Thursday, January 5, 2012

>ZYDUS WELLNESS: Pressure on Everyuth & Nutralite margins to fall due to higher palm oil prices.

Management call: subdued FY12, long-term growth intact

High competitive pressure on the Everyuth brand, the cyclical downturn in SugarFree’s revenues and higher raw material costs for Nutralite have impacted Zydus Wellness’s performance over the past two quarters. We, however, believe the strong long-term growth
potential is intact and view the correction in the stock price as an attractive entry point. We maintain our Buy rating on the stock.

 Higher competitive pressure on Everyuth. Everyuth continues to see high competitive pressures from MNCs. HUL has raised media spend on the face-wash and scrub categories, which account for larger part of Everyuth’s revenues. Pressure also comes from other players, such as Garnier and Nivea. This results in lower revenue growth for Everyuth.

■ SugarFree passing through a cyclical slow-growth patch. Management indicated that the current slowdown in SugarFree’s revenues is due to the four-quarter period of lower growth that SugarFree goes through after every 3-4 years, and that structurally the brand has strong
long-term growth potential. Management also indicated that Zydus’ market leadership has risen from 84% a year ago to 89% now.

 Nutralite margins to fall due to higher palm oil prices. As 75% of the Nutralite business is institutional and has lower pricing power, the company expects to continue to suffer on the margin front as palm oil prices continue to rule higher due to rupee depreciation.

 Excise duty to be lower from 2HFY13. As the company is required to pay excise in Sikkim and then collect the refund from the Government in the next year, the excise duty is likely to drop from the second year of operations. We expect the lower excise duty to start from 2HFY13.

■ Valuation. We value the stock at a DCF-based price target of `690. (Implied target PE of 30x FY13e earnings.) Risk. Higher competitive pressure.