Emami’s FY17 was lacklustre following weaker international (macro headwinds and distribution alignment) and domestic (demonetisation) sales. Headwinds exist as wholesale channel is expected to remain under stress till the implementation of GST. However, we remain enthused on a) new product launches b) potential of recovery in the international businesses and c) net cash at end-FY18, which would open up options for strategic acquisitions again. Maintain Buy.
Q4FY17 conference call takeaways
Emami management expressed confidence that a) the worst is over post demonetisation b) H2FY18 would be better than H1 once teething issues post GST implementation are resolved c) long term organic revenue growth target of 14-15% is achievable and d) there’s no risk to the margins. Emami would be debt free by end-FY18, which would open up options for strategic acquisitions again. Emami is focusing on reducing salience on the wholesale channel and expects to derive c.40% of sales from this channel in FY18, from c.50% currently. New products pipeline remains robust which the company would launch when the market conditions stabilise.
International Business continues to remain under pressure
Change of estimates
Emami is amortising goodwill from the Kesh King acquisition, which is suppressing profits in the near term. While there’s a slight tweak to our EBITDA estimates, we have increased our Depreciation & Amortisation estimates both in FY18 and FY19. Hence, our FY19 EPS estimate is now c.5.8% lower than expected earlier.
Investment thesis intact
Emami’s gross margins and the growth potential of blockbuster brands are best in the class. Emami has a long track record of integrating acquisitions successfully, as demonstrated through the Zandu acquisition in FY09 and more recently with the Kesh King acquisition. FY19E net cash/ EBITDA of 0.6x and a free cash flow yield of 3.1% make a compelling investment case, in our view.
Emami is currently trading at a 12-month forward P/E of 50.4x, which is at a 21% premium to the sector. We value Emami using a DCF-based methodology, with a WACC of 10.5%, earnings CAGR of 20.1% from FY16-19E (decreased from 23.3% earlier) and 15.4% from FY20-29E (increased from 12.8% earlier). A perpetual growth rate of 6% is assumed thereafter, which we believe is apt for a company the size of Emami.
We roll forward the DCF and increase the PT to Rs 1,266.26. Emami’s earnings growth potential is one of the best in the sector and we maintain Buy on the stock. As the effect of amortisation fades, profit margins would improve resulting in improvement in RoEs to 30.3% by FY19, from 22.9% in FY17. Risks: Disruptive competition, value destructive M&A and seasonality of the portfolio.