While both companies have similar product portfolios and presence in different markets, concerns loom large over Henkel’s losses and huge debt burden
Jyothy Laboratories’ aim to acquire a majority stake in Henkel India (HIL) comes with many challenges. Firstly, it may not come cheap given that there are other bidders. Secondly, even if it acquires control, there are challenges on the operational front as HIL has been making losses for many years now, besides the likely increase in Jyothy’s consolidated debt.
Not surprisingly, after the acquisition of a 14.9 per cent stake in HIL by Jyothy (on March 16) at Rs 35 per share in an all-cash deal worth Rs 60.7 crore, Jyothy’s stock has fallen over 11 per cent. The respite comes from the fact that Jyothy would gain from the synergies between the businesses of the two companies. This along with healthy prospects for Jyothy’s businesses make analysts believe that the stock is worth considering from a long-term perspective.
| JYOTHY LABS: STABLE SO FAR | |||
| In Rs crore | FY10 | FY11E | FY12E |
| Sales | 598 | 717 | 870 |
| % chg y-o-y | 64.5 | 19.9 | 21.4 |
| Ebitda (%) | 15.3 | 14.5 | 15.0 |
| chg in bps | 190.0 | -80.0 | 50.0 |
| Net profit | 75 | 90 | 106 |
| % chg y-o-y | 96.1 | 19.0 | 18.5 |
| PE (x) | 20.0 | 18.7 | 15.8 |
| E:Estimated Source: ICICI Direct.com | |||
Debt woes
Jyothy’s acquisition of the 14.9 per cent stake values HIL at Rs 857 crore (Rs 407 crore equity value plus debt of about Rs 450 crore) or 1.6 times HIL’s CY2010 sales, which looks reasonable. While this buy gives it an edge over peers like Emami, Godrej and Dabur in its quest to acquire Henkel AG’s- HIL’s Germany-based parent, 50.9 per cent stake, the acquisition (if it happens) of a majority control will strain its financials in the medium-term.
Reportedly, Henkel AG is expecting an equity valuation of Rs 600 crore. This means, Jyothy, which has cash of Rs 220 crore, will need to raise an equivalent amount of debt to complete the acquisition of Henkel AG’s stake and open offer for 20 per cent equity. Hence, a fall in interest income on this cash will be accompanied by higher interest expenses on the debt.
| EARNINGS GET DILUTED Calculation of equity value for Henkel AG’s stake | |||
| Case-1 | Case-2 | Case-3 | |
| Sales (Rs cr) | 534 | 534 | 534 |
| Enterprise value (EV) | 534 | 801 | 1,068 |
| EV/Sales (x) | 1.0 | 1.5 | 2.0 |
| EV per share (Rs) | 46.0 | 69.0 | 92.0 |
| Less: Debt | 500 | 500 | 500 |
| Equity value (Rs cr) | 34 | 301 | 568 |
| Equity value/share (Rs) | 2.9 | 25.8 | 48.8 |
| Scenario analysis of Jyothy’s Debt & EPS post buyout (FY12E) | |||
| Total debt (Rs cr) | 479 | 615 | 751 |
| Interest outgo (Rs cr) | 31 | 44 | 57 |
| EPS (Rs) | 7.5 | 6.2 | 4.9 |
| EV: Enterprise value (equity+debt); E: Estimated Source: Antique Stock Broking | |||
This in turn, along with the fact that Henkel India is loss-making (it reported loss of Rs 51.84 crore for year ended December 2010) would hit Jyothy’s consolidated profitability. Thus, reducing HIL’s huge debt burden of Rs 450 crore, which is responsible for half of its losses, will be vital to turnaround HIL.
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While Jyothy’s management said it will structure the deal in such a manner that debt is repaid before the acquisition, analysts believe that it will ultimately reflect in its books in one way or the other (a mix of equity and debt or higher equity value and nil debt).
Business synergies, but margin dilutive
Since HIL posted losses at both, operating as well net level, its acquisition would be margin and EPS dilutive for Jyothy. Hence, the success of this deal will depend on the speed and ability of Jyothy to turn around HIL into a profitable entity. Jyothy’s management believes HIL will be in investment mode for at least a year after the acquisition before returning to profits.
Positively, Jyothy can derive synergies given that both companies have presence in similar business segments like home care, fabric care, dish wash, personal care and household cleaning. Also, since HIL has larger presence in south and east markets and Jyothy in north and east India, there are clear distribution synergies.
A potential area of cost saving could be trimming selling and distribution expenses of HIL, which have ranged 22-25 per cent of sales in the last three years compared to Jyothy’s five-eight per cent.
However, if the company’s bid to buy Henkel AG’s 51 per cent stake fails, it could clock in profits of about Rs 25 crore by selling its 14.9 per cent stake in the open offer made by the new owner of HIL.
The road ahead
Apart from the deal’s valuations, the licensing period and fees which Jyothy will have to pay for use of Henkel's brands (like FA, Henko, Pril and Margo) is among key monitorables; analysts estimate it to be two per cent of sales.
Meanwhile, amidst intensifying competition, rising input costs are likely to keep Jyothy’s margins under check. Some of this pressure could get offset from a likely hike in price of its flagship brand Ujala in April 2011. Jyothy’s recent joint venture with the DRDO to produce mosquito repellents is expected to generate Rs 60 crore revenues in 2011-12, and boost mosquito repellent sales which dipped 15 per cent in December 2010 quarter. Jyothy’s laundry subsidiary has been doing well and recently acquired Delhi-based Diamond Fabcare, which will enable it to increase its foothold in the northern region. Analysts expect the business to break even by 2011-12.
In this backdrop and excluding HIL’s numbers, analysts expect Jyothy’s revenues and profits to rise by around 20 per cent in 2011-12. At Rs 208, the stock trades at almost 15 times its 2011-12 estimated earnings.