fast growing
Ben & Jerry's Premium ice cream Weak
Premium ice cream market is expanding fast; however, a retail store in India faces
hurdles around real estate cost, high staff attrition and lack of enough depth of
demand on a pan-India basis
Bertolli
Italian spreads and
sauces
Strong Niche market but fast growing
Hellman's Mayonnaise Weak Market yet to be developed
Radox
Premium bath
products
Weak Market yet to be developed
Simple
Colour, perfume
free personal
products
Weak May not be suitable for Indian markets given the preference for herbal products
St. Ives
Natural skincare
products
Strong Can be an attractive addition to the fast-growing premium skincare market
Sunlight Soaps Weak Saturated category already dominated by HUL
Timotei Shampoos Weak Saturated category already dominated by HUL
Toni & Guy Premium Salons Weak
Already have Lakme salon range; depth of demand for premium salons not significant
yet
VO5 Hair styling products Strong Attractive fast growing market; can complement TRESemme
Source: Ambit Capital research, Company
Consequently, we do not expect a material incremental benefit to HULs
operations from Unilevers increased ownership in the Indian entity through the
open offer.






Hindustan Unilever
Ambit Capital Pvt Ltd 51

Key assumptions
Exhibit 19: Key assumptions and estimates for HULs revenues
FY12 FY13E FY14E FY15E Comments
Soaps

Industry Value Growth 12.0% 20.0% 10.0% 10.0%
Market share change NA 1.0% 0.5% 0.5%
Total revenue growth 9.2% 22.2% 11.1% 11.1%
Whilst FY13 has seen price-led growth, growth in
FY14 and FY15 is likely to be much lower at 10%
with volume growth of around 5%
Detergents

Industry Value Growth NA 18% 10% 10%
Market share change NA 0% 0% 0%
Total revenue growth 29.2% 18.0% 10.0% 10.0%
Pricing is the largest component in FY13, and
detergents are likely to see strong product-mix-
led growth in FY14 with volume growth of
around 4-5%
Total S&D revenue growth % 20.9% 19.4% 10.9% 10.9%

Oral care

Industry Value Growth NA 14.0% 14.0% 14.0%
Market share change NA -0.1% -0.3% -0.2%
Total revenue growth 17.0% 13.6% 12.7% 13.1%
Forecast growth of around 13% in FY13-15, with
a market share loss of 50bps, as HUL lags
Colgate in terms of its dentist relationships and
rural initiatives
Skin care

Industry Value Growth 18% 8% 15% 15%
Market share change (existing products) NA -2.0% -0.5% -0.1%
New product contribution NA 0.0% 2.0% 0.0%
Total revenue growth 18.0% 4.6% 16.1% 14.8%
Whilst the mass skin lightening segment is likely
to see volume pressure, growth will be led by the
premium Ponds portfolio and the emerging face
wash category
Hair care

Industry Value Growth 18% 18% 18% 18%
Market share change (existing products) -1.0% 0.0% 0.0% 0.0%
New product contribution NA 0.5% 2.0% 2.0%
Total revenue growth 15.7% 18.5% 20.0% 20.0%
Whilst competition remains strong in hair care,
we expect HULs diversified portfolio to maintain
market share. Market share losses to LOreal are
likely to be made up by gains from Dabur and
other smaller players
Total PP revenue growth % 17.0% 9.1% 17.6% 17.3%

Tea

Industry Value Growth 10% 15% 15% 10%
Market share change NA -0.4% 0.0% 0.0%
Total revenue growth 9.4% 13.9% 15.0% 10.0%
Whilst volume growth will remain in low single
digits, FY14 is likely to see strong price-led
growth due to a sharp increase in tea prices
Coffee

Industry Value Growth 12% 12% 12% 12%
Market share change 0% 1.0% -1.0% -1.0%
Total revenue growth 18.0% 13.0% 10.1% 10.0%
Forecast 10% revenue CAGR over FY13-15, with
volume growth of 4-5% and market share losses
to Nescafe as it will likely lose out in the
premium 100% coffee segment
Total beverage revenue growth % 11.5% 13.6% 13.7% 10.0%

Ice Creams

Industry Value Growth 20% 15% 15% 15%
Market share change (existing products) 0.0% 0.5% 0.5% 0.5%
New product contribution NA 0.2% 0.5% 0.5%
Total revenue growth 30.3% 15.2% 19.7% 19.5%
Expect 20% CAGR over FY13-15 as the Kwality
Walls brand gains market share led by frequent
innovations and increasing distribution
Branded Staples

Industry Value Growth NA 2.0% 10.0% 10.0%
Market share change contribution NA 0.0% 0.0% 0.0%
Total revenue growth 11.4% 2.0% 10.0% 10.0%
Forecast moderate penetration-led growth in
branded staples of 12% over FY13-15
Culinary Products

Industry Value Growth NA 11.5% 18.0% 18.0%
New product contribution NA 2.0% 0.0% 0.0%
Total revenue growth 10.6% 13.5% 18.0% 18.0%
Expect the culinary foods portfolio to deliver 18%
CAGR over FY13-15 led by strong growth in the
sauces and soups segment
Total food revenue growth % 15.4% 10.8% 16.4% 16.5%

Source: Company, Ambit Capital research



Hindustan Unilever
Ambit Capital Pvt Ltd 52

Exhibit 20: Key assumptions and estimates (` mn)
FY12 FY13E FY14E FY15E Comments
Profit and loss
Total revenues 220,954 257,465 292,085 330,137
Growth (%) 12.1% 16.5% 13.4% 13.0%
Gross Profit 103,786 123,214 141,481 161,233
Gross margin (%) 46.9% 47.7% 48.4% 48.8%
HUL is likely to be a large beneficiary of premiumisation given its
diverse portfolio
Employee cost (% of
sale)
5.0% 5.1% 5.0% 5.0% Expect employee costs to remain stable
Advertising (% of sale) 11.9% 12.5% 12.8% 12.8%
Expect advertising spends to increase going forward given higher
competitive intensity and share of premium products
Carriage & freight (% of
sale)
4.8% 0.0% 4.8% 4.8% Expect carriage and freight expenses to remain stable
Other expenses (% of
sale)
9.0% 14.6% 8.7% 8.7% Expect other expenses to remain stable
EBITDA 32,913 40,038 44,509 50,307
EBITDA Margin 14.9% 15.5% 15.2% 15.2%
Expect EBITDA margins to expand given the above assumptions
Tax rate 23.4% 26.7% 28.0% 29.0%
Tax rate to increase going forward and the company will be a full
tax paying company in FY16
Contribution from
subsidiaries
993 1,092 1,201 1,321
Growth (%) NA 10.0% 10.0% 10.0%
Expect 10% CAGR in contribution from subsidiaries
Net Profit margin 11.6% 12.4% 11.4% 11.4% Higher taxes to keep growth in net margins subdued
Balance Sheet
Capex 521 3,971 2,500 2,500
Capital Work in
Progress
2,155 2,000 2,000 2,000
No material capex requirements expected over FY12-15
Working Capital days (55) (58) (56) (56) Expect working capital days to remain stable
Debtor days 11 12 12 12
Expect debtor days to reduce in FY12 (given lower CSD sales) and
to increase in FY13 (given higher modern trade contribution)
Current Liabilities days 91 89 90 90 Expect current liabilities days to remain stable
Inventory days 42 36 39 39 Expect inventory days to remain stable
Net debt/(cash) to
equity
(1.2) (1.4) (1.5) (1.5) No material changes in cash position expected
Cash flows (` mn)
Operating cash flows 32,139 41,792 39,589 45,936
Free cash flows 30,906 37,975 37,089 43,436
Expect free cash flows to increase strongly given low capex
requirements and negative working capital
Source: Ambit Capital research



Hindustan Unilever
Ambit Capital Pvt Ltd 53

Valuation
DCF valuation
Given the cash-generative nature of the business, we use a DCF-based model to
arrive at a fair value for HUL. The assumptions for the weighted average cost of
capital and terminal growth rates are shown in the exhibit below. We have
assumed zero debt on HULs balance sheet in the future given its strong cash
position and free-cash-flow-generative business; hence, the company has enough
surplus cash available on the balance sheet for capital expenditure in the future.
We use a three-stage DCF approach for HUL. Stage 1 includes explicit forecasts
for the income statement and balance sheet for the next five years with sales
CAGR of 13% and EPS CAGR of 13%. Stage 2 includes a decline in sales growth
over eight years from 13% in FY19 to 7% in FY26 i.e. sales CAGR of 10% and free
cash flow CAGR of 10% over this period. Stage 3 includes terminal growth
forecasts with a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `503/share (15% downside),
implying an FY14 P/E multiple of 31.6x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 22: Cash flow profiles for HUL (` mn)
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
50,000
C
Y
0
5
C
Y
0
6
C
Y
0
7
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
CFO (Rs mn) Free cash flow (Rs mn)

Source: Ambit Capital research
Exhibit 23: Return profiles for HUL (%)
0%
20%
40%
60%
80%
100%
120%
C
Y
0
5
C
Y
0
6
C
Y
0
7
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
-15%
-5%
5%
15%
25%
35%
ROE (%) (RHS) EBITDA margin (%)
EPS growth (%) Sales growth (%)

Source: Ambit Capital research
Relative valuation
HULs one-year forward P/E multiple of 37.3x is at a ~35% premium to its three-
year and five-year historical average of 27.0-28.0x. However, given the ongoing
and forthcoming drag on EBITDA margins as well as volume growth (HULs FY13-
15E EPS CAGR of 11% is one of the lowest in the sector), we believe that the extent
of this premium rating is not justified.
Unilevers open offer indicates the parent companys confidence in HULs long-
term leadership positioning in Indias fast growth consumption story. However, we
do not expect revenue and EPS CAGR to see any incremental benefits through the
parents increased ownership.
Moreover, its high cash generation is already factored into the price/cash flow
multiple, where the stock trades in line with the peer group average.
Exhibit 21: WACC calculation
for DCF on HUL
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.55
Equity risk premium (%) 7
Cost of equity (%) 12.4
Cost of debt (%) 12.0
Debt/Equity ratio (%) 0
Tax rate (%) 30
WACC (%) 12.4
Source: Company, Ambit Capital
research


Hindustan Unilever
Ambit Capital Pvt Ltd 54

Exhibit 24: One-year forward P/E bands for HUL
180
230
280
330
380
430
480
530
580
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
24x
27x
33x
30x
36x

Source: Ambit Capital research
Exhibit 25: One-year forward EV/EBITDA bands for HUL
180
230
280
330
380
430
480
530
580
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
19x
16x
25x
22x
28x

Source: Ambit Capital research
Exhibit 26: Sensitivity analysis
Bull case Base case Bear case
Revenue growth
Expect revenue growth of 14% over
FY13-23 driven by strong market share
gains across categories. Our terminal
growth rate assumption stands at 6%
Expect revenue growth of 12% over FY13-
23 led by strong growth of around 15% in
skin care, hair care and foods. Expect the
soaps, detergents and beverages to grow
slower at around 9% CAGR. Our terminal
growth rate assumption stands at 5%
Assume a revenue growth of 10% over
FY13-23 driven by no market share
gains in any category and losses in oral
care, skin care and coffee. Our
terminal growth rate assumption
stands at 4%
Operating margins
We assume EBITDA margin expansion of
30bps from 15.2% in FY14 to 15.5% in
FY17 led by higher benefit from
premiumisation (100bps over FY14-17)
and lower advertisement spends (by
30bps) offset by higher royalty payout
Expect EBITDA margins to contract by
20bps over FY14-17 to 15%, with 100bps
gross margin expansion to be partially
offset by increases in advertising spends
and royalty
Expect EBITDA margins to decline
70bps from 15.2% in FY14 to 14.5% in
FY17 led by higher advertising
expenditure due to high competitive
intensity and high royalty payout to the
parent
Fair value (`/share) 533 503 369
Upside/Downside -10% -15% -38%
Source: Ambit Capital research
Risks to our SELL stance
Recovery in sales of Fair & Lovely: We believe that increasing competitive
intensity and mass-market penetration levels for the price-sensitive Fair & Lovely
will restrict volume growth (to low single digits); however, any recovery in demand
as well as ability to absorb price increases by the market can boost revenues and
aid overall margins. (Recent price increases of 5-14% on the Fair & Lovely portfolio
led to volume declines.)
Reduction in competitive intensity can assist margins: We expect competitive
intensity to rise across categories given strong MNC balance sheets and increasing
A&P investments by local players. Reduction in competitive intensity will lead to the
opposite trend in advertisement spends and lead to a sharp improvement in
EBITDA margins.






Hindustan Unilever
Ambit Capital Pvt Ltd 55

Catalysts
Volume growth slowing down: 3QFY13 saw the first signs of a decline in
volume growth (5% growth vs 9% growth in 3QFY12); however, higher
competitive intensity along with an increase in penetration of most categories
in which HUL operates is likely to lead to further negative surprises around
valuation multiples warranted by HULs growth prospects.
Increasing competitive intensity to hit margins: Increasing competitive
intensity from LOreal, Nestle and P&G in the personal products, foods and
detergents space are likely to put pressure on market shares, which will lead to
HUL spending higher amounts on A&P. We expect a 30bps increase in A&P in
FY14.
Ambit vs consensus
Exhibit 27: Ambit vs consensus
Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments
FY14E

Net Sales (` mn) 292,085 288,312 1%
Our forecasts on the top-line are broadly
in line with consensus forecasts
EBITDA (` mn) 44,509 45,376 -2%
EPS (`/share) 15.4 16.7 -5%
We expect higher competitive intensity to
have a negative impact on EBITDA
margins through higher promotions and
advertisement spends
FY15E

Net Sales (` mn) 330,137 327,366 1%
Our forecasts on the top-line are broadly
in line with consensus forecasts
EBITDA (` mn) 50,307 51,995 -3%
We expect higher competitive intensity to
have a negative impact on EBITDA
margins through higher promotions and
advertisement spends
EPS (`/share) 17.5 18.5 -2%
We factor in a 100bps increase in tax
rate to 29% in FY15 due to lower
benefits from their tax exempt facility
Source: Ambit Capital research
Exhibit 28: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, HUL has reported excellent cash conversion, efficient management of working capital,
and low levels of loans and advances and contingent liabilities. Consequently, we give a high
rating to its accounting quality.
Predictability AMBER
Whilst HULs revenue growth has been fairly stable, the companys bottom-line has seen some
volatility, albeit generally there have been positive surprises over the past eight quarters.
Earnings momentum RED
In the past six months, consensus estimates have been downgraded by 6% for FY14 and 7% for
FY15.
Source: Ambit Capital research





Hindustan Unilever
Ambit Capital Pvt Ltd 56

Balance sheet (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Shareholders' equity 2,160 2,162 2,163 2,163 2,163
Reserves & surpluses 24,436 32,968 24,578 32,525 42,464
Total net worth 26,595 35,129 26,740 34,688 44,626
Deferred tax liability (2,097) (2,142) (2,048) (2,048) (2,048)
Total liabilities 24,499 32,987 24,692 32,640 42,578
Gross block 37,596 38,117 42,088 44,588 47,088
Net block 21,691 21,475 23,085 23,267 23,428
CWIP 2,888 2,155 2,000 2,000 2,000
Investments 12,607 24,382 23,307 38,307 46,307
Cash & equivalents 16,285 18,300 17,079 13,879 21,494
Debtors 9,432 6,790 8,335 9,603 10,854
Inventory 28,108 25,167 25,270 31,209 35,275
Loans & advances 8,167 8,820 10,326 12,003 13,567
Other current assets 354 353 3,676 3,201 3,618
Total current assets 62,345 59,429 64,685 69,895 84,808
Current liabilities 57,828 54,994 62,601 72,021 81,404
Provisions 17,203 19,459 25,784 28,808 32,561
Total current liabilities 75,031 74,453 88,385 100,829 113,965
Net current assets (12,687) (15,024) (23,700) (30,934) (29,157)
Miscellaneous - - - - -
Total assets 24,499 32,987 24,692 32,640 42,578
Source: Company, Ambit Capital research
Income statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income 197,355 221,164 258,102 292,085 330,137
% growth 11.3% 12.1% 16.7% 13.2% 13.0%
Operating expenditure 170,571 188,250 218,065 247,576 279,829
EBITDA 26,784 32,913 40,038 44,509 50,307
% growth -2.6% 22.9% 21.6% 11.2% 13.0%
Depreciation 2,208 2,183 2,360 2,318 2,339
EBIT 24,576 30,731 37,677 42,191 47,969
Interest expenditure 2 12 251 30 30
Non-operating income 2,729 2,783 6,069 4,001 5,243
Adjusted PBT 27,302 33,502 43,495 46,162 53,182
Tax 6,280 7,853 11,612 12,925 15,423
Adjusted PAT/ Net profit 21,022 25,649 31,883 33,236 37,759
% growth 0.6% 22.0% 24.3% 4.2% 13.6%
Extraordinaries (31) 77 - - -
Reported PAT / Net profit 21,053 25,572 31,883 33,236 37,759
Share of associates (99) 993 323 1,201 1,321
Adjusted Consolidated net profit 20,953 26,565 32,206 34,437 39,080
Reported Consolidated net profit 20,953 26,565 32,206 34,437 39,080
Source: Company, Ambit Capital research



Hindustan Unilever
Ambit Capital Pvt Ltd 57

Cash flow statement
Year to March FY11 FY12 FY13E FY14E FY15E
EBIT 27,304 33,514 43,746 46,192 53,212
Depreciation 2,208 2,183 2,360 2,318 2,339
Others 389 (58) (157) (30) (30)
Tax (6,280) (7,853) (11,612) (12,925) (15,423)
(Incr) / decr in net working capital (3,605) 4,353 7,454 4,034 5,838
Cash flow from operations 20,017 32,139 41,792 39,589 45,936
Capex (2,426) (1,233) (3,816) (2,500) (2,500)
(Incr) / decr in investments 34 (11,775) 1,076 (15,000) (8,000)
Others - - - - -
Cash flow from investments (2,392) (13,009) (2,741) (17,500) (10,500)
Interest paid (2) (12) (251) (30) (30)
Dividend paid (16,539) (17,546) (46,834) (27,847) (30,379)
Others (3,720) 444 6,813 2,588 2,588
Cash flow from financing (20,262) (17,115) (40,272) (25,289) (27,821)
Net change in cash (2,637) 2,016 (1,222) (3,200) 7,615
Closing cash balance 16,285 18,300 17,079 13,879 21,494
Free cash flow 17,591 30,906 37,975 37,089 43,436
Source: Company, Ambit Capital research
Ratio analysis
Year to March FY11 FY12 FY13 FY14E FY15E
Gross margin (%) 48.9% 46.9% 47.7% 48.4% 48.8%
EBITDA margin (%) 13.6% 14.9% 15.5% 15.2% 15.2%
EBIT margin (%) 13.8% 15.2% 16.9% 15.8% 16.1%
Net profit margin (%) 10.7% 11.6% 12.4% 11.4% 11.4%
Dividend payout ratio (%) 78.7% 68.4% 146.9% 83.8% 80.5%
Net debt: equity (x) (1.0) (1.2) (1.4) (1.5) (1.5)
Working capital turnover (x) (6.8) (6.6) (6.3) (6.5) (6.5)
Gross block turnover (x) 5.2 5.8 6.1 6.6 7.0
RoCE (%) 80.2% 83.1% 103.7% 108.3% 95.3%
RoE (%) 80.2% 83.1% 103.1% 108.2% 95.2%
Source: Company, Ambit Capital research
Valuation parameters
Year to March FY11 FY12 FY13 FY14E FY15E
EPS (`) 9.7 12.3 14.9 15.9 18.1
Diluted EPS (`) 9.7 12.3 14.9 15.9 18.1
Book value per share (`) 12.3 16.2 12.4 16.0 20.6
Dividend per share (`) 6.6 7.0 18.5 11.0 12.0
P/E (x) 61.1 48.0 39.7 37.2 32.8
P/BV (x) 48.1 36.4 47.9 36.9 28.7
EV/EBITDA (x) 47.1 38.3 31.5 28.5 25.0
Price/Sales (x) 6.5 5.8 5.0 4.4 3.9
Source: Company, Ambit Capital research


Consumer Goods June 04, 2013
Nestl
Bloomberg: NEST IN EQUITY
Reuters: NEST.NS
Accounting: GREEN
Predictability: AMBER
Earnings momentum: RED


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to December CY10 CY11 CY12 CY13E CY14E
Operating income (` mn) 62,547 74,908 83,023 94,569 109,304
EBITDA(` mn) 12,313 14,955 17,931 20,440 23,406
EBITDA Margin (%) 19.7% 20.0% 21.6% 21.6% 21.4%
Adjusted PAT(` mn) 8,187 9,615 10,679 11,886 13,952
Adjusted EPS (`) 84.9 99.7 110.8 123.3 144.7
RoE (%) 114.0% 90.3% 69.5% 60.3% 61.1%
P/E (x) 62.5 53.2 47.9 43.0 36.7
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `5,306
Target Price (March 14): `4,389
Previous TP: NA
Downside (%) 17%
EPS (CY13E): `123.3
Change from previous (%) NA
Variance from consensus (%) -2%
Stock Information
Mkt cap: `506bn/US$9,036mn
52-wk H/L: `5,544/4,300
3M ADV: `187mn/US$3.3mn
Beta: 0.5x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
11 10 16 5
Rel. to Sensex 7 3 -7 1
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Oct-12 J an-13 May-13
4200
4600
5000
5400
Sensex Nestle India

1-year forward P/E band chart
1000
1400
1800
2200
2600
3000
3400
3800
4200
4600
5000
5400
J
a
n
-
0
8
M
a
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-
0
8
S
e
p
-
0
8
F
e
b
-
0
9
J
u
n
-
0
9
O
c
t
-
0
9
M
a
r
-
1
0
J
u
l
-
1
0
N
o
v
-
1
0
M
a
r
-
1
1
A
u
g
-
1
1
D
e
c
-
1
1
A
p
r
-
1
2
A
u
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-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
2 1 x
4 1 x
3 6 x
3 1 x
2 6 x

Source: Bloomberg, Ambit Capital research
Attack on the nest eggs
Nestls leadership position in chocolates, baby foods, noodles and
premium coffees has historically been unchallenged; however, the
company has been facing increasing competition over the past 18
months from Ferrero and Cadburys in the chocolates segment, from
HUL in the premium coffee segment, and from ITC and HUL in the
noodles segment. Nestl will NOT be able to defend its market share
against this threat given its willingness to sacrifice volumes for EBITDA
margins. Also, Nestls biggest cash cow, the baby foods segment,
faces risk of market share loss from the increasing market presence of
Danone and Mead Johnson in the future. The stock is currently trading
at 43x CY13 P/E. We initiate coverage with a SELL stance.
Competitive position: STRONG Change to this position: STABLE
Market share loss across categories: Nestl is facing intense competition
from Ferrero and Cadburys in the chocolates segment, from ITC and HUL in
the noodles segment, and from HUL in the premium coffees segment. Nestl
did not face any competition in these categories over the past decade.
Moreover, Nestls focus on maintaining high EBITDA margins despite a loss
of sales growth momentum has meant that the company has reported volume
decline of 5% in milk products, 5% in beverages and 9% in chocolates in
CY12. Given the high competitive intensity, we expect the market share loss
for the company in these categories to continue in the future as well even if
macro-economic conditions are stable.
Competition to intensify in the baby foods segment over the long term:
The baby foods portfolio has been the biggest cash cow for Nestl given the
low advertising spends and weak competition until now. Whilst Nestl, Mead
Johnson and Danone dominate the global baby foods market, in India, the
market has historically had only two key playersNestl and Wockhardt
(brand Farex). However, in the coming months/years, Danone (targets to
double sales in three years through the Wockhardt acquisition) and Mead
Johnson (organic growth) are likely to expand their presence in India, given
the high birth rates and low penetration of baby foods in India.
Valuation: Nestl has a dominant presence in some of the fastest-growing
categories in the sector. Whilst this characteristic deserves a premium rating
for Nestl as compared to its peers, the stock currently trades at a 26%
premium to the sector average on P/E multiples. Given the headwinds
highlighted above across its portfolio both in the near term as well as the long
term, a smaller premium rating vs peers is justified. Our DCF-based valuation
generates a TP of `4,389/share (17% downside), an implied CY13 P/E
multiple of 35.6x and CY14 multiple of 29.4x.


Nestl India
Ambit Capital Pvt Ltd 59

Company Financial Snapshot
Profit and Loss (` mn)
CY12 CY13E CY14E
Net sales 83,023 94,569 109,304
Optg. Exp(Adj for OI.) 65,092 74,129 85,898
EBIDTA 17,931 20,440 23,406
Depreciation 2,772 3,327 3,220
Interest Expense 266 370 200
PBT 15,526 17,479 20,823
Tax 4,847 5,593 6,872
Adj. PAT 10,679 11,886 13,952
Profit and Loss Ratios

EBIDTA Margin % 21.6% 21.6% 21.4%
Adj Net Margin % 12.9% 12.6% 12.8%
P/E (X) 47.9 43.0 36.7
EV/EBIDTA (X) 29.0 25.2 21.8
Dividend Yield (%) 0.9% 1.4% 1.9%
Company Background
Nestl India is a subsidiary of Nestl S.A. of Switzerland, with
62.8% being held by the parent company. With seven
factories and a distribution reach of over 4mn outlets, the
company is the market leader in baby foods, noodles and
sauces.
The company has a presence in milk products and nutrition,
chocolates and confectionery, prepared dishes & cooking aids
and beverages. Its key brands include Nescaf, Maggi,
Everyday, KitKat and Cerelac, most of which are market
leaders in their respective categories.

Balance Sheet (` mn)
CY12 CY13E CY14E
Total Assets 51,639 55,700 56,281
Net Fixed Assets 35,484 35,716 34,696
Current Assets 12,507 16,336 17,936
Other Assets 3,649 3,649 3,649
Total Liabilities 51,639 55,700 56,281
Networth 17,984 21,466 24,212
Debt 10,502 8,000 2,000
Current Liabilities 21,532 24,614 28,449
Deferred Tax 1,621 1,621 1,621
Balance Sheet Ratios
ROE % 69.5% 60.3% 61.1%
ROCE % 41.0% 39.7% 47.8%
Net Debt/Equity 0.5 0.2 (0.1)
Equity/Total Assets 0.6 0.7 0.9
P/BV (X) 28.1 23.6 20.9

Cash Flow (` mn)

CY12 CY13E CY14E
PBT 15,526 17,479 20,823
Depreciation 2,772 3,327 3,220
Tax (4,847) (5,593) (6,872)
Change in Wkg Cap 718 1,301 1,978
Others 1,186 - -
CF from Operations 15,355 16,513 19,149
Capex (8,311) (3,559) (2,200)
Investments (2,305) - -
CF from Investing (10,616) (3,559) (2,200)
Change in Equity - - -
Debt 793 (2,502) (6,000)
Dividends (5,435) (8,404) (11,206)
Others - - -
CF from Financing (4,642) (10,906) (17,206)
Change in Cash 97 2,048 (256)



Maggis share of portfolio has increased whilst Nescafs
has declined over CY04-12
Nestl has amongst the best working capital cycles in
the FMCG space (days, FY13/CY12)
5%
10%
15%
20%
25%
30%
35%
40%
45%
Milk &
Nutrition
Beverages Packaged
Foods
Chocolates
CY04 CY06 CY08 CY10 CY12

(58)
(50)
(47)
(45)
30
46
(1)
(70)
(50)
(30)
(10)
10
30
50
70
H
U
L
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
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G
C
P
L
D
a
b
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M
a
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i
c
o

Source: Company, Ambit Capital research


Nestl India
Ambit Capital Pvt Ltd 60

Background
Exhibit 1: Nestls portfolio mix
Category Key brands
Key
competitors
Market
share rank
% of
domestic
turnover
CY09-11
growth
Milk Products
& Nutrition
Cerelac, Nan Lactogen, A+ Milk,
Slim Dahi, Milkmaid, Everyday
Dairy Whitener
Danone,
Amul,
Britannia
1 45% 20%
Beverages
Nescaf Classic, Nescaf Sunrise,
Nestea Iced tea
HUL 1* 13% 15%
Prepared
Dishes &
Cooking Aids
Maggi Noodles, Maggi Soups,
Maggi Sauces, Maggi Magic cubes
ITC, HUL 1 29% 27%
Chocolates
Kit Kat, Munch, Bar One, Polo,
Eclairs, Milky bar
Cadbury 2 13% 19%
Source: Ambit Capital research. Note:* pertains to value market share; HUL leads in volume market share.
As highlighted in the table above, Nestl enjoys a leadership position in most of
the product categories that it operates in. We estimate that around 70% of Nestls
revenues relate to products where it is a market leader.
Also, as shown in the chart below, Nestls portfolio mix has seen no change (over
CY03-11) in the proportion of revenues from milk/nutrition and chocolates whilst
the slow growth in beverages (Nescaf) has been offset by strong growth in
packaged foods (Maggi) over the past decade.
Exhibit 2: Maggis share of portfolio has increased as
Nescafs has declined over CY03-11 (%)
5%
10%
15%
20%
25%
30%
35%
40%
45%
Milk &
Nutrition
Beverages Packaged
Foods
Chocolates
CY04 CY06 CY08 CY10 CY12

Source: Company, Ambit Capital research
Exhibit 3: Segment volume growth for Nestl

-10%
-5%
0%
5%
10%
15%
20%
25%
30%
C
Y
0
4
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
Milk
Products
&
Nutrition
Beverage
s
Prepared
Dishes &
Cooking
Aids
Chocolat
es
Source: Company, Ambit Capital research
Exhibit 4: Market-leading portfolio across categories
Segment Market leadership
Milk Products & Nutrition Baby food, infant formula, dairy whitener
Beverages Instant coffee
Prepared Dishes & Cooking aids Instant noodles, sauces, paste and No.2 in sauces
Chocolates Wafer chocolates, white chocolates
Source: Company, Ambit Capital research
Nestls total distribution reach currently stands at around 4mn outlets. The
company had indicated that its focus will now be on generating distribution
efficiencies as against aggressive outlet expansion. Nestl has undertaken capacity
expansion over CY11 and CY12 to double capacity in almost every segment.



Nestl India
Ambit Capital Pvt Ltd 61

Exhibit 5: Distribution expansion by Nestl (mn outlets)
2.5
3.6
0.3
0.4
0.4
0.5
-
0.6
1.2
1.8
2.4
3.0
3.6
4.2
CY08 CY09 CY10 CY11 CY12
Distribution Addition

Source: Company, Ambit Capital research
Exhibit 6: Capex stepped up in CY11 and CY12 (` mn)
-
4,000
8,000
12,000
16,000
20,000
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
Capex Net Fixed Assets (RHS)

Source: Company, Ambit Capital research
SWOT analysis
Exhibit 7: SWOT analysis for Nestl
Strengths Weaknesses
Strong balance sheet support available from the parent for
expansion and market-building purposes. Nestl has invested
US$500mn in India over the past three years, which has been
funded through a low-cost loan (US$182mn) from the parent
company.
Strong brand equity supports the premium positioning of its
portfolio, enabling it to be one of the largest beneficiaries of
premiumisation. Nestls products sell at a premium to the
sector in baby foods, milk products, beverages and packaged
foods.
It is a market leader in segments like baby foods that have high
entry barriers (restriction on advertising under the Infant Milk
Substitute Act, 1992) and thus provides insulation from
competition.
Strict control over inventory (CY11 inventory days at 36) and
creditors (CY11 other current liabilities days at 49) helps Nestl
have amongst the best working capital cycles (CY11 working
capital cycle was -52 days) in its peer group.

Too much focus on margins leads to compromising
volumes and market share (volume growth in CY12 has
been in the low single digits, coupled with market share
losses as the company focused on expanding gross
margins which improved by 240bps YoY to 54.5%)
Response to competition has been weak, leading to loss of
market share in noodles, chocolates and coffee. Nestls
A&P spend was only 4.4% (in CY11) as against a sector
average of around 13%.
Opportunities Threats
Play on aspirational categories (such as baby foods, chocolates,
instant coffee and packaged foods) where high growth is
sustainable.
Access to the brand portfolio and the technology of the parent
company. The company has recently highlighted its intent to
enter the breakfast cereal space in India with its global brands.

