Emami Q1 review: Rural slowdown dampens volume growth; valuation at steep discount
- Flat volume growth on the back of a high base
- EBITDA margin improved on lower operating cost
- Kesh King range extends the rebound seen in FY19
- Promoter pledge remains a key non-operational risk
- Valuation compared to FMCG sector is at a significant discount
Emami in its quarterly results continued to witness a moderate sales growth due to muted volume pick-up.
In the past four quarters, the company underperformed the median sectoral performance due to adverse seasonality and a skewed exposure to rural demand.
In light of macro headwinds, the FMCG player has desisted from higher promotional expense and slowed the pace of product launches. We think of this as a prudent strategy, given the challenges.
Though due to this the company might play second fiddle to the market leader when consumption demand revives, valuation discount to the sector warrants investors’ attention.
Chart: Q1 financials
Consolidated sales grew by 5.6 percent YoY where the key drag has been domestic sales (+2 percent YoY) with flat volume growth on a high base of 16 percent in Q1 FY19. Rural sales growth has been a key laggard with 1 percent growth for the quarter while the urban sales growth was 2-2.5 percent.
Key product ranges – Navratna (4 percent YoY) and pain management (-6 percent) – reported subdued sales growth on a high base. However, the company reported higher volume market share in these categories. In terms of other product categories, major drags have been healthcare range (-3 percent YoY vs 28 percent in Q1 FY19) and male grooming range (-7 percent YoY vs 8 percent in Q1 FY19).
A key positive for the quarter has been strong performance by Kesh King range, which showed 30 percent growth YoY. Interesting to note is that the company posted a growth of 26 percent in Q3 and 15 percent in Q4 FY19, which marked a turnaround and speaks well about the management’s confidence in re-positioning of the brand in the premium hair oil segment.
The firm’s market share in premium oil category is 26 percent – 190 bps improvement YoY. In contrast to FY19, in FY18, sales for Kesh King Oil declined by 15 percent YoY. Its another premium hair oil offering – 7 Oils in One – saw a strong growth of 31 percent. Currently, this product contributes 1.5-2 percent of domestic business.
Additionally, international business (14 percent of sales) grew 34 percent in Q1. Excluding Creme 21 (acquired in January 2019), sales growth was 10 percent aided by growth in MENA and SAARC regions.
Furthermore, while gross margins contracted, EBITDA margin improved by 108 bps YoY as higher employee costs was offset by moderate increase in other expenses and lower advertising spend.
Key non-operational risk for the company is the overhang of promoter pledge. The management expects significant reduction on pledge holding in next 6-9 months. While the promoters have worked towards reducing the pledge amount, it is still high at Rs ~3,500 crore compared to market cap of Rs 14,165 crore. Promoter shareholding has come down from 73 percent (December 2018) to 53 percent in June filing while pursuing the reduction of pledge holding.
Pls read: Emami’s stake sale to alleviate key investor concern
The management’s growth expectation for FY20 has come down from 12-14 percent to 9-10 percent, which is closer to our earlier projections. A major part of growth outlook hinges on rural demand revival, which constitute about 40-45 percent of total sales.
In the past couple of years, the company has worked towards re-staging a few of its products, which has benefited it in premium hair oil category. Distribution mix has changed with a stable wholesale contribution now near 40 percent and modern trade share improving to 9 percent (earlier: 7 percent last year).
Furthermore, it boasts of strong distribution with direct reach at 9.5 lakh outlets, which makes it well positioned for a growth recovery in consumption. As of now, the company has slowed pace of product launches and advertising spend in light of demand slowdown. This seems a prudent strategy though it comes with a risk of market share loss to larger players. Note that market leader HUL’s advertising spend has also moderated and the HUL management had pointed out that this is due to lower competitive intensity.
Nevertheless, this should be supportive for margins in the near term. Also, raw material prices are in a downtrend. The firm expects the benefit of lower mentha prices from Q3 FY20 onwards due to higher high cost inventory at present. Overall, the management expects EBITDA margin to improve in FY20 (as against 28.3 percent in FY19).
In coming days, we look for a broad-based improvement in growth to get more constructive. Having said that, valuation discount is impressive. The stock is trading at 23x FY21e earnings, which is at a steep discount to the sector and warrants attention.
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