After the announcement of their merger post-market hours last Friday, the stocks of Jyothy Laboratories and Henkel dropped 5.3 per cent and 14 per cent, respectively. This is partly because the stocks had outperformed the broader market by a significant margin over the last month, led by an impressive performance by Jyothy Laboratories in the quarter ended March.
While analysts believe near-term upsides for Jyothy Laboratories’ stock are few, given the stiff valuations of 25 times FY13 estimated earnings, they suggest investors with a long-term perspective consider it on declines, given the business prospects. Their one-year average price target for the stock is Rs 270, reflecting an upside of 20 per cent from its current price of Rs 225.
Merger—a logical step
The merger between the companies, which was anticipated by the Street, would create a basket of products for Jyothy Laboratories and enable it to cater to diverse categories (fabric care, personal care, homecare), improve its region-wise sales mix significantly and create a huge common distribution network across India. These would ensure strong and sustainable long-term growth.
| ROBUST GROWTH | ||
| In Rs crore | FY12 | FY13E |
| Revenues | 913.0 | 1377.5 |
| % change y-o-y | 45.4 | 50.9 |
| Operating profit | 84.0 | 126.0 |
| % change y-o-y | 3.7 | 50.0 |
| Net profit | 44.6 | 63.5 |
| % change y-o-y | -35.4 | 42.4 |
| EPS (Rs) | 5.6 | 7.9 |
| P/E (x) | 39.8 | 23.4 |
| Part of the jump in FY13 financials is aided by consolidation of Henkel’s financials (12 months) as compared to seven months in FY12 E: Estimates Consolidated financials Source: Company, Analyst reports | ||
The merger would add seven brands (Henko, Pril, Fa, Margo, Mr White, Check, Neem) to Jyothy Laboratories’ three (Ujala, Maxo, Exo). It would also change the company’s rural-urban sales mix from 75:25 to 30:70. M P Ramachandran, chairman and managing director, Jyothy Laboratories, says, “The merger is one more step towards reaping the benefits of our efforts of deriving synergies in cost, marketing and distribution.”
Analysts have given a thumbs-up to the merger. States Aashish Upganlawar, analyst, Spark Capital in his post-merger note, “Given the relatively small scale of Henkel brands in their respective categories, the erstwhile underinvestment in branding, Jyothy’s focus on rejuvenating brands, leveraging joint distribution and an experienced new CEO (Raghunandan S) taking charge, we expect Henkel (branded products) sales to pick up.” Hemant Patel, executive director-consumer, Enam Securities, says, “We remain optimistic on the potential of Jyothy’s brands to generate sustainable economic profits.”
The company is now in the second phase of its integration process, which involves the appointment of a new senior management team, brand building (pricing, positioning, packaging, etc) and cross-selling of products through a common distribution network.
Gains, in the long run
Ramachandran expects the merger to be completed in six to eight months (the process started in August 2011) and the combined entity to record robust sales growth in FY13. However, analysts expect large gains in profitability only in FY14, led by a turnaround in profits in Henkel-related businesses, which they believe would be aided by cost-rationalisation efforts.
In the near term though, concerns remain. Hemant Patel says, “We expect short-term financial volatility to continue.” Apart from firm raw material costs, the company would also have to incur higher advertising spends (to start soon for Henkel’s brands) and interest costs (with a target of becoming debt-free in three years) in the medium term.
In a note on May 23, Bhaumik Bhatia, analyst, IDBI Capital, stated, “We are conservative, led by crude-rupee related cost pressures. Also, our interest estimates go up.” Tejashwini Kumari, analyst, Angel Broking, says, “We expect the margin to be under pressure because of increased raw material costs, owing to the rupee depreciation and the planned increase in advertisement expenses.” These factors could keep a tab on profitability in the short term.
The silver lining, however, is in the form of continued lower tax rates for three to four years (despite a few of Jyothy Laboratories’ manufacturing facilities losing 100 per cent tax exemption after FY13) due to carrying forward Henkel’s accumulated losses of about Rs 500 crore.
