This article provides in-depth fundamental analysis of Emami Ltd, a leading FMCG company in India, engaged in the manufacturing of herbal and ayurvedic products sold under Emami (Personal & Cosmetic), Himani (Ayurvedic) and Zandu brands.
Emami Ltd Research Report by Reader
Q: I would like to post an analysis on Emami Ltd to know whether I am in the right track in analysis of balance sheet.
Emami Ltd – high growth fmcg with niche in ayurvedic products and trading at rich valuations. Let’s look at its financials:
- Very good capital reserves.
- Minimal long term borrowings.
- Current liabilities easily funded by its current assets
- Good growth in sales
- Similarly, good increase in other expenses (primarily advt.)
- Increase in cash flow from operations.
If you take the snapshot of 10 yr. financials:
- ROCE and ROE are very good and consistent. CAGR of sales and EPS for 10 yr in mid 20’s. Good profit margin (profitability), increasing asset turnover (efficiency).
- Also consistently decreasing working capital days.
- High promoter holdings.
So many good factors except for the three concerns plus 18% promoter pledging.
I have certain doubts in Emami Ltd’s financials:
- Emami Ltd has INR 85 crores loss from sale of investments (loss on sale of current non trade investments and loss on derivative instrument)
- Huge jump in short term borrowings from 4.3 to 17.5 crores YOY
- Huge jump in intangible assets as well as impairment of goodwill from 2013 to 2014.
Aren’t these real concerns?? Can you throw light on these, please?
Dr Vijay Malik’s Response
Thanks Jeykumar for writing to me!
I appreciate the time & effort put in by you in analyzing Emami Ltd and sharing your analysis for the benefit of author and readers of www.drvijaymalik.com
Let us first analyse the consolidated financial performance of Emami Ltd over last 10 years.
Financial Analysis of Emami Ltd:
Emami Ltd has been growing its sales consistently at an excellent pace of 20-25% year on year since last 10 years (FY2006-15). It is important to note that this sales growth has been accompanied by sustained profitability. Operating profit margins (OPM) of Emami Ltd has been consistent at 24-25% since FY2010. This is a very good sign as it indicates that Emami is able to pass on the increase in cost of raw material to its consumers easily and protect its margins from commodity cycles.
The fact that the core product profile of Emami Ltd, which is mainly Ayurvedic products, is unique and faces less competition from other players. As per the rating rationale of Emami Ltd, prepared by CARE Ltd:
“The ratings continue to draw strength from the long and satisfactory track record, considerable experience of the promoters, established brands, diversified product portfolio with high market share in few products, higher brand recall through cost-effective advertising, wide distribution network, focus on emerging rural market, comfortable financial position, satisfactory financial performance, partial insulation from the intense competition by virtue of manufacturing ayurvedic products and favourable industry outlook.”
The strong position of Emami Ltd’s products in their markets is visible by the high market share each of its major products has in their categories. The following extract from investor presentation of Emami Ltd is helpful to understand it:
The market share of Emami Ltd’s product is good not only in domestic market, however, they enjoy good reputation in international markets as well, as highlighted in the presentation shared by the company with investors:
Such brand establishment does not come as a surprise when an investor notices that Emami Ltd has been continuously making heavy investments in advertisement & promotions of its brands. It has been spending about 15-17% of its sales inflow on its brand promotions every year, as highlighted in its investor presentation:
Emami Ltd has been paying taxes at 12-18% rate, which is less than the standard corporate tax rate in India. An investor should study more about the tax incentives that Emami Ltd is getting from govt. on its manufacturing operations and the expiry dates of the same.
Lower tax rates and increasing non-operating income and reducing interest expense have led to the net profit margins (NPM) of Emami Ltd increasing year on year. NPM has increased from 12% in FY2009 to 22% in FY2015. The non-operating income consists mainly of the interest and dividend on the cash & investments that Emami Ltd has made over the years.
Also Read: How to do Financial Analysis of a Company
Operating Efficiency Analysis of Emami Ltd:
Over the years, Emami Ltd has been reflecting improved operating efficiency. Net fixed assets turnover (NFAT) has been improving from 1.74 in FY2010 to 5.22 in FY2015.
Inventory turnover ratio of Emami Ltd has improved from 8.7 in FY2009 to 16.6 in FY2015. Improving asset and inventory turnover indicate that Emami Ltd is able to use its capital more efficiently and generate higher sales from same level of assets.
Receivables days of Emami Ltd have improved from 29 days in FY2007 to 15 days in FY2015. Improvement in receivables days indicates that the company has been able to collect the money from its customers faster, indicating its growing influence in the market. Improved collection practices lead to lower working capital finance requirements and thereby lower interest costs and improved profitability.
