GlaxoSmithKline Consumer BUY

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1 BUY Boost your portfolio Sector: FMCG Sensex: 15,881 CMP (Rs): 2,539 Target price (Rs): 2,912 Upside (%): Week h/l (Rs): 2,700 / 1,907 Market cap (Rscr) : 10,679 6m Avg vol ( 000Nos): 23 No of o/s shares (mn): 42 FV (Rs): 10 Bloomberg code: SKB IB Reuters code: GLSM.BO BSE code: NSE code: GSKCONS Prices as on 14 Dec, 2011 Shareholding pattern September '11 (%) Promoters 43.2 Institutions 30.7 Non promoter corp hold 10.4 Public & others 15.8 Performance rel. to sensex (%) 1m 3m 1yr GSK Cons Nestle HUL Dabur 4.0 (5.1) 16.7 Share price trend 150 GSK Cons Sensex Dec-10 Apr-11 Aug-11 Dec-11 Undisputed leader in the Malted Food Drinks segment GSK continues to dominate the ~Rs32bn Malted Foods Drinks (MFD) segment with a strong 70% market share despite rising competition from players like HUL, Amul and Dabur. The MFD segment continues to witness double digit volume growth and with low penetration levels, the scope for growth remains high. We expect GSK to register 18.1% revenue CAGR over CY10-13E. GSK s various strategies like leveraging strong brand equity of Horlicks brand for launching new products, premiumisation into value added malted foods, increased focus on north and west markets and expansion of distribution network will be the key growth drivers. Low penetration levels, premiumisation to fuel growth The low penetration levels in the malted foods segment at 22%, with 40% urban and mere 10% rural penetration provide high headroom for growth. GSK, being the market leader, will be the key beneficiary. To benefit highly from the changing market dynamics including willingness to spend higher for value-added products, GSK has launched premium variants of its major brand Horlicks Horlicks Gold. Despite being priced at a 30% premium to the base Horlicks, this product has gained nationwide market share of 2% in the first quarter of its launch, which is really commendable. Management confident of maintaining operating margins Despite firm input prices over the past one year, GSK managed to mitigate the input cost pressure by effecting price hikes. Being the market leader, GSK is better placed to pass on the input cost impact to consumers. Going forward, GSK plans to maintain its adspend to sales ratio at ~16-17% level as it will further introduce new products. We expect GSK to witness ~130bps expansion in operating margins over CY10-13E. To register 21% earnings CAGR over CY10-13E, maintain BUY With zero debt on its books and operating cash flows of ~Rs3-4bn per annum, GSK is a cash-rich company. Low penetration levels in the core Malted Food Drinks category will provide surplus headroom for growth for GSK. We expect GSK to register earnings CAGR of 21.1% over CY The management s confidence of sustaining volume growth and margins reaffirms our view. At the current market price of Rs2,535, the stock is trading at 20.1x CY13E EPS of Rs We maintain BUY, with a 9-month price target of Rs2,912. Financial highlights Revenues 23,061 27,563 32,699 37,984 yoy growth (%) Operating profit 3,767 4,617 5,681 6,685 OPM (%) Reported PAT 2,999 3,688 4,451 5,324 yoy growth (%) Research Analyst Vanmala Nagwekar research@indiainfoline.com EPS (Rs) P/E (x) Price/Book (x) EV/EBITDA (x) Debt/Equity (x) RoE (%) RoCE (%) December 15, 2011