Increasing competitive intensity across categories
(especially in noodles, coffee and chocolates by ITC, HUL
and Cadbury respectively) can force the company to
increase advertisement spend (we estimate a 100bps
increase in advertisement spend over CY11-13)
The company can be adversely affected if the slowdown in
packaged food growth sustains. Nestls volume growth
has declined from 17% in CY10 to around 3% in CY12.
We do not expect this to reverse in the near future until
discretionary spending returns.
Source: Company, Industry, Ambit Capital research



Nestl India
Ambit Capital Pvt Ltd 62

A well-managed business
The proportion of Nestls portfolio that is positioned as premium (around 70% of
total revenues) in its respective categories is amongst the highest in its peer group.
These premium products are Nescaf Classic, Maggi Atta Noodles, Nan, etc.
Whilst nominal per capita incomes in India have risen at around 13% over FY07-
12, Nestl has seen revenue CAGR of 22% over CY06-11. We expect the
proportion of premium products in the portfolio to rise to around 80% of revenues
(from 70% currently) over the next five years due to the following factors:
Benefits of a global footprint: Nestl's R&D has been a source of
competitive advantage at a global level. Moreover, the company recently set
up a new R&D centre in India to create India-specific new product innovations
with a focus on: (a) localisation; (b) technology; (c) cuisine; and (d) popularly
positioned products. This will help the company to enter new categories where
it does not have a presence currently and help localise its product offering.
Beyond its existing products in India, Nestls global portfolio of products
includes breakfast cereals, bottled water, frozen food, fruit and health drinks,
healthcare, ice creams, pet care and sports nutrition. However, note that
consumption trends in India are yet to evolve and to accept some of the
product categories on the companys global platform.
Tight control on working capital cycle: Nestl has improved its working
capital cycle significantly over the past decade (refer to the chart below) by
using its global expertise on working capital management and its tight control
over inventory and loans and advances. The company thereby generates
operating cash flows that are stronger than most of its MNC peers and well
ahead of its Indian counterparts.
Exhibit 8: Lower loans and advances helped in reducing
working capital cycle (days)
(55)
(50)
(45)
(40)
(35)
(30)
(25)
(20)
CY05CY06CY07CY08CY09CY10CY11CY12
6
8
10
12
14
16
18
20
22
Working Capital days (LHS) Loans and advances (RHS)

Source: Company, Ambit Capital research
Exhibit 9: Nestl has amongst the best working
capital cycles in the FMCG space (days, FY12/CY11)
(58)
(50)
(47)
(45)
30
46
(1)
(70)
(50)
(30)
(10)
10
30
50
70
H
U
L
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
e
G
C
P
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D
a
b
u
r
M
a
r
i
c
o

Source: Company, Ambit Capital research


Nestl India
Ambit Capital Pvt Ltd 63

Current valuation does not factor in
key risks
The stock is currently trading at CY13E P/E multiple of 43x, one of the richest
valuations in the consumer sector. Nestl deserves to trade at a premium to most
players in the FMCG sector given its strong cash generation and superior brand
recall and leadership control over some of the fastest-growing aspirational
consumption sectors currently in India. However, we believe that the current
valuations do not factor in the expected loss of market share by Nestl in some of
its key product categories, a phenomenon that Nestl has experienced in countries
outside India as well (China, for instance). We forecast a moderation in earnings
growth from 21% CAGR over CY07-12 to 14% over CY12-14.
Market share loss likely across several categories
Media reports and our discussions with primary data contacts suggest that Nestl
has lost significant market share in beverages (HUL is now the volume market
leader in instant coffee), chocolates (Nestls market share of around 20% in CY11
has slipped by at least 100-200bps in CY12) and noodles (Nestl is facing
pressure due to increased aggression from ITCs Yippee) over the past few
quarters. These market share losses have been driven by the following factors
(with the distinct likelihood of such trends continuing in the future):
Focus on margins rather than volumes
In the wake of moderation in discretionary consumption categories over the past
12 months (moderation in growth rates reported by Britannia, HULs food division,
Agro Tech Foods and United Spirits) and high food inflation over the past 18
months, Nestl has focused on operating margins rather than volume growth in
CY11 and CY12. Consequently, whilst most of its competitors have taken price
increases of 3-8% in CY12, Nestls price increases have been at 6-12%.
Aggressive price increases have led to a widening price gap between Nestl and
its competitors. Consequently, as shown in the chart below, over the past 18
months, Nestl has reported consistent declines in revenues and volumes for
steady gross margins. As a result, EPS CAGR for the company has moderated from
26% over CY07-10 to 16% over CY10-12.
Exhibit 10: Gross margins picked up from 3QCY11 whilst sales growth tapered off
49%
50%
51%
52%
53%
54%
55%
56%
4Q
CY09
1Q
CY10
2Q
CY10
3Q
CY10
4Q
CY10
1Q
CY11
2Q
CY11
3Q
CY11
4Q
CY11
1Q
CY12
2Q
CY12
3Q
CY12
4Q
CY12
1Q
CY13
-5%
0%
5%
10%
15%
20%
25%
30%
Volume Growth (RHS) Gross margins (LHS)
Revenue growth (RHS)

Source: Ambit Capital research




Nestl India
Ambit Capital Pvt Ltd 64

Exhibit 11: Category-wise volume, value and price growth in CY12
-10%
-5%
0%
5%
10%
15%
20%
Milk & Nutrition Beverages Packaged Foods Chocolates
Value Growth Volume Growth Realisation growth

Source: Company, Ambit Capital research
These declining volume and revenue trends clearly highlight high price elasticity of
demand for Nestls products despite the company having built strong brands in
each of its product categories. Therefore, we expect Nestl to continue losing
market share in the future even during periods of stable macro-economic factors.
High competitive intensity in coffee, packaged
foods and chocolates
Nestls product portfolio has seen increased competition across a large part of its
product portfolio as highlighted below:
Instant coffee (13% of revenues) Nescaf is NO longer the only
premium coffee: Aggressive campaigns by HUL for the Bru brand have
helped the company gain share against Nestls Nescaf despite a new
advertising campaign by Nestl. Also, HUL has launched new premium
variants like Bru Gold (launched in 2011) and Bru Exotica (launched in 2012)
to compete against Nescafs premium offering.
Packaged foods (28% of revenues) renewed aggression from ITC and
HUL: The company has lost market share in the noodles category owing to
high advertising spends by ITC for its Yippee brand and an inadequate
response from Nestl despite its new advertising campaign featuring the top
Indian celebrity, Mr. Amitabh Bachchan. Also, HULs Knorr Soupy Noodles
have been relaunched in 2012.
Chocolates (14% of revenues) Ferrero and Cadburys: Ferrero India has
reported over 30% YoY growth for the year-ending August 2012 against
Nestls CY12 YoY growth in chocolates of 8-10%. This has been due to a
combination of: (a) substantial increase in distribution reach of Ferrero Rocher
chocolates, Kinder Joy and Tic Tac; and (b) innovation-led promotions (like kids
toys inside Kinder Joy chocolates). Also, Cadburys has stepped up its
advertising push for Toblerone in the premium segment and for Perk (which
competes with Nestls highest-selling chocolate, Munch) in the mass segment.
Nestls advertising spends: Due to Nestls inability to advertise its nutrition
business under the Infant Milk Substitute Act, 1992, its overall advertisement
spends were at only 4.3% of sales in CY12. However, even after adjusting for the
baby foods business, Nestls advertising spend was at 5.2% of revenues in CY12,
well below its peer group average of 12-16%. We expect Nestls overall
advertisement spend to sales ratio to increase from 4.3% in CY12 to 5.4% in CY14
in response to this increase in competitive intensity (and we forecast revenue
growth for Nestl to rise to 17% over CY12-14). This increase in advertising
spends is likely to have a 5% negative impact on EPS for CY13 and CY14.


Nestl India
Ambit Capital Pvt Ltd 65

Exhibit 12: We expect advertisement expenses to rise in the wake of falling market
share
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
C
Y
0
4
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
C
Y
1
3
E
C
Y
1
4
E
4.2%
4.4%
4.6%
4.8%
5.0%
5.2%
5.4%
5.6%
Advertising & sales promotion (Rs mn) Adv as % of sales (%)

Source: Ambit Capital research
Competitive intensity likely to rise in baby foods
in the long term
The Baby foods segment currently forms around 20% of Nestls overall revenues.
However, with low advertising spends, weak competitive intensity and a strong
revenue growth rate of 20% in baby foods, this segment is the biggest cash cow
for Nestl.
Whilst globally, Nestl, Mead Johnson and Danone dominate the baby foods
market, in India, the market has historically had only two key playersNestl and
Wockhardt (brand Farex). However, over the past two years, the following steps
have been taken by its competitors:
Danones entry in the Indian baby food market was through its acquisition of
Wockhardts Farex brand in CY12. With a global presence in 137 countries,
Danone is a market leader in most Asia-Pacific countries. The company plans
to double its revenue in three years by consolidating its locally acquired brands
and then introducing select brands from its international nutrition portfolio.
Mead Johnson, a leader in baby foods in Asia and Latin America, with
brands including Enfamil, Enfagrow and Lactum, has set up an office in India.
The company is focused on emerging markets and plans to launch its baby
food portfolio in India.
Nestls strategy of focusing on price whilst allowing market share declines is
unlikely to help it respond to rising competitive intensity in the baby foods
category. Therefore, as the market penetration of baby foods increases in India,
we do not expect Nestls baby foods business to continue to be a cash cow for the
company in its current shape over the long term.
Due to a combination of the factors discussed above, we expect:
The milk product business to record a CAGR of 11% YoY over CY12-14
(marginally ahead of market growth) led by growth in value-added products
like Milkmaid and Dahi.
Increased aggression from Danone in its newly acquired baby food business to
lead to Nestls market share declining from 90% in CY11 to 87% in CY14
(nutrition segment growth of 17% CAGR over CY12-14).
Despite share losses in beverages during CY12 (we estimate 2%), we expect
Nestls strong brand equity and premium portfolio to help it recover its lost
share in CY13 and CY14 and record a CAGR of 14% over CY12-14.


Nestl India
Ambit Capital Pvt Ltd 66

Strong growth in the noodles and sauces space will likely make packaged
foods the fastest-growing category for Nestl (CAGR of 18% over CY12-14).
Market share reduction in chocolates to 18% in CY14 from 20% in CY11 due
to increased aggression from Cadbury could lead to revenue CAGR of 14% in
chocolates over CY12-14 for Nestl.
Overall revenue CAGR of 15% (vs 19% CAGR over CY07-12) and EPS CAGR of
14% (vs 21% CAGR over CY07-12) over CY12-14.
Exhibit 13: Category growth projections for Nestl
Category
Estimated Market
Share (CY11)
Estimated Market
Share (CY14)*
CAGR CY12-14
Milk Products NA NA 11%
Nutrition 90% 87% 17%
Beverages 49% 50% 14%
Prepared Dishes &
Cooking Aids
NA NA 18%
Chocolates 20% 18% 14%
Source: Ambit Capital research. * This is based on market share gains and category growth rates as
highlighted in our assumptions table in the following section.



Nestl India
Ambit Capital Pvt Ltd 67

Key assumptions
Exhibit 14: Key assumptions and estimates (` mn)

Contribution to
revenues
CY12 CY13E CY14E Comments
Profit and loss
Milk Products growth 27.2% 12.8% 10.0% 12.0%
Industry growth 12.8% 10.0% 12.0%
Market share related
growth
0.0% 0.0% 0.0%
Expect 11% CAGR in the milk products business over CY12-14.
Growth is likely to be driven by value added products like
milkmaid, dahi and dairy whiteners.
Nutrition growth 19.3% 18.7% 16.7% 17.1%
Industry growth 20.0% 18.0% 18.0%
Market share related
growth
-1.3% -1.3% -0.9%
Expect strong penetration led growth to sustain in the
segment. However, we expect Nestle to lose market share
going forward as Danone increases its India presence and
Mead Johnson looks to start distribution in India
Beverages growth 13.1% 5.1% 13.2% 14.4%
Industry growth 12.0% 12.0% 12.0%
Market share related
growth
-6.9% 1.2% 2.4%
Expect recovery in CY13-14 from share loss in CY12 led by
higher advertising spends and stronger brand specially in the
'100% coffee' segment leading to effective CAGR of 13% over
CY12-14
Prepared dishes and
cooking aids growth
28.3% 12.8% 16.2% 19.2%
Industry growth 12.8% 15.0% 18.0%
Market share related
growth
0.0% 1.2% 1.2%
Expect a CAGR of 17% over CY12-14 led by penetration led
growth in noodles and sauces under the Maggi brand
Chocolate and
Confectionery growth
13.6% 6.3% 13.8% 13.7%
Industry growth 15.0% 15.0% 15.0%
Market share related
growth
-8.7% -1.3% -1.3%
Expect further losses in market share as Nestle only
participates in the wafer chocolate segment and its
investments in the category are substantially lower than
market leader Cadbury
Gross Profit 45,259 51,742 60,023
Gross margin (%) 54.5% 54.7% 54.9%
Expect 40bps gross margin expansion over CY12-14 due to
improving product mix
Employee cost (% of sale) 8.0% 7.8% 7.7%
Expect higher employee costs in CY12 to reduce as Nestle
sees scale benefits from new plants in CY13-14
Advertising (% of sale) 4.3% 5.0% 5.3%
Expect advertising spends to increase going forward given
higher competitive intensity and share losses
Carriage & freight (% of sale) 4.6% 4.7% 4.7% Expect carriage and freight expenses to remain stable
Other expenses (% of sale) 15.0% 15.6% 15.8%
Expect other expenditure to normailse over CY13-14 after the
sudden drop in other expenditure in CY12
EBITDA 17,931 20,440 23,406
EBITDA Margin 21.6% 21.6% 21.4%
Expect EBITDA margins to remain flat over CY12-14 given
above assumptions
Tax rate 31.2% 32.0% 33.0%
Tax rate to increase in CY13 given higher surcharge and
marginally henceforth as benefits from the Pantnagar plant
expire
Net Profit margin 12.9% 12.6% 12.8%
Expect net margins to decline marginally over CY12-14 given
higher depreciation expense from new plants and increase in
tax rate
Balance Sheet (` mn)
Capex 18,753 6,000 2,200
Capital Work in Progress 3,441 1,000 1,000
Material capex undertaken in CY12, to be completed by CY13
Working Capital days (50) (49) (49) Expect working capital days to remain stable
Debtor days 4 4 4 Expect debtor days to remain stable
Current Liabilities days 48 48 48 Expect current liabilities days to remain stable
Inventory days 33 34 34 Expect inventory days to remain stable
Net debt/(cash) to equity 0.5 0.2 (0.1) Expect company to turn debt free in CY14
Cash flows (` mn)
Operating cash flows 15,355 16,513 19,149
Free cash flows 7,044 12,954 16,949
Expect free cash flows to grow strongly CY13 onwards once
capex is through
Source: Ambit Capital research


Nestl India
Ambit Capital Pvt Ltd 68

Valuation
DCF valuation
The assumptions for the weighted average cost of capital and terminal growth
rates are shown in the exhibit below. We have assumed the company to be debt-
free, because the strong cash flow generation will lead to Nestl turning into a net
cash company in CY14. Hence, the company would have enough surplus cash
available on its balance sheet for capital expenditure in the future.
We use a three-stage DCF approach for Nestl. Stage 1 includes explicit forecasts
for the income statement and balance sheet for the next five years with sales
CAGR of 15% and EPS CAGR of 16%. Stage 2 includes a decline in sales growth
over eight years from 16% in CY17 to 6% in CY26 i.e. sales CAGR of 10% and a
free cash flow CAGR of 10% over this period. Stage 3 includes terminal growth
forecasts with a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `4,389/share (17% downside),
implying an CY13 P/E multiple of 34.6x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 16: Cash flow profiles for Nestl (` mn)
(6,000)
(2,000)
2,000
6,000
10,000
14,000
18,000
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
C
Y
1
3
E
C
Y
1
4
E
CFO (Rs mn) Free Cash Flow (Rs mn)

Source: Ambit Capital research
Exhibit 17: Return profiles for Nestl (%)
0%
5%
10%
15%
20%
25%
30%
35%
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
C
Y
1
3
E
C
Y
1
4
E
60%
70%
80%
90%
100%
110%
120%
130%
ROE
(RHS)
EPS
Growth
Sales
growth
EBITDA
Margin

Source: Ambit Capital research
Relative valuation
Nestl has been the premium rated stock in the FMCG sector historically. Whilst its
premium rating has been justified because it has had: (a) one of the highest EPS
CAGR of 21% in the sector over CY07-12; (b) one of the most-efficient working
capital cycles, leading to high cash generation; and (c) an unchallenged leadership
position in its categories of operation such as chocolates, premium coffee, noodles
and baby foods. However, we expect the extent of the premium that Nestl
deserves to be lower going forward due to the likelihood of market share loss
across chocolates, noodles and beverages given intensifying competition amidst
Nestls focus on margins.
The company has recently invested around `20bn on capacity expansion, doubling
its capacity in almost every segment, and thus, Nestl will see efficient utilisation
of capacity only after a while, considering the weak volume growth in the current
environment. The effect of this expansion is likely to lead to a decline in its RoCEs
from 109% in CY10 to 48% in CY14 and to a decline in its RoEs from 114% in
CY11 to 61% in CY14.
Exhibit 15: WACC calculation
for DCF on Nestle
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.52
Equity risk premium (%) 7.0
Cost of equity (%) 12.1
Cost of debt (%) 12.0
Debt/Equity ratio (%) 0.0
Tax rate (%) 30.0
WACC (%) 12.1
Source: Company, Ambit Capital
research


Nestl India
Ambit Capital Pvt Ltd 69

Risks to our SELL stance
Strong recovery in demand: With the overall demand environment for
packaged foods currently under pressure, a strong recovery in demand for
packaged foods is likely to have a positive impact on volume growth for Nestl
and arrest the volume decline.
Market share gains in beverages and chocolates: Whilst CY12 has seen
strong market share declines for Nestl across categories (especially beverages
and chocolates), any reversal in the trend will help Nestl see a recovery in volume
growth.

Exhibit 18: One-year forward P/E bands for Nestl

1000
1400
1800
2200
2600
3000
3400
3800
4200
4600
5000
5400
J
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M
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J
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1
3
M
a
y
-
1
3
21x
41x
36x
31x
26x

Source: Ambit Capital research
Exhibit 19: One-year forward EV/EBITDA bands for
Nestl
1000
1400
1800
2200
2600
3000
3400
3800
4200
4600
5000
5400
J
a
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8
M
a
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8
S
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F
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O
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J
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N
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M
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3
13x
16x
19x
22x
25x

Source: Ambit Capital research
Exhibit 20: Sensitivity analysis
Bull case Base case Bear case
Revenue
growth
In our bull case, we model a revenue
CAGR of around 17% over CY12-22 led
by market share gains in beverages and
packaged foods and no market share
losses in any category. Our terminal
growth rate assumption stands at 6%
Expect revenue growth of 15% over CY12-
22 led by strong growth in the baby food
segment (despite small market share
losses) and prepared dishes and cooking
aids segment. Expect slower growth in the
milk products segment. Our terminal
growth rate assumption stands at 5%
Expect revenue growth of 13% over CY12-
22 led by market share losses in baby
foods and chocolates and no market share
gains in any categories. Our terminal
growth rate assumption stands at 4%
Operating
margins
We assume EBITDA margin expansion of
70bps over CY12-16 to 22.3%, entirely
led by gross margin expansion due to
premiumisation of the portfolio
Expect EBITDA margins to expand by 30bps
over CY12-17 to 20.9%, with gross
margin expansion of 80bps to be partially
offset by increases in advertising spends
Expect EBITDA margins to decline 80bps
from 21.6% in CY12 to 20.8% in CY16 due
to competitive-intensity-led increase in
advertising spends and no increase in
gross margins
Fair value
(`/share)
5,424 4,389 3,503
Upside/
Downside
2% -17% -34%
Source: Ambit Capital research








Nestl India
Ambit Capital Pvt Ltd 70

Ambit vs consensus
Exhibit 21: Ambit vs consensus
Ambit vs Consensus Ambit Consensus Divergence from consensus Comments
FY14E

Net Sales (` mn) 94,569 94,889 0%
Our forecasts are in line with consensus expectations
EBITDA (` mn) 20,440 21,237 -4%
Increase in advertisement spends due to competitive
intensity to affect EBITDA margins
EPS (`/share) 123.3 125.2 -2%
Higher depreciation from the capex undertaken is likely
to impact net profit
FY15E

Net Sales (` mn) 109,304 111,255 -2%
Expect market share losses in chocolates and nutrition
to lead to growth that is lower than consensus
expectations
EBITDA (` mn) 23,406 24,727 -5%
Increase in advertisement spends due to competitive
intensity to affect EBITDA margins
EPS (`/share) 144.7 148.3 -2%
Above impact on EBITDA likely to flow down to the net
profit level
Source: Ambit Capital research
Catalysts
Slowdown in revenue growth may sustain: Whilst volume growth in CY12
was in the low single digits, we believe a sustained slowdown in discretionary
spending will lead to volume growth remaining at subdued levels which could
be a potential trigger for the stock to be derated.
EBITDA margin contraction: Rising competitive intensity might likely lead to
Nestl deviating from its current strategy of focussing on gross margins. The
company may take pricing actions to support its historical volume growth
trajectory, which could also be supported by a large increase in its advertising
spends which currently are amongst the lowest in the industry.
Exhibit 22: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, Nestl has reported excellent cash conversion, efficient management of working
capital, and low levels of loans and advances and contingent liabilities. Consequently, we give a
high rating to its accounting quality.
Predictability AMBER
With discretionary spending under pressure over the past few quarters, Nestls revenue growth
has been well below the FMCG average and consensus estimates. However, EBITDA margins have
been more stable, within a 200bps band.
Earnings momentum RED
In the last six months, consensus estimates have been downgraded by 3% for FY14 and 5% for
FY15.
Source: Ambit Capital research


Nestl India
Ambit Capital Pvt Ltd 71

Balance sheet (` mn)
Year to December CY10 CY11 CY12 CY13E CY14E
Shareholders' equity 964 964 964 964 964
Reserves & surpluses 7,590 11,775 17,020 20,502 23,247
Total net worth 8,554 12,739 17,984 21,466 24,212
Debt - 9,709 10,502 8,000 2,000
Deferred tax liability 333 435 1,621 1,621 1,621
Total liabilities 8,887 22,883 30,107 31,087 27,832
Gross block 18,547 25,522 44,276 50,276 52,476
Net block 10,127 15,758 32,043 34,716 33,696
CWIP 3,489 14,186 3,441 1,000 1,000
Goodwill - - - - -
Investments 1,507 1,344 3,649 3,649 3,649
Cash & equivalents 2,553 2,272 2,369 4,417 4,161
Debtors 633 1,154 876 1,036 1,198
Inventory 5,760 7,340 7,456 8,809 10,182
Loans & advances 1,514 1,961 1,796 2,073 2,396
Other current assets - 3 10 - -
Total current assets 10,460 12,730 12,507 16,336 17,936
Current liabilities 7,617 10,096 10,974 12,436 14,374
Provisions 9,079 11,038 10,558 12,177 14,075
Total current liabilities 16,696 21,135 21,532 24,614 28,449
Net current assets (6,236) (8,404) (9,025) (8,278) (10,513)
Total assets 8,887 22,883 30,107 31,087 27,832
Source: Company, Ambit Capital research
Income statement (` mn)
Year to December CY10 CY11 CY12 CY13E CY14E
Operating income 62,547 74,908 83,023 94,569 109,304
% growth 21.9% 19.8% 10.8% 13.9% 15.6%
Operating expenditure 50,235 59,953 65,092 74,129 85,898
EBITDA 12,313 14,955 17,931 20,440 23,406
% growth 24.1% 21.5% 19.9% 14.0% 14.5%
Depreciation 1,278 1,533 2,772 3,327 3,220
EBIT 11,035 13,421 15,159 17,113 20,187
Interest expenditure 11 51 266 370 200
Non-operating income 427 509 633 736 837
Adjusted PBT 11,451 13,879 15,526 17,479 20,823
Tax 3,264 4,264 4,847 5,593 6,872
Adjusted PAT/ Net profit 8,187 9,615 10,679 11,886 13,952
% growth 25.0% 17.5% 11.1% 11.3% 17.4%
Extraordinaries - - - - -
Reported PAT / Net profit 8,187 9,615 10,679 11,886 13,952
Adjusted Consolidated net profit 8,187 9,615 10,679 11,886 13,952
Reported Consolidated net profit 8,187 9,615 10,679 11,886 13,952
Source: Company, Ambit Capital research



Nestl India
Ambit Capital Pvt Ltd 72

Cash flow statement (` mn)
Year to December CY10 CY11 CY12E CY13E CY14E
EBIT 11,462 13,930 15,792 17,849 21,023
Depreciation 1,278 1,533 2,772 3,327 3,220
Others 2 51 920 (370) (200)
Tax (3,264) (4,264) (4,847) (5,593) (6,872)
(Incr) / decr in net working capital 1,575 1,887 718 1,301 1,978
Cash flow from operations 11,052 13,138 15,355 16,513 19,149
Capex (5,136) (17,861) (8,311) (3,559) (2,200)
(Incr) / decr in investments 526 163 (2,305) - -
Cash flow from investments (4,610) (17,698) (10,616) (3,559) (2,200)
Net borrowings - 9,709 793 (2,502) (6,000)
Interest paid 11 51 266 370 200
Dividend paid (5,448) (5,430) (5,435) (8,404) (11,206)
Others (8) (51) (266) (370) (200)
Cash flow from financing (5,445) 4,279 (4,642) (10,906) (17,206)
Net change in cash 997 (281) 97 2,048 (256)
Closing cash balance 2,553 2,272 2,369 4,417 4,161
Year to March 5,916 (4,723) 7,044 12,954 16,949
Source: Company, Ambit Capital research
Ratio analysis
Year to December CY10 CY11 CY12 CY13E CY14E
Gross margin (%) 51.1% 52.1% 54.5% 54.7% 54.9%
EBITDA margin (%) 19.7% 20.0% 21.6% 21.6% 21.4%
EBIT margin (%) 18.3% 18.6% 19.0% 18.9% 19.2%
Net profit margin (%) 13.1% 12.8% 12.9% 12.6% 12.8%
Dividend payout ratio (%) 66.5% 56.5% 50.9% 70.7% 80.3%
Net debt: equity (x) (0.3) 0.6 0.5 0.2 (0.1)
Working capital turnover (x) (7.1) (7.0) (7.3) (7.4) (7.4)
Gross block turnover (x) 3.4 2.9 1.9 1.9 2.1
RoCE (%) 109.1% 60.8% 41.0% 39.7% 47.8%
RoE (%) 114.0% 90.3% 69.5% 60.3% 61.1%
Source: Company, Ambit Capital research
Valuation parameters
Year to December CY10 CY11 CY12E CY13E CY14E
EPS (`) 84.9 99.7 110.8 123.3 144.7
Diluted EPS (`) 84.9 99.7 110.8 123.3 144.7
Book value per share (`) 88.7 132.1 186.5 222.6 251.1
Dividend per share (`) 48.5 48.5 48.5 75.0 100.0
P/E (x) 62.5 53.2 47.9 43.0 36.7
P/BV (x) 59.8 40.2 28.4 23.8 21.1
EV/EBITDA (x) 41.3 34.7 29.0 25.2 21.8
Price/Sales (x) 8.2 6.8 6.2 5.4 4.7
Source: Company, Ambit Capital research

Consumer Goods June 04, 2013
Godrej Consumer
Bloomberg: GCPL IN EQUITY
Reuters: GOCP.NS
Accounting: GREEN
Predictability: AMBER
Earnings momentum: RED


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income (` mn) 36,461 48,662 64,074 78,636 90,185
EBITDA(` mn) 6,438 8,554 9,824 13,401 15,730
EBITDA Margin (%) 17.7% 17.6% 15.3% 17.0% 17.4%
Adjusted PAT(` mn) 5,147 7,268 7,961 9,108 10,910
Adjusted EPS (`) 14.9 15.5 19.6 26.8 32.1
RoE (%) 35.9% 24.3% 23.4% 26.9% 27.3%
P/E (x) 58.6 56.4 44.5 32.6 27.2
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `873
Target Price (Mar 14): `792
Previous TP: NA
Downside (%) 9%
EPS (FY14E): `26.8
Change from previous (%) NA
Variance from consensus (%) 3%
Stock Information
Mkt cap: `297bn/US$5,263mn
52-wk H/L: `965/465
3M ADV: `176mn/US$3.1mn
Beta: 0.6x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
4 17 55 21
Rel. to Sensex
4 13 33 20
Performance (%)
14,000
16,000
18,000
20,000
22,000
J un-12 Oct-12 J an-13 May-13
400
600
800
1000
Sensex Godrej Consumer

1-year fwd P/E band charts
100
200
300
400
500
600
700
800
900
A
p
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7
A
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14x
18x
22x
26x
30x

Source: Bloomberg, Ambit Capital research
Capital allocation concerns
Godrej Consumers (GCPL) domestic business is highly cash-
generative, with a constantly evolving product portfolio across soaps,
insecticides and hair colours, which is likely to help GCPL gain market
share in each of these categories over FY13-15. However, our analysis
on capital allocation towards M&A of foreign subsidiaries (just under
50% of consolidated revenues) suggests sub-par returns along with a
high risk of drag from integration hurdles, economic/infrastructural
uncertainties and acquisition of more such entities in the future. Our
DCF generates a fair value of `792, 9% downside. We initiate coverage
with a SELL stance.
Competitive position: MODERATE Change to this position: STABLE
Strength of the domestic franchise: GCPLs domestic business is highly
cash-generative, with a negative net working capital. Whilst operational
efficiencies targeted through the Sara Lee acquisition are yet to be fully
exploited, the company is likely to gain market share across soaps, home
insecticides, and hair care. This will be driven by: (a) premiumisation of its
soaps portfolio through the relaunch of Cinthol in a fully penetrated soaps
market; (b) expansion of the hair colour portfolio through the crme format;
and (c) distribution expansion and frequent innovation in its insecticides
portfolio. Also, in FY13, the company has launched a wide range of new
products such as air fresheners, shower gels, and deodorants.
Surplus capital deployment not value generative: ~60% of GCPLs
capital generated over the past five years has been deployed towards M&A,
predominantly outside India, thereby leading to a reduction in the dividend
payout ratio from ~90% to ~30% and reduction in RoCE from 51% to 13%
over this period. Our analysis suggests that the incremental returns generated
on this capital retained have been lower than the cost of equity of 13% so far.
Also, the management is likely to continue exploring such opportunities in
emerging markets over the longer term. The Group has successfully integrated
the Indonesian business and has derived synergies mainly relating to raw
material procurement; however, the smooth integration of the African and
Latin American businesses in the coming quarters faces substantial risk of drag
from economic/infrastructural uncertainties and intense competition from
incumbents. Evidence of this is visible in the high volatility of margins reported
by these businesses over the past eight quarters.
Valuation: GCPL currently trades at 32.6x FY14 P/E, at a 15% premium to its
three-year historical average on one-year forward P/E multiples. This multiple
is at a 12% discount to the broader FMCG peer group average which we
believe is warranted given the inefficient capital allocation history. Our DCF-
based valuation generates a TP of `792/share (9% downside), implying FY14
P/E multiple of 29.6x.


Godrej Consumer Products
Ambit Capital Pvt Ltd 74

Company Financial Snapshot
Profit and Loss (consolidated) (` mn)
FY13 FY14E FY15E
Net sales 64,074 78,636 90,185
Optg. Exp(Adj for OI.) 54,251 65,234 74,455
EBITDA 9,824 13,401 15,730
Depreciation 770 904 907
Interest Expense 775 679 429
PBT 8,957 12,597 15,290
Tax 1,792 2,897 3,670
Adj. PAT 7,961 9,108 10,910
Profit and Loss Ratios
EBIDTA Margin % 15.3% 17.0% 17.4%
Adj Net Margin % 11.2% 12.3% 12.9%
P/E (X) 44.5 32.6 27.2
EV/EBIDTA (X) 31.3 22.5 18.7
Dividend Yield (%) 0.7% 0.9% 1.1%
Company Background
Godrej Consumer, a household and personal care products
company, is a leader in the insecticides space with key
brands such as Good Knight and HIT (Insecticides), Cinthol
and Godrej No.1 (Soaps) and Expert (Hair Care).
Through a flurry of international acquisitions, the company
has a sizable presence in Africa, Latin America, Indonesia
and the UK, with the bulk of its investments made in hair
care. The firms overseas businesses now account for 40% of
revenues.
The company is promoted by the conglomerate, Godrej
Group, which holds 64% of equity and is professionally
managed.
Balance Sheet (consolidated) (` mn)
FY13 FY14E FY15E
Total Assets 76,811 82,869 86,913
Net Fixed Assets 17,285 17,380 17,473
Current Assets 30,441 36,404 40,356
Other Assets 29,085 29,085 29,085
Total Liabilities 76,811 82,869 86,913
Networth 33,130 39,064 46,006
Debt 19,486 14,486 6,986
Current Liabilities 24,334 29,459 34,061
Deferred Tax (140) (140) (140)
Balance Sheet Ratios
ROE % 23.4% 26.9% 27.3%
ROCE % 15.1% 18.4% 21.2%
Net Debt/Equity 0.3 0.1 (0.1)
Equity/Total Assets 0.6 0.7 0.8
P/BV (X) 8.5 7.2 6.1
Cash Flow (consolidated) (` mn)

FY13 FY14E FY15E
PBT 8,957 12,597 15,290
Depreciation 770 904 907
Tax (1,792) (2,897) (3,670)
Change in Wkg Cap 8,475 9,905 9,964
Others (2,806) (9,741) (9,286)
CF from Operations 13,604 10,768 13,206
Capex (9,845) (1,000) (1,000)
Investments - - -
CF from Investing (9,845) (1,000) (1,000)
Change in Equity - - -
Debt 717 (5,000) (7,500)
Dividends (2,381) (3,174) (3,968)
Others 194 (592) (710)
CF from Financing (1,470) (8,766) (12,178)
Change in Cash 2,289 1,001 28

Revenue contribution of soaps declined from 63% in FY05
to 21% in FY12 (%)
Quarterly revenue growth trends for soaps and
insecticides (%)
0%
20%
40%
60%
80%
100%
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
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8
F
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0
9
F
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1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
Others
International
Home
insecticides
Hair care
Soaps

5%
10%
15%
20%
25%
30%
35%
40%
45%
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Soaps Home insecticides

Source: Company, Ambit Capital research


Godrej Consumer Products
Ambit Capital Pvt Ltd 75

Background
From a domestic soap manufacturer to an emerging market MNC
Over the past decade, Godrej Consumer (GCPL) has evolved from a domestic
market soap manufacturer to a diversified emerging market MNC. The proportion
of soaps in GCPLs consolidated revenues has reduced to ~20% in FY13 from 63%
in FY05. This transition has happened predominantly due to the Sara Lees
acquisition of the home insecticides portfolio and a series of international
acquisitions since 2005 across Africa, Latin America, Indonesia and the UK. The
company has seen strong market share gains in the soaps segment (share up by
100bps to 11%) and home insecticides segment (share up by 350bps to 40%) in
FY12. The company is the market leader in home insecticides, powder hair dyes
and liquid detergents.
Sara Lee: After the company acquired Sara Lees 51% stake in their JV in May
2010 (renamed as Godrej Household Products - GHPL), the access to increased
distribution network and the home insecticides (29% of FY12 consolidated
revenues) portfolio of GHPL helped GCPL further diversify the distribution of their
domestic business. GHPL was subsequently merged into GCPL in FY11.
International acquisitions: Whilst GCPLs international ambitions took off in
2005 with an acquisition in the UK (Keyline brands), 2010 was the turning point
for its global aspirations, with four acquisitions across emerging markets (Africa,
Latin America and Indonesia).
Exhibit 1: Revenue contribution of soaps down from 63% in FY05 to 21% in FY12
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
Others
International
Home
insecticides
Hair care
Soaps

Source: Company, Ambit Capital research.
Exhibit 2: Godrej Consumers domestic portfolio mix (FY13)
Category Key brands Key competitors
% of domestic
turnover
% of overall
turnover
FY10-12
CAGR
Insecticides GoodKnight, Hit SC Johnson, Reckitt Benckiser 45% 25% 26%*
Soaps Godrej No. 1, Cinthol HUL, Wipro, Reckitt Benckiser 35% 20% 15%
Hair Colour Godrej Expert, Renew
L'Oreal, Cavin Care, Hygiene
Research Institute
10% 6% 11%
Liquid Detergents/
Exports
Ezee, Genteel, Godrej Dish Wash Amway, HUL 10% 6% 38%
Source: Ambit Capital research. Note: *FY12 growth, as the business was acquired in FY11






Godrej Consumer Products
Ambit Capital Pvt Ltd 76

Exhibit 3: Godrej Consumers international portfolio mix
Geography Category Presence Key brands
% of global
turnover
% of overall
turnover
Indonesia
Insecticides, baby
wipes, air fresheners
Hit Magic, Mitu, Stella 44% 20%
Africa Haircare, skincare Inecto, Tura, Kinky, Darling 25% 11%
Latin America
Haircare, skincare,
colour cosmetics
Pamela Grant, U2, Roby, Ilicit,
919, Issue, Villeneuve
19% 8%
UK Haircare, skincare
Touch of Silver, Cuticura, Soft
& Gentle
10% 4%
Source: Company, Ambit Capital research
Distribution: Godrejs distribution network spans across more than 5mn outlets in
FY13. It added more than 0.6mn outlets in FY12. The company is planning to use
the Darling Groups distribution network in Africa to launch home insecticides in
Nigeria.
SWOT analysis
Exhibit 4: SWOT analysis for Godrej Consumer
Strengths Weaknesses
Investments in talent (recruitments from top management
colleges) over the past 4-5 years have led to the creation of a
strong team and processes.
Access to technology from its global portfolio (Eg. using the
crme format hair colour technology from its LatAm business)
will enable the company to launch new products across markets
that it operates in.
Has a strong distribution network in emerging markets especially
Africa where it can cross sell products from other markets.
It is a market leader in household insecticides, a segment that
has high entry barriers (due to cumbersome and time consuming
regulatory approvals). It continues to deliver strong market share
gains in the category (42% market share in FY12).

