The Hindu Business Line : Marico Industries: Buy

Marico Industries has transformed itself into one of most the promising `growth' plays in the fast-moving consumer goods (FMCG) sector through a significant shift in strategy and a changing product profile. Investors with a three-year horizon can consider adding the stock to their portfolio, given the several growth engines- a healthy pipeline of new products, an expanding presence in the beauty and wellness space and a string of overseas acquisitions. However, the stock may be more suited to aggressive investors, as the acquisition-led strategy and the stock's current valuation levels (30 times trailing 12 month earnings), peg up risks.

Improving product mix

Brands such as Parachute (coconut oil) and Saffola (edible oil) traditionally made up the lion's share of Marico's sales, leading to strong commodity influences on the company's earnings and high sensitivity to input cost increases. However, the company's forays into less price-sensitive segments such as value-added hair oils (Hair & Care, Parachute Advansed, Mediker anti-lice), high-end hair care products (Parachute after-shower cream) and categories such as baby-care products (Sparsh) and soaps (Manjal) have helped improve its overall margin profile. Marico's operating profit margin has improved steadily over the past two years, from about 8.8 per cent in 2004-05 to 12.6 per cent in 2005-06, and further to 15.6 per cent this fiscal. Current margins, which are in line with those for Marico's peers, may be maintained as the company expands further into the beauty and wellness segments.

Why inorganic growth?

The company has embraced an acquisition-led strategy to expand its brand portfolio and geographic reach. Over the past year, it has bought out two domestic brands (Manjal soap and Nihar coconut oil) and made three cross-border acquisitions — soap brands (Aromatic and Camellia) in Bangladesh and hair-care brands (Fiancee and HairCode) in Egypt. These cross-border forays are not Marico's first ones; it has already made two overseas acquisitions — Sundari LLC and Kaya Skin — in previous years and markets its brands in West Asia, Bangladesh and the SAARC countries. The company plans to secure a gateway into new markets through its recent acquisitions.

With the domestic FMCG market expanding at a fast clip, the time does not seem particularly opportune to venture overseas. Moreover, acquisitions are bound to bring accompanying challenges of integrating operations, managing cross-border trade and foreign currency exposures.

However, the factors cited by Marico in favour of its inorganic growth strategy appear to hold water. One, since the acquired brands are ones with established market shares, the company expects the acquisitions to be earnings-accretive within a short time-frame.

Second, overseas acquisitions enable the company to add brands at lower multiples (10-14 times profits) than it would have otherwise paid within India. Third, the acquisitions are only being made in categories (hair care) where Marico has experience in managing domestic brands.

Track record in buyouts

The company's track record in managing and scaling up its previous acquisitions is also reasonable, though not an unqualified success.

The Kaya Skin Clinic business has made significant progress, with revenues rising from Rs 9 crore to Rs 54 crores in three years,with positive earnings expected this fiscal. But Sundari LLC (a US-based spa)has been making slow progress. Of the recent acquisitions, `Nihar' has made a significant contribution to sales growth, but there has been a nine-10 month hiatus in the relaunch of the Bangladeshi soap brands.

The company's focus on exploring overseas markets is also vindicated by its earlier successes in these markets. In the years from FY-04 to FY-07, Marico's international operations have seen sales doubling from Rs 78 crore to an annualised Rs 160 crore, registering a much faster pace of growth than the domestic business. These changes have helped the company's performance, with consolidated net sales growing by 38 per cent (including acquisitions) and profits by over 80 per cent, in the first half of FY07.

Risks

Though it does improve growth potential, the recent strategic shift at Marico does entail a few additional risks for investors in the stock:

Integration issues and the overseas exposures derived from the acquisitions may make for lesspredictable earnings.

The increased appetite for funds to finanace buyouts has drawn down the cash chest, making increases in interest costs and equity expansion a definite possibility. Already, a ramp-up in borrowings has changed Marico's zero-debt status (debt:-equity of 0.44:1), while the recent qualified institutional placement has diluted the equity base by about 5 per cent.

However, for investors with an appetite for risk, the stock remains a good addition to the portfolio.

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