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India Equity Research  FMCG    August 11, 2010 ADD  Target Price (INR)  Company Report  Last Price (INR)            Bloomberg  code Reuters code Avg. Vol. (3m) Avg. Val.(3m)(INRmn) 52‐wk H/L (INR) Sensex MCAP (INRbn/USDmn) Zydus Wellness  649  Scale and quality of growth can extend the rally  The  momentum  in  India’s  wellness  market  exceeds  that  in  the  FMCG  market. Lifestyle changes are creating demand for therapeutic as well  as preventive products. Sugar Free can leverage off ste
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  Please   refer   to   the   disclaimer   towards   the   end   of    the   document.   India   Equity   Research   FMCG   August   11,   2010 ADD   Zydus   Wellness   Target   Price   (INR)   649   Scale   and   quality   of    growth   can   extend   the   rally   Company   Report   The   momentum   in   India’s   wellness   market   exceeds   that   in   the   FMCG   market.   Lifestyle   changes   are   creating   demand   for   therapeutic   as   well   as   preventive   products.   Sugar   Free   can   leverage   off    steep   growth   in   the   diabetic   population.   Rising   diagnosis   and   usage   may   double   the   market   for   sweeteners   within   three   years.   Nutralite   is   a   play   on   cardiac   care   and   prevention.   The   three ‐ year   CAGR   of    25%   and   35%   in   revenue   and   net   profits,   respectively,   reveals   that   ZYWL’s   PEG   is   well   below   peers.   We   initiate   coverage   with   a   Jun11   target   of    INR649   and   an   Add   rating.   Niche   play   on   wellness   categories   Positioned   as   a   wellness   company,   ZYWL   is   a   niche   play   on   the   INR113.6bn   Indian   health   and   wellness   category.   With   50%   of    the   Indian   population   in   the   25 ‐ 50   years   age   group,   the   growth   for   wellness   products   is   likely   to   be   robust.   According   to   a   study   by   Tata   Strategic   Management,   the   wellness   market   is   estimated   to   reach   INR355bn   by   2015.   The   company   has   a   presence   in   these   categories   through   products   such   as   Sugar   Free,   which   has   82%   market   share   in   artificial   sweeteners,   and   Nutralite,   which   has   a   market   share   of    65%   in   spreads.   Combined,   these   products   account   for   76%   of    sales.   Increasing   health   ailments   likely   to   drive   demand   for   wellness   products   At   50.8mn,   India   had   one   of    the   largest   diabetic   populations   in   FY10.   With   an   improvement   in   health   awareness,   the   diagnostic   and   usage   rates   are   likely   to   increase,   leading   to   a   rise   in   the   number   of    diabetics   consuming   artificial   sweeteners   from   2.96mn   in   FY10   to   9.6mn   in   FY15f.   This   implies   the   artificial   sweetener   market   is   likely   to   increase   to   INR2.7bn   in   FY13f,   up   from   INR1.25bn   in   FY10.   Sales   of    Sugar   Free   (share   of    65%   in   table   sweeteners   and   17%   in   baking)   are   likely   to   grow   at   a   CAGR   of    29%   during   FY10 ‐ FY13f    to   INR2.2bn.   We   estimate   a   CAGR   of    22%   in   Nutralite   sales.   Thus,   ZYWL   is   likely   to   report   a   CAGR   of    25%   in   sales   during   FY10 ‐ FY13f.   Sikkim   unit   likely   to   drive   profitability   ZYWL   is   setting   up   a   facility   in   Sikkim   to   manufacture   EverYuth   and   Sugar   Free.   This   is   likely   to   decrease   the   company’s   effective   tax   rate   from   34.6%   in   FY10   to   19.0%   in   FY12f.   However,   it   is   unlikely   to   impact   net   sales   growth   as   the   company   avails   excise   benefits   on   sourcing   finished   products   from   backward   areas.   As   a   result,   net   profit   is   likely   to   grow   by   39%   in   FY11f    and   44%   in   FY12f.   Initiate   with   an   ADD   rating   and   Jun11   price   target   of    INR649   The   stock   has   seen   a   sharp   re ‐ rating   on   the   back   of    strong   earnings   growth.   