Management of working capital has been poorer than its
MNC counterparts. However, this is due to the
acquisitions made by the company over the past five
years. The domestic business enjoys a negative working
capital unlike its other domestic peers.
Lack of scale in its Latin American and European markets
puts margin pressure on the company when competitive
intensity rises.

Opportunities Threats
Shifting its portfolio from being dominant on the low-growth
soaps category to higher-growth markets like hair care and
insecticides (contribution from soaps is down from 63% in FY05
to ~20% in FY13E).
Potential upsides from ability to gain operational synergies in its
emerging market acquisitions and leverage their distribution
channels.

Increasing competitive intensity, especially in categories
like hair colours, where there is a strong MNC presence
can force the company to increase advertisement spends
(A&P spends have risen from 9.9% in FY09 to 12.1% in
FY12).
With most of its soaps portfolio (we estimate over 80%) in
the low-value category, it is sensitive to raw material price
fluctuations.
Source: Industry, Company, Ambit Capital research








Godrej Consumer Products
Ambit Capital Pvt Ltd 77

Strong foothold of the domestic
operations
Over the past eight quarters, the soaps and insecticides businesses have delivered
above market growth, averaging 24% (market growth of around 15%) and 27%
(market growth of around 12%) respectively. We believe GCPL has gained around
200bps market share in soaps (increase from 10% to 12%) and more than 500bps
market share in home insecticides (from 37% to 42%) over the past eight quarters.
Exhibit 5: Quarterly growth trends for soaps and insecticides (%)
5%
10%
15%
20%
25%
30%
35%
40%
45%
D
e
c
-
1
0
M
a
r
-
1
1
J
u
n
-
1
1
S
e
p
-
1
1
D
e
c
-
1
1
M
a
r
-
1
2
J
u
n
-
1
2
S
e
p
-
1
2
D
e
c
-
1
2
M
a
r
-
1
3
Soaps Home insecticides

Source: Company, Ambit Capital research
We expect market share gains to continue for GCPL in each of the three categories
of presence in India soaps, home insecticides and hair colour due to the
following strengths:
Insecticide segment: We expect the `30bn insecticides market to increase
12%-14% over FY12-15, as it increases penetration especially in the rural
areas (59% urban penetration and 18% rural penetration) and the frequency
of consumption increases. The acquisition of Sara Lee has provided GCPL with
a strong portfolio of household insecticides under the brand name HIT. This
segment contributes to around 47% of the total domestic revenues for GCPL.
Moreover, GCPL plans to achieve between `2.0bn and 2.5bn of cost synergies
over FY11-15 by leveraging on operational and supply chain efficiencies of the
Sara Lee business. This is likely to help gain market share from Reckitt
Benckiser and SC Johnson.
Godrej Expert portfolio expansion: The firms hair colour portfolio has
expanded with the companys entry into crme format hair colour by
leveraging on the technological access through its Latin American acquisition
in 2010.
Cinthol relaunch: Premiumisation of its soap portfolio through the relaunch
of Cinthol, which has now been repositioned as a premium brand.
Product innovation and new launches: In addition to the Godrej Expert
crme format and Cinthols rebranding, the company has launched a range of
new products, as highlighted in the table below. This includes its entry into air
fresheners, hand sanitisers, shower gels, and deodorants this year.






Godrej Consumer Products
Ambit Capital Pvt Ltd 78

Exhibit 6: Recent new launches by GCPL in India
Launch Use
New product/
Product Extension
Category
Good Knight Naturals Mosquito cream New product Home care
Good Knight Advanced Low
Smoke Coil
Repellent coil Product extension Home care
Godrej No.1 (new variants) Soap Product extension Personal wash
Godrej Protekt Hand sanitizer New product Others
Godrej Expert Care Hair colour Product extension Hair care
Godrej Expert Advanced Hair colour Product extension Hair care
Godrej Expert Rich Crme Hair colour New product Hair care
Cinthol Soaps (new variants) Soap Product extension Personal wash
Cinthol Deodorants Deodorants Re launched Others
Cinthol Shower Gel Shower gel New product Personal wash
Aer Air freshener New product Others
Hit Anti-Roach Gel Gel format insecticide New product Home care
Source: Ambit Capital research
Investments behind talent: Based on our primary data checks, over the past
couple of years, Godrej has started focusing on attracting the best possible
talent available and is revamping the business across functions and getting
processes in order.
Exhibit 7: Increasing investments in talent
-
1,000
2,000
3,000
4,000
5,000
6,000
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
5.0%
5.5%
6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
9.0%
9.5%
Employee Costs (Rs mn) (LHS) As % of sales

Source: Company, Ambit Capital research





Godrej Consumer Products
Ambit Capital Pvt Ltd 79

Sub-par surplus capital deployment
so far
GCPLs growth over the past decade can be divided into three phases:
FY02-05 moderate domestic growth; highly cash generative: During this
period, GCPL reported standalone revenue CAGR of 7%, with an EBITDA margin of
16-18% and an EBITDA CAGR of 10%. However, the firm was generating an RoE
and RoCE of over 100% and an average dividend payout ratio of ~90%
and a negative net working capital cycle (minus 15-20 days on average).
Whilst the firm had predominantly expanded organically over this period, it had
clearly indicated that M&A was going to be the preferred means of capital
deployment and hence expansion by the end of this period.
FY05-10 Indian operations gather pace, and so does the M&A strategy:
This period was characterised by a change in the management team with Mr.
Mahendran (ex-Godrej-Sara Lee), becoming the Managing Director from 1 July
2010. During this period, GCPL reported standalone revenue CAGR of 18% with
an EBITDA margin of 19-20% and an EBITDA CAGR of 24%. However, the
proportion of revenues from international operations increased from ~5% in FY06
to ~20% in FY09 and ~35% in FY10. To fund these acquisitions, the dividend
payout ratio declined from 90% to 45% over this period and new capital was
raised both through debt as well as equity. Due to these acquisitions, working
capital cycle for the consolidated entity became positive (minus 8 days in FY06 to
positive 62 days in FY10).
FY10-13 more inorganic than organic growth: This period saw another
management change with Mr. Vivek Gambhir, who was previously a strategy
consultant at Bain India, becoming the companys Chief Strategy Officer in 2009.
He will take over as the Managing Director from 1 July 2013. Through the
acquisition of the home insecticides business of Sara Lee in India and M&As in
Indonesia, Africa and Latin America, GCPLs consolidated revenues reported a
CAGR of 46% over FY09-13.
Exhibit 8: Increasing proportion of international revenues
-
5,000
10,000
15,000
20,000
25,000
30,000
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
International revenues (Rs mn) (LHS) Proportion of total revenues (%)

Source: Company, Ambit Capital research







Godrej Consumer Products
Ambit Capital Pvt Ltd 80

Exhibit 9: Godrejs international acquisitions are targeted at market leaders
Year
Company
acquired
Country Market position
2005 Keyline brands UK Hair care and skin care products
2006 Rapidol South Africa Leader in ethnic hair colour
2008 Kinky South Africa Manufacturer of hair accessories
2010 Tura Nigeria Manufactures soaps and skin creams
2010 Megasari Indonesia
Leader in baby wipes, air fresheners and No.2 in
household insecticides
2010 Issue Latin America Hair care products
2010 Argencos Argentina Leader in hair sprays, focused on hair colour
2011 Darling (ongoing) Pan-Africa Leader in hair extensions
2012
Cosmetica
Nacional
Chile Leader in hair colour
2012 Soft & Gentle UK Fourth-largest female deodorant brand
Source: Company, Ambit Capital research
As a result of this acquisition approach towards capital deployment, over the past
decade, GCPL stood out in the FMCG pack with the highest proportion of capital
deployed towards M&A/non-core investments.
Exhibit 10: Avenues of capital deployment for various companies over FY03-12
-20%
0%
20%
40%
60%
80%
100%
H
U
L
C
o
l
g
a
t
e
N
e
s
t
l
e
G
S
K
C
o
n
s
u
m
e
r
D
a
b
u
r
G
C
P
L
M
a
r
i
c
o
Investment in core Dividend Paid Non core Inv./Intl. M&A Change in cash Others

Source: Company, Ambit Capital research; Note: height of the bar for each company indicates the sum of
operating cash flows, new equity raised and increase in gross debt over the past ten years
Performance of the international businesses
Indonesia: Of the various new geographies in which GCPL has made
acquisitions, Indonesia has been the most successful integration, with the firm
deriving substantial synergies in the form of reduction in working capital cycle
mainly through streamlining of raw material procurement and cross-pollination of
products between the companys Indonesian and Indian businesses. Through the
launch of HIT Magic in 1QFY12 (a paper format mosquito repellant) and through
distribution expansion for the overall business, GCPLs Indonesian business has
reported revenue CAGR of 33% over FY11-13E.
Africa: GCPL's hair extensions business under the brand of Darling is well
managed and has earnings growth prospects of 12-14% CAGR over the short to
medium term, with a potential to expand the companys insecticides business in
these countries by leveraging on Darlings existing distribution network. However,
we do not expect the Darling acquisition to offer as strong an earnings growth as
that achieved in the Indonesian acquisitions. Whilst Africas macro-economic
indicators around the evolution of a middle class and growth potential of sectors,
like construction, cement, and infrastructure, remain strong in countries like
Kenya, other factors, like evolution of consumerism and foreign direct investments


Godrej Consumer Products
Ambit Capital Pvt Ltd 81

in the country, are likely to remain a challenge in the near to medium term. Also,
the company will not be fully shielded from events like the recent transporters
strike in South Africa, fuel price increases, and growth moderation related to
government elections in Kenya.
Latin America: GCPL controls the second-largest market share in hair colors in
Chile and Argentina. Latin America offers opportunities such as: (a) per capita
income growth to remain at around 4%; and (b) large middle class population
spending incrementally on premiumisation. However, the LatAm market is not
likely to be suitable for cross-pollination through soaps or insecticides given the
already high penetration levels for soaps and SC Johnson controlling 80-90%
market share of the insecticides segment in most LatAm markets.
Overall conclusions on international acquisitions: As highlighted in the
thematic section of this note, our analysis suggests that the incremental earnings
generated by GCPL through its international business are lower than the cost of
equity deployed over FY08-12. Also, as shown in the exhibit below, EBITDA
margins for the international subsidiaries have been highly volatile due to frequent
one-off unexpected gain/losses over the past few quarters.
Exhibit 11: EBITDA margin trends for the international business have been highly
volatile in the past
0%
5%
10%
15%
20%
25%
30%
D
e
c
-
1
0
M
a
r
-
1
1
J
u
n
-
1
1
S
e
p
-
1
1
D
e
c
-
1
1
M
a
r
-
1
2
J
u
n
-
1
2
S
e
p
-
1
2
D
e
c
-
1
2
M
a
r
-
1
3
Indonesia Africa Latin America UK

Source: Company, Ambit Capital research
Our discussions with GCPLs management team suggest that the company is likely
to focus on the subsequent phases of integration of the Darling acquisition in
Africa rather than seeking new M&A opportunities over the next 12-18 months.
The surplus cash generated from its existing businesses in the near future is likely
to be used for consolidation of Darling in Africa, debt repayment, and growth of
the acquired businesses.


Godrej Consumer Products
Ambit Capital Pvt Ltd 82

Key assumptions
Exhibit 12: Key assumptions and estimates for revenues

Contribution
to revenues
FY13 FY14E FY15E Comments
Domestic business
Soaps growth 19.6% 27.5% 12.7% 11.8%
Industry growth

20.0% 10.0% 10.0%
Growth from market share change 6.2% 2.5% 1.6%
Expect GCPL to gain from repositioning of the
Cinthol brand to the premium segment and growth
in line with the market for the Godrej No.1 brand
Hair colour growth 5.8 % 13.6% 25.0% 20.0%
Industry growth 19.0% 20.0% 18.0%
Growth from market share change -5.4% 5.0% 2.0%
Growth to be driven by share gain through the
newly launched crme format hair colour at a
disruptive price segment
Insecticide growth 25.2% 22.9% 16.0% 16.0%
Industry growth 14.0% 14.0% 14.0%
Growth from market share change 8.9% 2.0% 2.0%
Growth to be driven by: (1) distribution benefits
from the GHPL merger; and (2) frequent innovation
and strong marketing investments
Others 5.4% -3.9% 16.0% 16.0%
Entry into new categories like deodorants, air
fresheners, hand sanitisers and talcum powder
likely to see strong growth
Total domestic growth 20.2% 15.8% 15.0%

International business

Indonesia 19.6% 35.0% 18.0% 18.0%
Industry growth 13.0% 13.0% 13.0%
Growth from market share change 2.0% 5.0% 5.0%
Expect the Indonesian business to deliver growth
through: (1) frequent innovations; (2) marketing
investments in the Stella and Mitu brands; and (3)
distribution expansion
Africa 11.1% 68.5% 60.6% 13.6%
Industry growth 10.6% 10.6% 10.6%
Growth from market share change 70.0% 50.0% 3.0%
Revenue growth to be a function of consolidation of
revenues from the Darling acquisition and market
growth led by penetration and share gains by new
product innovation and launching of insecticides
Latin America 8.2% 83.9% 14.0% 14.0%
Industry growth 16.0% 14.0% 14.0%
Growth from market share change 60.0% 0.0% 0.0%
Expect market share gains in the competitive
market led by aggressive innovation and
promotions and strong market growth
Europe 4.5% 40.8% 5.0% 5.0%
Industry growth 4.0% 4.0% 4.0%
Growth from market share change 6.0% 1.0% 1.0%
Factor in growth only marginally ahead of the
FMCG average in the slow-growth UK market
despite the company having a strong historical
performance
Others 0.7% 5.4% 10.0% 10.0%
Factor in 10% growth in the other international
businesses
Total international growth 49.9% 31.5% 14.3%

Overall growth 31.7% 22.7% 14.7%

Source: Ambit Capital research












Godrej Consumer Products
Ambit Capital Pvt Ltd 83

Exhibit 13: Key assumptions and estimates - others
Profit and loss FY12 FY13 FY14E FY15E Comments
Domestic revenues 29,801 35,810 41,461 47,682
Growth (%) 20.8% 20.2% 15.8% 15.0%
Expect hair care and household insecticides to be the
drivers of growth led by new launches in hair care
and market share gains in insecticides
International revenues 18,861 28,264 37,174 42,503
Growth (%) 31.8% 31.7% 22.7% 14.7%
Besides consolidation of acquisitions in Africa and
Chile, growth from emerging markets and cross
pollination of products to lead to strong growth in the
international business
Total revenues 48,661 64,074 78,636 90,185
Growth (%) 33.5% 31.7% 22.7% 14.7%

Gross Profit 25,477 34,563 42,732 49,189
Gross margin (%) 52.4% 53.9% 54.3% 54.5%
Expect premiumisation effects in the soaps and hair
colour business to lead to increase in gross margins
Employee cost (% of sale) 8.1% 9.2% 9.0% 8.8%
Expect operational and scale efficiencies to lead to
benefits in employee costs
Advertising (% of sale) 12.1% NA 12.6% 12.6% Expect advertising spends to be maintained
Freight & forwarding (% of sale) 3.2% NA 3.4% 3.4% Expect freight expenses to remain stable
Other expenses (% of sale) 11.4% NA 12.3% 12.3%
Expect minor operational efficiencies in other
expenses
EBITDA 8,554 9,824 13,401 15,730
EBITDA Margin 17.6% 15.3% 17.0% 17.4%
Above changes to lead to improvement in EBITDA
margins in FY14 and FY15
Tax rate 29.1% 20.0% 23.0% 24.0%
Tax benefits gains in Africa in FY13; FY14 and FY15
should see effective tax rates inching upwards
Net Profit margin 11.3% 11.2% 12.3% 12.9%
Lower interest costs and slower increase in
depreciation to help boost net profit margin
Balance Sheet
Capex 1,256 2,215 1,000 1,000
Capital Work in Progress 376 376 376 376
No material capex requirements for FY14 and FY15
Working Capital days 33 (1) 1 1 Expect working capital days to remain stable
Debtor days 35 42 42 42 Expect debtor days to remain stable
Current Liabilities days 87 122 120 120 Expect current liabilities to remain stable
Inventory days 59 60 59 59
Better inventory management to lead to decrease in
inventory days
Net debt/(cash) to equity 0.4 0.3 0.1 (0.1) Expect GCPL to turn into a net cash company in FY15
Cash flows (` mn)
Operating cash flows 7,033 13,604 10,768 13,206
Free cash flows 6,076 11,389 9,768 12,206
With no material capex requirements, free cash flows
to increase strongly over FY12-15
Source: Ambit Capital research



Godrej Consumer Products
Ambit Capital Pvt Ltd 84

Valuation
DCF valuation
Given the cash-generative nature of the business, we use a DCF-based model to
arrive at a fair value for Godrej Consumer. The assumptions for the weighted
average cost of capital and terminal growth rates are shown in the exhibit below.
We have assumed zero debt on GCPLs balance sheet in the future given its strong
cash generation. Hence, the company would have enough surplus cash available
on its balance sheet for capital expenditure in the future.
We use a three-stage DCF approach for GCPL. Stage 1 includes explicit forecasts
for the income statement and balance sheet for the next five years, with sales
CAGR of 16% and EPS CAGR of 21%. Stage 2 includes a decline in PBIT growth
over six years from 14% in FY18 to 7% in FY26 i.e. CAGR of 11% and a free cash
flow CAGR of 9% over this period. Stage 3 includes terminal growth forecasts with
a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model arrives at a target pr ice of `792/share (5% downside), implying
an FY14 P/E multiple of 29.6x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 15: Cash flow profiles for GCPL (` mn)
-
2,000
4,000
6,000
8,000
10,000
12,000
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
(12,000)
(9,000)
(6,000)
(3,000)
-
3,000
6,000
9,000
12,000
CFO (Rs mn) Free Cash Flow (Rs mn) (RHS)

Source: Ambit Capital research
Exhibit 16: Return profiles for GCPL (%)
-20%
10%
40%
70%
100%
130%
160%
190%
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
-20%
0%
20%
40%
60%
80%
100%
120%
ROE (LHS) EBITDA Margin
EPS Growth YoY Growth in sales

Source: Ambit Capital research

Exhibit 14: WACC calculation
for DCF on GCPL
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.52
Equity risk premium (%) 7
Cost of equity (%) 12.1
Cost of debt (%) 11.0
Debt/Equity ratio (%) 10.0
Tax rate (%) 30
WACC (%) 12.0
Source: Company, Ambit Capital
research


Godrej Consumer Products
Ambit Capital Pvt Ltd 85

Relative valuation
GCPL currently trades at 32.6x FY14 P/E multiple. This rating is at a 12% discount
to the sector average of 37.2x. GCPLs domestic business has a strong portfolio
positioning with the likelihood of market share gains across soaps, insecticides as
well as hair colors. However, given the sub-par incremental returns generated
from the capital allocated towards international acquisitions and given the
uncertainties attached to its international portfolio around events like the recent
transporters strike in South Africa, fuel price increases, and growth moderation
related to government elections in Kenya, we expect GCPL to trade at a discount to
the broader FMCG pack on P/E multiples.
As shown in the charts below, GCPL has consistently traded at a P/E multiple band
of 25.0x to 29.0x. Given the high quality of its domestic business, we believe this
valuation band is justified. Consequently, on our DCF-based fair value, GCPL
trades at an implied FY14 P/E multiple of 29.6x.
Exhibit 17: 1-year forward P/E bands for GCPL
100
200
300
400
500
600
700
800
900
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
14x
18x
22x
26x
30x

Source: Bloomberg, Ambit Capital research
Exhibit 18: 1-year forward EV/EBITDA bands for GCPL
100
200
300
400
500
600
700
800
900
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
21x
18x
24x
12x
15x

Source: Bloomberg, Ambit Capital research
Sensitivity analysis
Exhibit 19: Sensitivity analysis
Bull case Base case Bear case
Revenue growth
We model a revenue CAGR of around 16% over
FY14-23 led by strong market share gains in
soaps and household insecticides in the
domestic business and strong revenue growth in
the Indonesian business with no market share
losses in any category. Our terminal growth rate
assumption stands at 6%
Expect revenue growth of 14% over
FY14-23 assuming market share
gains in soaps and household
insecticides and strong growth in
Indonesia. Our terminal growth rate
assumption stands at 5%
Expect revenue growth of 13%
over FY14-23 assuming no
market share gains in soaps and
household insecticides and
slowing down of growth in the
Indonesia business. Our terminal
growth rate assumption stands at
4%
Operating margins
Expect EBITDA margins to expand to 19% by
FY17, led by gross margin expansion and
efficiencies in employee costs with no increase in
advertisement spends
Expect EBITDA margins to expand by
100bps over FY14-17 to 18%, led by
gross margin expansion and
efficiencies in employee costs being
partially offset by increase in
advertisement spends
Expect EBITDA margins to decline
by 10bps to 17.9% in over FY14-
17 led by gross margin expansion
being partially offset by an
increase in advertisement spends
Fair value (`/share) 998 792 650
Upside/Downside 14% -9% -26%
Source: Ambit Capital research




Godrej Consumer Products
Ambit Capital Pvt Ltd 86

Risks to our SELL stance
Emerging market economic growth: A sudden rise of the middle class
population in emerging market economies can lead to a strong growth for
segments in which GCPL operates internationally.
New acquisitions at cheap multiples: With the managements view of
continued focus on M&A as one of the growth drivers over the longer term, the
acquisition of an asset at a cheap valuation can lead to an upside potential for
the stock from the current levels.
Catalysts
Acquisition and integration risks: As highlighted previously in this note, GCPL
has had a volatile trend of EBITDA margins over the past eight quarters driven
mainly by unexpected one-off events linked either to the economy, politics or
infrastructure. Also, as GCPL integrates the acquired businesses and attempts to
generate operational synergies, there is a risk of execution-related issues like
departure of key personnel or infrastructure-related issues, which can lead to a
substantial drag on the overall business of GCPL.
Increasing competitive intensity: With the companys entry into the more
premium segment of both hair colour and soaps, higher competitive intensity from
the incumbent MNCs with strong balance sheets in these premium categories is
likely to lead to downward pressure on EBITDA margins through increased spends
on advertising and promotions.
Currency risks: With the contribution from its overseas business crossing 40% of
revenues in FY13, the company is subject to significant currency risk and any
material depreciation in currencies can pose translation risks for the company.
Ambit vs consensus
Exhibit 20: Ambit v/s consensus
Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments
FY14E
Net Sales (` mn) 78,636 77,293 2%
Expect strong growth in the domestic
insecticide and hair colour business and
Indonesia in the international business
EBITDA (` mn) 13,401 13,118 2%
Expect GCPL to gain from gross margin
expansion and efficiencies of scale in
operations
EPS (`/share) 26.8 26.0 3%
Above-mentioned expectations to lead to
EPS around 3% above consensus.
FY15E
Net Sales (` mn) 90,185 91,843 -2%
Our revenue forecasts are broadly in line
with consensus
EBITDA (` mn) 15,730 15,866 -1%
Expect GCPL to gain from gross margin
expansion and efficiencies of scale in
operations
EPS (`/share) 32.1 31.6 1%
Above-mentioned expectations to lead to
EPS marginally above consensus
Source: Ambit Capital research
Exhibit 21: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, Godrej Consumer has reported excellent cash conversion, efficient management of
working capital in the domestic business, and reasonable levels of loans and advances and
contingent liabilities. Consequently, we give a high rating to its accounting quality.
Predictability AMBER
Whilst the company has seen strong performance in its domestic business, it is still investing in its
African and Latin American businesses, which tend to bring volatility in its reported numbers at the
EBITDA margin level.
Earnings momentum RED Consensus EPS estimates have been downgraded by 6% in FY14 and 7% in FY15.
Source: Ambit Capital research


Godrej Consumer Products
Ambit Capital Pvt Ltd 87

Balance sheet (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Shareholders' equity 323 340 340 340 340
Reserves & surpluses 16,928 27,812 32,790 38,724 45,666
Total networth 17,251 28,152 33,130 39,064 46,006
Minority Interest - 882 2,095 2,687 3,397
Debt 20,054 18,769 19,486 14,486 6,986
Other long term liabilities - 294 273 273 273
Deferred tax liability 14 (5) (140) (140) (140)
Total liabilities 37,319 48,092 54,844 56,369 56,522
Gross block 19,147 20,403 22,618 23,618 24,618
Net block 15,373 15,464 16,909 17,005 17,097
CWIP 154 376 376 376 376
Goodwill 15,404 21,454 29,085 29,085 29,085
Cash & equivalents 2,269 6,399 8,688 9,689 9,717
Debtors 3,840 4,725 7,288 9,048 10,377
Inventory 4,394 7,839 10,471 12,711 14,578
Loans & advances 4,559 3,911 3,995 4,955 5,683
Other current assets - - - - -
Total current assets 15,062 22,874 30,441 36,404 40,356
Current liabilities 8,448 11,555 21,381 25,853 29,650
Provisions 225 521 585 646 741
Total current liabilities 8,673 12,075 21,967 26,499 30,391
Net current assets 6,389 10,799 8,475 9,905 9,964
Total assets 37,319 48,092 54,844 56,369 56,522
Source: Company, Ambit Capital research
Income statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income 36,461 48,662 64,074 78,636 90,185
% growth 78.4% 33.5% 31.7% 22.7% 14.7%
Operating expenditure 30,023 40,108 54,251 65,234 74,455
EBITDA 6,438 8,554 9,824 13,401 15,730
% growth 57.1% 32.9% 14.8% 36.4% 17.4%
Depreciation 499 644 770 904 907
EBIT 5,939 7,910 9,054 12,497 14,823
Interest expenditure 519 658 775 679 429
Non-operating income 698 520 678 779 896
Adjusted PBT 6,118 7,772 8,957 12,597 15,290
Tax 1,302 2,261 1,792 2,897 3,670
Adjusted PAT/ Net profit 4,816 5,511 7,165 9,700 11,620
% growth 45.7% 27.0% 15.2% 40.6% 21.4%
Extraordinaries 331 2,002 1,289 - -
Reported PAT / Net profit 5,147 7,513 8,454 9,700 11,620
Minority Interest - (245) (493) (592) (710)
Adjusted Consolidated net profit 5,147 7,268 7,961 9,108 10,910
Reported Consolidated net profit 5,147 7,268 7,961 9,108 10,910
Source: Company, Ambit Capital research


Godrej Consumer Products
Ambit Capital Pvt Ltd 88

Cash flow statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
EBIT 6,637 8,430 9,732 13,277 15,719
Depreciation 499 644 770 904 907
Others (571) 499 282 (87) 281
Tax (1,302) (2,261) (1,792) (2,897) (3,670)
(Incr) / decr in net working capital (3,604) (280) 4,613 (428) (32)
Cash flow from operations 1,658 7,033 13,604 10,768 13,206
Capex (25,686) (7,007) (9,845) (1,000) (1,000)
(Incr) / decr in investments 670 - - - -
Cash flow from investments (25,016) (7,007) (9,845) (1,000) (1,000)
Net borrowings 19,686 (1,285) 717 (5,000) (7,500)
Interest paid (519) (658) (775) (679) (429)
Dividend paid (1,966) (1,948) (2,381) (3,174) (3,968)
Others 5,374 7,995 969 87 (281)
Cash flow from financing 22,574 4,104 (1,470) (8,766) (12,178)
Net change in cash (783) 4,130 2,289 1,001 28
Closing cash balance 2,269 6,399 8,688 9,689 9,717
Free cash flow (24,027) 26 3,759 9,768 12,206
Source: Company, Ambit Capital research
Ratio analysis
Year to March FY11 FY12 FY13 FY14E FY15E
Gross margin (%) 52.0% 52.4% 53.9% 54.3% 54.5%
EBITDA margin (%) 17.7% 17.6% 15.3% 17.0% 17.4%
EBIT margin (%) 18.2% 17.3% 15.2% 16.9% 17.4%
Net profit margin (%) 13.2% 11.3% 11.2% 12.3% 12.9%
Dividend payout ratio (%) 40.8% 35.3% 33.2% 32.7% 34.1%
Net debt: equity (x) 1.0 0.4 0.3 0.1 (0.1)
Working capital turnover (x) 8.8 11.1 (301.0) 365.0 365.0
Gross block turnover (x) 1.9 2.4 2.8 3.3 3.7
RoCE (%) 22.1% 14.0% 15.1% 18.4% 21.2%
RoE (%) 35.9% 24.3% 23.4% 26.9% 27.3%
Source: Company, Ambit Capital research
Valuation parameters
Year to March FY11 FY12 FY13 FY14E FY15E
EPS (`) 14.9 15.5 19.6 26.8 32.1
Diluted EPS (`) 14.9 15.5 19.6 26.8 32.1
Book value per share (`) 50.7 82.7 97.4 114.8 135.2
Dividend per share (`) 5.0 4.8 6.0 8.0 10.0
P/E (x) 58.6 56.4 44.5 32.6 27.2
P/BV (x) 17.2 10.6 9.0 7.6 6.5
EV/EBITDA (x) 46.6 36.2 31.3 22.5 18.7
Price/Sales (x) 7.7 6.1 4.6 3.8 3.3
Source: Company, Ambit Capital research

Consumer Staples June 04, 2013
Dabur
Bloomberg: DABUR IN EQUITY
Reuters: DABU.NS
Accounting: GREEN
Predictability: AMBER
Earnings momentum: GREEN


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income (` mn) 41,045 53,054 61,761 70,346 80,031
EBITDA(` mn) 8,013 8,902 10,298 11,827 13,455
EBITDA Margin (%) 19.5% 16.8% 16.7% 16.8% 16.8%
Adjusted PAT(` mn) 5,686 6,449 7,726 8,821 10,216
Adjusted EPS (`) 3.3 3.7 4.4 5.1 5.9
RoE (%) 48.9% 41.5% 40.0% 37.0% 34.9%
P/E (x) 48.4 42.7 35.9 31.2 27.0
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `158
Target Price (Mar 14): `136
Previous TP: NA
Downside (%) 14%
EPS (FY14E): `5.1
Change from previous (%) NA
Variance from consensus (%) -5%
Stock Information
Mkt cap: `274bn/US$4,891mn
52-wk H/L: `166/101
3M ADV: `191mn/US$3.4mn
Beta: 0.5x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
(2) 22 53 23
Rel. to Sensex
(2) 18 30 22
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Sep-12 J an-13 May-13
90
110
130
150
170
Sensex Dabur India

1-year forward P/E band chart
40
60
80
100
120
140
160
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14x
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26x
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Source: Bloomberg, Ambit Capital research
Stuck in the mass market
Daburs sales growth is expected to moderate from 21% CAGR
(supported by M&A) over FY08-13 to 14% CAGR over FY13-15. More
than two-thirds of Daburs domestic product portfolio positioning does
not leave much scope for premiumisation or market share gains. Also,
the drag on its international business from Namaste is unlikely to
recede over the next 12 months. The stock is currently trading at an
16% discount to its peer group average (based on its 1-year forward
P/E). We believe this is justified given the companys relatively weaker
cash generation and growth profile. We initiate coverage with a SELL
stance.
Competitive position: MODERATE Change to this position: STABLE
Whilst Dabur has reported revenue CAGR of 21% over FY08-13, supported by
international acquisitions. We expect a moderation in growth from 16% YoY in
FY13 to 13.8% over FY13-16 due to :
Weak portfolio positioning: 45% of Daburs domestic revenues comes from
oral care, hair care and skin care, which face headwinds from a combination
of mass-market positioning, intense competition from Colgate, Marico and
HUL, and relatively high penetration of these segments (especially in urban
India). Another 23% of the portfolio includes health supplements and
digestives, which offers no scope for premiumisation. Moreover, products such
as Hajmola have achieved more than 80% market penetration in India and
Glucose-D faces tough competition from Heinzs Glucon-D. These factors limit
Daburs scope for strong revenue growth, gross margin benefits and better
defense against competition. The juices and home care segments (15% of
consolidated revenues) remain the only two areas of strength in its portfolio.
Capital allocation risk: Based on our capital allocation analysis, whilst
Daburs organic expansion in the Middle East has performed well in the past,
its capital deployment towards M&A, especially for the Namaste business has
been disappointing so far, due to: (a) distribution-related disruptions; (b)
rebranding of the US portfolio in FY13 due to regulatory constraints; and (c)
fairly large management reshuffles in the US business. Hence, Namastes
growth rates are unlikely to normalise for at least another 12 months. With
~`10bn of surplus capital currently on the balance sheet which will most likely
be deployed towards M&A in India in the coming years, Dabur will face a
capital allocation risk.
Valuation: Dabur currently trades at 31x FY14 earnings, towards the bottom
end of the FMCG sector range. Given the factors highlighted above, we
believe this discount is justified. Our DCF-based valuation generates a target
price of `136 (14% downside), implying 26.8x FY14 P/E.