When we analyse the cumulative profits and cumulative cash flow from operations of Emami Ltd over past decade, then we notice that Emami Ltd has been able to convert its profits into cash flow from operations. This is a good sign. Emami Ltd has PAT for last 10 years (FY2006-15) of INR 2,158 cr. whereas the CFO over the similar period is INR 2,304 cr.
Margin of Safety in the Business of Emami Ltd:
i) Self-Sustainable Growth Rate (SSGR):
Self-Sustainable Growth Rate (SSGR) of Emami Ltd is about 40%. As mentioned in the article on Self-Sustainable Growth Rate, SSGR does not factor in working capital changes. However, we can estimate whether funds are being tied up in working capital by comparing cPAT with cCFO.
Analysis of SSGR indicates that if Emami Ltd can manage its working capital management and operating efficiency properly, then it can grow continuously at about 40% growth rate without creating additional debt burden on the balance sheet. As Emami Ltd has been growing at a rate of 20-25%, it has been able to manage its grow story without leveraging its balance sheet. It has minuscule amount of debt on its book as reflected by its debt to equity ratio of 0.02.
These findings of SSGR get re-affirmed when an investor analyses the cash flow from operations (CFO) of Emami Ltd with its capital expenditure (Capex) requirements last 10 years (FY2006-15).
ii) Free Cash Flow Analysis of Emami Ltd:
During this period, Emami Ltd realized total CFO of INR 2,304 cr. and out of it Emami Ltd to spend INR 1,157 cr. into capital expenditure, thereby releasing free cash flow (FCF) of INR 1,148 cr. as surplus for shareholders.
This data indicates that Emami Ltd is a good example of efficient capital utilization. Despite meeting its entire capex requirements, Emami Ltd was able to generate FCF of INR 1,148 cr. out of which it distributed INR 757 cr. as dividend to shareholders (including dividend distribution tax).
The ability of Emami Ltd to grow its sales with Ltd capex from its CFO and generating good amount of free cash flow (FCF) indicates that the company has a good advantageous business model.
However, Emami Ltd has acquired Kesh King in June 2015 for about INR 1,650 cr, which as per CARE Ltd would be funded by debt of INR 950 cr. and balance by equity. The debt of INR 950 cr. is significant and would impact the profitability margins in terms of higher interest costs and amortization of brand. Below is the extract from CARE Ltd’s rationale for Emami Ltd release in June 2015:
“Emami Ltd (EL) is acquiring ‘Kesh King’ and allied brands in the personal and healthcare segment at a consideration of Rs.1,651 crore, to be funded at a debt of Rs.950 crore and balance from available cash surplus. The acquisition shall put pressure on the profit margins in view of higher capital charge (interest cost as well as amortization of brand), and also lead to temporary weakening of liquidity and gearing.”
As has been rightly pointed out by CARE Ltd, the incremental debt is visible on the balance sheet data released by Emami Ltd as part of Q2-FY2016 results. Short term debt in both standalone as well as consolidated balance sheet has increased by about INR 940 cr. at September 30, 2015 when compared to the short term debt at March 31, 2015.
Emami Ltd has been paying regular dividend to its shareholders. Company has been increasing its dividend payout with increasing profits. It amounts to sharing the fruits of growth with shareholders. These are signs of a shareholders’ friendly management.
Share market too seems to have recognized it. The market capitalization of the Emami Ltd has increased by INR 22,108 cr. against retained earnings of INR 1,400 cr. over last 10 years (FY2006-15). Management has created a value of INR 15.79 for the shareholders from every INR 1 of earnings retained & not distributed to shareholders.
Margin of Safety in the market price of Emami Ltd:
Emami Ltd is currently available at a P/E ratio of above 50, which does not offer any margin of safety as described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Additional aspects and annual report analysis of Emami Ltd:
1) Emami Ltd has INR 85 crores loss from sale of investments (loss on sale of current non trade investments and loss on derivative instrument):
As rightly mentioned by you, the loss on sale of investments is a combination of loss on current non-trade investments (INR 67cr) and loss on derivative instrument (INR 18cr.). A look on the note to accounts for the current non trade investments shows that the company had a lot of investments in liquid mutual funds which it sold in FY2015 and invested in other liquid mutual funds. It has such investments of about INR 500cr in FY2015.The losses seem to relate to the valuations at which Emami Ltd sold the previously owned mutual funds. It might be part of a strategy to book tax losses to reduce the tax outgo. However, the timing of sale of these mutual funds is not mentioned in the annual report, therefore the conclusion of booking losses for tax purposes might be incorrect as well.
