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Headwinds from high inflation impacting sale of discretionary products such as artificial sweeteners and butter substitutes along with stiff competition in the health drinks space has seen the Zydus Wellness (ZydusW) stock correct 33 per cent from its one-year high touched in October last year.
Following this, the stock is currently lower than the ₹1,800 levels at which we gave a ‘buy’ call in September 2020. The fall now presents a good entry point for long-term investors. Market leadership in many of its brands, underpenetrated nature of offerings which provide long runway for growth and discounted valuation compared to FMCG peers make the stock attractive at this juncture. At the current price of ₹1,622, ZydusW trades at about 32 times its trailing 12-month earnings, at a good discount to mid-cap peer Jyothy Labs (40 times) and bigger players such as Hindustan Unilever (69 times), Dabur (58 times) and Marico (56 times).
Room for penetration
Unlike foods, home care or some personal care products which are overcrowded spaces with high penetration alongside, ZydusW is present in some niche segments. These provide good scope for volume as well as value growth in the years to come. ZydusW makes the artificial sweetener ‘Sugar Free’ and ‘Sugarlite’ and is the market leader in this space with 96 per cent share. ZydusW also manufacturers the Nutralite brand of butter substitutes where it is currently the number one player in the institutional segment. In the long run, increasing health consciousness can be a key growth driver for both these categories. Even in the personal care space, Zydus’ differentiated offerings — Everyuth scrubs and peel-offs — place the company in the number one position in these categories.
In October 2018, the company acquired Complan, Glucon-D, Nycil and Sampriti brands from Heinz India. Put together, Complan, Glucon-D and Nycil currently bring about 55 per cent of the revenues for ZydusW and are also relatively higher margin products. However, the acquired brands have, in a way, proved to be the proverbial Achilles’ heel for the company. Despite market leadership position in Glucon-D and Nycil, lockdowns during the summers of 2020 and 2021 — the peak season for sale of these products — impacted volumes for the company in the last two fiscals.
Besides, even at the time of acquisition by Zydus, stiff competition from brands such as Horlicks had brought down the market share of Complan to about 5 per cent. Despite operating in the health foods segment which is under-penetrated, Complan’s market share 3-4 years post the buy still stands at around the same levels. ZydusW, though, is making amends.
Innovations to drive growth
To drive growth in these acquired brands, the company is adopting a three-pronged strategy. One, it is differentiating the brand positioning. Instead of just focusing on it as a go-to-drink in summer, for example, Glucon-D has now been positioned as a drink for recovery from general tiredness and exhaustion at any point; campaigns around Nycil also position it as an a companion for outdoors rather than only a solution for prickly heat.
Two, in Complan, low unit packs and lower priced pouches are being used to improve penetration and match competition, though the company was initially reluctant to do it due to the diluting effect on margins. Pouch packs were tested out mainly in West Bengal in Q4FY22 and will be scaled up nationally.
Three, variants or adjacencies are also being launched. Complan Nutrigro, targeted at children, is one. Sugar free chocolates, cookies and spreads, Nycil body mist, wipes and sanitisers, Everyuth body lotion and Glucon-D Immunovolt, focused on building immunity, are some of the new products introduced in the last 2-3 years.
With many of its products being urban-centric, the company is consciously improving reach through modern trade channels (rather than general trade) and e-commerce. Its pharmacy-oriented distribution network for products such as Sugar Free has been handy to push Complan and Glucon-D as well.
Thanks to all these initiatives as well as the normal summer this year, volume growth for the company in the June 2022 quarter stood at 10.3 per cent, as against 2.3 per cent for the whole of FY22.
Financials
For the quarter ended June 2022, net sales grew by 18 per cent year-on-year to ₹693 crore and adjusted profits, by 7 per cent to ₹137 crore. Operating margins came in at 20.9 per cent vs. 23.8 per cent in the June 2021 quarter. Margins have been under pressure in the last 2 quarters from increase in raw material prices. In the three months ending June 2022, prices of inputs such as milk and refined palm oil moved by 20-25 per cent and aspartame, by 55 per cent over the April-June 2021 period. While some portion of the price increase has been passed on to customers, advertisement expenses increased to 13.8 per cent of sales from 11.7 per cent, a year ago.
The cooling off in some inputs, such as palm oil and HDPE (packaging material) post the June 2022 quarter, offers some solace. Repayment of about ₹1,500 crore debt taken for the Heinz acquisition (₹4,600 crore) is happening in stages, with lower interest costs benefitting the bottom line. The company expects to be gross debt free by mid-2023. Return ratios, which came down to mid-single digit levels due to the Heinz acquisition and fund raising through issuance of equity to promoters and QIBs, can improve as profitability betters from here on.
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