Dabur
Ambit Capital Pvt Ltd 90

Company Financial Snapshot
Profit and Loss (` mn)
FY13 FY14E FY15E
Net sales 61,761 70,346 80,031
Optg. Exp(Adj for OI.) 51,463 58,519 66,576
EBITDA 10,298 11,827 13,455
Depreciation 1,124 1,160 1,199
Interest Expense 589 601 451
PBT 9,530 11,027 12,932
Tax 1,826 2,205 2,716
Adj. PAT 7,704 8,821 10,216
Profit and Loss Ratios

EBIDTA Margin % 16.7% 16.8% 16.8%
Adj Net Margin % 12.4% 12.5% 12.8%
P/E (X) 35.9 31.2 27.0
EV/EBIDTA (X) 27.4 23.5 20.3
Dividend Yield (%) 0.9% 1.1% 1.4%
Company Background
Dabur, a healthcare products manufacturer, was formed in
1884 and promoted by the Burman family (68.7% stake).
The companys product lines include Ayurvedic Products,
Personal care, Healthcare, Homecare and Foods. Key brands
for the company include Dabur, Vatika, Hajmola, Real and
Fem.
The company has 17 manufacturing facilities with a presence
in more than 60 countries. It is currently headed by Mr. Sunil
Duggal.
Balance Sheet (consolidated) (` mn)
FY13 FY14E FY15E
Total Assets 47,365 51,990 58,470
Net Fixed Assets 16,745 17,385 17,986
Current Assets 24,301 28,286 34,165
Other Assets 6,319 6,319 6,319
Total Liabilities 47,365 51,990 58,470
Networth 21,244 26,419 32,179
Debt 11,634 8,634 6,634
Current Liabilities 14,125 16,575 19,295
Deferred Tax 362 362 362
Balance Sheet Ratios
ROE % 40.0% 37.0% 34.9%
ROCE % 26.5% 27.1% 28.3%
Net Debt/Equity 0.5 0.3 0.2
Equity/Total Assets 0.6 0.7 0.8
P/BV (X) 13.0 10.4 8.6
Cash Flow (consolidated) (` mn)

FY13E FY14E FY14E
PBT 9,530 11,027 12,932
Depreciation 1,124 1,160 1,199
Tax (1,826) (2,205) (2,716)
Change in Wkg Cap (3,537) (541) (331)
Others 741 601 451
CF from Operations 6,031 10,041 11,535
Capex (1,189) (1,800) (1,800)
Investments (775) - -
CF from Investing (1,964) (1,800) (1,800)
Change in Equity - - -
Debt 770 (3,000) (2,000)
Dividends (3,038) (3,646) (4,456)
Others (1,156) (601) (451)
CF from Financing (3,424) (7,247) (6,907)
Change in Cash 644 994 2,828
Hair oils segments revenue growth muted due to
Parachutes entry into the amla hair oil market
Daburs oral care revenues have increased slower than
that of Colgate over the past eight quarters
19%
13%
12%
18%
10%
27%
22%
20%
8%
9%
12%
0%
5%
10%
15%
20%
25%
30%
1
Q
F
Y
1
1
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
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1
2
3
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1
2
1
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Y
1
3
2
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Y
1
3
3
Q
F
Y
1
3

3%
6%
9%
12%
15%
18%
21%
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
1
2
3
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1
2
4
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F
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1
2
1
Q
F
Y
1
3
2
Q
F
Y
1
3
3
Q
F
Y
1
3
F
Y
1
3
E
F
Y
1
4
E
F
Y
1
5
E
Dabur Colgate

Source: Company, Ambit Capital Research


Dabur
Ambit Capital Pvt Ltd 91

Background
Exhibit 1: Daburs domestic portfolio mix
Category Key brands Key Competitors
Market
share rank
% of
turnover
FY10-13
CAGR
Hair care
Amla Hair Oil, Vatika
Shampoo
Parachute,
CavinKare, HUL
3
18% 9%
Health
supplements
Dabur Chyawanprash, Dabur
Honey, Dabur Glucose-D
Emami, Heinz,
Baidyanath
1*
12% 18%
Oral care Babool, Red, Meswak Colgate, HUL
3
10% 12%
Foods Real, Hommade Pepsico
1
10% 25%
Digestives Hajmola, Pudin Hara
SSG Pharma, Anil
Foods
1
5% 10%
OTC &
ethicals
Honitus, Lal Tail J&J, Pfizer
NA
7% 12%
Home care
Odomos, Odonil, Odopic,
Sanifresh
Reckitt Benchiser,
Godrej Consumer,
HUL
NA
4% 25%
Skin care Gulabari, Fem, Uveda HUL, L'Oreal, Jolen
NA
4% 13%
International
business
Hobby, Organic root
stimulator
Local players,
L'Oreal, P&G
NA
30% 21%
Source: Ambit Capital research. Note:* Market share rank of #2 in Glucose-D
Dabur has a presence in categories that have historically had low competition.
Nearly 60-70% of its domestic portfolio is exposed to strong competitive intensity
from MNCs (note that Amla hair oil, health supplements, digestives and OTC are
fairly insulated from MNC pressure).
Daburs international business is essentially focused on hair care (with a presence
in the US, Africa, the Middle East and Asia) and oral care (strong Middle Eastern
presence). Whilst the company has expanded organically in geographies, such as
Asia and the Middle East, its presence in markets such as Africa, Turkey and the
US has been achieved through acquisitions over the past three years.
Over FY07-12, Dabur has delivered a consolidated revenue CAGR of 21% and a
PAT CAGR of 18% (boosted by its overseas acquisitions), whilst its EBITDA margins
have contracted by 30bps from 17.1% in FY07 to 16.8% in FY12. Whilst the fruit
juices, hair oils and home care segments have been the strongest segments for
Dabur over FY10-12 (mainly led by higher market penetration), increased
competitive intensity has taken its toll on the shampoo, oral care and skin care
segments. Even the health supplements segment has seen moderation in revenue
growth in FY12 (8% YoY) after delivering strong growth in FY11 (31% YoY).
The companys distribution network spans 3.5mn outlets for its most widely
distributed product (Vatika shampoo), whilst its total reach in all outlets stands at
5.8mn. The company has a direct reach of 0.8mn outlets.
Over the past two years, Dabur has undertaken two distribution initiatives: (1)
Project Double distribution reach of villages to be increased from 14,000 villages
to 27,000 villages, and (2) Project Speed merger of the Consumer Health
division with the HPC division (now called Consumer Care). The purpose of this
initiative was to give the chemist channels access to the entire portfolio. This is
likely to have around an incremental positive impact of 1-2% on volumes for the
companys Indian business through increased penetration of rural markets.


International business
segment
Revenue
share
Africa 22%
Middle East 33%
Asia 18%
USA 22%
Others 5%


Dabur
Ambit Capital Pvt Ltd 92

SWOT analysis
Exhibit 2: SWOT analysis for Dabur
Strengths Weaknesses
Well-established distribution and brand recall in Indias rural
markets in oral care, hair care, digestives, health supplements
and skin care.
It is a market leader in segments like digestives, chyawanprash
and honey and also in categories like fruit juices where it has
successfully taken on MNCs.
Gaining from distribution by: (1) leveraging its access to the
chemist channels through its consumer and health division, and
(2) doubling its rural reach from 14,000 to 30,000 villages.

Cannot use the doctor channel because doctors are better
incentivised by pharmaceutical companies to promote
conventional medicines.
Response to competition has been weak and has led to
loss of market share in shampoos, toothpastes and hair
oil.
Presence in categories and product positioning with
limited ability to premiumise consumers. Eg. Hajmolas
Re1 price point; difficulty in premiumising digestives,
honey, ethicals etc.
Opportunities Threats
Entry into new categories based on Ayurvedic healthcare, where
it has expertise and has established brand equity.
Access to an international distribution channel through its
acquisitions as well as ability to cross sell its international
portfolio in India.

Loss of share in MNC-dominated categories can force the
company to increase advertisement spends.
Rebranding of its US business due to regulatory
restrictions on the keyword Organic may lead to loss of
revenues as consumers may switch brands.
Source: Ambit Capital research




Dabur
Ambit Capital Pvt Ltd 93

Constrained by portfolio positioning
and international business drag
As shown in the chart below, whilst Dabur has been able to generate a strong
revenue CAGR of 21% over FY08-13, the firm has reported: (a) moderation in
consolidated revenue growth from 29.3% YoY in FY12 to 16.4% YoY in FY13; (b)
gross margin reduction of 350bps over the past three years; and (c) EBITDA
margin reduction of 250bps over the past three years.
Exhibit 3: Daburs revenue growth and margin profile
12%
14%
16%
18%
20%
22%
24%
26%
28%
30%
FY08 FY09 FY10 FY11 FY12 FY13
48%
49%
50%
51%
52%
53%
54%
55%
Revenue growth EBITDA Margin (%) Gross Margin (%) (RHS)

Source: Company, Ambit Capital research
We expect Daburs EBITDA margins to remain under pressure and overall revenue
growth to moderate in the future because: (a) the positioning of its product
portfolio does not leave significant scope for growth acceleration, premiumisation,
or market share gains; and (b) the drag on its international business from Namaste
is not likely to recede significantly over the next 12 months.
Constraints related to portfolio positioning
As shown in the table below, whilst we expect strong revenue growth in juices and
home care products (22% of domestic revenues), we expect an overhang on
overall revenue growth from most other products including digestives, oral care,
health supplements, hair care and skin care (~66% of domestic revenues), either
due to slow category growth or due to prospective market share losses.
Exhibit 4: Our category-wise revenue growth expectations for Dabur
Category
Contribution to
consolidated
revenues
Revenue growth
reported over
FY11-13
FY13-15
revenue CAGR
expectation
Comments
Hair care 18% 12% 14%
Higher competitive intensity in hair care with slower market
growth in amla hair oils.
Health
Supplements
12% 12% 13%
Slower market growth in Chyawanprash is likely to offset the
stronger penetration-led growth in Glucose-D.
Foods 11% 26% 20%
Juices to drive growth in the segment driven by higher penetration
and frequency of consumption.
Oral care 10% 10% 11%
We expect weak product portfolio to lead to market share losses
and hence record slower than industry category growth.
OTC and
Ethical
7% 12% 15%
We expect the OTC segment to drive the growth of this segment
through strong growth in 'Lal Tail'.
Digestives 4% 8% 11%
High penetration and inability to premiumise Hajmola is likely to
be an overhang despite strong growth in the OTC Pudin Hara.
Home care 4% 20% 18%
Strong penetration-led growth in surface cleaners would likely
lead segment growth.
Skin care 3% 13% 13%
Weak portfolio with a mass focus and low marketing spends to
lead to market share losses in the category.
International 31% 23% 13%
Namaste is likely to be an overhang on the international business
despite strong penetration-led growth in the Middle East
Source: Company, Ambit Capital research.


Dabur
Ambit Capital Pvt Ltd 94

Oral care (15% of domestic revenues) drag from toothpowders
shrinking category size and Babools mass market presence
Dabur derives around 25-30% of its oral care revenues from toothpowders, a
category which is shrinking in size by around 3-5% in revenue terms annually, as
consumers shift from toothpowders to toothpastes.
Half of the remaining oral care portfolio includes Babool toothpaste which has a
mass market positioning and hence despite new variant launches it will at best
report flat YoY growth. Over the past two years, Babool has suffered from its
inability to pass on price increases. As a result, the company has taken initiatives
which, even the management believes, are likely to stem the shrinkage in size of
its Babool portfolio without any scope for increase in the size of this portfolio over
time. These initiatives include: (a) introduction of value-added variants like Babool
Salt; and (b) marginal price increases through grammage reductions. Low price
has been one of the key drivers for Babool to expand its market share in the past.
Also, a large proportion of Daburs oral care portfolio includes toothpowder, which
given the shrinking category size, leads to underperformance of Dabur against
Colgate in the overall oral care portfolio. We expect the gradual premiumisation of
customers away from Daburs Babool towards Colgate, Pepsodent and Close-up.
As highlighted in the chart below, we expect Daburs recent underperformance in
revenue growth vis--vis the market leader Colgate to continue going forward.
Exhibit 5: Daburs oral care revenue has increased slower than Colgate
consistently over the past eight quarters
3%
6%
9%
12%
15%
18%
21%
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
1
2
3
Q
F
Y
1
2
4
Q
F
Y
1
2
1
Q
F
Y
1
3
2
Q
F
Y
1
3
3
Q
F
Y
1
3
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
Dabur Colgate

Source: Company, Ambit Capital research
Hair care (26% of domestic revenues) drag from weak amla hair
oil category growth and lack of a premium offering in
premiumisation-led shampoos category
Dabur has a strong brand recall in the mass market in both the hair oil as well as
the shampoo category (with Dabur Amla and Vatika Shampoo, respectively).
However, with rising competitive intensity in both these categories, we expect
Dabur to lose its market share to competitors.
Hair oils: Anecdotal industry data suggests that the amla categorys revenue
CAGR of ~12% is lower than the overall hair oil category growth of around
15% due to higher growth in the light hair oil segment. This works against
Daburs amla-oriented hair oils portfolio. Moreover, after the price cuts over
FY10-12, Maricos amla product offering, under the Shanti Amla brand, is now
40% cheaper than that of Dabur. Also, the company saw a moderation in hair
oils revenue growth due to a price hike taken on its Vatika branded coconut
oils portfolio. Consequently, as shown in the exhibits below, Daburs revenue
growth in the hair oil segment has been under pressure over the past three
quarters and we expect this moderation in growth rates to continue.


Dabur
Ambit Capital Pvt Ltd 95

Shampoos: Vatika is Daburs only offering in the shampoo market and is
priced at a ~25% discount to premium shampoo brands like Pantene and
Dove. However, as highlighted in the thematic section of this report,
premiumisation is the biggest driver of growth in the shampoo category.
Hence, within the overall shampoo categorys revenue growth of 18% over
FY12-15, premium shampoos are likely to significantly outperform the mass
market brands. Also, after a sudden rise in competitive intensity from premium
brands (including a sachet product of HULs Dove in FY11 and FY12), Daburs
shampoo segment revenues have reported negative growth rates for six
consecutive quarters (see the exhibit below). Although Dabur had reported
high revenue growth in the shampoo segment during FY13 (owing to a low
base effect and receding competition from Dove in the sachet format), we
expect the medium- to long-term growth of Daburs portfolio to lag
significantly behind its premium branded competitors.
Exhibit 6: Hair oil segments revenue growth muted due
to Parachutes entry into the amla hair oil segment
19%
13%
12%
18%
10%
27%
22%
20%
8%
9%
12%
7%
0%
5%
10%
15%
20%
25%
30%
1
Q
F
Y
1
1
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
1
2
3
Q
F
Y
1
2
4
Q
F
Y
1
2
1
Q
F
Y
1
3
2
Q
F
Y
1
3
3
Q
F
Y
1
3
4
Q
F
Y
1
3

Source: Company, Ambit Capital research
Exhibit 7: Shampoo segments revenues declined due to
aggression from MNCs in the sachet format
-30%
-22%
-25%
4%
17%
23%
40%
30%29%
-17%-15% -19%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
1
Q
F
Y
1
1
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
1
2
3
Q
F
Y
1
2
4
Q
F
Y
1
2
1
Q
F
Y
1
3
2
Q
F
Y
1
3
3
Q
F
Y
1
3
4
Q
F
Y
1
3

Source: Company, Ambit Capital research
Skin care lack of product width; susceptible to rising competitive
intensity
Daburs skin care portfolio includes: (a) Uveda branded skin creams; (b) Fem
branded bleach and hand washes; and (c) Gulabari branded skin creams.
Of these three products, we expect revenue growth for the Gulabari and Uveda
brands to be in single digits going forward due to: (a) weak promotional spends
for the Uveda brand; and (b) the Gulabari portfolio being positioned for the mass
market, which is expanding at a materially slower pace than the premium market
(we estimate the mass market growth to be at ~10% as against ~25% for the
premium market). Although we expect the Fem portfolio to maintain its market
leadership in bleaches (led by strong brand and regular innovation), we expect
market share losses for Daburs overall skin care segment, given its lack of range
of products and hence susceptibility to increase in competitive intensity.
Health supplements strong competition from Heinz and Emami
Daburs health supplements portfolio includes Chyawanprash, Honey and
Glucose-D. Chyawanprash forms around 50% of the health supplements category
and has seen a market growth of around 10-12% YoY. Competition from Emamis
Sona Chandi Chywanprash in the chyawanprash category is likely to be a
significant drag on overall revenue growth for the health supplements category.
We expect the honey category, with its new positioning as a slimming aid, to help
bring in new consumers on the wellness platform and thereby sustain its current
growth trajectory of around 15%. For Glucose-D, we expect no gains in market
share given strong competition from the market leader Heinzs Glucon-D (55%


Dabur
Ambit Capital Pvt Ltd 96

market share vs Daburs 25%). However, we expect revenue growth of ~15% in
this product for Dabur since the segment itself is increasing at 15-20% currently.
Digestives high penetration and mass-market focus will constrain
price increases to offset input cost inflation
Although we expect the OTC Pudin Hara to record revenue CAGR of 14%
(impacted by reclassification), Daburs Hajmola portfolio is likely to be a significant
overhang on the digestives portfolio growth due to: (a) high penetration of around
80%; and (b) mass market focus of the Hajmola product, which does not allow
premiumisation or frequent price increases to offset cost inflation over time.
Consequently, we expect the Hajmola digestive tablet to record revenue growth in
the high single-digits going forward vis--vis Daburs overall digestives portfolio
revenue growth of 11% over FY13-15.
Overall challenges due to limited scope of
premiumisation
Exhibit 8: Dabur will struggle to premiumise its product offering
Category
Ability to
premiumise
Comment
Honey Low Difficult to introduce commercial value-added variants
Chyawanprash Medium
Whilst the company can introduce premium variants, consumer
acceptance to a higher price point remains a challenge
Digestives Low Difficult to introduce commercial value-added variants
OTC & Ethicals Low Difficult to introduce commercial value-added variants
Glucose Medium
Flavoured variants can be introduced at a higher price point; however,
at a discount to Heinz's Glucon-D, to avoid market share losses
Hair care Medium
Whilst the segment offers high potential to premiumise, Dabur's ability is
restricted due to its mass-oriented brand image (Vatika brand) and
herbal offering
Home care Low
Limited ability to premiumise, given its presence in utility products;
premium offerings may lead to consumers shifting to MNC offerings at
similar price points
Oral Care High
Strong ability to premiumise, because the company is the strongest
player in the herbal toothpaste category
Skin Care Medium
Given the mass segment image that Dabur currently enjoys, it will
struggle to premiumise consumers whilst encountering MNC competition
Foods (Juices) High
Being a market leader in the segment, the opportunity to shift
consumers to Real Activ is strong
Source: Company, Ambit Capital research
Almost 35% of Daburs domestic revenues are positioned at the lower end of the
consumption spectrum. Also, unlike most of the mass-market products of its
competitors (including, HUL, Colgate and Marico), Daburs portfolio offers limited
potential to premiumise consumers in the relevant product categories. This
characteristic of Daburs product portfolio creates the following challenges:
Limited gross margin benefit related to product mix change towards premium
variants/brands over time.
Limited revenue growth vis--vis its peers since revenues from premium
products in most categories are increasing faster than mass-market products.
Limited scope to defend its market share whenever competitive intensity
from, say MNCs, rises in the future. Whilst its competitors can plough back
gross margin benefits from their premium-positioned portfolio towards higher
advertising spends, Dabur will not enjoy such a luxury given the limited
likelihood of margin expansion on its existing portfolio.
High price elasticity of demand in mass-market products does not enable even
strong brands like Babool to undertake price increases without sacrificing
volume growth. Consequently, as shown in the exhibit below, Dabur has
reported a gross margin decline of ~300bps over the past three years.


Dabur
Ambit Capital Pvt Ltd 97

Drag from the international business
Dabur derives around 30% of its consolidated revenues from its international
subsidiaries. One-third of these international revenues are related to its acquired
portfolio of Namaste branded hair care products.
The Namaste business was acquired in FY11 for US$100mn (or `4.5bn) with an
aim to leverage on its strong US presence and to expand in Africa. Currently, two-
thirds of Namastes overall revenues are derived from the US whilst the balance
comes from Africa. The management expects to achieve 6-8% revenue CAGR in
the US business and 15-20% revenue CAGR in the African business from the
Namaste portfolio with plans to set up in-house manufacturing in Africa to better
manage its supply chain and localise it to reduce the impact of import duties
(which are quite severe for some African nations).
However, over the past three quarters, the Namaste portfolio has reported weak
revenue growth due to the factors mentioned below. Whilst the management has
guided for a recovery in the US business by 1QFY14, we expect the Namaste
portfolio to continue to be a drag on the overall business in FY14 due to the
following:
Rebranding: A recent legislation in the US requires the company to change
the name of its key brand, Organic Root Stimulator (as the use of the word
Organic was not permitted). The company has rebranded the product as ORS
across the United States. As a result, Daburs Namaste portfolio saw a 10%
YoY decline in revenues in FY13 which, we expect, was a combination of a 20-
30% YoY decline in the US and a broadly flat YoY growth in Africa. Whilst the
drag from this rebranding exercise will be felt in the base quarter from
1QFY14 onwards, we do not expect the new brand to gather significant
momentum before at least another 12 months.
Management reshuffles: As confirmed by the management during the
quarterly conference calls, the Namaste senior management team is
undergoing significant reshuffles, with Dabur moving senior personnel from
India and Dubai to Chicago to manage its US operations. Changes such as
these do not indicate a likelihood of a significant recovery in the business in a
short span of time.
Execution issues in Africa: According to the managements comments during
the recent quarterly conference calls, Namastes African business is
undergoing a restructuring of its distribution network.
International margins will be dragged downwards by Namaste: Until
the Namaste business returns to the normal growth rates, it will have to be
supported by strong marketing-related investments given the need for product
rebranding in the US.
Macro-economic scenario in Africa: Based on our discussions with
economic experts in Africa, we believe that the fastest-growing African
countries like Kenya have seen a revenue CAGR of 12-14% in hair care
product category over the past five years. Moreover, whilst there exists a
significant middle-class population in some of these African countries, we see
limited potential for a hair care brand to derive sustainable high growth rates
in the continent because: (a) the hair care market is highly fragmented; (b) the
concept of consumerism is yet to pick up materially outside of South Africa;
and (c) poor infrastructure around rail, road and ports increases the complexity
of distribution for a pan-African player.



Dabur
Ambit Capital Pvt Ltd 98

Daburs Middle Eastern business which contributes to one-third of the overall
international business has been the only jewel in the crown of the companys
international portfolio. This business has been developed organically for Dabur
over the past two decades. Daburs portfolio of products in the Middle East
predominantly includes hair oils, hair creams and shampoos with a focus on the
herbal proposition.
Consequently, whilst we forecast 16.5% revenue CAGR for Daburs Middle Eastern
business over FY13-15, we forecast 6.9% revenue CAGR in the US business,
12.0% for the Africa business and 14.2% for the rest of Daburs international
business over the same period.


Dabur
Ambit Capital Pvt Ltd 99

Key assumptions
Exhibit 9: Key assumptions and estimates for revenues (` mn)

Share of
revenues
FY13E FY14E FY15E Comments
Domestic business
Health Supplements Growth 12.2% 16.2% 12.9% 12.4%
Market Growth 15.6% 12.0% 12.0%
Growth led by market share change 0.5% 0.8% 0.4%
Whilst glucose will likely remain the fastest growing
segment, we expect weakness from lower penetration
and higher competitive intensity to affect the
Chyawanprash business
Digestives Growth 4.1% 3.9% 10.6% 10.6%
Market Growth 6.0% 10.0% 10.0%
Growth led by market share change -2.0% 0.5% 0.5%
Difficulty in undertaking prices increases along with
high category penetration is likely to lead to slow
growth for Hajmola, with the OTC Pudin Hara likely
to grow around the health proposition
OTC & Ethicals Growth 6.9% 16.1% 15.0% 15.0%
Market Growth 15.0% 15.0% 15.0%
Growth led by market share change 1.1% 0.0% 0.0%
Expect stronger growth in the OTC category owing to
market-led growth in Dabur Lal Tail (baby oils
segment)
Hair care Growth 16.7% 11.7% 14.0% 13.0%
Market Growth 15.0% 16.0% 16.0%
Growth led by market share change -2.8% -1.7% -2.6%
Expect market share losses in hair care due to: (1)
high competitive intensity, (2) mass positioning, and
(3) slower growth in the amla segment
Home care Growth 3.7% 25.3% 18.0% 18.0%
Market Growth 20.0% 20.0% 20.0%
Growth led by market share change 3.3% -2.0% -2.0%
Expect market-led growth in home care, with air
fresheners and surface cleaners driving growth for the
category
Oral Care Growth 9.3% 10.3% 11.3% 11.2%
Market Growth 13.0% 14.0% 14.0%
Growth led by market share change -2.4% -2.4% -2.4%
Expect weak product portfolio to lead to market share
losses and large contribution of toothpowder to lead
to slower than category growth
Skin Care Growth 3.5% 15.4% 14.0% 14.0%
Market Growth 12.0% 15.0% 15.0%
Growth led by market share change 3.4% -1.0% -1.0%
Expect market share losses due to: (1) weak product
portfolio due to its mass focus (2) low marketing
spends and (3) high competitive intensity from the
MNCs
Foods Growth 10.8% 24.7% 20.0% 20.0%
Market Growth 22.3% 20.0% 20.0%
Growth led by market share change 1.9% 0.0% 0.0%
Expect market-driven growth and share to be
maintained despite new entrants in the space driven
by the strong brand and frequent innovation
Other Domestic Growth 3.2% 34.1% 12.0% 12.0%
Expect growth in line with the market
Total Domestic growth 15.8% 14.4% 14.1%

International business

Africa - Growth 6.4% 15.6% 12.0% 12.0%
Market growth 10.6% 8.0% 8.0%
Growth led by market share change 5.0% 4.0% 4.0%
Whilst we assume growth in line with the hair care
market in Africa, we highlight that growth will remain
difficult despite entering new geographies as
execution has remained a challenge for Dabur
Middle East - Growth 9.6% 27% 17% 16%
Market growth 9.0% 9.0% 9.0%
Growth led by market share change 18.0% 8.0% 7.0%
The Middle East is likely to remain a fast-growing
market for Dabur, given the under-penetration of the
portfolio and the potential demand for ayurvedic oral
and hair care products in view of the regional tastes
and preferences
Asia - Growth 5.2% 30.0% 15.0% 15.0%
Market growth 10.0% 10.0% 10.0%
Growth led by market share change 20.0% 5.0% 5.0%
Accounting for around 16% of the international
business, the Asian market is likely to see growth led
mainly by expanding the distribution of its portfolio
USA - Growth 6.5% -0.6% 6.4% 7.4%
Market growth 4.4% 4.4% 4.4%
Growth led by market share change -5.0% 2.0% 3.0%
Expect mid-single-digit growth in the US business as
the rebranding of the Namaste portfolio is likely to
have an adverse impact of revenues and is likely to be
associated with large rebranding and restructuring
expenses
Others - International 1.8% 16.0% 12.0% 12.0%
Assume growth broadly in line with Dabur's
international revenues
Total International growth 17.1% 12.9% 12.9%

Total growth 16.2% 14.0% 13.8%

Source: Ambit Capital research


Dabur
Ambit Capital Pvt Ltd 100

Exhibit 10: Key assumptions and estimates (` mn)
FY12 FY13E FY14E FY15E Comments
Profit and loss
Domestic revenues 37,428 43,331 49,568 56,575
Growth (%) 14.7% 15.8% 14.4% 14.1%
Expect domestic revenue growth to be led by fruit
juices and home care, whilst oral care and skin care
will be laggards
International revenues 15,461 18,110 20,451 23,096
Growth (%) 87.7% 17.1% 12.9% 12.9%
Expect strong growth in Middle East and Hobi
business, whilst rebranding of products in the US
business may lead to muted growth
Total revenues (ex-other income) 52,889 61,442 70,019 79,671
Growth (%) 29.4% 16.2% 14.0% 13.8%

Gross Profit 26,202 31,568 36,026 41,066
Gross margin (%) 49.4% 51.1% 51.2% 51.3%
Expect only nominal increase in gross margins as the
rate of premiumisation will be much slower than
competitors given its mass focused portfolio
Employee cost (% of sale) 7.3% 7.6% 7.5% 7.5%
Expect operational efficiencies to lead to minor
benefits in employee costs
Advertising (% of sale) 12.4% 13.6% 13.8% 13.9%
Increasing competitive intensity to lead to higher
advertisement spends
Freight & forwarding (% of sale) 2.0% NA 2.0% 2.0% Expect freight expenses to remain stable
Other expenses (% of sale) 10.9% NA 11.1% 11.1% Expect minor operational efficiencies in other expenses
EBITDA 8,902 10,298 11,827 13,455
EBITDA Margin 16.8% 16.7% 16.8% 16.8%
Above changes to lead to improvement in EBITDA
margins in FY14 and FY15
Tax rate 18.5% 19.2% 20.0% 21.0%
Tax rates to increase only marginally until FY16, after
which tax benefits will start to fade
Net Profit margin 12.2% 12.4% 12.5% 12.8%
Lower interest costs and slower increase in
depreciation to help boost net profit margin
Balance Sheet
Capex 2,500 1,189 1,800 1,800
Capital Work in Progress 226 226 226 226
No material capex requirements for FY14 and FY15
Working Capital days 10 30 29 27
Marginal improvement in working capital cycle due to
inventory and creditor management
Debtor days 32 29 30 30
Minor increase in debtors led by increasing share of
modern trade
Current Liabilities days 67 70 70 70 Expect current liabilities days to remain stable
Inventory days 57 50 50 50
Better inventory management to lead to decrease in
inventory days
Net debt/(cash) to equity 0.0 0.0 (0.1) (0.3) Expect Dabur to turn into a net cash company in FY13
Cash flows (` mn)
Operating cash flows 7,075 5,442 9,440 11,084
Free cash flows 4,673 4,253 7,640 9,284
Expect free cash flows to increase strongly over FY12-
15E
Source: Ambit Capital research



Dabur
Ambit Capital Pvt Ltd 101

Valuation
DCF valuation
Given the cash-generative nature of the business, we use a DCF-based model to
arrive at a fair value for Dabur. The assumptions for the weighted average cost of
capital and terminal growth rates are shown in the exhibit below. We have
assumed zero debt on Daburs balance sheet in the future given its strong cash
generation. Hence, the company has enough surplus cash available on its balance
sheet for capital expenditure in the future.
We use a three-stage DCF approach for Dabur. Stage 1 includes explicit forecasts
for the income statement and balance sheet for the next five years, with sales
CAGR of 14% and EPS CAGR of 16%. Stage 2 includes a decline in sales growth
over six years from 14% in FY18 to 7% in FY26 i.e. sales CAGR of 10% and a free
cash flow CAGR of 10% over this period. Stage 3 includes terminal growth
forecasts with a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `136 per share (14% downside),
implying an FY14 P/E multiple of 26.8x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 12: Cash flow profiles for Dabur (` mn)
-
2,000
4,000
6,000
8,000
10,000
12,000
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
(6,000)
(4,000)
(2,000)
-
2,000
4,000
6,000
8,000
10,000
CFO Free Cash Flow

Source: Ambit Capital research
Exhibit 13: Return profiles for Dabur (%)
0%
10%
20%
30%
40%
50%
60%
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
0%
10%
20%
30%
40%
50%
60%
70%
80%
ROE (LHS) EBITDA Margin
EPS Growth YoY Growth in sales

Source: Ambit Capital research
Relative valuation
Dabur currently trades at 31x FY14 P/E multiple, towards the bottom end of the
current range of the FMCG sector on this metric. We believe this discount is
justified given:
Portfolio positioning vs peers: Since Daburs portfolio is skewed towards
mass brands, the company loses out to its peers on premiumisation across
segments such as oral care and hair care.
International portfolios drag: Given the underperformance of the Namaste
portfolio, Dabur deserves to trade at a discount to its peers, given the relatively
higher probability of unexpected events dragging the overall earnings growth
for the company.
Exhibit 11: WACC calculation
for DCF on Dabur
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.55
Equity risk premium (%) 7
Cost of equity (%) 12.4
Cost of debt (%) 12.0
Debt/Equity ratio (%) 0
Tax rate (%) 30
WACC (%) 12.4
Source: Company, Ambit Capital
research


Dabur
Ambit Capital Pvt Ltd 102

On one-year forward P/E multiples, Dabur currently trades at a 16% premium to
its three-year average of 26.6x. However, given the moderation in its revenue
CAGR and EPS CAGR (FY13-15 EPS CAGR of 14% vs 19% over FY08-13), we
believe the stock deserves to trade at a discount to its historical average trading
multiple.
Exhibit 14: 1-year forward P/E bands for Dabur
40
60
80
100
120
140
160
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
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14x
30x
26x
22x
18x

Source: Ambit Capital research
Exhibit 15: 1-year forward EV/EBITDA bands for Dabur
40
60
80
100
120
140
160
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M
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11x
14x
17x
20x
23x

Source: Ambit Capital research
Sensitivity analysis
Exhibit 16: Sensitivity analysis
Bull case Base case Bear case
Revenue CAGR over
FY13-23
13% driven by strong growth in both
domestic and international business
(assume recovery in Namaste).
Terminal growth rate = 6%
13% with similar growth profiles in
both the domestic business and the
international business. Terminal
growth rate = 5%
12% driven by only 9% growth in the
international business as the Namaste
business does not pick up pace.
Terminal growth rate = 4%
Operating margins
Increase from 16.6% in FY13 to 17.3%
in FY17 driven by premiumisation-led
gross margin expansion and lower
advertising spends and remain stable
thereafter
Increase from 16.7% in FY13 to 17% in
FY18 mainly through gross margin
benefits. Advertisement spends grow
40bps and remain stable at 14%
Decline marginally to 16.5% in FY17
led by higher advertising expenditure
due to high competitive intensity
Fair value (` mn) 166 136 100
Upside/Downside 5% -14% -37%
Source: Ambit Capital research
Risks to our SELL stance
Strong market share gains in fruit juice segment: Daburs fruit juice
segment has seen strong traction by consistently maintaining its market share
(over Pepsis Tropicana) to remain the largest fruit juice player in the category.
Continuing market share gains (we factor in unchanged market share going
forward) along with easing raw material pressure could lead to improvement
in revenues and margins.
Vatika relaunch and growth in hair oil portfolio: Increasing competition
from Parachute has led to market share losses in the hair oil portfolio for
Dabur. Daburs ability to pull back any market share losses in the category as
well as success in the shampoo space (with Vatika shampoo being relaunched
in a premium avatar) can lead to potential upsides to our valuation.