We   believe   current   valuations   are   likely   to   sustain,   given   higher   earnings   growth   and   leadership   in   categories   such   as   artificial   sweeteners.   We   have   used   the   average   PEG   of    0.62   for   the   past   six   months   and   the   earnings   CAGR   of    41.3%   during   FY10 ‐ FY12f    to   arrive   at   our   target   P/E   of    25.6x.   Based   on   the   one ‐ year   forward   rolling   EPS   of    INR25.3   (75%   of    FY12f    EPS   of    INR23.9   and   25%   of    FY13f    EPS   of    INR29.7)   and   the   target   P/E,   we   arrive   at   our   Jun11   target   of    INR649,   at   a   14%   upside.   At   our   target   price,   the   rolling   PEG   would   be   0.68,   lower   than   the   current   rolling   PEG   of    0.72.   We   initiate   coverage   with   an   Add   rating.   Last   Price   (INR)   571.4 Bloomberg   codeReuters   codeAvg.   Vol.   (3m)Avg.   Val.(3m)(INRmn)52 ‐ wk   H/L   (INR)SensexMCAP   (INRbn/USDmn) Shareholding   (%) 03/10 06/10 PromotersMFs,   FIs,   BanksFIIsPublicOthers Stock   Chart   (Relative   to   Sensex)Stock   Perfm.   (%) 1m   6m   1yr   AbsoluteRel.   to   Sensex Financials   (INRmn) 03/10 03/11f 03/12f  Salesy ‐ o ‐ y   (%)EBITDA   (%)A.PATSh   o/s   (diluted)A.EPS   (INR)y ‐ o ‐ y   (%)D/E   (x)P/E   (x)EV/E   (x)RoCE   (%)RoE   (%) Quarterly   Trends   09/09 12/09 03/10 06/10 Sales   (INRmn)PAT   (INRmn)0.5   11.8  ‐  4,2493,40016.617487415.3   79.915.80.411.3  ‐  72.5 72.518,220   22.32   /   4812,681379.7358.318.416.297.783.3763950526373923.94423.726934 ‐ 1.139 ‐ 1.125256482718.13825467 ‐ 1.23912.0849964947.431.25555143754ZYWL   INZYSY.BO160,656579   /   11523.8535234.2 0150300450600 Aug09 Dec09 Mar10 Jul10 Zydus wellness Sensex Rebased   Yasmin   R   Shah ,   +91   022   66842855   yasmin.shah@avendus.com     India Equity Research Zydus   Wellness   FMCG   2   Investment   Summary   The   outperformance   of    Zydus   Wellness   and   its   premium   valuation   derives   strong   support   from   the   scale   and   quality   of    growth   of    its   businesses.   Demand   for   wellness   products   can   continue   to   grow   considerably   faster   than   the   broader   FMCG   market,   driven   by   lifestyle   changes   that   are   leading   to   health   ailments.   Rising   incomes   and   awareness   of    the   risks   is   leading   the   population   in   the   age   bracket   of    25   to   50   to   respond   by   consuming   safer   alternatives   to   regular   food   products.   ZYWL   is   present   in   two ‐ artificial   sweeteners   and   margarine ‐ of    these   categories   through   the   brands   Sugar   Free   and   Nutralite.   Their   reach   is   being   extended   through   brand   extensions.   The   steep   growth   in   the   population   of    diabetics   in   India   presents   a   huge   opportunity.   We   forecast   the   market   for   sweeteners   to   more   than   double   in   three   years,   driven   by   increased   diagnosis   and   deeper   penetration   in   the   diagnosed   population.   ZYWL’s   revenue   and   net   profits   are   forecast   to   grow   at   a   three ‐ year   CAGR   of    25%   and   35%,   respectively.   Though   the   stock   appears   near   the   top   end   among   peers   if    measured   on   P/E,   it   is   close   to   the   bottom   on   PEG.   The   higher   growth   of    ZYWL   deserves   a   higher   valuation   for   the   forecast   period.   We   assign   a   target   P/E   of    25.6x   (arrived   from   the   mean   PEG   for   the   past   six   months)   and   arrive   at   a   Jun11   target   price   of    INR649,   which   implies   a   14%   upside.   We   initiate   coverage   with   an   Add   rating.   Niche   play   on   the   cINR114bn   wellness   category   Zydus   Wellness   (ZYWL)   is   a   niche   player   in   the   health   and   wellness   space   with   a   CAGR   of    84%   in   sales,   including   acquisitions,   during   FY07 ‐ FY10.   