Losses on derivatives: Ideally, a company that uses derivatives to hedge its foreign currency or interest rate exposures, should not have losses/gains on account of derivatives. However, such gains or losses may arise occasionally, if the underlying transaction do not materialize and the derivatives become naked instruments without anything underlying to cover. As per Emami Ltd FY2015 annual report, it enters into derivatives contracts based on forecasted transactions as well, which increases the risk of derivatives acting as naked exposures and thereby such losses/gains on derivatives:
Further advised reading: How to Identify if Management is Misallocating Capital
2) Huge jump in short term borrowings from 4.3 to 17.5 crores YOY
These borrowings are mainly working capital facilities, which every company keeps to meet business requirements. In any case, an amount of INR 17.5 cr. is not a huge borrowing against a net worth in excess of INR 1,200 cr. I personally do not see any concern related to these facilities as well the increase in outstanding amount related to the same at the end of FY2015.
3) Huge jump in intangible assets as well as impairment of goodwill from 2013 to 2014.
From FY2013 to FY2014, the net intangible assets decreased from INR 67 cr. to INR 7.78 cr. The decline in goodwill by INR 60.97 cr. is regular amortization charge by which Emami Ltd has been decreasing its gross goodwill of INR 478.99 cr. over the years. In previous years, it has been amortizing the goodwill at about INR 100-102cr. per annum. Below is the relevant extract from FY2014 annual report of Emami Ltd:
One important thing that I noticed while analyzing the amortization of goodwill by Emami Ltd is that it is transferring an amount equal to the yearly goodwill amortization from its general reserve to profit & loss statement every year.
FY2014 annual report, page 139:
This entry nullifies the impact of goodwill amortization on its profits. Though it does not impact the overall cash position of the company.If Emami Ltd were not following this practice of transferring amounts from general reserve to profit & loss statement, then its profit before tax would have been lower by an equal amount every year. Emami Ltd has disclosed this practice in its significant accounting policies:
Intangible Assets : a. Goodwill – Consequent to the scheme of arrangement being accounted for under Purchase Method by adopting book value method, the cost representing goodwill recognised is being amortised to Statement of Profit & Loss over, the estimated useful life of five years. As per the terms of the scheme equivalent amount of such amortisation is transferred from General Reserve.
In normal course of business, it might amount to overstating of profits, however, as explained by Emami Ltd, it is doing the same as per the scheme of arrangement, which I assume that would have been approved by any competent authority (in most cases a court of law) that would have allowed the company to adjust goodwill amortization directly against its reserves without impacting profit & loss statement. The annual report does not provide details of which competent authority, if any, has approved/allowed such treatment of goodwill amortization against general reserve.
Further advised reading: How Companies Inflate their Profits
4) Your concern about pledging of promoters’ shares is a valid concern. As per September 30, 2015 shareholding pattern details released by Emami Ltd, its promoters’ have pledged about 23.28% of promoters’ shareholding is pledged.
Promoters usually pledge their shares either as an additional credit comfort to support borrowing by the company or its subsidiaries, if the company/subsidiary on its own does not have good credit strength. However, this does not seem to the be case here, as Emami Ltd which is rated AA+ by CARE has sufficient credit strength on its own. Otherwise, it might be the case that promoters have raised funds against their stake in Emami Ltd to fund their personal venture, whose details are not present in the Emami Ltd annual report.
The pledged stake of promoters has a market value of about INR 4,000 cr. at current share price, which if we assume a loan to value ratio (LTV) of 0.50 times, would amount to a debt of INR 2,000cr, which the promoters would have given as credit comfort or used to fund any other venture/promoter group company.
An investor should use the informal channels to understand, if she can get any idea about the requirement of promoters to pledge their stake in Emami Ltd.
Further advised reading: How to know if Promoters are Losing Commitment to the Company
Overall, Emami Ltd appears to be a company growing at a fast pace, with sustained profitability margins & improving operating efficiency. It has been able to meet its capex requirements from its cash flow from operations and able to generate free cash flows. The company has a very healthy SSGR, which can ensure that it can keep on growing without needing debt to fund its growth, if it can manage its working capital efficiently and does not go for debt funded acquisitions.
These are my views about Emami Ltd. However, you should do your own analysis before taking any investment related decision about the company.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Additionally, the investor should keep track of the future performance of the company for signs of improvement or worsening as part of their monitoring exercise. She may use the steps explained in the following article for monitoring stocks in her portfolio.
Also Read: How to Monitor Stocks in your Portfolio
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
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