Dabur
Ambit Capital Pvt Ltd 103

Catalysts
Inability to recover in the Namaste business: Whilst the management has
guided that the Namaste business in the US will see a recovery in FY14, we
believe Dabur will face an uphill task to create the brand recall and record strong
revenue growth. Whilst we expect a full recovery to take at least four quarters, a
decline in revenues is likely to be a negative trigger for the stock.
Decline in volume growth in the domestic business: Whilst the management
has guided for volume growth to sustain between 8% and 12%, the inability to
meet the guidance or only the bottom of the guidance will be a key negative
catalyst. We expect volume growth to sustain around 8% levels given the
heightened competitive intensity in hair care, oral care and skin care.
Ambit vs Consensus
Exhibit 17: Ambit vs consensus
Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments
FY14E

Net Sales (` mn)

70,346
71,459 -2%
Expect market share losses in haircare, oral
care and skin care to lead to revenues growth
below consensus
EBITDA (` mn)

11,827
12,298 -4%
Higher spends on A&P due to high competitive
intensity will likely lead to lower than
consensus EBITDA margins
EPS (`/share) 5.1 5.3 -5%
Above expectations to lead to EPS 5% below
consensus
FY15E
Net Sales (` mn)

80,031
82,546 -3%
Expect market share losses in haircare, oral
care and skin care to lead to revenues growth
below consensus
EBITDA (` mn)

13,455
14,378 -6%
Higher spends on A&P due to high competitive
intensity will likely lead to lower than
consensus EBITDA margins
EPS (`/share) 5.9 6.3 -7%
Above expectations to lead to EPS 7% below
consensus
Source: Bloomberg, Ambit Capital research
Exhibit 18: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, Dabur has reported strong cash conversion and working capital management,
and low levels of loans and advances and contingent liabilities. Consequently, we give a
high rating to its accounting quality.
Predictability AMBER
Daburs earnings trajectory has been slightly volatile and has been strongly influenced by the
level of competitive intensity during the quarter and input cost pressures.
Earnings momentum GREEN
Over the past six months, easing raw material prices have led to an upgrade in consensus
forecasts for Dabur by 2% for FY14 and FY15.
Source: Ambit Capital research


Dabur
Ambit Capital Pvt Ltd 104

Balance sheet (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Shareholders' equity 1,741 1,742 1,743 1,743 1,743
Reserves & surpluses 12,170 15,427 19,501 24,676 30,436
Total networth 13,911 17,169 21,244 26,419 32,179
Minority Interest 41 33 121 121 121
Debt 10,208 10,743 11,514 8,514 6,514
Deferred tax liability 189 274 362 362 362
Total liabilities 24,349 28,219 33,240 35,415 39,175
Gross block 19,337 21,837 23,026 24,826 26,626
Net block 14,986 16,454 16,519 17,159 17,760
CWIP 325 226 226 226 226
Investments 5,207 5,544 6,319 6,319 6,319
Cash & equivalents 2,805 4,484 5,128 6,122 8,950
Debtors 3,555 4,617 4,841 5,782 6,578
Inventory 7,085 8,239 8,439 9,636 10,963
Loans & advances 4,666 5,869 2,173 2,505 2,850
Other current assets 601 789 3,720 4,240 4,824
Total current assets 18,712 23,999 24,301 28,286 34,165
Current liabilities 7,696 9,790 11,764 13,491 15,348
Provisions 7,184 8,214 2,361 3,084 3,947
Total current liabilities 14,880 18,004 14,125 16,575 19,295
Net current assets 3,832 5,995 10,176 11,711 14,870
Total assets 24,349 28,219 33,240 35,415 39,175
Source: Company, Ambit Capital research
Income statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income 41,045 53,054 61,761 70,346 80,031
% growth 20.2% 29.3% 16.4% 13.9% 13.8%
Operating expenditure 33,032 44,153 51,463 58,519 66,576
EBITDA 8,013 8,902 10,298 11,827 13,455
% growth 22.4% 11.1% 15.7% 14.8% 13.8%
Depreciation 952 1,032 1,124 1,160 1,199
EBIT 7,061 7,869 9,174 10,667 12,256
Interest expenditure 303 538 589 601 451
Non-operating income 321 574 945 960 1,126
Adjusted PBT 7,079 7,905 9,530 11,027 12,932
Tax 1,390 1,464 1,826 2,205 2,716
Adjusted PAT/ Net profit 5,689 6,441 7,704 8,821 10,216
% growth 13.7% 13.2% 19.6% 14.5% 15.8%
Extraordinaries - - (46) - -
Reported PAT / Net profit 5,689 6,441 7,750 8,821 10,216
Minority Interest (3) 8 (24) - -
Share of associates - - - - -
Adjusted Consolidated net profit 5,686 6,449 7,726 8,821 10,216
Reported Consolidated net profit 5,686 6,449 7,726 8,821 10,216
Source: Company, Ambit Capital research


Dabur
Ambit Capital Pvt Ltd 105

Cash flow statement (` mn)
Year to March FY11 FY12 FY13E FY14E FY15E
EBIT 7,382 8,443 10,119 11,627 13,383
Depreciation 952 1,032 1,124 1,160 1,199
Others 110 85 152 (0) (0)
Tax (1,390) (1,464) (1,826) (2,205) (2,716)
(Incr) / decr in net working capital (1,095) (484) (3,537) (541) (331)
Cash flow from operations 5,960 7,613 6,031 10,041 11,535
Capex (9,496) (2,402) (1,189) (1,800) (1,800)
(Incr) / decrin investments (2,566) (338) (775) - -
Cash flow from investments (12,061) (2,739) (1,964) (1,800) (1,800)
Net borrowings 8,415 535 770 (3,000) (2,000)
Interest paid (303) (538) (589) (601) (451)
Dividend paid (2,241) (2,632) (3,038) (3,646) (4,456)
Others 1,113 (559) (567) - -
Cash flow from financing 6,983 (3,194) (3,424) (7,247) (6,907)
Net change in cash 881 1,680 644 994 2,828
Closing cash balance 2,805 4,484 5,128 6,122 8,950
Free cash flow (3,536) 5,211 4,842 8,241 9,735
Source: Company, Ambit Capital research
Ratio analysis
Year to March FY11 FY12 FY13 FY14E FY15E
Gross margin (%) 52.8% 49.4% 41.4% 51.2% 51.3%
EBITDA margin (%) 19.5% 16.8% 16.7% 16.8% 16.8%
EBIT margin (%) 18.0% 15.9% 16.4% 16.5% 16.7%
Net profit margin (%) 13.9% 12.2% 12.4% 12.5% 12.8%
Dividend payout ratio (%) 39.4% 40.8% 39.6% 41.3% 43.6%
Net debt: equity (x) 0.7 0.6 0.5 0.3 0.2
Working capital turnover (x) 40.0 35.1 12.2 12.6 13.5
Gross block turnover (x) 2.1 2.4 2.7 2.8 3.0
RoCE (%) 33.3% 26.2% 26.5% 27.1% 28.3%
RoE (%) 48.9% 41.5% 40.0% 37.0% 34.9%
Source: Company, Ambit Capital research
Valuation parameters
Year to March FY11 FY12 FY13 FY14E FY15E
EPS (`) 3.3 3.7 4.4 5.1 5.9
Diluted EPS (`) 3.3 3.7 4.4 5.1 5.9
Book value per share (`) 8.0 9.9 12.2 15.2 18.5
Dividend per share (`) 1.1 1.3 1.5 1.8 2.2
P/E (x) 48.4 42.7 35.9 31.2 27.0
P/BV (x) 19.8 16.0 13.0 10.4 8.6
EV/EBITDA (x) 35.2 31.6 27.4 23.5 20.3
Price/Sales (x) 6.7 5.2 4.5 3.9 3.4
Source: Company, Ambit Capital research

Consumer Goods June 04, 2013
GSK Consumer
Bloomberg: SKB IN EQUITY
Reuters: GLSM.NS
Accounting: GREEN
Predictability: GREEN
Earnings momentum: AMBER


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to December CY10 CY11 CY12 CY13E CY14E
Operating income (` mn) 23,061 26,855 30,794 35,577 40,992
EBITDA(` mn) 3,741 4,249 4,653 5,584 6,556
EBITDA Margin (%) 16.2% 15.8% 15.1% 15.7% 16.0%
Adjusted PAT(` mn) 2,999 3,552 4,368 5,099 6,099
Adjusted EPS (`) 71.2 86.0 103.8 121.2 145.0
RoE (%) 32.1% 34.4% 34.9% 34.7% 35.9%
P/E (x) 77.4 64.1 53.1 45.5 38.0
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `5,515
Target Price (Mar14): `3,945
Previous TP: NA
Downside (%) 29%
EPS (CY13E): `121.2
Change from previous (%) NA
Variance from consensus (%) 1%
Stock Information
Mkt cap: `232bn/US$4,112mn
52-wk H/L: `6,348/2,179
3M ADV: `175mn/US$3.1mn
Beta: 0.5x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
36 38 100 45
Rel. to Sensex
36 34 77 44
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Oct-12 J an-13 May-13
2000
3000
4000
5000
6000
Sensex GSK Consumer

1-year forward P/E band chart
400
1000
1600
2200
2800
3400
4000
4600
5200
5800
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8
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17x
45x
38x
31x
24x

Source: Bloomberg, Ambit Capital research
Growth beyond Horlicks?
GSK Consumer currently benefits from the strength of its Horlicks
franchise in south and east India and from its capital-light auxiliary
income stream. However, its milk food drinks (MFD) portfolio currently
faces headwinds from growth moderation in the south and east
market, given the high penetration levels and market share loss in the
north and west (due to increased competitive intensity from Complan).
Despite 23% CAGR in auxiliary income over CY12-15E, EPS CAGR over
the same period is likely to be only 18%. We initiate coverage with a
SELL stance and a target price of `3,945 (29% downside).
Competitive position: MODERATE Change to this position: STABLE
We expect EBITDA margin expansion of ~100bps over CY12-15 led by higher
in-house manufacturing (after the recent capacity expansion), product mix
change and the recent pricing action. However, we expect PAT CAGR to
moderate from 22% over CY07-12 to 18% over CY12-15 due to:
Moderation in volume growth: GSKs MFD market share in south and east
(S&E) India is around 74% vs around 30% in north and west (N&W) India. Over
the past five years, it has lost market share to Complan and we expect this
trend to continue due to: (a) high penetration levels of MFDs in S&E (50%
currently) leading to moderation in category growth rates vs historical rates;
(b) weak presence of Horlicks in the premium MFD segment where competitive
intensity is rising (dominated by Abbotts Pediasure); (c) strong competition
from Complan in N&W; and (d) the mass-market brand recall of Horlicks
constraining a successful super-premium variant launch.
Risks around capital allocation: Over `10bn of surplus cash accumulated
over the past five years will be used to fund portfolio diversification. Given the
unsuccessful attempts at diversifying beyond the MFD segment in the past, this
surplus capital would either remain unutilised over the next 2-3 years or be
deployed towards M&A, which, given the current high valuations in the overall
FMCG sector, is not likely to be significantly value accretive.
Potential of the auxiliary portfolio: We assume sales CAGR of 40% for
Sensodyne and 22% for Eno over CY12-15 to drive 23% CAGR in auxiliary
income for GSK Consumer over this period (vs 28% over CY09-12). Whilst this
remains the biggest attraction for GSKs future growth potential, even a highly
successful new launch is not likely to add more than 50bps to its revenue
CAGR over the next three years.
Valuation: The stocks CY13E P/E multiple of 45.5x is at a 22% premium to its
peers. Given the factors around moderating earnings growth, we find this
premium to be unjustified. Our DCF-based valuation generates a TP of
`3,945/share (29% downside), implying FY14 P/E multiple of 32.5x.


GSK Consumer
Ambit Capital Pvt Ltd 106

Company Financial Snapshot
Profit and Loss (` mn)
CY12 CY13E CY14E
Net sales 30,794 35,577 40,992
Optg. Exp(Adj for OI.) 26,141 29,993 34,435
EBITDA 4,653 5,584 6,556
Depreciation 361 493 544
Interest Expense 24 - -
PBT 6,487 7,714 9,131
Tax 2,120 2,615 3,031
Adj. PAT 4,367 5,099 6,099
Profit and Loss Ratios

EBIDTA Margin % 15.1% 15.7% 16.0%
Adj Net Margin % 14.2% 14.3% 14.9%
P/E (X) 53.1 45.5 38.0
EV/EBIDTA (X) 46.7 38.4 32.3
Dividend Yield (%) 0.8% 1.1% 1.4%
Company Background
GlaxoSmithKline Consumer Healthcare (GSK Consumer) is
one of the largest players in the health food drinks industry in
India. Its flagship brand, Horlicks is more than 100 years old
in India.
The company is an Indian associate of GlaxoSmithKline Plc,
UK, and it has more than 2,700 employees in India and
direct coverage of 0.7mn retail outlets.
The company also manufactures Boost, Maltova, Viva,
biscuits, noodles (brand Foodles) and promotes and
distributes OTC products such as Eno, Crocin and Iodex.
Balance Sheet (` mn) CY12 CY13E CY14E
Total Assets 24,928 28,893 33,407
Net Fixed Assets 3,911 4,146 4,402
Current Assets 21,018 24,748 29,005
Other Assets - - -
Total Liabilities 24,928 28,893 33,407
Networth 13,610 15,766 18,188
Debt - - -
Current Liabilities 11,935 13,743 15,835
Deferred Tax (616) (616) (616)
Balance Sheet Ratios
ROE % 34.9% 34.7% 35.9%
ROCE % 36.5% 36.2% 37.3%
Net Debt/Equity (1.1) (1.1) (1.1)
Equity/Total Assets 1.0 1.0 1.0
P/BV (X) 17.0 14.7 12.8
Cash Flow (` mn)

CY12 CY13E CY14E
PBT 6,487 7,714 9,131
Depreciation 361 493 544
Tax (2,120) (2,615) (3,031)
Change in Wkg Cap 2,088 776 964
Others (217) - -
CF from Operations 6,599 6,367 7,608
Capex (554) (2,200) (800)
Investments - -
CF from Investing (554) (2,200) (800)
Change in Equity - - -
Debt - - -
Dividends (2,199) (2,942) (3,678)
Others 0 - -
CF from Financing (2,199) (2,942) (3,678)
Change in Cash 3,846 2,697 3,130
Recent moderation in volume growth for GSK Consumer

Indexed revenue growth by the incumbents over CY07-
11
0%
2%
4%
6%
8%
10%
12%
14%
16%
1
Q
C
Y
1
1
2
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4
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2
3
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1
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4
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2
1
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Volume Growth Price Increase

100
120
140
160
180
200
220
240
CY07 CY08 CY09 CY10 CY11
GSK Consumer Bournvita (Cadbury)
Complan (Heinz)

Source: Company, Ministry of Company Affairs, Ambit Capital research


GSK Consumer
Ambit Capital Pvt Ltd 107

Background
Exhibit 1: GSK Consumers portfolio mix
Category Key brands Key competitors
Market
share rank
% of turnover
(CY12)
CY09-12
CAGR
Milk Food
Drinks
Horlicks, Boost, Viva,
Maltova
Complan, Bournvita
1
85% 17%
Biscuits Horlicks, Nutribic Britannia, Parle, ITC
Low
7% 30%
Exports (MFD) Horlicks, Boost NA
NA
8%
Category Key brands Key competitors
Market
share rank
% of PBT
(CY12)
CY09-12
CAGR
Auxiliary
income
Sensodyne, Iodex,
Eno, Crocin
Colgate, Vicks,
Digene

15% 28%
Source: Ambit Capital research
As highlighted in the table above, GSK Consumers presence in India relates
predominantly to Milk Food Drinks (MFD). The companys key brands are
Horlicks (in the white category) and Boost (in the brown category). Thanks to
these brands, the firm controls ~60% of the MFD category. Over the past two
decades, the company has diversified into the biscuits and noodles categories with
a minority share in both. The company also derives auxiliary income, equivalent
to ~15% of PBT, through a distribution alliance with GSK Asia (for Sensodyne,
Crocin and Eno) and GSK Pharma (for Iodex). Under this alliance, GSK distributes
the products and in turn receives a revenue-based commission of 16.7% from GSK
Asia and 10.5% from GSK Pharma for the distribution of these products. There is
no material incremental capital employed by GSK Consumer for this revenue
stream. Exports to the Middle East, Nepal, Bangladesh and Sri Lanka account for
around 8% of revenues.
As shown in the chart below, north and west India contribute to only ~10% of GSK
Consumers overall revenues, with the south and the east contributing to the lions
share. Whilst the company controls a market share of 75-80% in both south as
well as east India, it controls a market share of ~25-30% in the north and west.
The bulk of the disparity between N/W and S/E markets relates to Horlicks
capitalising on the lack of milk availability in the south and east (which results in
strong demand for MFDs as milk substitutes).
Exhibit 2: Geographic revenue split (CY11)
Exports,
8%
West, 4%
South,
46%
East, 37%
North, 6%

Source: Company, Ambit Capital research
Exhibit 3: GSK market share in milk food drinks (CY11)
Others,
1%
Abbot, 3%
Cadbury,
13%
Heinz,
20%
GSK
Consumer,
63%

Source: Company, Ambit Capital research
The company has three manufacturing facilities in Nabha (Punjab), Rajamundry
(Andhra Pradesh) and Sonepat (Haryana). It is currently expanding capacity in its
current facilities for the MFD business with a capex of around `3.5bn (equal to
around 23% its CY12 year-ending capital employed). This capacity expansion will
fully come on stream by June 2013.


GSK Consumer
Ambit Capital Pvt Ltd 108

Direct distribution reach stands at around 0.75mn outlets for the MFD business
and around 0.4mn outlets for the biscuits business (around 1.2mn outlets overall
for the MFD business). The company is looking at expanding its rural penetration
(currently accounting for around 26% of sales) by around 10,000 villages in CY12
(from 50,000 villages currently), leading to around `750mn of incremental
revenue (~2% of overall revenues).
SWOT analysis
Exhibit 4: SWOT analysis for GSK Consumer
Strengths Weaknesses
Strong market-leading health-focused brand (Horlicks) with
around 63% market share.
Strong balance sheet with more than `11bn of cash balance that
the company can use for new product launches as well as
inorganic growth.
Has successfully taken on new entrants like HUL, Nestle and
Dabur earlier, all of which eventually exited the milk food drinks
market over 2008-11.
Strict control over inventory (inventory days of 50 in CY11) and
creditors (other current liabilities days of 91 in CY11) helps GSK
Consumer rank favourably in its peer group for working capital
cycles (working capital cycle of -47 days in CY11).

More than 93% of its revenues are dependent on only
milk food drinks whilst biscuits and oats account for less
than 6% of revenues.
Has a relatively weak premium portfolio (Its premium
variant Horlicks Gold is a relatively new product and does
not have a product in the super-premium category) and is
likely to lose share to Heinz in the fast-growing premium
category.
Have seen multiple product failures in the past whilst
trying to enter new categories like toothpastes, nutrition
bars, energy drinks, etc.
Opportunities Threats
Health-focused brand that can be extended into other health-
based categories. Current brand extensions include biscuits and
oats.
Has a presence in an under-penetrated category (MFD category
penetration stands at 22% for urban and 11% for rural) where
the potential for growth remains significant.
Support from the parents global portfolio for new product
launches (mainly OTC products), both in terms of distribution
arrangements and new product development.

Increasing competitive intensity can force the company to
increase advertisement spends (which already stand at a
high 16.3% of sales in CY11) especially as it tries to build
its presence in the north and west where it has been
traditionally weak.
The company can be adversely affected if the slowdown in
packaged food growth seen during CY12 is sustained.
Source: Industry, Company, Ambit Capital research


GSK Consumer
Ambit Capital Pvt Ltd 109

Volume growth moderation likely
Whilst GSK Consumer has reported volume CAGR of around 10% over CY10-12,
the volume growth has been moderating significantly in recent quarters, as shown
in the chart below.
Exhibit 5: Recent volume growth trends for GSK Consumer (%)
0%
2%
4%
6%
8%
10%
12%
14%
16%
1
Q
C
Y
1
1
2
Q
C
Y
1
1
3
Q
C
Y
1
1
4
Q
C
Y
1
1
1
Q
C
Y
1
2
2
Q
C
Y
1
2
3
Q
C
Y
1
2
4
Q
C
Y
1
2
1
Q
C
Y
1
3
Volume Growth Price Increase

Source: Company, Ambit Capital research
At the same time, Heinz India (~62% of revenue contribution from milk food
drinks under the brand Complan) has reported revenue CAGR of 27% over FY06-
11 with EBITDA CAGR of 30% over FY06-11 (see the table below). Glucon-D,
medicated powders (Nycil) and sauces form 26%, 10% and 1% of revenues for
Heinz respectively, three categories which are likely to have recorded less than
25% CAGR over this period. Therefore, we expect Heinz Indias revenue growth to
have been led predominantly by ~30% CAGR in revenues from Complan over
the past five years, thereby suggesting substantial market share gains by
Complan from Horlicks in the recent past.
Exhibit 1: Heinz India - financial summary (` mn)
Heinz FY06 FY07 FY08 FY09 FY10 FY11
Net Sales 3,650 4,962 6,049 7,207 9,332 11,973
YoY growth in sales
36% 22% 19% 29% 28%
EBITDA Margin 18.9% 16.6% 16.4% 17.7% 18.6% 21.0%
PAT Margin 9.5% 8.9% 9.5% 10.2% 11.3% 16.3%
YoY growth in PAT
27% 30% 28% 44% 84%
Source: Ambit Capital research
Complans market share gains against both Horlicks as well as Bournvita are also
visible from the chart shown below.
Exhibit 6: Indexed revenue growth by the incumbents over CY07-11
100
120
140
160
180
200
220
240
CY07 CY08 CY09 CY10 CY11
GSK Consumer Bournvita (Cadbury) Complan (Heinz)

Source: Company, Ambit Capital research. Note: Complan growth pertains to FY07-11.


GSK Consumer
Ambit Capital Pvt Ltd 110

Whilst penetration of MFDs in India currently stands at around 45-50% in south
and east India (S&E), it is as low as 10-12% in north and west India (N&W). GSKs
management claims that N&W presents a bigger opportunity for Horlicks as
compared to S&E through a focus on distribution expansion in N&W regions and in
rural India. However, as shown in the chart below, GSKs share of revenues from
S&E regions has not reduced in recent quarters, which implies that N&W regions
for GSK Consumer have NOT grown faster than S&E regions in recent
quarters.
Exhibit 7: Quarterly trend of geographical revenue split
6% 6% 6% 6% 6%
35%
38%
36%
38%
36%
47%
45% 45% 45%
44%
4% 4% 4%
5% 5%
9%
6%
9%
5%
8%
0%
10%
20%
30%
40%
50%
1QCY11 3QCY11 1QCY12 3QCY12 1QCY13
North East South West Exports

Source: Ambit Capital research
We expect a moderation in volume growth to 8% over CY12-15 and revenue
CAGR of 15% over CY12-15 due to the following reasons: (a) saturation of market
share in S&E India, (b) moderation of category growth rate in S&E India given high
penetration levels, and (c) market share loss to Heinzs Complan brand especially
in N&W regions. Each of these factors is elaborated in subsequent pages.
Penetration saturation in S&E and rising competition in N&W
Based on companies reported data and anecdotal data, we believe that whilst
GSK Consumers MFD market share in south and east (S&E) is around 74%, its
market share in north and west (N&W) is around 30% (see the table below).
Moreover, we reckon that both Complan as well as Bournvita control higher
market shares than GSK Consumer in the N&W regions.
Exhibit 8: Region-wise market shares in the MFD space
Market Share in Zone (%)
Pan-India
GSK brands market share 63%
Complan market share 20%
Bournvita market share 13%
South & East (75% of Indian MFD)
GSK brands market share 74%
Complan market share 15%
Bournvita market share 7%
North & West (25% of Indian MFD)
GSK brands market share 30%
Complan market share 35%
Bournvita market share 30%
Source: Company, Ambit Capital research
We believe that GSK Consumers market share loss in the MFD space has been
driven by the following factors (which the company is not likely to overcome in the
near term):


GSK Consumer
Ambit Capital Pvt Ltd 111

Weak positioning in the premium segment: As shown in the table below,
Horlicks current portfolio is skewed towards the bottom-end of the MFD
markets price range. Therefore, Horlicks is unfavourably placed to capitalise
on the faster growth in the premium segment.
Exhibit 9: Horlicks is positioned at the mass-end whilst Pediasure is a super-
premium brand
Brand Manufacturer Price* (`) Weight (gms) Price/100gms (`)
Horlicks Chocolate GSK Consumer 170 500 34
Bournvita 5 Star Magic Cadbury 171 500 34
Horlicks base GSK Consumer 174 500 35
Complan base Heinz 192 500 38
Boost GSK Consumer 173 450 38
Horlicks Gold GSK Consumer 200 500 40
Horlicks Junior GSK Consumer 200 500 40
Complan - Chocolate Heinz 416 1000 42
Horlicks Lite GSK Consumer 217 500 43
Mother's Horlicks GSK Consumer 326 500 65
Pediasure Abbot 1019 1000 102
Source: Company, Ambit Capital research; *Prices as of March 2013
Brand extensions have not helped gain market share so far: The
premium MFD segment has been expanding by around 33% over the past few
years as compared to 16% revenue CAGR for the overall MFD segment. To
capitalise on this fast-growing segment, GSK Consumer has sought to
leverage the Horlicks brand the firm has introduced not only premium
extensions of Horlicks in MFD, but also biscuits, noodles and oats, as shown in
the table below. However, Horlicks non-MFD variants form only around 8% of
GSK Consumers overall revenues (up from 5% three years ago).
Exhibit 10: Leveraging the Horlicks brand
Year Product Target
Estimated Revenues
(` mn)*
New categories
1992 Horlicks Biscuits
Available in both cookies and cream formats with
a nutrition focus
1,000
2009 Horlicks Foodles Positioned on a health-based platform 500
2011 Horlicks Oats Health-focused breakfast cereal targeted at adults 300
MFD Extension
1997
Mother's
Horlicks
For lactating women and breast-feeding mothers 250
1997 Junior Horlicks For children between the ages of 2 and 5 2,200
2005 Horlicks Lite
High fiber, low fat formulation for adults and
diabetics
250
2008
Women's
Horlicks
Targeted at health-conscious urban working
women
300
2011 Horlicks Gold
Premium offering to meet the increasing
nutritional requirements of kids
400
Source: Ambit Capital research. * As of CY11
A new super-premium variant unlikely to change its fortunes: After the
recent success of Abbots super-premium MFD brand, Pediasure (3-4% market
share, with most of the gains over the last 24 months), GSK Consumer intends
to introduce a super premium variant of Horlicks in the coming quarters.
However, with Horlicks brand recall being related to a mass-market product
rather than a premium discretionary product, we do not believe that a brand
extension of Horlicks in the super premium category is likely to help the
company gain market share in the overall MFD market.


GSK Consumer
Ambit Capital Pvt Ltd 112

Consequently, we expect 14.7% revenue CAGR for GSK Consumer in the MFD
space over CY12-14 (vs 17% CAGR from CY08-12). This is around 30bps lower
than the market growth rate, because we expect the market share of Horlicks and
Boost to decline from 63% in CY11 to 62% in CY14). We also expect the biscuits
and oats business to record a revenue CAGR of 23% and 29% respectively over
CY12-14, led by distribution expansion and the launch of new variants in these
categories.
Exhibit 11: Category growth projections for GSK Consumer*
Category Market Share (CY11) Market share (CY14) CAGR CY12-14
Milk Food Drinks 63% 62% 15%
Biscuits NA NA 23%
Oats 11% 12% 29%
Source: Ambit Capital research. * This is based on anecdotal data for category growth rates and our
assumptions around market share changes in the various categories
Potential to expand auxiliary income
GSK Consumer receives commission for distributing products of its group entities
(classified as auxiliary income). It has a distribution alliance with GSK Asia (for
Sensodyne, Crocin and Eno) and GSK Pharma (for Iodex) where GSK distributes
the product and in turn receives a commission of 16.7% from GSK Asia and 10.5%
from GSK Pharma. Consequently, there is no material incremental capital
employed by GSK Consumer for this revenue stream. Auxiliary income currently
forms around 15% of GSKs PBT.
Exhibit 12: Contribution of auxiliary income to GSKs PBT
0
50
100
150
200
250
300
350
1
Q
C
Y
1
0
2
Q
C
Y
1
0
3
Q
C
Y
1
0
4
Q
C
Y
1
0
1
Q
C
Y
1
1
2
Q
C
Y
1
1
3
Q
C
Y
1
1
4
Q
C
Y
1
1
1
Q
C
Y
1
2
2
Q
C
Y
1
2
3
Q
C
Y
1
2
4
Q
C
Y
1
2
1
Q
C
Y
1
3
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
Auxillary Income (Rs mn) As % of PBT

Source: Company, Ambit Capital research
The gradual rise in auxiliary income as a percentage of PBT has been led by a 27%
CAGR in consignment sales for GSK Consumer over CY09-12, which in turn has
been driven by two key products: (a) Eno, which reported a revenue CAGR of 31%
over this period; and (b) Sensodyne, which has achieved sales of ~`1.4bn in
CY12, up from only `37mn in CY10. Over CY12-15, we expect Sensodyne to
report a 40% CAGR in revenues as it maintains its dominant market positioning in
the sensitive toothpaste segment which is growing at ~35-40% YoY currently.
Also, we expect Eno to report a 22% CAGR in revenues over CY12-15 as its brand
recall in the antacid segment is unchallenged currently. Consequently, we expect
23% CAGR in auxiliary sales for GSK Consumer over CY12-15.
Prospects of successfully adding new products to auxiliary sales going
forward: The recent open offer made by the parent for GSK Consumer to acquire
31.8% of the entitys shareholding at `3,900, a premium of around 30% to the
then prevailing share price, raises the possibility that the parent intends to: (a)
launch new products from the parents portfolio through the auxiliary income
route; or (b) enter into new product categories.


GSK Consumer
Ambit Capital Pvt Ltd 113

However, given a history of launches that have not met with success (Lucozade,
Nutribars, Foodles, Aquafresh, Horlicks Chilled Doodh, etc), we believe it is pre-
mature to expect a new launch to lead to a revenue growth that is as strong as
that reported by Sensodyne over CY10-12.
Surplus capital utilisation prospects
Whilst GSK Consumers working capital management and cash generation is
amongst the best in the sector, the companys dividend payout ratio has ranged
between 35% and 50% over the past ten years, leaving around 50% of cash
generated unutilised over the past ten years (after capex). Attempts to leverage on
the Horlicks brand to enter into categories like biscuits, noodles, energy drinks and
health bars have not been successful in most cases. Consequently, GSK
Consumers RoEs have been consistently at 20-30% over the past ten years,
several notches below that of its peers.
The firm currently holds ~`10.8bn of surplus capital on its balance sheet,
equivalent to 95% of overall net worth. Over the past three years, the
company has highlighted prospective M&A as a mode of surplus capital
deployment. Moreover, over the past four years, GSK Consumer has tried to
leverage on the brand recall of Horlicks and Boost to enter into new product
categories including biscuits, cookies, nutribars and has also tried to launch new
brands/products including Foodles (noodles). Most of these initiatives are yet to
materially gather momentum for GSK Consumer. Based on a combination of these
factors/initiatives/comments made by the company we believe that: (a) GSK
Consumer is NOT likely to repatriate a significant proportion of surplus capital;
and b) The risk of making a non-core acquisition remains high in the future, and
until then, surplus capital will remain a drag on return ratios.
Implications of recent capex of `2.4bn
In 2010, the company had announced a capex of `2.4bn for 18,000 tonnes of
capacity expansion (~18% increase in installed capacity) which was commissioned
in February 2013. This plan was launched because the total production of malt-
based foods had already exceeded 85% of installed capacity in CY10.
Consequently, we do NOT see the capacity expansion initiative to either be: (a) an
indication of stronger growth expectations from the business internally; or (b) a
material capital deployment initiative since the quantum of this capex was only 2%
of the cash available on the balance sheet.