We   estimate   the   market   for   health   and   wellness   products   in   India   to   be   worth   INR113.6bn;   it   is   likely   to   grow   at   15%   to   20%   per   annum.   With   50%   of    the   population   in   the   25 ‐ 50   years   age   group,   India   is   one   of    the   largest   markets   for   wellness   products.   According   to   a   study   by   Tata   Strategic   Management,   the   market   for   health   and   wellness   food   &   beverages   is   estimated   at   INR101.5bn   in   2010,   which   is   likely   to   grow   to   INR355bn   by   2015.   ZWYL   has   a   presence   in   these   categories   through   products   such   as   Sugar   Free,   which   has   82%   market   share   in   artificial   sweeteners,   and   Nutralite,   which   has   a   market   share   of    65%   in   spreads.   Combined,   these   products   account   for   76%   of    sales.   Increasing   health   ailments   to   drive   demand   for   wellness   products   At   50.8mn,   India   had   one   of    the   largest   diabetic   populations   in   FY10.   However,   only   2.96mn   consume   artificial   sweeteners   because   of    the   low   diagnostic   rate   and   lower   usage   rate.   With   an   improvement   in   health   awareness,   both   the   diagnostic   and   usage   rates   are   likely   to   improve,   resulting   in   an   increase   in   the   total   number   of    diabetics   consuming   artificial   sweeteners   to   9.6mn   in   FY15f.   This   implies   that   the   market   size   of    artificial   sweeteners   is   likely   increase   to   INR2.7bn   in   FY13f    up   from   INR1.25bn   in   FY10.   Sales   of    Sugar   Free   (share   of    65%   in   table   sweeteners   and   17%   in   baking)   are   likely   to   grow   at   a   CAGR   of    29%   during   FY10 ‐ FY13f    to   reach   INR2.2bn.   Sikkim   unit   to   drive   profitability   ZYWL   is   setting   up   a   facility   in   Sikkim   to   manufacture   Sugar   Free   and   EverYuth.   The   facility   is   likely   to   cost   INR350mn   and   would   be   operational   in   2HFY11f.   The   capacity   would   be   able   to   meet   demand   for   the   next   five   years.   The   plant   is   likely   to   have   income   tax   benefits   till   2017.   This   is   likely   to   reduce   the   effective   tax   rate   for   ZYWL   from   34.6%   in   FY10   to   19.0%   in   FY12f    and   lead   to   tax   savings   of    INR55mn   in   FY11f    and   INR181mn   (after   taking   MAT   into   consideration)   in   FY12f.   As   a   result,   the   profit   is   likely   to   grow   by   39%   in   FY11f    and   44%   in   FY12f.   Product   concentration   and   raw   material   cost   increases   are   concerns   ZYWL   derives   76%   of    its   sales   from   two   brands:   Sugar   Free   and   Nutralite.   High   product   concentration   and   the   growth   opportunity   in   both   categories   are   likely   to   draw   competition.   In   case   of    Sugar   Free,   which   contributes   40%   of    sales,   the   new   range   of    herbal   sweeteners   using   the   stevia   plant   could   pose   a   big   threat   to   artificial   sweeteners   based   on   aspartame   and   sucralose.   If    approved,   they   could   capture   50%   of    the   market.   Another   risk   is   the   price   of    key   raw   materials   such   as   aspartame.   Unlike   other   FMCG   products,   the   company   does   not   undertake   frequent   price   changes   in   Sugar   Free   as   it   looks   to   grow   the   market.   This   is   likely   to   put   pressure   on   margins.   ZYWL   is   a   niche   play   on   the   INR101.5bn   market   for   health   and   wellness   food   &   beverages,   which   is   likely   to   grow   to   INR355bn   by   2015.   Sugar   Free   sales   to   grow   at   a   CAGR   of    29%   during   FY10 ‐ FY13f    on   the   back   of    an   increase   in   diabetics   consuming   artificial   sweeteners.   Profit   likely   to   grow   by   39%   in   FY11f    and   44%   in   FY12f    on   the   back   of    income   tax   benefits.     