Zydus Wellness Ltd - Stock Valuation and Financial Performance

Results: Zydus Wellness Ltd. (Zydus) reported a year on year sales growth of 17% and operating profit growth of 38%.

Key highlights: 

• Zydus lost ~100 crore sales in March due to lockdown. The month contributes substantial summer product sales like Glucon-D and Nycil.
• With restaurants, malls, cafes closed during lockdown, the key brand Nutralite’s sales were negatively impacted given two-third of its sales contributed by ‘out of home’ consumption
• Gross margins got impacted due to higher milk prices & change in composition of products due to acquisition. However, company reduced its marketing spend by 30% & other overheads by 9% leading to operating profit growth.
• The company continued to regain its lost market share in malt based beverage category after the acquisition. However, there was a steep increase in milk prices which still remains a challenge for the company.

Outlook: After the acquisition of Heinz, Zydus now has five brands (Sugarfree, Everyuth, Glucon-D, Complan & Nycil) in different categories with strong customer recall value. The company is looking to double the direct distribution reach in general trade & further enhance its chemist channel. As of now the company is looking to save various costs by reducing duplication of costs after the integration with Heinz Business. Marketing expenditure, which is ~13% of sales, will come down in the near term. Zydus is looking to increase Complan volumes through the chemist channel. As per the management, the wholesale channel is slowly recovering. Tier 2, 3 cities are witnessing good traction. The company does not have much sales contribution from rural.

Zydus has a predominant presence in chemists and urban (both kirana and modern retail stores) whereas Heinz India has large presence in rural and groceries. Since both the companies have different supply chain model, they can use for each other’s distribution to cross their different products. We believe current traction in sales growth will last over few quarters as products will be pushed through new channels. Based on our estimate, Zydus is just marginally overvalued. If we see any weakness due to market sentiment, we would consider Zydus for purchase. For those who already own the stock, may continue to HOLD.

About the company

Zydus Wellness, subsidiary of Cadila Healthcare, is one of the leaders in Sugar Substitute in the country. The brand, SugarFree, is almost synonymous to sugar substitute for consumers.

Zydus also have other small products in bouquet like Everyuth, Nutralite. Recently Zydus Wellness acquired Heinz India portfolio. It includes Nycil, Complan, Glucon-D, etc. We believe this has improved growth prospects for Zydus.

MoneyWorks4me Opinion

We were of opinion that Zydus didn’t leverage its distribution enough versus other FMCG/Wellness products due to inadequate bargaining power with the distributors and retailers. Setting up distribution channel for a single product is not very efficient. Large number of brands gives an FMCG company more sales traction as it can push more brands to retailer/distributors along with their blockbuster products. For example: ITC has large demand for Cigarettes. It can push biscuits/atta/chips to retailer/distributor or else threaten them to stop supplying them blockbuster Cigarettes.

Now that Zydus has got large portfolio of products in its fold, it can utilize its existing channels for supplying more products as well as increase its own presence by leveraging Heinz’s supply chain. Not only that, even its SugarFree has got better competitive edge over competitors who sell "sugar substitutes" only. 

Heinz India has large presence in rural and groceries versus Zydus predominant presence in chemists and modern/urban retail. Since both the companies have different supply chain model, they can use for each other’s products to scale up sales faster. We believe that current traction in sales will last over few quarters as products will be flushed through new channels.

We are very optimistic on Zydus’s prospects from long term point of view. Earlier we were sceptical about very bright prospects and assigned lower P/E multiple to Zydus due to i) single product ii) high cash balance iii) low bargaining power wrt distribution channel.

Concerns/Risks

• Beverages is slow growing and very competitive market. Complan operates in a market that is dominated by large companies with deep pockets like Cadbury’s (Bournvita in west), HUL (Horlicks across India), Nestle (Re-introducing Milo). Marketing spends could be substantial if Zydus plans to expand market share in this category.
• Debt of Rs. 1,500 Cr is high versus the cash flows of ~Rs. 400 Cr annually. However, due to sticky product categories, interest servicing shouldn’t be an issue.

Valuation

We were expecting sales traction to start after 4-6 quarters till supply chain restructuring happens. However, jump in sales volumes was a surprise. We expect that this momentum to sustain over few more quarters, post which it will have to invest in marketing to grow volumes.

Based on our estimate, Zydus Wellness is just marginally overvalued. If we see any weakness due to market sentiment, we would consider Zydus Wellness for purchase. For those who already own the stock, may continue to HOLD.

Positives:

Sugar Free

India is said to be the diabetic capital of world with around 5 crore people suffering with diabetes and the numbers is growing at an increasing rate. Artificial Sweeteners market in India is growing at ~5% a year and currently pegged at 300 crores. More than 50% of Zydus’ revenues come from Sugar Free. Our back of the envelope calculations suggest not more than 40-60 lakh people consume Sugar Free. This leaves decent scope for penetration of artificial sweetener category as a whole. As per the management interviews, 40% of people consuming sugar free comes from people who are not diabetics, but consume it for health reasons. Zydus Wellness has been spending decent amount on Advertisement and Sales but not something which we would like them to spend. Since the growth numbers are not linear, we understand that the advertisement spends vary from time to time. However, we are very happy with distribution of Sugar Free. The management is further expanding the same. Looking at global trends the company is introducing various brand extensions e.g. Sugar Free Green was launched as a sugar substitute manufactured from stevia leaves that are natural and ~200% times sweeter than sugar.

Everyuth / Nutralite

1.Everyuth is a comprehensive brand with three categories viz: 1. Face wash 2.Scrubs 3.Peels. Zydus has a good market share in 2^nd and 3^rd category with an intense competition from other brands.

2.Nutralite is a butter substitute (margarine). It has lesser cholesterol and lower amount of hydrogenated fats as compared to butter. Zydus is a category creator with this brand as it calls Nutralite ‘better than butter’ for health conscious people. But Nutralite is not gaining significant traction as of now.

With a market share across all categories and good brand equity, Zydus generates high ROE due to higher margins and lower investment requirement. We believe that this is likely to remain intact.

Concerns:

1.      Mostly concerns are on growth side. Cash is getting accumulated on balance sheet and it has to be deployed in efficient manner. The management is exploring for new acquisitions of new brands in consumer health space. The growth could come from inorganic route. Till then we can’t factor in lot of growth into the future. We are not sure whether new venture would have almost similar ROE as existing business (54% pre-tax)

2.      The lack of entry barriers is a risk as R&D is not a major prerequisite for manufacturing of artificial sweeteners. Since the market is in its nascent stage,as the demand increases, many more FMCG players or MNC counterparts may enter this segment. High dependence on one major revenue stream makes the business little vulnerable to competition. However, if the company keeps making advertisement expenditures, it could defend competition well.

Current share price factors in all the positives of the business. Besides, we also believe that current price also anticipates growth from inorganic route. We would be monitoring deals and value generated by acquisitions in the future. For those who hold the stock, considering selling the stock partially.