GSK Consumer
Ambit Capital Pvt Ltd 114

Key assumptions
Exhibit 13: Key assumptions and estimates (` mn)
CY11 CY12 CY13E CY14E Comments
Profit and loss
Milk Food Drinks 26,560 30,556 35,083 40,281
Market Growth 15.0% 15.0% 15.0% 15.0%
Growth led by market share
changes
1.3% -0.7% -0.4% -0.2%
Growth (%) 16.3% 14.3% 14.6% 14.8%
Expect a mix of volume growth of around 8% and price
increase of 6% from increasing penetration. Weak
presence in the premium segment will likely lead to
market share losses to Complan and Pediasure
Biscuits and Oats 1,761 2,031 2,417 2,927
Market Growth 12.0% 10.0% 12.0% 12.0%
Growth led by market share
changes
12.4% 11.2% 9.1% 9.1%
Growth (%) 24.4% 21.2% 21.1% 21.1%
Whilst market growth remains around 12%, new
product launches in biscuits and expansion into other
geographies to lead to market share gains in biscuits
Gross revenues 28,321 32,586 37,500 43,208
Growth (%) 16.5% 15.1% 15.1% 15.2%
Gross Profit 16,628 19,275 22,376 25,864
Gross margin (%) 61.9% 62.6% 62.9% 63.1%
Increasing premium mix in the Horlicks portfolio to
offset lower gross margin biscuits and oats portfolio
Employee cost (% of sale) 9.6% 9.8% 9.8% 9.8%
Do not expect scale benefits as new plant will keep
employee costs elevated
Advertising (% of sale) 16.3% 16.1% 16.2% 16.3%
Expect advertising spends to increase as competitive
intensity rises
Carriage & Freight (% of
sale)
4.9% 5.1% 5.1% 5.0%
Expect minor benefits in CY14 as new plant leads to
freight efficiencies
Royalty (% of sale) 3.5% 3.4% 3.4% 3.4% Expect royalty to remain stable
Other expenses (% of sale) 11.8% 13.1% 12.7% 12.6%
Expect minor benefits from lower conversion charges
paid to third parties and scale efficiencies
EBITDA 4,249 4,653 5,584 6,556
Above changes to lead to EBITDA margin expansion of
90bps over CY11-14
EBITDA Margin 15.8% 15.1% 15.7% 16.0%
Other Income 1,648 2,219 2,623 3,118
Growth (%) 40.3% 34.7% 18.2% 18.9%
Other income growth to be led by a CAGR of 23% in
auxiliary commissions, 10% in interest income and 11%
in miscellaneous income over CY11-14
Tax rate 33.0% 32.7% 33.9% 33.2%
Expect tax rates to be stable at the maximum marginal
rate
Net Profit margin 13.5% 14.2% 14.3% 14.9%
Expect net profit margin increase of 90bps over CY11-
14
Balance Sheet
Capex 377 196 2,200 800
Capital Work in Progress 1,711 1,972 500 500
`2.5bn expansion to be completed in CY13
Working Capital days (47) (66) (65) (65) Expect working capital days to be stable
Debtor days 13 13 13 13 Expect debtor days to be stable
Current Liabilities days 42 43 43 43 Expect current liabilities days to be stable
Inventory days 50 44 45 45 Expect inventory days to be stable
Net debt/(cash) to equity (0.9) (1.1) (1.1) (1.1) Expect net cash balance to increase to `17bn by CY14
Cash flows (` mn)
Operating cash flows 3,884 6,599 6,367 7,608
Free cash flows 2,813 6,045 5,640 6,808
Free cash flows to improve materially in CY14 as no
incremental funds are required for capex
Source: Company, Ambit Capital research.


GSK Consumer
Ambit Capital Pvt Ltd 115

Valuation
DCF valuation
Given the cash-generative nature of the business, we use a DCF-based model to
arrive at a fair value for GSK Consumer. The assumptions for weighted average
cost of capital and terminal growth rates are shown in the exhibit below. We have
assumed zero debt on GSKs balance sheet in the future given its strong cash
generation. Hence, the company would have enough surplus cash available on its
balance sheet for capital expenditure in the future.
We use a three-stage DCF approach for GSK Consumer. Stage 1 includes explicit
forecasts for the income statement and balance sheet for the next five years, with
sales CAGR of 15% and EPS CAGR of 17%. Stage 2 includes a decline in sales
growth over eight years from 16% in CY17 to 5% in CY25 i.e. sales CAGR of 12%
and free cash flow CAGR of 12% over this period. Stage 3 includes terminal
growth forecasts with a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `3,945/share (29% downside),
implying an FY14 P/E multiple of 32.5x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 15: Cash flow profiles for GSK Consumer (` mn)
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
C
Y
1
2
C
Y
1
3
E
C
Y
1
4
E
Operating Cashflow Free cash flow

Source: Ambit Capital research
Exhibit 16: Return profiles for GSK Consumer (%)
10%
15%
20%
25%
30%
35%
40%
45%
C
Y
0
5
C
Y
0
6
C
Y
0
7
C
Y
0
8
C
Y
0
9
C
Y
1
0
C
Y
1
1
E
C
Y
1
2
C
Y
1
3
E
C
Y
1
4
E
YoY EPS Growth (%) ROE (%)
YoY Sales growth (%) EBIT Margin (%)

Source: Ambit Capital research
Relative valuation
Over the past three years, GSK Consumer has consistently traded in a band of
22.0x-26.0x one-year forward P/E multiple. However, after the parent companys
open offer at a 30% premium to the then prevailing price for an increase in stake
from 43% to a maximum of 75%, the stock rerated by over 50%. It currently trades
at a CY13E P/E multiple of 45.5x. However, we believe this rerating is unjustified:
Yet to prove its capability to expand auxiliary income: Whilst the auxiliary
income offers GSK Consumer a healthy revenue stream with zero capital
employed, given a history of unsuccessful auxiliary product launches
(Lucozade, Nutribars, Foodles, Aquafresh and Horlicks Chilled Doodh), we
believe it is premature to attach a significant value to the parents potential of
introducing new OTC products through GSK Consumers distribution network
and achieve significant success.
Exhibit 14: WACC calculation
for DCF on GSK Consumer
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.55
Equity risk premium (%) 7
Cost of equity (%) 12.4
Cost of debt (%) 12.0
Debt/Equity ratio (%) 0
Tax rate (%) 30
WACC (%) 12.4
Source: Company, Ambit Capital
research


GSK Consumer
Ambit Capital Pvt Ltd 116

Risk of surplus capital deployment: Surplus cash on GSK Consumers
balance sheet currently amounts to `14bn, almost 100% of its net worth. Also,
the companys dividend payout ratio has hovered between 38% and 82%
(special dividend) over the past three years. Given the limited scope for rapid
product diversification through its only successful brand (Horlicks), there exists
a risk of capital deployment towards areas/M&A which could be a drag on the
growth momentum or return profiles of GSK Consumer.
Exhibit 17: One-year forward P/E bands for GSK
400
1000
1600
2200
2800
3400
4000
4600
5200
5800
J
a
n
-
0
8
M
a
y
-
0
8
S
e
p
-
0
8
F
e
b
-
0
9
J
u
n
-
0
9
O
c
t
-
0
9
M
a
r
-
1
0
J
u
l
-
1
0
N
o
v
-
1
0
M
a
r
-
1
1
A
u
g
-
1
1
D
e
c
-
1
1
A
p
r
-
1
2
A
u
g
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
17x
45x
38x
31x
24x

Source: Bloomberg, Ambit Capital research
Exhibit 18: One-year forward EV/EBITDA bands for GSK
400
1000
1600
2200
2800
3400
4000
4600
5200
5800
J
a
n
-
0
8
M
a
y
-
0
8
S
e
p
-
0
8
F
e
b
-
0
9
J
u
n
-
0
9
O
c
t
-
0
9
M
a
r
-
1
0
J
u
l
-
1
0
N
o
v
-
1
0
M
a
r
-
1
1
A
u
g
-
1
1
D
e
c
-
1
1
A
p
r
-
1
2
A
u
g
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
10x
17x
24x
35x
42x

Source: Bloomberg, Ambit Capital research
Exhibit 19: Sensitivity analysis
Bull case Base case Bear case
Revenue growth
In our bull case, we model a revenue
CAGR of around 15% over CY13-22 led
by market share gains in Horlicks and
distribution-led gains in the biscuits and
oats segment. Our terminal growth rate
assumption stands at 6%
We expect a revenue CAGR of around
12% over CY13-22 led by 10bps market
share loss annually in Horlicks over
FY15-17. The biscuit and oats portfolio
is likely to see distribution expansion
related gains. Our terminal growth rate
assumption stands at 5%
We expect a revenue CAGR of around
10% over CY13-22 led by 100bps
market share loss annually in Horlicks
over FY15-17. We assume no
distribution-related gains in the biscuits
and oats portfolio. Our terminal growth
rate assumption stands at 4%
Operating margins
We assume EBITDA margins expansion
of 170bps over CY11-FY17 to 17.4%,
led by gross margin expansion due to
premiumisation of the portfolio as well
as lower advertisement spends
assuming cooling down of competitive
intensity in the segment
We expect EBITDA margins expansion of
130bps over CY12-FY17 to 16.4%, led
by gross margin expansion due to
premiumisation of the portfolio as well
as stable advertisement spends
assuming competitive intensity remains
unchanged.
Expect EBITDA margins to expand 30bps
from 15.7% in CY11 to 16.0% in FY17,
factoring in small gains from gross
margin expansion which are offset by
competitive-intensity-led increase in
advertising spends
Fair value (`/share) 4,658 3,945 3,005
Upside/Downside -16% -29% -46%
Source: Ambit Capital research
Risks to our SELL stance
Capital deployment: If GSK Consumer deploys its surplus capital towards an
acquisition or expansion initiative in a highly efficient manner, this could lead
to an increase in the firms return ratios and our earnings forecasts.
Auxiliary income: A highly successful launch of a range of new products by
the parent company can potentially add to our auxiliary income forecasts and
hence earnings growth estimates on the company.


GSK Consumer
Ambit Capital Pvt Ltd 117

Ambit vs consensus
Exhibit 20: Ambit vs consensus
Ambit v/s Consensus Ambit Consensus Divergence from consensus Comments
CY13E

Net Sales (` mn) 35,577 35,938 -1% Broadly in line with consensus
EBITDA (` mn) 5,584 6,151 -9%
Expect EBITDA margin expansion of 60bps to
15.7% over CY11-FY14. Our estimates do not
factor in auxiliary income, which is likely the
cause for deviation from consensus
EPS (`/share) 121.2 120.2 1%
Our EPS forecast for FY14 is broadly in line
with consensus
CY14E
Net Sales (` mn) 40,992 42,038 -2%
Our EPS forecast for FY15 is broadly in line
with consensus
EBITDA (` mn) 6,556 7,310 -10%
Expect premiumisation-led EBITDA margin
expansion of 30bps to 16% in FY15. Our
estimates do not factor in auxiliary income,
which is the likely cause for deviation from
consensus
EPS (`/share) 145.0 143.9 1%
Our EPS forecast for FY15 is broadly in line
with consensus
Source: Ambit Capital research
Catalysts
Value-destructive M&A announcement: Given the large quantum of
surplus capital and hence a substantial drag on RoE, there is a high likelihood
of an announcement around M&A activity by the company. With high current
valuations in the entire FMCG sector, such an M&A transaction is likely to be at
valuations which are not earnings accretive for shareholders at least over the
short to medium term.
Rising competitive intensity and input cost inflation could adversely
affect margins: Whilst GSK has seen an average input cost inflation of
around 7-8%, sustained inflation at high levels will likely impact gross margins.
Competitive intensity, especially for the premium segment products, could lead
to market share losses for GSK, which could necessitate a rise in A&P spends.
Exhibit 21: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, GSK has reported excellent cash conversion, efficient management of working
capital, and low levels of loans and advances and contingent liabilities. Consequently, we
give a high rating to its accounting quality.
Predictability GREEN
Although discretionary spending has been under pressure over the past few quarters, GSK
has maintained a strong revenue growth run rate. It has also maintained a strong margin
profile due to gross margin expansion.
Earnings momentum AMBER
In the last six months, consensus EPS estimates have been downgraded by 2% for CY13 and
remained unchanged for CY14.
Source: Ambit Capital research


GSK Consumer
Ambit Capital Pvt Ltd 118

Balance sheet (` mn)
Year to December CY10 CY11 CY12 CY13E CY14E
Shareholders' equity 421 421 421 421 421
Reserves & surpluses 9,180 11,021 13,189 15,346 17,767
Total net worth 9,600 11,442 13,610 15,766 18,188
Deferred tax liability (267) (399) (616) (616) (616)
Total liabilities 9,333 11,043 12,994 15,150 17,572
Gross block 5,990 6,367 6,562 8,762 9,562
Net block 2,023 2,007 1,938 3,646 3,902
CWIP 1,083 1,711 1,972 500 500
Investments 0 - - - -
Cash & equivalents 9,761 10,797 14,642 17,340 20,470
Debtors 505 992 1,126 1,267 1,460
Inventory 3,120 3,700 3,696 4,386 5,054
Loans & advances 501 721 1,115 1,267 1,460
Other current assets 344 492 438 487 562
Total current assets 14,231 16,701 21,018 24,748 29,005
Current liabilities 1,134 3,067 3,630 4,191 4,829
Provisions 3,300 2,712 3,521 3,996 4,605
Total current liabilities 4,435 5,779 7,151 8,188 9,434
Net current assets 9,796 10,922 13,867 16,560 19,571
Miscellaneous - - - - -
Total assets 12,902 14,639 17,778 20,706 23,973
Source: Company, Ambit Capital research
Income statement (` mn)
Year to December CY10 CY11 CY12 CY13E CY14E
Operating income 23,061 26,855 30,794 35,577 40,992
% growth 20.0% 16.5% 14.7% 15.5% 15.2%
Operating expenditure 19,320 22,606 26,141 29,993 34,435
EBITDA 3,741 4,249 4,653 5,584 6,556
% growth 22.0% 13.6% 9.5% 20.0% 17.4%
Depreciation 397 460 361 493 544
EBIT 3,344 3,790 4,292 5,091 6,013
Interest expenditure - 35 24 - -
Non-operating income 1,174 1,648 2,219 2,623 3,118
Adjusted PBT 4,518 5,403 6,487 7,714 9,131
Tax 1,522 1,784 2,120 2,615 3,031
Adjusted PAT/ Net profit 2,996 3,619 4,367 5,099 6,099
% growth 30.1% 20.8% 20.7% 16.7% 19.6%
Extraordinaries (3) 66 (0) - -
Reported PAT / Net profit 2,999 3,552 4,368 5,099 6,099
Adjusted Consolidated net profit 2,999 3,552 4,368 5,099 6,099
Reported Consolidated net profit 2,999 3,552 4,368 5,099 6,099
Source: Company, Ambit Capital research


GSK Consumer
Ambit Capital Pvt Ltd 119

Cash flow statement (` mn)
Year to December CY10 CY11 CY12 CY13E CY14E
EBIT 4,518 5,437 6,511 7,714 9,131
Depreciation 397 460 361 493 544
Others (157) (166) (242) - -
Tax (1,522) (1,784) (2,120) (2,615) (3,031)
(Incr) / decr in net working capital 1,954 (62) 2,088 776 964
Cash flow from operations 5,189 3,884 6,599 6,367 7,608
Capex (1,180) (1,072) (554) (2,200) (800)
Cash flow from investments (1,180) (1,072) (554) (2,200) (800)
Interest paid - 35 24 - -
Dividend paid (2,452) (1,711) (2,199) (2,942) (3,678)
Others 6 (101) (24) - -
Cash flow from financing (2,446) (1,777) (2,199) (2,942) (3,678)
Net change in cash 1,563 1,036 3,846 2,697 3,130
Closing cash balance 9,761 10,797 14,642 17,340 20,470
Free cash flow 4,009 2,813 6,045 5,640 6,808
Source: Company, Ambit Capital research
Ratio analysis
Year to December CY10 CY11 CY12 CY13E CY14E
Gross margin (%) 62.5% 61.9% 62.6% 62.9% 63.1%
EBITDA margin (%) 16.2% 15.8% 15.1% 15.7% 16.0%
EBIT margin (%) 19.6% 20.2% 21.1% 21.7% 22.3%
Net profit margin (%) 13.0% 13.5% 14.2% 14.3% 14.9%
Dividend payout ratio (%) 81.9% 47.3% 50.4% 57.7% 60.3%
Net debt: equity (x) (1.0) (0.9) (1.1) (1.1) (1.1)
Working capital turnover (x) (6.5) (7.7) (5.5) (5.6) (5.6)
Gross block turnover (x) 3.9 4.2 4.7 4.1 4.3
RoCE (%) 32.8% 35.7% 36.5% 36.2% 37.3%
RoE (%) 32.1% 34.4% 34.9% 34.7% 35.9%
Source: Company, Ambit Capital research
Valuation parameters
Year to December CY10 CY11 CY12 CY13E CY14E
EPS (`) 71.2 86.0 103.8 121.2 145.0
Diluted EPS (`) 71.2 86.0 103.8 121.2 145.0
Book value per share (`) 228.3 272.1 323.6 374.9 432.5
Dividend per share (`) 50.0 35.0 45.0 60.0 75.0
P/E (x) 77.4 64.1 53.1 45.5 38.0
P/BV (x) 24.2 20.3 17.0 14.7 12.8
EV/EBITDA (x) 59.4 52.0 46.7 38.4 32.3
Price/Sales (x) 10.1 8.6 7.5 6.5 5.7
Source: Company, Ambit Capital research




Consumer Goods June 04, 2013
Colgate Palmolive
Bloomberg: CLGT IN EQUITY
Reuters: COLG.NS
Accounting: GREEN
Predictability: RED
Earnings momentum: RED


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income (` mn) 22,861 26,932 31,638 36,501 42,106
EBITDA(` mn) 5,146 5,785 6,568 7,185 8,415
EBITDA Margin (%) 22.5% 21.5% 20.8% 19.7% 20.0%
Adjusted PAT(` mn) 4,026 4,465 4,968 5,179 5,839
Adjusted EPS (`) 29.6 32.8 36.5 38.1 42.9
RoE (%) 113.4% 109.0% 107.4% 101.6% 107.4%
P/E (x) 49.0 44.2 39.7 38.1 33.8
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `1,451
Target Price (Mar14): `1,227
Previous TP: NA
Downside (%) 15%
EPS (FY14E): `38.1
Change from previous (%) NA
Variance from consensus (%) -12%
Stock Information
Mkt cap: `197bn/US$3.5bn
52-wk H/L: `1,580/1,097
3M ADV: `169mn/US$3mn
Beta: 0.54x
BSE Sensex: 19,610
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
(4) 11 23 (7)
Rel. to Sensex
(4) 7 (0) (8)
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Oct-12 J an-13 May-13
1000
1200
1400
1600
Sensex Colgate Palmolive

1-year fwd P/E bandchart
200
400
600
800
1000
1200
1400
1600
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
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-
1
2
M
a
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1
2
S
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1
2
J
a
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-
1
3
M
a
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1
3
15x
39x
33x
27x
21x

Source: Bloomberg, Ambit Capital research
All foamed out
Colgates EBITDA CAGR of 30% over FY07-12 was supported by gross
margin expansion. We do NOT expect further market share gains
given the aggression from P&G (Oral-B toothpaste launch next
month), GSK Consumer (Sensodyne) and the rumoured entry of ITC in
this segment. We also model declining gross margins given limited
scope for further consolidation of contract manufacturing and shift
towards toothpaste from toothpowder. Rising advert to sales ratio and
tax rate will lead to only 8% EPS CAGR over FY13-15, lower than the
24% reported over FY07-12. Current valuations of 38x FY14 EPS do not
appear to factor in this approaching growth moderation and rising
competitive intensity. We initiate coverage with a SELL stance.
Competitive position: MODERATE Changes to this position: STABLE
Colgates leadership presence is supported by: (a) focused initiatives around
dentists and rural consumers that are stronger than HULs; and (b) a broader
oral care portfolio allowing premiumisation. We expect significant moderation
in EBITDA CAGR from 30% over FY07-12 to 8% over FY13-15 due to:
High competitive intensity: Since oral care is one of the highest gross
margin categories (~60%) in the FMCG universe, the competitive intensity has
increased substantially with the successful new entry of players like GSK
(Sensodyne and Paradontax), proposed launch of Oral-B toothpaste by P&G
next month, and rumours of ITCs entry into this segment. Consequently, we
expect the A&P spends to sales ratio to increase by ~100bps over FY13-15
and hence be a substantial drag on earnings growth.
Consolidation of contract manufacturing: Replacement of contractual
outsourced manufacturing locations with Colgates in-house manufacturing
units over the past decade has led to a gross margin benefit of 13-15
percentage points. However, with the purchase of traded goods:sales ratio
declining from 42% in FY02 to 7% in FY12, there is only a limited scope for
further consolidation.
Shift from toothpowder to toothpastes: Due to consumers shifting from
toothpowder to toothpaste, the contribution of toothpowder to Colgates
overall revenues has declined from 22% in FY01 to 11% in FY12, providing a
200bps benefit to EBITDA margins over the past decade. Once again, we see
limited potential for further reduction in this ratio going forward.
Valuation: Colgates FY14 P/E multiple of 38.1x is at ~45% premium to its
historical (FY10-13) average one-year forward trading multiple of 26.4x.
Given our expectation of a moderation in earnings growth, as discussed
above, we believe this premium is unjustified. Our DCF-based valuation
generates a TP of `1,227/share, 15% downside (implied FY14 P/E of 32.2x).


Colgate Palmolive
Ambit Capital Pvt Ltd 121

Company Financial Snapshot
Profit and Loss (` mn)
FY13 FY14E FY15E
Net sales 31,638 36,501 42,106
Optg. Exp (Adj for OI.) 25,070 29,316 33,691
EBITDA 6,568 7,185 8,415
Depreciation 437 627 734
Interest Expense - - -
PBT 6,630 7,046 8,109
Tax 1,663 1,867 2,271
Adj. PAT 4,968 5,179 5,839
Profit and Loss Ratios

EBIDTA Margin % 20.8% 19.7% 20.0%
Adj Net Margin % 15.7% 14.2% 13.9%
P/E (X) 39.7 38.1 33.8
EV/EBIDTA (X) 29.4 27.1 23.1
Dividend Yield (%) 1.7% 1.9% 2.1%
Company Background
Colgate entered into the Indian market in 1937 and soon
became a market leader in the toothpaste segment. The
company currently has a market share of 54% in this
segment. Its product portfolio comprises toothpastes,
toothbrushes, and toothpowder under the Colgate brand and
a small personal care portfolio under the Palmolive brand.
Colgate enjoys a distribution reach of around 4.6mn outlets.
With the support of its parent Colgate-Palmolive (51%
holding), the company benefits from access to the parents
global portfolio and brand equity.
Balance Sheet (` mn)
FY13 FY14E FY15E
Total Assets 12,843 14,477 16,190
Net Fixed Assets 3,826 5,700 6,466
Current Assets 8,546 8,277 9,224
Other Assets 471 500 500
Total Liabilities 12,843 14,477 16,190
Networth 4,896 5,301 5,571
Debt - - -
Current Liabilities 8,172 9,400 10,844
Deferred Tax (224) (224) (224)
Balance Sheet Ratios
ROE % 107.4% 101.6% 107.4%
ROCE % 111.6% 106.3% 112.0%
Net Debt(cash)/Equity (0.9) (0.5) (0.5)
Equity/Total Assets 1.0 1.0 1.0
P/BV (X) 41.1 38.0 36.1
Cash Flow (` mn)

FY13E FY14E FY15E
PBT 6,630 7,046 8,109
Depreciation 437 627 734
Tax (1,663) (1,867) (2,271)
Change in Wkg Cap 1,339 86 614
Others (103) - -
CF from Operations 6,641 5,892 7,186
Capex (1,025) (2,500) (1,500)
Investments 0 (29) -
CF from Investing (1,025) (2,529) (1,500)
Change in Equity - - -
Debt - - -
Dividends (4,296) (4,774) (5,569)
Others (129) - -
CF from Financing (4,425) (4,774) (5,569)
Change in Cash 1,190 (1,411) 117

Market penetration of oral care products in India (%) Colgates A&P/sales ratio vs other FMCG players (FY12)
69
70
71
72
73
74
76
78
79 79
82
44 44 44
45
46
50
51
54
57
59
64
70
36
35
36
34
35 35 35 35
31
28
26
82
84
66
24
21
20
30
40
50
60
70
80
90
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
Dentrifrice Toothpaste Toothpowder

3%
5%
7%
9%
11%
13%
15%
17%
G
S
K
C
o
n
s
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m
e
r
C
o
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g
a
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D
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G
C
P
L
H
U
L
M
a
r
i
c
o
N
e
s
t
l
e

Note: Company, Ambit Capital research; Note: Dentifrice comprises toothpaste, toothpowder and mouthwash


Colgate Palmolive
Ambit Capital Pvt Ltd 122

Background
Exhibit 1: Colgates portfolio matrix
Category Key brands Key competitors
Market
share rank
% of
turnover
FY10-13
CAGR
Toothpaste
Colgate Dental Cream, Total,
Max Fresh, Sensitive, Cibaca,
Active Salt
HUL, Dabur, GSK
Consumer, Vicco,
Anchor
1 74% 15%
Toothbrush
Colgate 360, Sensitive, Extra
Clean, Zig Zag P&G, HUL, Anchor
1 13% 17%
Toothpowder Colgate Toothpowder
Dabur, Anchor
1 8% -5%
Personal/Home
Products
Palmolive portfolio of hand
wash, body wash, shower gel,
shaving cream, skin cream,
Axion dishwash J&J, Elder Health
NA 4% 10%
Mouthwash Colgate Plax
HUL, L'Oreal,
Gillette
2 1% 30%
Source: Company, Ambit Capital research
As shown in the table above, 96% of Colgates revenues are derived from oral
care products and the company is the market leader across all categories of
products in oral care. Its personal products portfolio forms less than 4% of
revenues and the company is currently not focusing on this category. Colgates key
competitors in the oral care market include HUL (Close-Up and Pepsodent), P&G
(Oral-B) and GSK (Sensodyne and Paradontax). Over the past five years, Colgate
has increased its market share in the toothpaste segment from around 49% in
2008 to 54% in 2012.
As highlighted in the charts below, over FY04-13, Colgate has reported a 13%
revenue CAGR, 12% volume CAGR and 520bps EBITDA margin expansion.
Exhibit 2: Revenue growth vs volume growth
-5%
0%
5%
10%
15%
20%
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
5%
7%
9%
11%
13%
15%
17%
Revenue growth Volume growth

Source: Company, Ambit Capital research
Exhibit 3: EBITDA vs EBITDA margin
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
10%
12%
14%
16%
18%
20%
22%
24%
26%
EBITDA EBITDA Margin

Source: Company, Ambit Capital research



Colgate Palmolive
Ambit Capital Pvt Ltd 123

Distribution
The oral care brand Colgate is the second most-distributed brand (after Lifebuoy)
in India. The company currently enjoys a reach of 5.5mn outlets (direct reach of
1mn) from around 4mn outlets in 2008. As shown in the table below, the
distribution-led penetration of Colgates products in the relevant markets (as
defined by the company) is almost completely saturated.
Exhibit 4: Distribution reach at relevant outlets for Colgate
2008 2009 2010 2012
Urban 97% 97% 97% NA
Rural 93% 95% 94% NA
Urban + rural 95% 96% 96% 98%
Source: Company, Ambit Capital research

SWOT
Exhibit 5: SWOT analysis for Colgate
Strengths Weaknesses
Debt-free balance sheet and strong free cash flow generation
enables cash availability for capex and high dividend payouts
(averaged 86% payout ratio over FY07-12).
One of the strongest brands in the country likely to be the
main beneficiary of penetration and premiumisation.
Colgates distribution reach is 4.6mn outlets, around 98% of its
targeted distribution reach.
Strict control over inventory and creditors helps Colgate
maintain a negative working capital cycle of around 35 days.

Fully dependent on one categoryoral care. Its personal
product portfolio is not a meaningful contributor (less than
4% of revenues).
Colgate has limited competitive advantages in
toothbrushes and mouthwashes (the fastest categories in
the oral care space, with toothbrushes being a
commoditised product and Listerine being a market leader
in mouthwashes).
Opportunities Threats
The category has a penetration of only 91% in urban and 63% in
rural markets.
Colgate is well positioned to be a disproportionate beneficiary of
consumers migrating to more premium toothpastes and
categories like mouthwashes.

New entrants like GSK Consumer are aggressively
targeting the fast-growing sensitive teeth market and P&G
is likely to enter the market in CY15 with Crest.
Increasing competitive intensity especially from HUL is
likely to keep advertisement spends at an elevated level.
Source: Industry, Company, Ambit Capital research



Colgate Palmolive
Ambit Capital Pvt Ltd 124

Growth drivers for Colgate
We expect the overall market for oral care to record a revenue CAGR of 12-13% in
the coming years aided by: (a) increased penetration (owing to ~91% penetration
of organised oral care products in urban markets and ~63% penetration in rural
markets currently); (b) a shift in consumption from toothpowders towards
toothpastes; and (c) premiumisation trends within the toothpaste and toothbrush
categories. However, we expect Colgate to record 16% revenue CAGR over FY13-
15, faster than the broader oral care market growth rates, due to:
Push through dentists: Based on our discussions with dentists across India,
we believe that the quantum of benefits provided and hence the strength of
Colgates association with dentists is significantly higher than that of HUL.
These benefits include: (a) free product samples to dentists; (b) subsidised
product packs available for sale to patients through dentists; (c) alliances with
dental schools; and (d) participation in dental conventions in India. Our
discussions with dentists suggest that none of these initiatives are followed by
either HUL or Dabur for their oral care brands and hence most dentists
recommend Colgates products to their patients.
Rural initiatives: Colgate has launched aggressive rural initiatives like: (a)
the Bright Smiles Bright Future campaign where it goes to schools in rural
areas and imparts information on dental hygiene to children and distributes
free samples; and (b) oral care month (started in 2004 and extended to two
months since 2009) where the company provides free oral care health check-
ups to consumers in rural areas.
Wide product portfolio: Colgate is the only player in oral care with a
leadership presence in all segments (mass, mid and premium) and a portfolio
that has a material presence across all categories (toothpaste, toothbrush,
mouthwash and toothpowder), thereby helping customers upgrade to premium
products within Colgates portfolio.
Exhibit 6: Colgates volume market share has increased
over 300bps since FY09
51.0%
51.5%
52.0%
52.5%
53.0%
53.5%
54.0%
54.5%
55.0%
55.5%
Q
1
F
Y
1
0
Q
3
F
Y
1
0
Q
1
F
Y
1
1
Q
3
F
Y
1
1
Q
1
F
Y
1
2
Q
3
F
Y
1
2
Q
1
F
Y
1
3
Q
3
F
Y
1
3

Source: Company, Ambit Capital research
Exhibit 7: Dentist participation in oral care month

0
200
400
600
800
1000
1200
2005 2007 2010 2012
0
5000
10000
15000
20000
25000
30000
Towns Covered (LHS)
Dentist participation (RHS)

Source: Company, Ambit Capital research


Colgate Palmolive
Ambit Capital Pvt Ltd 125

Moderation in EPS CAGR likely
Colgates rerating historically (as shown in the chart below) has been led by an
EPS CAGR of 25% and EBITDA CAGR of 31% over FY07-12. Even though the
company has reported revenue CAGR of only 16% over FY07-12E (helped by
500bps market share gains over this period), EBITDA margin expansion has been
the primary reason for strong earnings growth over this period.
Exhibit 8: One-year forward P/E band chart for Colgate
200
400
600
800
1000
1200
1400
1600
A
p
r
-
0
7
A
u
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-
0
7
D
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c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
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-
1
2
M
a
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-
1
2
S
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-
1
2
J
a
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-
1
3
M
a
y
-
1
3
15x
39x
33x
27x
21x

Source: Bloomberg, Ambit Capital research
Whilst we expect revenue CAGR of 15% over FY13-15, we expect only 8% EPS
CAGR for Colgate over this period, as we expect competitive intensity to rise and
hence exert downward pressure on EBITDA margins over the next 24 months. The
reasons for the same are elaborated below.

Rising competitive intensity will constrain market
share gains and EBITDA margin expansion
As shown in the chart below, growth in the overall oral care market in India over
the past five years has been led predominantly by an increase in penetration and a
shift from toothpowder to toothpaste. We expect 14% CAGR for the oral care
market over FY13-15, with Colgate likely to gain share by only 20bps each year,
underpinned by its competitive advantages (highlighted on the previous page).
Exhibit 9: Penetration of oral care in India
69
70
71
72
73
74
76
78
79 79
82 82
84
44 44 44
45
46
50
51
54
57
59
64
70
36
35
36
34
35 35 35 35
31
28
26
24
66
21
20
30
40
50
60
70
80
90
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Dentrifrice Toothpaste Toothpowder

Source: Company, Ambit Capital research


Colgate Palmolive
Ambit Capital Pvt Ltd 126

However, the rate of this market share gain will be limited by rising competitive
intensity in the oral care segment. Oral care is one of the highest gross margin
categories in the FMCG universe (~60% as against an FMCG average of ~50%),
and thus, competitive intensity is likely to remain high in this category. New
entrants (such as GSK) have already been aggressively pushing their premium
brands (such as Sensodyne and Paradontax) over the past 12 months. Also, it is
widely speculated that P&G is looking to enter the Indian oral care markets by
2015.
As shown in the chart below, Colgates advertisement spends to sales ratio (A:S
ratio) is one of the highest in the industry. In the wake of increased competitive
intensity, we expect Colgates A:S ratio to rise gradually towards its historical
average of 15.5% from FY15 onwards (up from an average of 15.1% over FY10-
12).
Exhibit 10: A&P trends for Colgate
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
F
Y
0
1
F
Y
0
2
F
Y
0
3
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
E
F
Y
1
4
E
F
Y
1
5
E
13%
14%
15%
16%
17%
18%
19%
20%
21%
Advertising spends Adv as % of sale

Source: Company, Ambit Capital research
Exhibit 11: Colgates A&P vs its FMCG peers (FY12)
3%
5%
7%
9%
11%
13%
15%
17%
G
S
K
C
o
n
s
u
m
e
r
C
o
l
g
a
t
e
D
a
b
u
r
G
C
P
L
H
U
L
M
a
r
i
c
o
N
e
s
t
l
e

Source: Company, Ambit Capital research
During the previous instance of increase in competitive intensity between HUL and
Colgate over FY01-03, A&P spends for Colgate averaged around 20% of sales
(FY01-03) as against an average of 15-16% over FY04-12. Consequently, given
Colgates reliance on a single product category and given its push to premiumise
its customers to Colgate Total and Colgate Sensitive, we see a high risk of increase
in the A:S ratio in the future and hence pressure on EBITDA margins in the future.




Colgate Palmolive
Ambit Capital Pvt Ltd 127

and gross margin expansion is unlikely
Colgates gross margins have expanded by 13 percentage points since FY04 (see
the table below) helped by the following factors:
Consolidation of contract manufacturing: As shown in the chart below,
Colgates margin expansion has been driven predominantly by replacement of
contractual outsourced manufacturing locations with Colgates in-house
manufacturing units. We expect this to have led to a gross margin benefit of
~13-15% over the past eight years. However, note that this gross margin
benefit was partly offset by the increase in royalty payouts from 1% in FY04 to
5.2% in FY12.
Exhibit 12: Share of traded goods has reduced sharply
as contract manufacturers were merged into Colgate
(%)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
Raw material consumed Purchase of traded goods

Source: Company, Ambit Capital research
Exhibit 13: Lower contract manufacturing led to royalty
payments being made from the standalone entity (%)

45%
47%
49%
51%
53%
55%
57%
59%
61%
63%
F
Y
0
4
F
Y
0
5
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
0%
1%
2%
3%
4%
5%
6%
Gross Margin Royalty (as % of sale) (RHS)

Source: Company, Ambit Capital research
Shift from toothpowder to toothpaste: The contribution of toothpowder to
Colgates overall revenues has declined from 22% in FY01 to 11% in FY12.
This, we believe, has led to a ~200bps expansion in gross margins over the
past ten years.
Premiumisation: We believe that premiumisation within Colgates toothpaste
portfolio is likely to have contributed to around gross margin expansion of
150bps over the past ten years.
We do not expect any further material gross margin benefits from the three
factors highlighted above, because: (a) purchase of traded goods as a proportion
of net sales has reduced from 42% in FY02 to only 7% in FY12, leaving limited
scope for further consolidation; (b) proportion of toothpowder in overall dentrifice
has reduced from 45% in 2001 to less than 25% in 2000. Consequently, we expect
an annual gross margin expansion of only 100bps for Colgate until FY18 (after
which we expect margins to stabilise) driven by premiumisation of its product mix.