India Equity Research Zydus   Wellness   FMCG   3   CAGR   of    25%   in   sales   and   35%   in   profits   during   FY10 ‐ FY13f    We   estimate   a   CAGR   of    25%   in   overall   sales   during   FY10 ‐ FY13f,   driven   by   a   CAGR   of    22%   in   Nutralite,   22%   in   EverYuth   and   29%   in   Sugar   Free.   We   forecast   a   CAGR   of    26%   in   EBIDTA   during   FY10 ‐ FY13   on   the   back   of    sales   growth,   rather   than   an   improvement   in   margins,   as   advertising   expenses   are   unlikely   to   decline   substantially.   We   estimate   a   PAT   CAGR   of    35%,   driven   by   EBIDTA   growth   and   a   reduction   in   effective   taxes   after   commissioning   of    the   new   unit   at   Sikkim.   Initiate   with   an   Add   rating   and   Jun11   price   target   of    INR649   The   strong   rally   over   the   past   6   months   has   lifted   the   valuation   of    ZYWL   close   to   the   top   of    the   FMCG   universe,   if    measured   on   the   metrics   of    P/E   and   Mcap/sales.   The   valuation   derives   strong   support   from   the   35%   CAGR   in   net   profits   till   Mar13f,   which   is   driven   by   the   large   opportunity   in   the   sweetener   market,   where   ZYWL   enjoys   leadership,   and   in   other   segments   of    the   wellness   market.   However,   ZYWL   has   the   lowest   PEG   at   0.83   (see   Exhibit   20).   At   41.3%,   its   earnings   CAGR   for   the   two   years   ending   Mar12   is   forecast   to   be   close   to   twice   the   mean   for   the   other   stocks   in   that   group.   The   higher   growth   of    ZYWL   deserves   a   higher   valuation   for   the   forecast   period.   We   have   used   the   PEG   to   arrive   at   the   target   P/E.   The   average   PEG   during   the   past   six   months   has   been   0.62.   Given   the   CAGR   of    41.3%   in   earnings   during   FY10 ‐ FY12f,   we   arrive   at   our   target   P/E   of    25.6x.   Based   on   the   one ‐ year   forward   rolling   EPS   of    INR25.3   (75%   of    FY12f    EPS   of    INR23.9   and   25%   of    FY13f    EPS   of    INR29.7)   and   a   target   P/E   of    25.6x,   we   arrive   at   a   fair   value   of    INR649.   The   assigned   target   P/E   of    25.6x   is   higher   than   that   for   Emami   (HMN   IN,   Hold)   and   for   Dabur   (DABUR   IN,   Hold).   The   target   P/E   for   these   stocks   was   set   at   23x   and   25.2x;   their   earnings   CAGR   is   forecast   at   23%   and   18.5%,   respectively,   during   FY10 ‐ FY13f.   Further,   at   our   target   price,   the   PEG   would   be   lower,   at   0.68,   than   the   current   rolling   PEG   of    0.72.   The   Jun11   target   of    INR649   implies   a   14%   potential   upside.   We   initiate   coverage   with   an   Add   rating.   Exhibit   1:   Forward   P/E   chart   25.60612182430Mar06 Oct06 Apr07 Oct07 Apr08 Nov08 May09 Nov09 May10 Dec10 Jun11   Source:   Avendus   Research   Exhibit   2:   Valuation   summary   (INRmn)   Net   Sales EBITDA Net   Profit EPS   (INR) P/E   (x) EV/EBITDA   (x)   EV/Sales   (x) P/B   (x) Mar09   1,947 387 254 6.5 87.1 55.7   11.1 32.1Mar10   2,681 672 467 12.0 47.4 31.2   7.8 22.0Mar11f    3,400 866 648 16.6 34.2 23.8   6.1 15.1Mar12f    4,249 1,090 934 23.9 23.7 18.1   4.7 10.4Mar13f    5,185 1,344 1,159 29.7 19.1 14.0   3.6 3.6Source:   Avendus   Research   We   estimate   a   PAT   CAGR   of    35%,   driven   by   EBIDTA   growth   and   a   reduction   in   effective   taxes.   ZYWL   has   the   lowest   PEG   at   0.83,   despite   higher   P/E   and   Mcap/sales   ratios   in   the   FMCG   universe.     India Equity Research Zydus   Wellness   FMCG   4   Table   of    Contents   Investment   Summary ........................................................................................................................ 