Stock Call. What makes the stock of Zydus Wellness a good bet

Investors with a long-term perspective can buy the Zydus Wellness stock. Its presence in the promising health and wellness segment, synergies and expansion of product portfolio as a result of the Heinz India acquisition and debt-reduction plans bode well for the stock over the next two to three years. At ₹1,801 now, the stock trades at 35 times its estimated earnings (as per Bloomberg consensus estimates) for FY22. Note that bigger FMCG players such as Britannia, Dabur and HUL trade at 45-50 times their estimated FY22 earnings.

Acquisition synergies

Unlike many other consumer companies, Zydus is present in less-crowded segments, with good scope for both volume and as well as value growth in the years to come.

Zydus makes the artificial sweetener ‘Sugar Free’ and has is the market leader in this space with 95 per cent market share.

Zydus also manufacturers the Nutralite brand of butter substitutes. Nutralite sales, being predominantly focussed on the institutional segment, have as taken a hit this year due to Covid-related lockdowns. While Sugar Free sales also took a hit initially, the company has seen reasonable recovery in the same.

In the long run though, increasing health consciousness can be a key growth driver for both these categories.

In October 2018, the company acquired Complan, Glucon-D, Nycil and Sampriti brands from Heinz India.

Much like its own portfolio of health brands, Complan and Glucon-D belong to the premium health foods/drinks segment. The Nycil brand also complements the company’s existing foothold in the personal care segment through the Everyuth brand of skin-care products.

At the time of the acquisition, the four brands of Heinz India accounted for ₹1,150 crore of revenues, in comparison with the ₹513 crore of revenue clocked by Zydus for the year ended March 2018.

Thus, after the acquisition, Glucon-D and Complan put together bring about 50 per cent of the revenues for Zydus.

At the time of acquisition by Zydus, stiff competition from brands such as Horlicks brought down the market share of Complan to under 10 per cent. Despite operating in the health foods segment which is under-penetrated, Complan’s market share is only 5.4 per cent. Zydus is, however, making amends. To improve market share, Zydus has embarked on product innovations in the category.

For instance, earlier this year, Complan Nutrigro was launched targeting children in the age of 2-6 years. To increase penetration, low unit packs (75 grams) of Complan have been introduced. On the distribution side, pharmacy-oriented distribution network for products such as Sugar Free is handy to push Complan and Glucon-D. The company is pursuing product innovations in acquired brands as well.

To take advantage of the increased focus on building immunity in Covid times, Glucon-D ImmunoVolt has been introduced. Nycil hand sanitisers are on the shelves, too.

Financials

For the quarter ended June 2020, consolidated net sales dropped by 13.4 per cent to ₹537.4 crore year-on-year. However, thanks to lower material costs as well as other cost- -control efforts, an expansion in operating margin helped the bottom line.

Operating margin moved up from 19. 7 per cent a year ago to 22.7 per cent now. Profits showed a 10.9 per cent growth to touch 89.2 crore.

While interest costs have remained somewhat stagnant at about ₹34 crore in the three months ended June 2020 over June 2019, the company’s interest costs have galloped since the Heinz acquisition.

The consideration of about ₹4,600 crore paid to Heinz was part-funded by debt (redeemable non-convertible debentures) to the extent of ₹1,500 crore. Due to this, interest costs shot up from under ₹1 crore in the December 2018 quarter to about ₹28.75 crore in the quarter ended March 2019. It has hovered around ₹35 crore in every quarter since. The debt-to-equity ratio stood only at 0.45 as of March 2020.

Last month, the company raised ₹1,100 crore through the issue of equity shares to promoters as well as QIBs.

Later, in October , Zydus announced that it will initiate the process of re-purchase of ₹1,500 crore worth debentures in tranches. As per the terms of issue, one tranche of ₹500 crore worth of debentures each mature in January 2022, 2023 and 2024.

This signifies that the company could repay a good portion of the debt through the equity raised. While this would bring down the interest cost, equity dilution would bring down the return ratios for shareholders. Already, for the year ended March 2020, return on capital employed is at around 5-6 per cent from over 20 per cent levels seen before the acquisition.

However, once profitability improves from higher volumes as well as superior product mix, return rations could become healthy again.

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