2 GSK's key brands Brands Horlicks Junior Horlicks Women, Mother's Horlicks Horlicks Biscuits Boost Maltova Viva Others (Horlicks NutriBar, Foodles, Sports drink - Lucozade, Boost Glucose) Source: Company Undisputed leader of the MFD category GSK Consumer (GSK) continues to dominate the ~Rs32bn Malted Food Drinks (MFD) market with a strong 70% market share, led by its flagship brand Horlicks. GSK faces no major competitive threat with large players like Nestle and HUL exiting the category after making significant investments in product development and brand-building. The MFD segment has a very sticky consumer loyalty and with GSK s strong brand portfolio and innovative new launches, the entry barriers have become higher. GSK s various strategies like leveraging strong brand equity of Horlicks brand for launching new products, premiumisation into value-added malted foods, increased focus on north and west market and sharp expansion in distribution network will be the key growth drivers. Given the low penetration levels of 22% of the MFD category headroom for growth is very high. We believe, GSK will continue its revenue growth trajectory of ~18-20% yoy and register 18.1% revenue CAGR over CY10-13E. GSK s segment wise revenue break-up (CY10) Players in the MFD segment (market shares) Biscuits 5.6% Ghee 0.5% Complan 10% Others 4% Horlicks* 54% Bournvita 16% Malt based food 94.0% Boost* 16% *GSK s brands Strong brand portfolio Driving Line Extensions Company Report 2

3 Players in MFD segment Company White Brown GSK Consumer Horlicks, Viva Horlicks, Boost, Maltova Heinz Complan Complan Cadbury N.A. Bournvita Amul N.A. Nutramul, Shakti Dabur N.A. Chyawan Junior HUL* N.A. Kissan Nutrismart * New entrant HUL, Nestle unable to dent GSK s leadership position Over the years, GSK has successfully maintained its market share in the MFD category despite the presence of large players like HUL, Nestle and Amul who have large distribution network. Nestle had to withdraw its instant drink product Milo in 2008 followed by Hindustan Unilever Amaze Brain Food. During the current year, HUL has again entered the market with the launch of Kissan Nutrismart under its Kissan brand as Brain food. The product is priced at 25% premium to base Horlicks and is being test marketed in Tamil Nadu and Andhra Pradesh. Dabur is also present in the market with its brand - Dabur Chyawan Junior (launched in 2007). However, we do not see these products posing a major threat for GSK, as Dabur s product is a chyawanprash-based health drink (the company has restricted further investments) while HUL s Amaze is priced at almost ~25% premium to Horlicks. Competitor s unsuccessful efforts to enter MFD category Company Product Launch year Comments Nestle Milo 1997 Withdrawn in 2008 with a market share ~3% Withdrawn in 2009 after two years of test HUL Amaze 2007 Dabur Chyawan Junior 2007 supplement Kissan HUL Nutrismart 2011 marketing in three states Launched to use the equity of Chyawanprash brand as a health Priced at 25% premium to Horlicks, is being test marketed in two south Indian states Segments and products in MFD category White Malted Brown Malted Beverages Beverages Horlicks Chocolate Horlicks Viva Boost Chocoblast Complan (White) Bournvita Maltova Complan Chocolate Source: Industry, India Infoline Research Derives ~85% revenues from the South and East regions The MFD market is divided into two segments white and brown health drinks. It is primarily dominated by the white malted beverages, which accounts for ~65% of the total beverage volumes. The brown-malted beverages segment accounts for balance ~35% and is largely focused on the kids (age group of 6-16 years) with chocolate as the key component. GSK derives almost 85% of its revenues from the South and East region, where white beverages are preferred as substitute for milk, since these regions have been traditionally milk deficient. Going forward, GSK plans to expand its distribution network, increase national advertising for Horlicks and Boost and introduce low unit packs (LUP) of its brands for increasing penetration in the rural (contributing ~25% to revenues) as well as North and West market (contributing ~10% to revenues). GSK s region-wise revenue break-up Region-wise volume market shares Exports 6% North 6% North 16% West 11% East 37% East 38% South 46% West 4% South 36% Company Report 3