Colgate Palmolive
Ambit Capital Pvt Ltd 128

Tax benefits will expire in FY16
Colgates tax holiday (excise and corporate tax) on production from its unit in
Baddi, Himachal Pradesh, is set to expire in FY15-16. The new units in Gujarat
and Andhra Pradesh will not be eligible for any tax benefits, resulting in the
effective tax rate rising from around 22% currently to around 33% in FY16. This is
likely to have a significant negative impact on Colgates EPS growth over FY14-17.
Key assumptions
Exhibit 14: Key assumptions and estimates (` mn)
FY12 FY13E FY14E FY15E Comments
Profit and loss
Toothpaste revenues (including
mouthwash and toothpowder)
24,138 28,435 32,819 37,880
Market growth 16.0% 14.0% 15.0% 15.0%
Growth from market share
change
1.2% 3.8% 0.4% 0.4%
Growth (%) 17.2% 17.8% 15.4% 15.4%
Growth led by 15% industry growth and factor in 0.5%
market share gains from Dabur and HUL in FY14 and
FY15 as Colgate benefits from a stronger product
portfolio, distribution and aggressive rural initiatives
Toothbrush revenues 3,198 3,700 4,292 4,979
Market Growth 27.9% 16.0% 16.0% 16.0%
Growth from market share
change
0.0% -0.3% 0.0% 0.0%
Growth (%) 27.9% 15.7% 16.0% 16.0%
Growth led by 16% industry growth and expect Colgate
to maintain share in the segment due to high competitive
intensity from Oral B
Total revenues 26,932 31,638 36,501 42,106
Growth (%) 17.8% 17.5% 15.4% 15.4%

Gross Profit 16,430 19,136 22,150 25,636
Gross margin (%) 61.0% 60.5% 60.7% 60.9%
Estimate gains in gross margins led by positive mix
change as the share of toothpowder reduces and
mouthwash and premium toothpaste gain
Employee cost (% of sale) 8.0% 7.9% 7.8% 7.7%
Expect marginal benefits from employee cost leverage in
FY15
Advertising (% of sale) 15.3% NA 16.5% 16.5%
Advertising cost to rise as the premium products are
advertised more and competitive intensity rises
Royalty (% of sale) 5.2% 5.3% 5.3% 5.3% Expect royalty payouts to remain stable at 5.3%
Other expenses (% of sale) 11.0% 35.1% 11.4% 11.4% Expect other expenses to remain flat
EBITDA 5,785 6,568 7,185 8,415
EBITDA margin 21.5% 20.8% 19.7% 20.0%
Above changes to lead to margins improvement in
EBITDA margins in FY15
Tax rate 24.1% 25.1% 26.5% 28.0%
Whilst tax rates should increase moderately till FY15,
FY16 will see a rise in tax rates as the tax holiday expires
Net profit margin 16.6% 15.7% 14.2% 13.9%
Effect of higher depreciation from new plants and higher
tax rates to lead to decline in net profit margins
Balance Sheet
Capex 333 1,719 2,000 1,500
Capital Work in Progress 694 - 500 500
Capex relates to 2 new plants for toothpaste in Gujarat
and toothbrushes in Andhra Pradesh
Working capital days (35) (45) (40) (40) Do not expect material changes in working capital days
Debtor days 12 9 10 10
Marginal increase led by increasing contribution from
modern trade
Current liabilities days 80 83 82 82 Expect current liabilities days to stay constant
Inventory days 30 21 25 25 Do not expect material changes in inventory days
Net debt/(cash) to equity (0.7) (0.9) (0.5) (0.5)
Colgate is a net cash company with a high dividend
payout
Cash flows (` mn)
Operating cash flows 4,181 6,641 5,892 7,186
Free cash flows 3,182 5,615 3,392 5,686
Free cash flows to grow strongly in FY16 as expansion
related capex ceases in FY15
Source: Ambit Capital research



Colgate Palmolive
Ambit Capital Pvt Ltd 129

Valuation
DCF valuation
The assumptions for the weighted average cost of capital and terminal growth
rates are shown in the exhibit below. We have assumed zero debt on Colgates
balance sheet in the future given its strong cash generation and hence we have
assumed that enough surplus cash would be available for capital expenditure in
the future.
We use a three-stage DCF approach for Colgate Palmolive. Stage 1 includes
explicit forecasts for the income statement and balance sheet for the next five
years, with sales CAGR of 15% and EPS CAGR of 14%. Stage 2 includes a decline
in sales growth over eight years from 15.4% in FY18 to 6% in FY23 i.e. sales CAGR
of 11% and free cash flow CAGR of 11% over this period. Stage 3 includes
terminal growth forecasts with a growth rate to perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `1,227/share (15% downside),
implying an FY14 P/E multiple of 32.2x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 16: Cash flow profile for Colgate
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
CFO (Rs mn) Free Cash Flow (Rs mn)

Source: Ambit Capital research
Exhibit 17: Return profiles for Colgate
-10%
0%
10%
20%
30%
40%
50%
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
-30%
-10%
10%
30%
50%
70%
90%
110%
130%
150%
ROE (%) EPS Growth (YoY)
EBIT Margin (%) YoY growth in sales

Source: Ambit Capital research
Relative valuation
As shown in the charts below, Colgates current one-year forward P/E multiple of
38x is at a 41% premium to its historical (FY10-13) average one-year forward
trading multiple of ~27.0x. Historically, the stocks trading multiples have been
supported by significant margin expansion through the consolidation of
manufacturing units, shift from powder to paste, and reduction in competitive
intensity. However, in the absence of these supporting levers going forward, we
believe this premium rating is unjustified.
Moreover, Colgates current valuation multiples deserve a derating owing to: (a)
`4bn of surplus cash on the balance sheet as Colgate is a single product
company, there are limited avenues for deployment of this surplus cash to expand
its current product franchise. Hence, it raises the possibility of deployment towards
initiatives which can be value-destructive. (b) Threat of increased competition:
Exhibit 15: WACC calculation
for DCF on Colgate
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.54
Equity risk premium (%) 7
Cost of equity (%) 12.3
Cost of debt (%) 12.0
Debt/Equity ratio (%) 0
Tax rate (%) 30
WACC (%) 12.3
Source: Company, Ambit Capital
research


Colgate Palmolive
Ambit Capital Pvt Ltd 130

Colgate currently faces tough competition predominantly from HULs Close-up and
Pepsodent brands and GSKs Sensodyne brand. Also, P&G has recently announced
its intention to launch Oral-B toothpastes over the next few months to capitalise on
the rapid growth of oral care and the brand recall of Oral-B in India.
Exhibit 18: 1-year forward P/E bands for Colgate
200
400
600
800
1000
1200
1400
1600
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
15x
39x
33x
27x
21x

Source: Bloomberg, Ambit Capital research
Exhibit 19: 1-year forward EV/EBITDA bands for Colgate
200
400
600
800
1000
1200
1400
1600
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
11x
27x
15x
23x
19x

Source: Bloomberg, Ambit Capital research
Exhibit 20: Sensitivity analysis
Bull Case Base Case Bear Case
Revenue Growth
We have modeled a revenue CAGR of
15% over FY13-23 assuming higher
market growth rates and market share
gains of 400bps over FY13-17. Our
terminal growth rate assumption is at
6%.
We have modeled a revenue CAGR of
13% over FY13-23 assuming market
growth of 15% and market share
gains of 100bps over FY13-17. Our
terminal growth rate assumption
stands at 5%.
We have modeled a revenue CAGR of
11% over FY13-23 assuming higher
market growth rates and no changes
in market share over FY13-17. Our
terminal growth rate assumption is at
4%.
Operating margins
We assume EBITDA margins to
increase to 22.6% by FY17 and
stabilise thereafter assisted by an
increase in gross margins and lower
advertisement spends.
We assume EBITDA margins to
increase from 20.8% in FY13 to 21.5%
in FY18 and stabilise thereafter
assisted by an increase in gross
margins.
We assume EBITDA margins to
increase only marginally to 22% by
FY17, as the increase in gross margins
would be partially offset by an
increase in A&P. We expect margins to
stabilise at 22%.
Fair Value (`/share) 1,413 1,227 907
Upside -3% -15% -38%
Source: Ambit Capital research
Risks to our SELL stance
Market share gains: We expect Colgate to gain a market share of 50bps every
year over FY13-15, and any share increase above this level could warrant an
upgrade to our earnings forecasts and hence valuation.
Competitive intensity in the segment cooling off: Any reduction of competitive
intensity in the oral care segment will ease the pressure on A&P spends and
positively impact margins.
Buyback from the parent: Colgates global parent owns a 51% equity stake in
the company. After the recently announced buyback from HUL and GSK
Consumer, Colgates parent company could increase its stake in Colgate with a
view to either invest in Indias long-term growth story or expand the Palmolive-
branded portfolio of the company.



Colgate Palmolive
Ambit Capital Pvt Ltd 131

Catalysts
Things to watch out for over the next six months
Volume growth coming under pressure: Higher penetration level (of 84%) in
oral care is likely to lead to volume growth tapering lower to single digits from the
current 10-12% levels.
Increasing competitive intensity to hit margins: Increasing competitive
intensity from HUL and GSK in the premium market and from Dabur in the mass
market is likely to impact margins, as the company undertakes higher A&P spends
to protect its market share.
Ambit vs consensus
Exhibit 21: Ambit vs consensus
Ambit vs Consensus Ambit Consensus Divergence from consensus Comments
FY14E

Net Sales (` mn) 36,501 36,091 1%
EBITDA (` mn) 7,185 7,790 -8%
Divergence since our forecasts assume a 120bps
increase in advert spends to sales ratio over FY12-
14 given rising competitive intensity.
EPS (`/share) 38.1 43.2 -12%
Factor in higher tax rates, as the production from
tax-free zones is at full capacity and incremental
production is fully taxable
FY15E

Net Sales (` mn) 42,106 41,846 1%
Divergence likely due to our expectation of market
share gains of 20bps annually for Colgate
EBITDA (` mn) 8,415 9,126 -8%
Factor in higher advertisement spends, as we
expect competitive intensity to increase
EPS (`/share) 42.9 49.9 -14%
Factor in higher tax rates, as the production from
tax-free zones is at full capacity and incremental
production is fully taxable
Source: Bloomberg, Ambit Capital research
Exhibit 22: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting GREEN
In the past, Colgate has reported excellent cash conversion, efficient management of
working capital, and low levels of loans and advances and contingent liabilities.
Consequently, we give a high rating to its accounting quality.
Predictability RED
Colgate has a very volatile earnings trajectory, as its margins are strongly influenced by the
timing of its advertising and marketing campaigns which tend to be erratic.
Earnings momentum RED
In the past six months, consensus estimates have been downgraded by 6% for FY14 and
FY15.
Source: Ambit Capital research


Colgate Palmolive
Ambit Capital Pvt Ltd 132

Balance sheet (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Shareholders' equity 136 136 136 136 136
Reserves & surpluses 3,705 4,218 4,760 5,165 5,435
Total networth 3,841 4,354 4,896 5,301 5,571
Debt 1 - - - -
Deferred tax liability (168) (121) (224) (224) (224)
Total liabilities 3,673 4,233 4,672 5,077 5,346
Gross block 5,798 6,132 7,851 9,851 11,351
Net block 2,550 2,544 3,826 5,200 5,966
CWIP 82 694 - 500 500
Investments 387 471 471 500 500
Cash & equivalents 3,951 3,098 4,288 2,877 2,995
Debtors 753 873 812 1,000 1,154
Inventory 1,537 2,177 1,853 2,500 2,884
Loans & advances 837 1,254 1,548 1,800 2,076
Other current assets 73 64 45 100 115
Total current assets 7,152 7,466 8,546 8,277 9,224
Current liabilities 5,916 5,870 7,177 8,200 9,459
Provisions 583 1,073 995 1,200 1,384
Total current liabilities 6,499 6,942 8,172 9,400 10,844
Net current assets 653 524 374 (1,123) (1,620)
Miscellaneous - - - - -
Total assets 3,673 4,233 4,672 5,077 5,346
Source: Company, Ambit Capital research
Income statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income 22,861 26,932 31,638 36,501 42,106
% growth 12.3% 17.8% 17.5% 15.4% 15.4%
Operating expenditure 17,715 21,147 25,070 29,316 33,691
EBITDA 5,146 5,785 6,568 7,185 8,415
% growth 3.3% 12.4% 13.5% 9.4% 17.1%
Depreciation 342 393 437 627 734
EBIT 4,803 5,392 6,131 6,558 7,681
Interest expenditure 16 15 - - -
Non-operating income 412 507 499 488 428
Adjusted PBT 5,199 5,884 6,630 7,046 8,109
Tax 1,174 1,419 1,663 1,867 2,271
Adjusted PAT/ Net profit 4,026 4,465 4,968 5,179 5,839
% growth -4.9% 10.9% 11.3% 4.3% 12.7%
Reported PAT / Net profit 4,026 4,465 4,968 5,179 5,839
Adjusted Consolidated net profit 4,026 4,465 4,968 5,179 5,839
Reported Consolidated net profit 4,026 4,465 4,968 5,179 5,839
Source: Company, Ambit Capital research


Colgate Palmolive
Ambit Capital Pvt Ltd 133

Cash flow statement (` mn)
Year to March FY11 FY12 FY13E FY14E FY15E
EBIT 5,216 5,899 6,630 7,046 8,109
Depreciation 342 393 437 627 734
Others (6) 32 (103) - -
Tax (1,174) (1,419) (1,663) (1,867) (2,271)
(Incr) / decr in net working capital 210 (724) 1,339 86 614
Cash flow from operations 4,588 4,181 6,641 5,892 7,186
Capex (444) (999) (1,025) (2,500) (1,500)
(Incr) / decr in investments (177) (84) 0 (29) -
Cash flow from investments (621) (1,082) (1,025) (2,529) (1,500)
Net borrowings (45) (1) - - -
Interest paid (16) (15) - - -
Dividend paid (3,489) (3,951) (4,296) (4,774) (5,569)
Others 59 15 (129) - -
Cash flow from financing (3,492) (3,952) (4,425) (4,774) (5,569)
Net change in cash 476 (853) 1,190 (1,411) 117
Closing cash balance 3,951 3,098 4,288 2,877 2,995
Free cash flow 4,145 3,182 5,615 3,392 5,686
Source: Company, Ambit Capital research
Ratio analysis
Year to March FY11 FY12 FY13 FY14E FY15E
Gross margin (%) 61.9% 61.0% 60.5% 60.7% 60.9%
EBITDA margin (%) 22.5% 21.5% 20.8% 19.7% 20.0%
EBIT margin(%) 22.8% 21.9% 21.0% 19.3% 19.3%
Net profit margin (%) 17.6% 16.6% 15.7% 14.2% 13.9%
Dividend payout ratio (%) 86.7% 88.5% 86.5% 92.2% 95.4%
Net debt: equity (x) (1.0) (0.7) (0.9) (0.5) (0.5)
Working capital turnover (x) (6.9) (10.5) (8.1) (9.1) (9.1)
Gross block turnover (x) 3.9 4.4 4.0 3.7 3.7
RoCE (%) 118.8% 113.2% 111.6% 106.3% 112.0%
RoE (%) 113.4% 109.0% 107.4% 101.6% 107.4%
Source: Company, Ambit Capital research
Valuation parameters
Year to March FY11 FY12 FY13 FY14E FY15E
EPS (`) 29.6 32.8 36.5 38.1 42.9
Diluted EPS (`) 29.6 32.8 36.5 38.1 42.9
Book value per share (`) 28.2 32.0 36.0 39.0 41.0
Dividend per share (`) 22.0 25.0 27.0 30.0 35.0
P/E (x) 49.0 44.2 39.7 38.1 33.8
P/BV (x) 51.4 45.3 40.3 37.2 35.4
EV/EBITDA (x) 37.6 33.6 29.4 27.1 23.1
Price/Sales (x) 8.6 7.3 6.2 5.4 4.7
Source: Company, Ambit Capital research


Consumer Goods June 04, 2013
Marico
Bloomberg: MRCO IN EQUITY
Reuters: MRCO.NS
Accounting: AMBER
Predictability: AMBER
Earnings momentum: RED


Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Please refer to the Disclaimers at the end of this Report.
SELL




Key financials
Year to March FY11 FY12 FY13E FY14E FY15E
Operating income (` mn) 31,350 40,083 45,962 48,587 55,255
EBITDA(` mn) 4,181 4,844 6,258 7,297 8,354
EBITDA Margin (%) 13.3% 12.1% 13.6% 15.0% 15.1%
Adjusted PAT(` mn) 2,864 3,171 3,959 4,589 5,578
Adjusted EPS (`) 3.9 5.2 5.6 7.1 8.7
RoE (%) 30.3% 31.0% 23.2% 22.0% 23.4%
P/E (x) 60.7 45.2 41.7 33.0 27.1
Source: Company, Ambit Capital research
INITIATING COVERAGE
Rakshit Ranjan, CFA
Tel: +91 22 3043 3201
rakshitranjan@ambitcapital.com
Shariq Merchant
Tel: +91 22 3043 3246
shariqmerchant@ambitcapital.com
Recommendation
CMP: `234
Target Price (Mar14): `198
Previous TP: NA
Downside (%) 16%
EPS (FY14E): `7.1
Change from previous (%) NA
Variance from consensus (%) -4%
Stock Information
Mkt cap: `151bn/US$2,647mn
52-wk H/L: `252/165
3M ADV: `55mn/US$1.0mn
Beta: 0.45x
BSE Sensex: 19,160
Nifty: 5,939
Stock Performance (%)
1M 3M 12M YTD
Absolute
8 7 38 7
Rel. to Sensex
8 3 15 6
Performance (%)
15,000
17,000
19,000
21,000
J un-12 Oct-12 J an-13 May-13
160
200
240
Sensex Marico

1-year forward P/E band chart
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16x
32x
28x
24x
20x

Source: Bloomberg, Ambit Capital research
On a slippery slope
Maricos moderation in volume growth in both the coconut oils as well as
edible oils segment is likely to continue going forward. Weak copra prices
will continue to favour unorganised coconut oil players, thereby
hampering the growth prospects of organised players. Also, a ~100%
price premium of safflower oil over sunflower oil will keep Saffola at a
disadvantage to Agro Techs Sundrop. Price cuts and higher advertising
spends will put pressure on margins. With an unimpressive track record of
managing international expansion in the past, Maricos intended capital
allocation towards becoming an emerging market MNC is a substantial
risk to future earnings. Execution-related issues in its MENA business and
portfolio constraints in Bangladesh will continue to be a drag in FY14. We
initiate coverage with a SELL stance.
Competitive position: MODERATE Change to this position: STABLE
Whilst the management has targeted double-digit volume growth from FY14
onwards, we expect only 13.9% revenue CAGR over FY13-16 driven by:
Coconut oils high penetration, competition from unorganised market:
Despite gross margin benefits from the 30-40% decline in copra prices over the
past 18 months, intense competition from unorganised coconut oil players has
constrained the growth in the organised market. Although market share gains
from organised peers are likely due to recent price cuts and rise in advert spends
to sales ratio, we expect Marico to record 11% revenue CAGR over FY13-15 in the
coconut oils segment with pressure on EBITDA margins.
Edible oils rising competition and adverse commodity price trends:
Assuming no change in commodity prices from the current levels, we expect
Saffola to face headwinds from: (a) ~100% higher raw material cost as compared
to sunflower-based oils like Sundrop; (b) the recent increase in competitive
intensity from rice-bran-based oil brand Fortune; and (c) drag on gross margins
from ~2% price cuts undertaken recently.
Capital allocation risks: Based on our discussions with the management, Marico
is targeting M&A in countries like Indonesia and Africa to become an emerging
market MNC. This could be a significant risk to earnings growth given its historical
track record of generating incremental returns through M&As and international
expansions. Also, lack of execution capabilities around re-packaging of its hair
cream portfolio in the MENA region and portfolio-related constraints around
market share gains in Bangladesh are likely to continue to be a drag on
performance in FY14.
Valuation: Given the correlation between commodity prices and volume growth
of the coconut hair oil and premium edible oil segments, and given the uncertainty
around growth prospects of international operations, we do not regard Marico to
be as defensive as its peers in the broader FMCG sector. Our DCF-based valuation
generates a TP of `198/share (including `6/share for Kaya), a 16% downside and
an implied FY14 P/E multiple of 27.8x.



Marico
Ambit Capital Pvt Ltd 135

Company Financial Snapshot
Profit and Loss (` mn)
FY13 FY14E FY15E
Net sales 45,962 48,587 55,255
Optg. Exp(Adj for OI.) 39,704 41,290 46,901
EBITDA 6,258 7,297 8,354
Depreciation 866 969 962
Interest Expense 580 500 276
PBT 5,187 6,212 7,543
Tax 1,462 1,553 1,886
Adj. PAT 3,959 4,589 5,578
Profit and Loss Ratios

EBIDTA Margin % 13.6% 15.0% 15.1%
Adj Net Margin % 7.9% 9.4% 10.1%
P/E (X) 41.7 33.0 27.1
EV/EBIDTA (X) 25.0 21.0 17.9
Dividend Yield (%) 0.4% 0.5% 0.6%
Company Background
Marico is a consumer products and services company in the
beauty and wellness space. The company is promoted by the
Mariwalas (62.8% stake) and is the leading hair oil
manufacturer in India.
Marico has a presence in more than 25 countries across Asia
and Africa. The company recorded revenues of `40bn in FY12
(of which 24% was from the overseas businesses).
Marico has a presence in the hair care, skin care and edible
oils segments. Its portfolio includes brands such as Parachute,
Saffola, Hair & Care, Nihar, Mediker, Revive and Manjal.
Balance Sheet (consolidated) (` mn)
FY13 FY14E FY15E
Total Assets 37,072 35,302 38,672
Net Fixed Assets 18,180 17,460 17,698
Current Assets 17,376 16,325 19,458
Other Assets 1,516 1,516 1,516
Total Liabilities 37,072 35,302 38,672
Net worth 19,815 21,860 25,828
Debt 8,258 5,015 2,795
Current Liabilities 8,941 8,369 9,991
Deferred Tax 58 58 58
Balance Sheet Ratios
ROE % 23.2% 22.0% 23.4%
ROCE % 17.1% 18.0% 20.8%
Net Debt/Equity 0.3 0.1 (0.0)
Equity/Total Assets 0.7 0.8 0.9
P/BV (X) 7.3 6.6 5.6
Cash Flow (consolidated) (` mn)

FY13E FY14E FY15E
PBT 5,187 6,212 7,543
Depreciation 866 969 962
Tax (1,462) (1,553) (1,886)
Change in Wkg Cap (201) 395 (531)
Others 285 (0) 0
CF from Operations 4,675 6,024 6,089
Capex (10,072) (1,000) (1,200)
Investments 1,440 - -
CF from Investing (8,632) (1,000) (1,200)
Change in Equity - - -
Debt 278 (3,313) (2,300)
Dividends (752) (902) (1,128)
Others 5,510 (1,642) (482)
CF from Financing 5,036 (5,857) (3,910)
Change in Cash 1,079 (83) 979
Volume growth trends for Marico Market share trends for Maricos portfolio (%)
2%
4%
6%
8%
10%
12%
14%
16%
18%
1
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1
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Parachute Saffola Overall volumes

50
52
54
56
58
60
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20
21
22
23
24
25
26
27
28
Coconut Oils Saffola Hair Oils (RHS)

Source: Company, Ambit Capital research


Marico
Ambit Capital Pvt Ltd 136

Company background
Exhibit 1: Maricos portfolio mix (FY13)
Category Key brands Key competitors
% of domestic
turnover
% of overall
turnover
Estimated
FY13 growth*
Coconut Oils Parachute, Nihar uttam Dabur, KLF Nirmal 36% 26% 9%
Value-added hair oils
Parachute advansed, Hair & care, Nihar
Naturals
Dabur, Bajaj Corp,
Emami
22% 16% 28%
Branded edible oils Saffola Agro Tech 21% 15% 12%
Skin care products Parachute advansed HUL, Beiersdorf, L'Oreal 1% 1% 48%
Foods
Saffola Oats, Saffola muesli, Saffola
Cholesterol Management, Saffola Arise
Kellogg, GSK Consumer,
Quaker
5% 4% 7%
Deodorants Set Wet, Zatak
HUL, Raymond, Mcnroe
Consumer Products
2% 1% 20%
Hair gels Set Wet Gatsby, HUL 1% 1% 18%
Post wash conditioners Livon, Silk and Shine NA 2% 1% 17%
Skin Clinics Kaya VLCC, HUL NA 7% 20%
Others Mediker, Manjal, Revive NA 10% 4% NA
Source: Company, Ambit Capital research; Note: * The skin care range was launched in FY11 and growth in the foods category was on a small base;
growth in deodorants, hair gels and post wash conditioners pertains to market growth (acquired in FY13)
In the past, Maricos domestic business has predominantly been a combination of
its coconut hair oil brand, Parachute, and premium edible oil brand, Saffola.
Parachute, one of the strongest brands in the hair oil space, controls more than
55% of the coconut oil market and 25% of the value-added hair oil market.
Saffola, on the other hand, controls ~58% market share in the premium edible
oils market, and Sundrop is its key competitor.
Over the past six years, Marico has expanded outside India through acquisitions
(except for Bangladesh and Middle East where it has expanded organically), as
shown in the tables below.
Exhibit 2: Maricos global portfolio
Region
% of
turnover
% of
international
revenues
Year of
Expansion
Type Category
Bangladesh 9% 42% 2000 Greenfield
Coconut Oil, Edible
Oils, Soaps, Hair
Colour
Middle East &
North Africa
4% 20%
Middle East
1990s; North
Africa 2006
Middle East Greenfield;
North Africa Acquisition
in Egypt
Hair Care, Skin
Care
South Africa 2% 10% 2007
Acquisition of Enaleni
Pharmas consumer
division
Hair care,
Healthcare
South East
Asia
5% 24% 2011
Acquisition of
International Consumer
Products in Vietnam
Hair care, Foods,
Home care
Source: Company, Ambit Capital research
Marico has built its global presence through six international acquisitions, with
reasons varying from building an emerging market presence to strengthening its
skin clinic portfolio. Marico is a market leader in hair oils in Bangladesh with 80%
market share through the Parachute brand. It is currently looking to expand its
product base in Bangladesh by diversifying its presence.







Marico
Ambit Capital Pvt Ltd 137

Exhibit 3: Maricos acquisitions since 2006
Company/Brand Year of acquisition Country of acquisition Category
Nihar 2006 India Coconut Oil
Manjal 2006 India Soaps
Hair Code and Fiancee 2006 Egypt Male grooming
Enaleni (Consumer Division) 2007 South Africa Hair care
Code 10 2010 Malaysia Male grooming
Derma Rx 2010 Singapore Skin care solutions
Ingwe 2010 South Africa OTC Health care
ICP (85%) 2011 Vietnam Male grooming
Halite (Paras) 2012 India Male grooming
Source: Company, Ambit Capital research
Exhibit 4: Volume growth trends for Marico
2%
4%
6%
8%
10%
12%
14%
16%
18%
1
Q
F
Y
1
1
2
Q
F
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1
1
3
Q
F
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1
1
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3
3
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F
Y
1
3
4
Q
F
Y
1
3
Parachute Saffola Overall volumes

Source: Company, Ambit Capital research
Exhibit 5: Market share trends for Maricos portfolio
50
52
54
56
58
60
1
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F
Y
1
1
2
Q
F
Y
1
1
3
Q
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4
Q
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1
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F
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1
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3
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1
3
4
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F
Y
1
3
20
21
22
23
24
25
26
27
28
Coconut Oils Saffola Hair Oils (RHS)

Source: Company, Ambit Capital research
Marico recently entered into the deodorant, hair oil and post wash hair
conditioning space through the acquisition of the consumer business of the
erstwhile Paras Pharmaceuticals from Reckitt Benckiser (with a turnover of `1.5bn
in FY12). Marico has also recently organically extended into the oats and muesli
categories through brand extensions of Saffola.
Exhibit 6: Newly acquired `1.5bn personal care portfolio
Category
Market size
(` bn)
Market
Growth
Maricos
market Share
Key brands
acquired
Key competitors
Post wash
conditioners
1 15% 84% Livon NA
Deodorants 14 35% 6% Set wet, Zatak
HUL, Raymond, Mcnroe
Consumer Products
Hair gels 2 20% 36% Set wet Gatsby, HUL
Source: Company, Ambit Capital research.
Maricos total distribution reach in India is around 4mn outlets and it has recorded
a CAGR of around 10% over the past five years. Its direct reach accounts for
around 1mn outlets.





Marico
Ambit Capital Pvt Ltd 138

SWOT analysis
Exhibit 7: SWOT analysis for Marico
Strengths Weaknesses
Parachutes strong brand equity has led to strong brand loyalty,
with only a few consumers switching away from the brand.
Strong pricing power in hair oils (the company is the price
maker). Prices increases taken by Marico in the past have not
resulted in volume growth coming off.
Distribution reach of more than 4mn outlets of which the direct
distribution reach stands at around 1mn outlets.
Diversified portfolio in foods, personal care and services. Hair
oils which formed a dominant part of the portfolio earlier have
now reduced to 40% of the overall portfolio, with a presence in
foods, personal care and edible oils.

Marico has a working capital cycle of 51 days (in FY12)
which is amongst the poorest in the FMCG space.
Its international portfolio has been a drag on the overall
business with its Bangladesh portfolio (40% of
international revenues) and MENA portfolio (25% of
international revenues) struggling for growth.
Opportunities Threats
Can leverage its distribution network in its newly acquired
personal care portfolio of the erstwhile Paras Pharmaceuticals.
Has a presence in high-growth aspirational categories like
premium edible oils, breakfast foods and skincare. Whilst skin
care has a market size of around `40bn, premium edible oils
and breakfast foods are nascent categories with a market size of
`10bn each.
Has the ability to extend the Parachute power brand to other
categories (has already extended to skin care).

Still building a presence in packaged foods and skin care,
segments in which it competes with MNCs with strong
balance sheets.
High penetration levels (80% in urban, 67% in rural) in
hair oils will likely see volume growth coming off at an
industry level.
The company can be affected if the slowdown in packaged
food growth sustains.
Source: Industry, Company, Ambit Capital research


Marico
Ambit Capital Pvt Ltd 139

Domestic portfolio adversely affected
by commodity prices and competition
Of the three segments of Maricos domestic product portfoliococonut oils, value-
added hair oils and premium edible oilsthe only segment which has NOT seen a
substantial moderation in revenue growth in the recent quarters has been value-
added hair oils. As shown in the chart below, volume growth for both of Maricos
flagship brandsParachute (coconut oil) and Saffolahave moderated
substantially in FY13.
Exhibit 8: Parachute and Saffola - volume growth trends
2
4
6
8
10
12
14
16
18
4
Q
F
Y
1
0
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F
Y
1
1
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3
3
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F
Y
1
3
4
Q
F
Y
1
3
Parachute Volume Growth (%) Saffola Volume Growth (%)

Source: Company, Ambit Capital research
The factors driving the volume growth moderation in coconut oils and premium
edible oils have been linked to the changes in their respective commodity prices
over the past 12-24 months. Whilst a softening of copra prices has led to increase
in competition from unorganised players, a rise in the commodity price of
safflower oil as compared to sunflower and rice bran oil has led to Maricos edible
oils product portfolio being priced at a substantial disadvantage to its peers.
Coconut oils drag from unorganised competition
amidst softening commodity prices
As highlighted previously in this note, anecdotal evidence suggests that the hair
oils market in India has reached penetration levels of around 80% in the urban
markets and around 67% in the rural markets. Around 65% of the overall coconut
hair oil market in India is controlled by organised players, with Parachute
controlling 58% of the organised market. Given that copra is the main raw
material for coconut oil, input costs for coconut oil manufacturers have been
significantly volatile in the past (refer to the charts below)
Exhibit 9: Copra prices have been volatile over the past two years
3,000
3,500
4,000
4,500
5,000
5,500
6,000
6,500
7,000
J
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3
Copra Price (Rs/100Kg)

Source: Company, Ambit Capital research
Around 65% of the overall
coconut hair oil market in India
is controlled by organised
players, with Parachute
controlling 58% of the
organised market.


Marico
Ambit Capital Pvt Ltd 140

Organised competitors of Parachute (highlighted in the table below) do not
possess as strong a brand recall or as wide a distribution network as that of
Parachute. This has allowed Marico to gain substantial market share from its peers
in the coconut oil segment over the past few years (refer to the chart below).
Exhibit 10: Market shares in the branded coconut oil
market (FY12)
Brand Market Share
Parachute 58%
Shalimar 9%
VVD Coconut Oil 4%
Dabur Anmol 3%
Others 26%
Source: Company, Ambit Capital research

Exhibit 11: Parachutes volume growth and market
share
2
6
10
14
18
3
Q
F
Y
1
0
4
Q
F
Y
1
0
1
Q
F
Y
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2
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1
3
52
53
54
55
56
57
58
Volume growth Market share (RHS)

Source: Company, Ambit Capital research; Note: Black shaded region
indicates price increase taken during the quarter
However, weaker prices of copra (the raw material for coconut oil) leads to
competition from unorganised players who bring the proposition of freshly
prepared oil, thereby disincentivising consumers from switching over to branded
coconut oils. This, as shown in the chart below, has led to a significant moderation
in the overall growth rate for the coconut oil market despite continued market
share gains and gross margin expansion for Parachute.
Exhibit 12: Industry volumes follow copra prices with a two-quarter lag
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
1
Q
F
Y
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Q
F
Y
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Q
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1
3
4
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F
Y
1
3
-5%
0%
5%
10%
15%
20%
Change in copra price (QoQ) Branded Coconut Oil Industry growth (RHS)

Source: Company, Ambit Capital research
In response to this increase in competitive intensity, Parachute has cut prices by 3-
7% across various SKUs during Feb-Mar 2013. We expect these price cuts to have
a drag of 100-150bps on Maricos consolidated gross margins in FY14, with
continued moderation in volume growth despite market share gains in the overall
coconut oil segment.