2   Niche   play   on   the   cINR114bn   wellness   category...................................................................................2   Increasing   health   ailments   to   drive   demand   for   wellness   products......................................................2   Sikkim   unit   to   drive   profitability............................................................................................................2   Product   concentration   and   raw   material   cost   increases   are   concerns .................................................2   CAGR   of    25%   in   sales   and   35%   in   profits   during   FY10 ‐ FY13f.................................................................3   Initiate   with   an   Add   rating   and   Jun11   price   target   of    INR649...............................................................3   Niche   play   on   the   cINR114bn   wellness   category...............................................................................5   Sugar   Free   likely   to   ride   on   rising   number   of    diabetics.........................................................................5   Exponential   growth   opportunities   in   Sugar   Free...................................................................................5   Nutralite   sales   likely   to   be   driven   by   demand   for   health   food..............................................................8   Carving   a   niche   in   skincare....................................................................................................................9   New   categories,   brand   extensions,   new   unit   likely   to   drive   growth ...............................................10   Tapping   into   the   drinks   market...........................................................................................................10   Foray   into   Menz;   an   INR5bn   category.................................................................................................10   Sikkim   unit   and   backward   area   benefits   likely   to   drive   profitability...................................................11   Product   concentration   and   raw   material   cost   increases   are   concerns ...........................................12   Herbal   sweeteners   could   eat   into   the   market.....................................................................................12   Higher   dependence   on   two   products..................................................................................................12   Increased   risks   of    competition   entering   the   segments.......................................................................12   Rise   in   key   raw   material   prices   likely   to   impact   revenues...................................................................13   CAGR   of    25%   in   sales   and   35%   in   profits   during   FY10 ‐ FY13f...........................................................14   CAGR   of    25%   in   sales   on   growth   in   existing   products.........................................................................14   EBIDTA   CAGR   of    26%   during   FY10 ‐ FY13f.............................................................................................14   Profit   growth   likely   to   be   driven   by   lower   tax   rates............................................................................14   Likely   to   ready   a   war   chest   of    INR3.2bn   in   FY13f ................................................................................14   Initiate   with   Add   and   a   Jun11   target   of    INR649,   upside   of    14%......................................................15   Substantial   expansion   in   multiples......................................................................................................15   Initiate   with   Jun11   target   price   of    INR649;   upside   of    14%..................................................................16   About   the   company.........................................................................................................................18   Financials   &   Valuations   ...................................................................................................................19  
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