Jyothy Laboratories: In hard waters

At 67 per cent, the Jyothy Laboratories stock’s one-year gain is leaps ahead of the 8 per cent rise clocked by the BSE FMCG index. That’s not without reason — the company has successfully integrated acquired brands Pril, Margo, and Henko in the past two years. Its own brands — cash cow Ujjala, Maxo and Exo — have also clocked good growth.

Overall, Jyothy Labs’ 8.7 per cent volume growth in 2014-15 is better than industry behemoth Hindustan Unilever’s. Control over costs, such as staff and power, and replacing term loans with zero-coupon debentures helped net profit margins improve to 6.1 per cent in 2014-15 from 4.5 per cent two years ago. Jyothy Labs has also moved from being a mostly South-based regional player to a national-level player.

But at 44 times the trailing 12-month earnings, the stock’s prospects seem priced in. The FMCG index trades at a lower 41 times. The PE multiples of far larger peers, Godrej Consumer and Dabur India, are at par with Jyothy Labs. A potential drop in rural demand and lack of a leadership position in urban markets can keep a lid on growth.

With most of the savings on raw material being ploughed back into advertising, profitability improvement is also limited. Investors can make the most of the stock’s run and book profits in their holdings. Henkel Germany’s option to buy up to 26 per cent stake in Jyothy Labs in 2016, either through purchase of shares or fresh issue of shares at a price that will be decided then, is another overhang.

Detergent brand Henko recorded strong growth of 23 per cent in the recent fiscal, thanks to a strong marketing push and re-launch. But with a market share of 2.3 per cent in premium washing powders, the company is overshadowed by HUL and P&G.

Raw material prices for soaps and detergents have been trending down for a few quarters now. But the company hasn’t yet cut product prices, unlike competitors. This may hurt volumes.

Growth in brands such as Margo (soaps), Pril and Exo (dishwash), while healthy at 13-18 per cent in 2014-15, has decelerated from the year before. As with Henko, the company lacks a leadership position and faces tough competition. It does have a play in the niche household insecticides category through Maxo, but still faces the might of market leader Godrej Consumer Products. Jyothy Labs also has a more limited ad spend budget than its far bigger competitors.

The company had a key advantage over peers thus far since it derived a third of its sales from the rural region.

But rural demand has been hit by benign crop prices, only slight hikes in minimum support prices and no increase in welfare schemes. Deficient rains can squeeze farm incomes further. So, a strong rural presence may not help if the demand slackens.

Jyothy Labs, in its turnaround and integration efforts, rationalised costs to improve margins. Operating margins moved to 11.6 per cent in 2013-14, from 9.2 per cent in 2012-13.

Margin improvement capped

But in 2014-15, margins dropped to 10.6 per cent even as material costs corrected. With crude oil derivatives being the primary input, raw material costs as a proportion to sales have dipped significantly over the past two quarters. The March 2015 quarter, for instance, saw the figure at 52 per cent against 57 per cent a year ago. But a chunk of these savings has been channelled into advertising and promotion.

Ad spend as a proportion of sales has been rising over the past two years as the company unleashed a drive to push its six main brands.

From 8.3 per cent of sales in 2012-13, ad spends now account for 12.1 per cent. The company’s marketing drive will continue as it seeks to protect its market. HUL as well as other large players have begun increasing their own ad spends too, having cut back on it earlier to shore up margins. With such higher advertising intensity, margin improvement may be capped.

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