4 GSK has launched various innovative products under Horlicks brand umbrella Consumers are now willing to pay a premium for the value added malted foods Premium variant Horlicks Gold has gained market share of 2% in the first quarter of its launch New product launches, introduction of products from parent s portfolio coupled with entry into new segments will further strengthen GSK s position in the MFD category Leveraging on Horlicks brand to launch new products GSK is strategically leveraging the strong brand equity of it s ~Rs13bn flagship brand Horlicks by entering into all the possible nutritional categories. Under this brand, GSK has launched various innovative products like Horlicks Nutribar, Horlicks Chill Dood, ActiGrow, Junior Horlicks Biscuits and Horlicks Foodles. At the recent analyst meet, the management confirmed the changing market dynamics where consumers are now willing to pay a premium for value-added malted foods. As a result, share of GSK s value-added products like Junior, Mother s and Women s Horlicks has increased from 16% in 2007 to 23%. The premium variant of Horlicks Horlicks Gold was also well received by the market and contributed ~3% of sales of Horlicks portfolio during Q3 CY11. Despite being priced at a 30% premium to the base Horlicks, this product has gained nationwide market share of 2% in the first quarter of its launch, which is really commendable. GSK aims to have a niche play in the Rs130bn biscuits segment, targeting a market share of ~3% in 2-3 years (current ~1%), implying revenues of Rs3-4bn. This can be a material growth driver for GSK. GSK s strategy of introducing smaller SKUs of its products is also doing very well resulting in increasing the contribution of the recruiter pack in the overall Horlicks portfolio to 3.5% in Q3 CY11. Though this initiative is marginally margin dilutive, the management is confident that it will attract more consumers into the category. Horlicks mega brand concept Entry into new formats Contribution of non-mfd products to revenues has increased from 3% to 7% over the past four years GSK recently entered the Rs2bn oats market breakfast space with the launch Horlicks oats New categories can become key growth drivers in 2-3 years GSK has increased its presence to five non-malted food categories - noodles, biscuits, glucose, sports drinks and nutritional bars. However, the company is reviewing its strategy in the noodles and Nutribar segment as it has been unable to sustain the initial growth momentum. GSK was unable to grow its national market share in noodles beyond 3% - key reason being the lack of additional capacity at its third-party manufacturer Indo-Nissan. GSK has also withdrawn Horlicks Nutribar from the market due to some supply side issues. GSK has recently entered the Rs2bn oats market breakfast space with the launch Horlicks oats (currently test marketed in South India). We believe the ramp up of new products will take time and these products may require at least 2-3 years to be key growth drivers. Company Report 4

5 Products likely to be launched from parent s portfolio Products Segment Nicotine and Smoking cessation Nicoderm products Aquafresh Oral care Ribena Premium fruit juice Source: Company, Industry GSK plans to start marketing new OTC products from the parent's global portfolio GSK plans to add 50,000 outlets per year to its direct reach Launches from parent s portfolio to diversify revenue base Apart from introducing variants of its Horlicks brand, GSK has launched products from its parent - GlaxoSmithKline plc. U.K. s portfolio like Sensodyne toothpaste, Breathe Right nasal strips and Lucozade energy drink (for athletes). GSK targets to make Sensodyne a Rs1.5bn brand and capture up to 5% market share of the Indian toothpaste market within the next 4-5 years. These products are expected to have a strong demand potential in the Indian market and we believe it will help GSK further strengthen its position in the Indian market. GSK currently distributes OTC brands like Crocin, Iodex and Eno from its parent s portfolio which are clubbed under the business auxiliary services segment. GSK receives business auxiliary income for the distribution of these products. GSK plans to start marketing new OTC products from the parent's global portfolio and expects the auxiliary services segment to grow in the region of 15-20% and to further fuel bottomline growth. Distribution expansion, low penetration level to fuel growth GSK s total distribution network of 1.5mn outlets is very low compared to ~4-5mn outlets of Nestle. GSK plans add 50,000 outlets per year to its direct reach (current 700,000 outlets). GSK is also working on a model to cover 50,000 villages, which will add-up additional 200,000 outlets to the distribution network. It has strategically lowered the number direct distributors from over 2,000 to 500 and increased the sub-stockist points from 2,000 to 4,000+, thus increasing the town coverage. We believe the sharp expansion in distribution network with increased rural reach will fuel growth. Low penetration levels of 22% in the malted foods segment, with 40% urban and mere 10% rural penetration provide high headroom for growth for GSK. Management confident of maintaining operating margins Over the past six months, most of the key material prices for GSK like milk (20% yoy), skimmed milk powder, malt & malt extract and barley (18% yoy) were on uptrend. Sugar prices provided some relief by declining by ~19% yoy. With its strong pricing power GSK managed to mitigate the input cost pressure with price hikes (~7.5% in the current year till date) and lower adspend. The management has guided for input price inflation of ~10% in CY12. However, being the market leader we believe, GSK is better placed to pass on the input cost impact to consumers. Going forward, GSK plans to maintain its adspend to sales ratio at ~16-17% level as it will further ramp up new products. We expect GSK to witness ~130bps expansion in operating margins over CY10-13E. Trend in operating margins 20 (%) Raw material mix CY10 Others 27% Milk Pow der 20% CY05 CY06 CY07 CY08 CY09 CY10 CY11E CY12E CY13E Four (Wheat) 8% Malt and Malt Extract 24% Liquid milk 21% Company Report 5

