Neutral rating GSK Consumer Healthcare: Slowing volume growth a concern

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Updated: November 23, 2015 1:06:58 AM

Q2 results fell short of expectations, missing net sales estimates by 6.6%/6.2%. Ebitda margin expanded by 390bps y-o-y to 21.1%

Action: Cut FY16F/17F EPS by 4.1%/9.7%; maintain Neutral

GSK Consumer’s Q2FY16 results fell short of expectations, missing our/consensus net sales estimates by 6.6%/6.2%. Ebitda margin expanded by 390bps y-o-y to 21.1%, vs our expectation of 18.5%. Adjusted PAT (profit after tax) of R1.6 bn was 8% below our expectation. With volume growth still a concern and the anticipated pick-up in urban consumption taking longer than expected, we are cutting our FY16F/17F earnings forecasts by 4.1%/9.7%. That said, we expect margins to stabilise at around the 19.5% level for the full year, as the company reaps the benefits of low input prices, cost-saving initiatives, and network optimisation.

Catalysts: Urban consumption doesn’t seem to be picking up; input prices stable for the time being

Input prices should be stable for the company for the time being; milk and barley prices were up 2% y-o-y and down 5.2% y-o-y, respectively, as of Oct 2015. However, the steady slowdown in volume growth over the past few quarters is a concern, with the company registering sequential volume growth rates of -1.5% to 0%. While the company is optimistic that consumer sentiment is on the rise, we remain cautious on the pace of recovery, and cut our estimates accordingly.

Valuation: Value core business at 35x one-year forward EPS

The shares are trading in line with the sector average one-year forward P/E (price-to-earnings ratio) of 32x, but this is on reported earnings. In our SOTP (sum of the parts) valuation, we value the core operating business at 35x one-year forward EPS (earnings per share) of R160.1 and cash at book value to arrive at our new TP (target price) of R6,117. We retain our Neutral stance on the stock as we believe that the near-term earnings are at risk and we prefer to wait for a significant pick-up in consumption.


Q2FY16 results: below expectations

GSK Consumer’s Q2FY16 results were below our forecasts at revenue and PAT levels. While revenue was 6.6% and 6.2% below our and consensus expectations, respectively, adjusted PAT was 7.5% and 12.9% below, despite higher-than-expected Ebitda margins of 21.1% due to a higher tax rate.

Key details:
* Revenues at Rs 11.26 bn increased 1.1% y-o-y, versus our estimates of R12.06 bn and consensus estimates of R12 bn.
* Ebitda totalled Rs 2.38 bn, an increase of 21.4% y-o-y.
* Gross margins expanded 394bps y-o-y to reach 66.8% for the quarter, in line with the softness in input prices.
* Despite the company increasing their A&P spend this quarter (96bps y-y), Ebitda margins were able to expand 390bps y-o-y due to a significant fall in other overheads.
* The company recognised an exceptional item of Rs 560.5m, which represented the write-back of a tax provision no longer required.
* As a result, adjusted PAT was disappointing at Rs 1.63 bn, compared to Nomura’s estimates of R1.77 bn and street expectations of Rs 1.87 bn.

Management commentary
* The company witnessed 5% growth in gross sales, primarily driven by price and mix.
* Single digit growth was witnessed in the base Horlicks brand, and double digit growth was observed in its variants.
* The company was able to gain market share in the North and West parts of the country. The company also mentioned that the growth rates in these parts of the country are higher than the rest of India.
* Volume growth: The company witnessed negative volume growth on a company level, primarily driven by de-growth in sales of their sachets as well as their international business (Nepal).
* Market share: The Health food drinks (HFD) category gained 1.2% share during the quarter, Horlicks gained 0.4% market share.
* Regarding consumer sentiment, the company mentioned that they are observing a slowdown in the rural
* The other expenses of the company have seen a decline of 10% y-o-y—the company attributes this to their cost initiatives and network optimisation. •
* Capex plans for the company remain at R10 bn over the next three years. However, given the current consumer sentiment, plans have been shifted to the later part of 2016. •
* As a part of its outlook, the company mentioned that consumer confidence is gradually on the rise. The company is looking to strengthen the category growth overall, due to which they have increased their A&P spends recently. As a percentage of sales, A&P now accounts for 17.3% as compared to 16.3% a year ago.

Cutting FY16F/FY17F earnings

After the company’s 2QFY16 results, we cut earnings for FY16F/FY17F by 4.1%/9.7% respectively on slower-than-expected recovery in urban consumption and a further slowdown in rural expansion. We now expect the company to achieve revenue growth of 10% over FY16F and expect this to increase to 14% in FY17F and 16% thereafter as consumption picks up.

On the Ebitda margins front, we expect them to expand ~150bps over FY15 due to favourable input prices and initiatives taken by the company on cost control and network optimisation. We expect margins to stabilise around the 19.5% levels in FY17F.

New TP at Rs 6,117— retain our Neutral stance

For FY16F, we estimate that ~30% of the company’s net income should be derived from ‘other income’. For other consumer companies in the sector this is a very small portion of their income and hence we are able to value them on a reported P/E basis after making adjustments for non-operating income or losses. For GSK Consumer since the number is nearly 30%, we do a SOTP. We believe this is essential as cash on the books should not be given the same multiple that we give to the operating assets of the business as it does not generate similar returns.

We roll forward our valuation and keep our valuation multiple unchanged at 35x, in line with movements of the multiples across the sector. Based on this, we arrive at our TP of Rs 6,117. We retain our Neutral stance for the following reasons:
* There has been a significant slowdown in the growth trajectory for the past five quarters. While the recent slowdown can be explained by the poor retail sentiment, the slowdown the company experienced in May last year was surprising given its strong and continued impetus on A&P and new product launches. This makes us slightly sceptical on the pace of recovery that the company will experience going into FY17F.
* Current valuations seem to be capturing the margin uptrend expected for the stock due to softness in commodity prices.

However, the long-term potential of the malted drinks category remains intact, and GSK’s ability to diversify into various sub-segments such as Mothers Horlicks, Women’s Horlicks etc. should help it achieve revenue growth in the future. Apart from this, another key growth driver over the next few years will be expansion in the north and west regions, currently the regions which are underpenetrated.

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