Marico
Ambit Capital Pvt Ltd 141

Exhibit 13: Maricos coconut and value-added hair oil growth forecasts
Coconut oils
FY12 FY13E FY14E FY15E
Revenues 10,822 12,122 13,477 14,982
Market share 53.9% 55.9% 56.5% 57.1%
Marico growth 38% 12.0% 11.2% 11.2%
Market growth 10% 5% 10% 10%
Source: Ambit Capital research
Consequently, as highlighted in the table above, assuming that commodity prices
remain unchanged going forward, we expect only 10% revenue CAGR for the
market and 11% revenue CAGR for Maricos coconut oil segment over FY13-15.
Saffola adverse commodity fluctuations; rising
competitive intensity from Adani Wilmar
Sundrop has historically been the only competitor in the premium edible oils
segment for Saffola. As shown in the chart below, Maricos average volume
growth rate in premium edible oils was at ~14% during FY11 and FY12. Whilst
this momentum was driven by market share gains from Sundrop over this period,
the segment has seen a trend reversal over the past 12 months, with a substantial
moderation in volume growth for Marico to ~5% YoY in FY13.
Exhibit 14: Saffola volume growth and market share trends
2
5
8
11
14
17
20
1
Q
F
Y
1
1
2
Q
F
Y
1
1
3
Q
F
Y
1
1
4
Q
F
Y
1
1
1
Q
F
Y
1
2
2
Q
F
Y
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2
3
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F
Y
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2
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3
Q
F
Y
1
3
4
Q
F
Y
1
3
50
52
54
56
58
60
Saffola Volume growth (%) Market Share (%) (RHS)

Source: Company, Ambit Capital research.
We view Saffolas brand recall in the premium edible oils segment to be
substantially superior to that of Sundrop, and we acknowledge the investments
behind the Saffola brand by Marico including customer initiatives like World Heart
Day and Heart Age Calculator. However, we do not expect any incremental
market share gains for Marico in the edible oils portfolio over the next five years
due to:
Rising competitive intensity: With the aggressive pricing and advertising
campaign by Adani Wilmar for its rice brand premium edible oils brand
Fortune, competitive intensity in this segment has increased substantially over
the past six months.
At a disadvantage vs competition on input costs: With the widening price
gap between sunflower oil and safflower oil over the past five quarters, and
price cuts by manufacturers of sunflower-based edible oils, there has been a
significant moderation in the rate of market share gains for Saffola over
Sundrop. Whilst Marico has reduced its product prices by 2-3% on average
across the edible oils portfolio in Feb-Mar 2013, this is not likely to materially
benefit Maricos volume growth in this segment until safflower prices soften
materially from the current levels.


Marico
Ambit Capital Pvt Ltd 142

Exhibit 15: Premium of safflower oil (kardi oil) over sunflower oil
-10%
10%
30%
50%
70%
90%
110%
N
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0
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1
J
u
l
-
1
1
S
e
p
-
1
1
N
o
v
-
1
1
J
a
n
-
1
2
M
a
r
-
1
2
M
a
y
-
1
2
J
u
l
-
1
2
S
e
p
-
1
2
N
o
v
-
1
2
J
a
n
-
1
3
M
a
r
-
1
3
Premium of Kardi Oil over Sunflower Oil

Source: Company, Ambit Capital research
Exhibit 16: Maricos Saffola - growth forecasts
FY12 FY13E FY14E FY15E
Revenues 6,012 6,704 7,642 8,712
Market Share 58.0% 58.0% 58.0% 58.0%
Market Growth 5% 12% 14% 14%
Saffola growth 28% 12% 14% 14%
Source: Ambit Capital research

Value-added hair oils benefitting from strong
category growth
Value-added hair oils, which contributed to 16% of overall revenues for Marico in
FY13, is the only area of strong growth momentum in Maricos domestic portfolio
with strong revenue growth reported over the past three years. This growth
momentum, we believe, is driven by a combination of: (a) premiumisation towards
value-added hair oils in the fully penetrated hair oils category; and (b) Maricos
ability to leverage on Parachutes strong brand recall through its brand extensions.
However, we do not expect the value-added hair oils segment to be a significant
driver of earnings growth for Marico because: (a) the company makes substantially
weak margins in this segment as compared to the rest of its domestic product
portfolio; and (b) competitive intensity is substantially high with significant
aggression from peers like Emami, Bajaj Corp and Dabur in this segment.





Marico
Ambit Capital Pvt Ltd 143

Capital allocation risks and the drag
from international businesses
Maricos dividend payout ratio has reduced from more than 50% until FY07 to
~20% currently. This retained cash flow has been predominantly deployed towards
the expansion of the international portfolio. As highlighted previously in our
capital allocation section of the note, Maricos capital allocation towards non-
core/international businesses in the past has not generated significant incremental
returns relative to the corresponding capital investments behind these initiatives.
Revenue growth from Maricos international operations has moderated from 18%
(organic) in FY12 to 5% in FY13E, as shown in the chart below. Maricos South-
East Asian business has reported strong growth over the past two years. Whilst the
companys South African business had reported a temporary drag from the
transporters strike in 2QFY13, other geographies including Bangladesh and the
MENA region have reported weakness related largely to company specific factors,
which we believe are unlikely to be shortly resolved.
Exhibit 17: International business has been a drag in FY13

% of FY12
revenues
FY12 FY13E FY14E
Bangladesh
9.6%
11% 0% 10%
Middle East and North Africa
6.0%
35% 1% 9%
South Africa
2.4%
~10% 10% 10%
South East Asia
6.0%
NA 15% 13%
Source: Company, Ambit Capital research
Bangladesh
Maricos Bangladesh business relates almost entirely to Parachute branded hair
oils. Underperformance in the Bangladesh business over the past two years is
related to:
Market-share-related limitations: Maricos market share in the coconut oil
segment has increased from ~70% 12 months ago to ~80% currently.
Consequently, there is a limited potential to gain further market share for
Marico in Bangladeshs coconut oil market.
Overall moderation in consumption growth for the country? Our
discussion with the management suggests that Bangladesh has seen high
inflation in FY12 and FY13 (10.6% and 7.6% respectively) along with a
moderation in GDP growth from 6.7% in FY11 to 6.3% in FY12. However,
players like Reckitt Benckiser have reported a revival in growth in CY12, with
13% YoY growth in 9MCY12 and 4% YoY growth in CY11.
Other external factors: Factors such as strikes during 3QFY13 have also
contributed to the weak performance.
In response to the market-share-related limitations in the coconut oil segment,
Marico is currently investing in advertising and R&D in the value-added hair oils
and hair dyes segments and the contribution from coconut oil has reduced to to
90% from 100% over the past two years. Whilst we expect factors such as strikes to
be temporary, we expect the drag on revenues related to portfolio constraints and
consumption spends to sustain at least over the next few years.


Marico
Ambit Capital Pvt Ltd 144

MENA region
Maricos operations in the Middle East have been a drag, owing to:
Packaging changes: Marico introduced certain packaging-related changes in
its hair cream in 2QFY13, with the intention to make it more attractive as well
as cost efficient. However, due to a lack of good-quality execution of this re-
packaging initiative, consumer response to the hair cream was significantly
poor than the companys expectation.
Distribution restructuring: Marico has also undertaken distribution
restructuring initiatives in FY13 in certain MENA markets which has led to
lower off-take of sales and inventory pipeline reduction in the distribution
channel.
These factors of underperformance are related specifically to Maricos execution of
strategy, and thus we do not expect the business to show a rapid turnaround in a
short period of time.
Kaya and the impact from its demerger
We believe the managements recent announcement to demerge the Kaya
business from Marico into a separate listed entity (owned by the shareholders of
Marico) is likely to marginally benefit shareholders of Marico because: (1) it
removes the drag on net profit that Kaya brought to Maricos consolidated
accounts; (2) it positively impacts EBITDA margins and return ratios, as it reduces
the capital employed in the core Marico business (its FY12 RoCE would rise by
410bps from 23.3% to 27.4% if the Kaya business were to be excluded); (3) it gives
investors the option of separately investing in the non-core Kaya business; and (4)
it is value accretive for shareholders, as the drag on net profit (because it was
making losses) will be given a positive value when the Kaya business is listed
separately. We estimate the drag on EBIT margin to be 160bps in FY12.
Valuation of Kaya: Based on an assumed valuation of 1.0x revenue (lower than
Maricos 2.8x FY14 revenues, given that the business is loss making), we estimate
Kayas valuation to be `6/share for existing shareholders of Marico.
Exhibit 18: Impact of the Kaya business demerger on Marico (` mn)
Marico (ex-Kaya) Kaya Marico (incl Kaya)
Revenues 37,293 2,790 40,083
EBIT 4,735 (291) 4,444
EBIT Margin (%) 12.7 (10.4) 11.1
Capital Employed 17,252 1,807 19,059
ROCE (%) 27.4 (16.1) 23.3
Source: Company, Ambit Capital research
Capital allocation strategy going forward
Our recent discussions with the management team indicate that the company
intends to focus initially on increasing the volume growth of its Indian portfolio into
double digits, following which the firm is likely to focus on capital allocation
towards M&A in countries like Indonesia and Africa with the intent to evolve as an
emerging market MNC in the future.
Given the track record of generating returns on capital retained and deployed
towards M&A so far, we see this as a substantial long-term risk on Maricos
earnings growth potential.


Marico
Ambit Capital Pvt Ltd 145

Key assumptions
Exhibit 19: Key assumptions and estimates for Maricos revenues

Contribution
to revenues
FY13E FY14E FY15E Comments
Domestic business
Coconut Oils growth 27.0% 9.0% 11.1% 11.1%
Industry growth 2.4% 10.0% 10.0%
Market share change growth 6.6% 1.1% 1.1%
High penetration levels and slowdown in discretionary spending
is likely to affect overall market growth for coconut oils.
However, market share gains are likely to continue on the back
of the strong brand
Value added hair oils
growth
17.4% 28.3% 17.7% 17.7%
Industry growth 14.5% 16.0% 16.0%
Market share change growth 13.8% 1.7% 1.7%
Expect premiumisation to continue aggressively benefiting the
'Parachute advansed' portfolio. Expect market share gains for
Parachute on the back of strong brands, wide portfolio and
aggressive pricing in segments where they are not market
leaders
Saffola edible oils
growth
15.7% 11.5% 14.0% 14.0%
Industry growth 11.5% 14.0% 14.0%
Market share change growth 0.0% 0.0% 0.0%
With the discretionary segment continuing to be under pressure,
the market growth is likely to be below historical levels. Expect
the rate of market share gains to come off its historical levels as
raw material inflation restricts its ability on pricing
Skin care growth 1.1% 48.4% 31.4% 22.2%
Industry growth 6.0% 15.0% 15.0%
Market share change growth 42.4% 16.4% 7.2%
Gains here likely to be driven by increasing its distribution and
the high growth is a function of the low base it enjoys
Saffola Foods growth 4.2% 7.1% 26.5% 26.5%
Industry growth 2.0% 15.0% 15.0%
Market share change growth 5.1% 11.5% 11.5%
Whilst its rice and atta offerings have not met with success, the
growth is likely to be led by its launches in the oats and muesli
segment where it has already captured around 12% market
share
Others 7.2% 2.8% 10.0% 10.0%
Includes brands like Mediker, Manjal, Oil of Malabar and Revive
which are not focus areas for Marico
Deodorants growth 1.8% 17.7% 17.0% 17.0%
Industry growth 28.0% 25.0% 25.0%
Market share change growth -10.3% -8.0% -8.0%
Strong competitive intensity is likely to affect market share as
brands like Park Avenue and Wildstone have started gaining
share
Hair gels growth 1.4% 17.7% 17.0% 17.0%
Industry growth 16.0% 16.0% 16.0%
Market share change growth 1.7% 1.0% 1.0%
Expect low market share gains for the segment as the company
sees the benefit of leveraging its distribution over the acquired
distribution
Post wash conditioner
growth
1.6% 17.3% 17.3% 14.4%
Industry growth 18.0% 18.0% 15.0%
Market share change growth -0.7% -0.7% -0.6%
With almost 90% market share, the company is likely to expand
slower than the market as it faces market share related
restrictions with increasing competition from L'Oreal
Total domestic
business
77.5% 17.6% 15.8% 14.6%
International business
Bangladesh growth 9.6% 10.0% 10.0% 10.0%
Market growth

12.0% 12.0% 12.0%
Market share related growth -2.0% -2.0% -2.0%
Do not expect the issues in Bangladesh, both macro and
internal, to be resolved immediately and expect the growth to be
below the market
MENA growth 4.1% -16.2% -1.0% 9.0%
Market growth

9.0% 9.0% 9.0%
Market share related growth -25.2% -10.0% 0.0%
Whilst the market holds strong potential, Marico's execution in
the region has been poor. Do not expect above market growth
until the company can establish sustained execution capabilities
South Africa growth 2.3% 4.8% 10.2% 10.2%
Market growth

6.2% 6.2% 6.2%
Market share related growth -1.4% 4.0% 4.0%
Whilst the business has seen disruptions, expect around 10%
sustainable growth as the company holds a strong premium hair
care portfolio
South East Asia growth 5.6% 0.6% 13.0% 13.0%
Market growth

10.0% 10.0% 10.0%
Market share related growth -9.4% 3.0% 3.0%
The company has seen strong growth in its South East Asian
business as its market-leading hair care brands have seen
market share gains, one of Marico's most successful acquisitions
yet
Total international business 21.9% 22.5% 21.9%
Total revenue growth 14.7% 14.4% 14.5%
Source: Ambit Capital research


Marico
Ambit Capital Pvt Ltd 146

Exhibit 20: Key assumptions and estimates [` mn]
FY12 FY13E FY14E FY15E Comments
Profit and loss
Domestic revenues 27,657 32,527 37,651 43,161
Growth (%) 37.0% 17.6% 15.8% 14.6%
Expect growth to be driven by value-added hair oils and the
new personal care business
International revenues 9,620 10,076 10,936 12,094
Growth (%) 30.0% 4.7% 8.5% 10.6%
Expect South East Asia business to expand fastest at 15%
and recovery in Bangladesh business (CAGR of 12% over
FY12-15)
Kaya 2,790 3,360 3,994 4,971
Growth (%) 16.7% 20.4% 18.9% 24.4%
Expect same-store growth of 15% and addition of ten stores
in FY14 and FY15 each
Total revenues 40,083 45,962 48,587 55,255
Growth (%) 27.9% 14.7% 5.7% 13.7%

Gross Profit 19,096 23,863 25,080 28,632
Gross margin (%) 47.6% 51.9% 51.6% 51.8%
Expect mix benefit led by premiumisation, changing
business mix and reversal of exceptionally low raw material
costs in FY13
Employee cost (% of sale) 7.7% 8.3% 7.2% 7.2% Expect marginal benefit due to scale advantages
Advertising (% of sale) 11.2% 13.0% 12.8% 12.9%
Expect advertising spends to rise led by changing portfolio
mix
Carriage & freight (% of sale) 4.2% 4.2% 4.2% 4.2% Expect carriage and freight expenses to remain stable
Other expenses (% of sale) 12.5% 20.4% 12.4% 12.4% Expect other expenses to remain stable
EBITDA 4,844 6,258 7,297 8,354
EBITDA Margin 12.1% 13.6% 15.0% 15.1%
Expect improvement in EBITDA margins led by the above
changes
Tax rate 19.5% 28.2% 25.0% 25.0%
Expect tax rates to rise as the proportion of fully taxable hair
oils rises and tax holidays expire
Net Profit margin 8.0% 7.9% 9.4% 10.1%
Lower interest costs and slower depreciation growth to help
net profit margins
Balance Sheet
Capex 1,400 10,072 1,000 1,200
Capital Work in Progress 94 94 94 94
No material capex requirements in FY14 and FY15
Working Capital days 51 46 40 39 Expect working capital days to remain stable
Debtor days 17 16 18 18
Expect debtor days to rise as the proportion of modern trade
increases
Current Liabilities days 53 52 61 56 Expect stable current liabilities days
Inventory days 66 69 66 55
Expect improvement in inventory days as FY13 will hold
higher stock due to lower raw material prices
Net debt/(cash) to equity 0.5 0.3 0.1 (0.0) Expect Marico to turn into a net cash company in FY15
Cash flows (` mn)
Operating cash flows 3,103 4,675 6,024 6,089
Free cash flows 1,937 (5,397) 5,774 4,889
Strong growth in free cash flows as capex requirements are
low
Source: Ambit Capital research



Marico
Ambit Capital Pvt Ltd 147

Valuation
DCF-based valuation
Given the cash-generative nature of the business, we use a DCF-based model to
arrive at a fair value for Marico. The assumptions for the weighted average cost of
capital and terminal growth rates are shown in the exhibit below. We have
assumed marginal debt (debt:equity of 0.1) on Maricos balance sheet in the
future given its strong cash position and free cash flow generative business.
Hence, the company has enough surplus cash available on its balance sheet for
capital expenditure in the future.
We use a three-stage DCF approach for Marico. Stage 1 includes explicit forecasts
for the income statement and balance sheet for the next four years (FY14-18) with
sales CAGR of 14% (adjusted for the Kaya de-merger) and EPS CAGR of 20%.
Stage 2 includes a decline in sales growth over eight years from 14% in FY19 to
7% in FY26 i.e. sales CAGR of 10% and free cash flow CAGR of 9% over this
period. Stage 3 includes terminal growth forecasts with a growth rate to
perpetuity of 5%.
The discount rate assumptions used in our DCF model are shown in the exhibit
below. Our model generates a target price of `198/share (including `6/share for
the to-be-demerged Kaya business, based on 1x revenues), a 16% downside and
implying an FY14 P/E multiple of 27.6x.
The cash flow and return profiles generated by our model are shown in the
exhibits below:
Exhibit 22: Cash flow profiles for Marico (` mn)
(5,400)
(3,400)
(1,400)
600
2,600
4,600
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
CFO (Rs mn) Free Cash Flow (Rs mn)

Source: Ambit Capital research; Note: FY14 cash flows reflect the impact
of the Kaya demerger
Exhibit 23: Return profiles for Marico (%)
0%
10%
20%
30%
40%
50%
60%
70%
F
Y
0
6
F
Y
0
7
F
Y
0
8
F
Y
0
9
F
Y
1
0
F
Y
1
1
F
Y
1
2
F
Y
1
3
F
Y
1
4
E
F
Y
1
5
E
-10%
0%
10%
20%
30%
40%
50%
60%
ROE (LHS) EBITDA Margin
EPS Growth YoY Growth in sales

Source: Ambit Capital research
Relative valuation
As highlighted previously in this note, our analysis of Maricos capital deployment
over the past decade suggests a sub-par performance with a likelihood of
increased M&A activity by the company as it targets to expand into an emerging
market MNC. Moreover, as explained in the earlier sections of this note, the
company is likely to face increasing downward pressure on gross margins both for
its Parachute as well as Saffola franchises owing to recent product price cuts.
As shown in the chart below, over the past 12 months, Marico has been re-rated
(in line with the re-rating of the broader FMCG sector) by 25-30% from 24.0x one-
Exhibit 21: WACC calculation
for DCF on Marico
Item Value
Risk free rate (%) 8.5
Beta (2-year monthly) 0.55
Equity risk premium (%) 7.0
Cost of equity (%) 12.4
Cost of debt (%) 10.0
Debt/Equity ratio (%) 10.0
Tax rate (%) 30.0
WACC (%) 12.0
Source: Company, Ambit Capital
research


Marico
Ambit Capital Pvt Ltd 148

year forward P/E multiple to 33.0x FY14 P/E multiple currently. As a result, the
stock currently trades at a ~35% premium to its three-year historical average
trading multiple.
Exhibit 24: 1-year forward P/E bands for Marico
40
60
80
100
120
140
160
180
200
220
240
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
16x
32x
28x
24x
20x

Source: Bloomberg, Ambit Capital research
Exhibit 25: 1-year forward EV/EBITDA bands for Marico
40
60
80
100
120
140
160
180
200
220
240
A
p
r
-
0
7
A
u
g
-
0
7
D
e
c
-
0
7
A
p
r
-
0
8
A
u
g
-
0
8
D
e
c
-
0
8
A
p
r
-
0
9
A
u
g
-
0
9
D
e
c
-
0
9
A
p
r
-
1
0
S
e
p
-
1
0
J
a
n
-
1
1
M
a
y
-
1
1
S
e
p
-
1
1
J
a
n
-
1
2
M
a
y
-
1
2
S
e
p
-
1
2
J
a
n
-
1
3
M
a
y
-
1
3
12x
14x
16x
18x
20x

Source: Bloomberg, Ambit Capital research
Given the correlation between commodity prices and volume growth prospects of
the coconut hair oil and premium edible oil segments, and given the uncertainty
around the growth prospects of the international operations including Bangladesh
and MENA regions, we do not regard Marico to be as defensive as its peers in the
broader FMCG sector.
Consequently, we expect the relative valuation multiples of the stock to reflect an
overhang from a disadvantaged positioning given the current commodity prices
and drag from the international subsidiaries on growth.
Exhibit 26: Sensitivity analysis
Bull case Base case Bear case
Revenue growth
Expect revenue growth of 17% over
FY13-23 driven by strong market
share gains across categories and a
recovery in the international business
led by Bangladesh. Our terminal
growth rate assumption stands at 6%
Expect revenue growth of 14% over
FY13-23 led by strong growth (~16%)
in the value-added hair oils segment.
Expect the coconut oil and
international business to record
around 10% CAGR. Our terminal
growth rate assumption stands at 5%
Assume a revenue growth of 12% over
FY13-23 driven by no market share gains
and around 15% growth in the value-added
hair oils segment and around 9% growth in
the hair oils segment and the international
business. Our terminal growth rate
assumption stands at 4%
Operating margins
We assume EBITDA margin expansion
of 120bps from 14.7% in FY14 to
15.9% in FY17 led by higher benefit
from premiumisation (90bps) and
lower advertisement spends lower by
30bps
Expect EBITDA margins to expand by
50bps over FY14-18 to 15%, with
80bps gross margin expansion to be
partially offset by increases in
advertising spends.
Expect EBITDA margins to decline 30bps
from 14.7% in FY14 to 14.4% in FY17 led by
higher advertising expenditure due to high
competitive intensity and no benefit from
premiumisation led gross margin expansion
Fair value (`/share) 248 198 144
Upside/Downside 6% -16% -39%
Source: Ambit Capital research


Marico
Ambit Capital Pvt Ltd 149

Risks to our SELL stance
Reversal of commodity price movements: A combination of a significant
increase in copra prices and a significant reduction in safflower prices is likely
to lead to a volume growth revival for the organised coconut oil segment and
a gross margin revival for the Saffola portfolio.
Valuation of Maricos Kaya business on listing: In case the company is
successful at listing its Kaya business later this year at a significant premium to
our current expectations, then the benefits for Maricos current shareholders
from this demerger would be more than what we have priced in.
Catalysts
Things to watch out for over the next 6 months
Volume growth under pressure: We expect volume growth for both Saffola
and Parachute Coconut Oil to be under pressure owing to: (1) subdued
discretionary consumption growth; (2) increasing penetration in the coconut
hair oil segment; and (3) unfavourable movement of raw material prices.
Rising raw material costs to impact gross margins: With raw material
prices for both copra and safflower increasing, the gross margin benefit that
Marico enjoyed through FY13 is likely to reverse. As competitor pricing still
remains aggressive, it will be a challenge for Marico to pass on prices to the
consumers.
Ambit vs consensus
Exhibit 27: Ambit vs consensus
Ambit vs Consensus Ambit Consensus Divergence from consensus Comments
FY14E

Net Sales (` mn) 48,587 52,208 -7%
We factor in the demerger of the Kaya business in our
numbers and we expect a decline in volume growth in the
coconut oil and Saffola business
EBITDA (` mn) 7,297 7,334 -1%
Expect EBITDA margin expansion of 60bps in FY14 led by the
Kaya demerger and 10bps in FY15 led by the net effect of
gross margin expansion and increased advertisement spends
EPS (`/share) 7.1 7.4 -4%
Expect tax rates to stay at elevated levels (25%) as we expect
the Saffola business (tax-exempt) to remain under pressure in
FY14
FY15E

Net Sales (` mn) 55,255 60,534 -9%
Variation from consensus due to a combination of the Kaya
demerger and lower volume growth expectations for Saffola
and Parachute coconut oil.
EBITDA (` mn) 8,354 8,589 -3%
Expect 10bps EBITDA margin expansion led by the net effect
of gross margin expansion and increased advertisement
spends
EPS (`/share) 8.7 9.0 -3%
Expect tax rates to stay at elevated levels (25%) as we expect
the Saffola business (tax-exempt) to remain under pressure
Source: Bloomberg, Ambit Capital research
Exhibit 28: Explanation for our forensic accounting scores on the first page
Segment Score Comments
Accounting AMBER
In the past, Marico has reported strong cash conversion, management of working capital and low
levels of loans and advances, but it still stands lower than the overall FMCG average and runs the
risk of contingent liabilities not working in its favour.
Predictability AMBER
Marico is strongly influenced by commodity price volatility. Whilst the company has historically
reported strong volume growth, certain segments like Saffola and its international portfolio have
seen erratic growth trends in recent quarters.
Earnings momentum RED In the past six months, consensus estimates have been downgraded by 8% for FY14 and FY15.
Source: Ambit Capital research


Marico
Ambit Capital Pvt Ltd 150

Balance sheet (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Shareholders' equity 614 615 645 645 645
Reserves & surpluses 8,540 10,815 19,170 21,215 25,183
Total net worth 9,155 11,430 19,815 21,860 25,828
Minority Interest 219 249 351 421 501
Debt 7,224 7,629 7,907 4,594 2,294
Deferred tax liability (299) (223) 58 58 58
Total liabilities 16,299 19,084 28,131 26,933 28,681
Gross block 7,615 9,015 19,087 19,337 20,537
Net block 4,250 4,924 14,130 13,411 13,649
CWIP 328 94 94 94 94
Goodwill 3,976 3,955 3,955 3,955 3,955
Investments 889 2,956 1,516 1,516 1,516
Cash & equivalents 2,206 1,588 2,667 2,584 3,563
Debtors 1,779 1,816 1,966 2,346 2,725
Inventory 6,011 7,202 8,627 7,286 8,326
Loans & advances 1,556 1,995 2,555 2,562 3,028
Other current assets 1,038 1,416 1,562 1,547 1,817
Total current assets 12,590 14,017 17,376 16,325 19,458
Current liabilities 4,537 5,665 7,727 7,004 8,326
Provisions 1,197 1,197 1,214 1,364 1,665
Total current liabilities 5,734 6,862 8,941 8,369 9,991
Net current assets 6,856 7,155 8,435 7,957 9,467
Total assets 16,299 19,084 28,131 26,933 28,681
Source: Company, Ambit Capital research
Income statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
Operating income 31,350 40,083 45,962 48,587 55,255
% growth 17.8% 27.9% 14.7% 5.7% 13.7%
Operating expenditure 27,169 35,239 39,704 41,290 46,901
EBITDA 4,181 4,844 6,258 7,297 8,354
% growth 11.5% 15.8% 29.2% 16.6% 14.5%
Depreciation 708 725 866 969 962
EBIT 3,473 4,118 5,392 6,328 7,391
Interest expenditure 410 424 580 500 276
Non-operating income 212 326 375 384 428
Adjusted PBT 3,275 4,020 5,187 6,212 7,543
Tax 850 783 1,462 1,553 1,886
Adjusted PAT/ Net profit 2,425 3,238 3,725 4,659 5,658
% growth -0.3% 33.5% 15.0% 25.1% 21.4%
Extraordinaries 489 (18) 332 - -
Reported PAT / Net profit 2,914 3,220 4,057 4,659 5,658
Minority Interest 50 50 98 70 80
Share of associates - - - - -
Adjusted Consolidated net profit 2,864 3,171 3,959 4,589 5,578
Reported Consolidated net profit 2,864 3,171 3,959 4,589 5,578
Source: Company, Ambit Capital research



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Cash flow statement (` mn)
Year to March FY11 FY12 FY13 FY14E FY15E
EBIT 3,685 4,444 5,767 6,712 7,819
Depreciation 708 725 866 969 962
Others (49) (368) (295) (500) (276)
Tax (850) (783) (1,462) (1,553) (1,886)
(Incr) / decr in net working capital (932) (916) (201) 395 (531)
Cash flow from operations 2,562 3,103 4,675 6,024 6,089
Capex (1,289) (1,166) (10,072) (1,000) (1,200)
(Incr) / decr in investments (3,188) (2,046) 1,440 - -
Others - - - - -
Cash flow from investments (4,477) (3,212) (8,632) (250) (1,200)
Net borrowings 2,765 405 278 (3,313) (2,300)
Interest paid (410) (424) (580) (500) (276)
Dividend paid (472) (501) (752) (902) (1,128)
Others 1,122 12 6,090 (1,142) (206)
Cash flow from financing 3,005 (509) 5,036 (5,857) (3,910)
Net change in cash 1,091 (618) 1,079 (83) 979
Closing cash balance 2,206 1,588 2,667 2,584 3,563
Free cash flow 1,273 1,937 (5,397) 5,774 4,889
Source: Company, Ambit Capital research
Ratio analysis
Year to March FY11 FY12 FY13 FY14E FY15E
Gross margin (%) 48.4% 47.6% 51.9% 51.6% 51.8%
EBITDA margin (%) 13.3% 12.1% 13.6% 15.0% 15.1%
EBIT margin (%) 11.8% 11.1% 12.5% 13.8% 14.2%
Net profit margin (%) 7.6% 8.0% 7.9% 9.4% 10.1%
Dividend payout ratio (%) 16.5% 15.8% 19.0% 19.7% 20.2%
Net debt: equity (x) 0.5 0.5 0.3 0.1 (0.0)
Working capital turnover (x) 6.7 7.2 8.0 9.0 9.4
Gross block turnover (x) 4.1 4.4 2.4 2.5 2.7
RoCE (%) 20.0% 20.0% 17.1% 18.0% 20.8%
RoE (%) 30.3% 31.0% 23.2% 22.0% 23.4%
Source: Company, Ambit Capital research
Valuation parameters
Year to March FY11 FY12 FY13 FY14E FY15E
EPS (`) 3.9 5.2 5.6 7.1 8.7
Diluted EPS (`) 3.9 5.2 5.6 7.1 8.7
Book value per share (`) 14.9 18.6 32.2 35.5 42.0
Dividend per share (`) 0.66 0.70 1.00 1.20 1.50
P/E (x) 60.7 45.2 41.7 33.0 27.1
P/BV (x) 15.8 12.6 7.3 6.6 5.6
EV/EBITDA (x) 35.7 31.0 25.0 21.0 17.9
Price/Sales (x) 4.6 3.6 3.3 3.1 2.7
Source: Company, Ambit Capital research


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Institutional Equities Team
Saurabh Mukherjea, CFA Head of Equities (022) 30433174 saurabhmukherjea@ambitcapital.com
Research
Analysts Industry Sectors Desk-Phone E-mail
Aadesh Mehta Banking / NBFCs (022) 30433239 aadeshmehta@ambitcapital.com
Achint Bhagat Cement / Infrastructure (022) 30433178 achintbhagat@ambitcapital.com
Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 ankurrudra@ambitcapital.com
Ashvin Shetty Automobile (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power / Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Dayanand Mittal Oil & Gas (022) 30433202 dayanandmittal@ambitcapital.com
Gaurav Mehta Strategy / Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Harshit Vaid Power / Capital Goods (022) 30433259 harshitvaid@ambitcapital.com
Jatin Kotian Metals & Mining / Healthcare (022) 30433261 jatinkotian@ambitcapital.com
Karan Khanna Strategy (022) 30433251 karankhanna@ambitcapital.com
Krishnan ASV Banking (022) 30433205 vkrishnan@ambitcapital.com
Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 nitinbhasin@ambitcapital.com
Nitin Jain Technology (022) 30433291 nitinjain@ambitcapital.com
Pankaj Agarwal, CFA NBFCs (022) 30433206 pankajagarwal@ambitcapital.com
Pratik Singhania Real Estate / Retail (022) 30433264 pratiksinghania@ambitcapital.com
Parita Ashar Metals & Mining (022) 30433223 paritaashar@ambitcapital.com
Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 rakshitranjan@ambitcapital.com
Ritika Mankar Mukherjee Economy / Strategy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Healthcare (022) 30433292 ritumodi@ambitcapital.com
Ravi Singh Banking / NBFCs (022) 30433181 ravisingh@ambitcapital.com
Shariq Merchant Consumer (022) 30433246 shariqmerchant@ambitcapital.com
Tanuj Mukhija E&C / Infrastructure (022) 30433203 tanujmukhija@ambitcapital.com
Utsav Mehta Telecom / Media (022) 30433209 utsavmehta@ambitcapital.com
Sales
Name Regions Desk-Phone E-mail
Deepak Sawhney India / Asia (022) 30433295 deepaksawhney@ambitcapital.com
Dharmen Shah India / Asia (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta India / Europe / USA (022) 30433053 diptimehta@ambitcapital.com
Parees Purohit, CFA USA (022) 30433169 pareespurohit@ambitcapital.com
Pramod Gubbi, CFA India / Asia (022) 30433228 pramodgubbi@ambitcapital.com
Praveena Pattabiraman India / Asia (022) 30433268 praveenapattabiraman@ambitcapital.com
Sarojini Ramachandran UK +44 (0) 20 7614 8374 sarojini@panmure.com
Production
Sajid Merchant Production (022) 30433247 sajidmerchant@ambitcapital.com
Joel Pereira Editor (022) 30433284 joelpereira@ambitcapital.com
E&C = Engineering & Construction



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Explanation of Investment Rating

Investment Rating Expected return
(over 12-month period from date of initial rating)
Buy
>5%
Sell
<5%


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