6 With zero debt on its books and operating cash flows of ~Rs3-4bn per annum, GSK is a cash-rich company GSK is in the process of increasing capacity at its Sonepat plant by 16-18,000MT p.a. by CY12 Huge cash flows can be used for rewarding investors With zero debt on its books and operating cash flows of ~Rs3-4bn per annum, GSK is a cash-rich company (cash on books Rs8.8bn as on June 2011). GSK is in the process of increasing capacity at its Sonepat plant by 16-18,000MT p.a. by CY12. The company till date has incurred a capex of ~Rs1.6bn (including normal capex) and expects to spend ~Rs2bn in CY12. GSK plans to add 50,000 outlets per year to its direct distribution network, which will be a key revenue growth driver. We believe that the surplus cash would be utilized to acquire businesses/brands or to reward shareholders in the form of higher dividend payout. The company is scouting for acquisitions in segments such as nutrition, medicinal and OTC products. Acquisitions, if any, could be a major growth driver. Cash per share (Rs) CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11E CY12E CY13E Management s confidence of sustaining volume growth and margins reaffirms our view To register 21% earnings CAGR over CY10-13E, maintain BUY With its dominant position and strong brand portfolio, we believe GSK is well positioned to continue its 18-20% revenue growth trajectory. Low penetration levels in the core MFD category will provide surplus headroom for growth. A strong pipeline of new product launches, premiumisation into value-added malted foods coupled with sharp expansion in distribution network including rural and north & west India, will be the key growth drivers. Ramp up in noodles and new categories like glucose will further fuel growth. We expect GSK to witness ~130bps expansion in operating margins over CY10-13E, which would translate into earnings CAGR of 21.1%. Management s confidence of sustaining volume growth and margins reaffirms our view. At the current market price of Rs2,539, the stock is trading at 20.1x CY13E EPS of Rs We maintain BUY, with a 9-month target price of Rs2,912. Revenues and net profit expected to increase 1.6x and 1.8x respectively over CY10-13E 40 (Rs bn) (Rs bn) CY07 CY08 CY09 CY10 CY11E CY12E CY13E - CY07 CY08 CY09 CY10 CY11E CY12E CY13E Company Report 6

7 Concerns Milk and milk products account for more than 45% of the total raw material cost for the company. Any steep increase in milk prices would impact operating margins directly. GSK enjoys 70% market share in the MFD segment and entry of any strong entrant into the category may result in erosion of market share. Entry of any major players like ITC (ITC Foods is likely to launch energy bars and nutrient bars in the near future) in the health food segment will result in increased competition. Company Report 7

