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Sunday, December 24, 2006

Emami: Hold


With over a three-fold rise in stock price since its public offer in March 2005, Emami has outperformed several of its larger peers in the FMCG space over this period. The company has managed a strong pace of growth in its topline and earnings over the past year with successful launches in the personal-care space. After the recent re-rating, the stock's valuation levels are stiff though in line with well-established competitors such as Marico Industries and Godrej Consumer.

Emami would remain among the riskier FMCG stocks because of the company's small size, which makes it more vulnerable to competitive pressures; the low liquidity in the stock is another issue. However, investors can hold the stock for now as there is scope for a significant ramp up in earnings in the coming quarters and potential for higher growth on a small base.

Reaching out

With brands such as Boroplus, Navratna oil, Sona Chandi Chyawanprash, Menthoplus balm and the recently launched Fair & Handsome, Emami occupies lucrative niche segments in the FMCG market (such as cooling hair oils, antiseptic creams, prickly heat powder and pain relief). Emami's focus is on aspirational categories such as personal care, health and grooming, all of which are now seeing strong growth momentum. Value growth in most of these categories over the past two years has outpaced volume expansion — a sign of the pricing power of the players.

The company is leveraging its Ayurvedic origins to foray into OTC (over-the-counter) and beauty products — again two high-growth segments. The company also has a good distribution network (2,200 distributors directly covering 3.8-lakh retail outlets), with extensive penetration into small towns and the rural areas. It is, thus, well positioned to exploit the expanding rural offtake of FMCG products (in 2006, the rural demand for FMCGs has outpaced that from the urban areas).

Finally, a significant presence for Emami's brands in the SAARC region and West Asia, helps it leverage on growth opportunities there. These factors have translated into accelerated growth in the company's topline and earnings over the past two years. The company followed up a 37.6-per cent growth in its topline in 2005-06, with a further 34.9 per cent growth in the six months ended September 2006. Net profits expanded by 67 per cent in 2005-06 and by 19 per cent in the first half of 2006-07.

The flip side

Despite the high growth rates and the focus on lucrative segments, Emami's relatively small size (revenues of Rs 300 crore in FY-06) exposes it to relatively high risks. Though the niche strategy and its distribution reach into smaller towns have so far insulated the company, to some extent, from competitive pressures, this could change. Apart from large players such as Dabur and Marico, several local brands are also trying to expand their presence in the personal care, health and beauty segments.

Several mid-size pharma companies have aggressive plans for OTC product rollouts, which would be pitted against Emami's brands. Intensifying competition could call for higher investments in advertising and promotions by Emami.

However, with adspend already accounting for over 20 per cent of sales, the company already spends substantially more on promotions than other listed FMCG companies (10-15 per cent).

Higher outlays on adspend could, thus, have a significant impact on Emami's operating margins, and leave it with a lower cushion to handle inflation in input costs.

Having exclusively adopted the celebrity endorsement route for its brands, the burgeoning adspends could continue to be a problem area for the company.

The company's ability to sustain the current pace of growth, as the profit and revenue base expand, is thus subject to some uncertainty.

For investors, the relatively low floating stock (promoters hold 88.2 per cent of the stock and institutions another 7.08 per cent) is an additional risk to factor in, as it makes for thin trading volumes on occasion and could magnify the downside in the event of a decline in stock price.

However, investors can hold on to the stock for now. Because of a seasonal business, Emami typically registers the bulk of its earnings in the second half of the year.

This, combined with the proposed merger of the group's distribution and marketing arm which is likely to bolster overall margins, suggests a potential for significant ramp-up in earnings in the coming quarters.