8 Financials Income statement Revenue 23,061 27,563 32,699 37,984 Operating profit 3,767 4,617 5,681 6,685 Depreciation (397) (435) (516) (586) Interest expense (26) (35) (35) (35) Other income 1,174 1,357 1,513 1,882 Profit before tax 4,518 5,504 6,644 7,946 Taxes (1,520) (1,816) (2,192) (2,622) Net profit 2,999 3,688 4,451 5,324 Balance sheet Equity capital Reserves 9,180 11,146 13,383 16,247 Net worth 9,600 11,566 13,803 16,667 Debt Total liabilities 9,600 11,566 13,803 16,667 Fixed assets 3,106 4,181 5,250 6,150 Investments Def, tax asset (net) Net working cap (3,534) (3,793) (4,341) (4,888) Inventories 3,120 3,776 4,479 5,203 Sundry debtors Other curr.assets 845 1,175 1,385 1,595 Sundry creditors (3,569) (4,153) (4,927) (5,724) Other current liab. (4,435) (5,195) (5,995) (6,795) Cash 9,761 11,068 12,784 15,295 Total assets 9,600 11,566 13,803 16,667 Cash flow statement Profit before tax 4,518 5,504 6,644 7,946 Depreciation Tax paid (1,520) (1,816) (2,192) (2,622) Working capital 1, Other op. items Operating cashflow 5,350 4,382 5,515 6,456 Capital exp. (1,180) (1,510) (1,585) (1,485) Free cash flow 4,169 2,872 3,930 4,971 Equity raised (0) Investments Dividends paid (2,452) (1,722) (2,214) (2,460) Other items (157) Net in cash 1,563 1,307 1,716 2,511 Key ratios Y/e 31 Dec CY10 CY11E CY12E CY13E Growth matrix (%) Revenue growth Op profit growth EBIT growth Net profit growth Profitability ratios (%) OPM EBIT margin Net profit margin RoCE RoNW RoA Per share ratios EPS Dividend per share Cash EPS Book value per share Valuation ratios (x) P/E P/CEPS P/B EV/EBIDTA Payout (%) Dividend payout Tax payout Liquidity ratios Debtor days Inventory days Creditor days Leverage ratios Interest coverage Net debt / equity (1.0) (1.0) (0.9) (0.9) Net debt / op. profit (2.6) (2.4) (2.3) (2.3) Du-Pont Analysis Tax burden (x) Interest burden (x) EBIT margin (x) Asset turnover (x) Financial leverage (x) RoE (%) Company Report 8

9 Recommendation parameters for fundamental reports: Buy Absolute return of over +10% Market Performer Absolute return between -10% to +10% Sell Absolute return below -10% Published in India Infoline Ltd 2011 This report is for the personal information of the authorised recipient and is not for public distribution and should not be reproduced or redistributed without prior permission. The information provided in the document is from publicly available data and other sources, which we believe, are reliable. Efforts are made to try and ensure accuracy of data however, India Infoline and/or any of its affiliates and/or employees shall not be liable for loss or damage that may arise from use of this document. India Infoline and/or any of its affiliates and/or employees may or may not hold positions in any of the securities mentioned in the document. The report also includes analysis and views expressed by our research team. The report is purely for information purposes and does not construe to be investment recommendation/advice or an offer or solicitation of an offer to buy/sell any securities. The opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. Investors should not solely rely on the information contained in this document and must make investment decisions based on their own investment objectives, risk profile and financial position. The recipients of this material should take their own professional advice before acting on this information. India Infoline and/or its affiliate companies may deal in the securities mentioned herein as a broker or for any other transaction as a Market Maker, Investment Advisor, etc. to the issuer company or its connected persons. This report is published by IIFL India Private Clients research desk. IIFL has other business units with independent research teams separated by 'Chinese walls' catering to different sets of customers having varying objectives, risk profiles, investment horizon, etc and therefore, may at times have, different and contrary views on stocks, sectors and markets. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to local law, regulation or which would subject IIFL and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. IIFL, IIFL Centre, Kamala City, Senapati Bapat Marg, Lower Parel (W), Mumbai For Research related queries, write to: Amar Ambani, Head of Research at amar@indiainfoline.com or research@indiainfoline.com For Sales and Account related information, write to customer care: info@5pmail.com or call on