Customized Research Report

Zydus Wellness Limited

Independent Equity Research

January - 2016

Equentis Wealth Advisory Services (P) Ltd

Registered Office:
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 ZYDUS WELLNESS LIMITED

Background and Business

Zydus Wellness Limited (ZWL) is an Ahmedabad-based company belonging to Zydus Cadila group. As on 30th Sep’15
promoters held 72.54% in the company (with zero pledging) of which 72.08% is owned by Cadila Healthcare Ltd
(Cadila) and rest by promoter Patel family. ZWL offers consumers an array of health and wellness products in
categories such as sugar substitutes, face wash, peel-off, face scrub, margarine and the newly launched health drink.
With its brands (Sugar Free, EverYuth, Nutralite, Actilife), it is a niche but significant player in India's consumer
healthcare market. Its widespread distribution reach enjoys not only very strong brand recall but also healthy market
share in each of its niche segments.

Management

ZWL and Cadila are part of the Zydus Family Trust owned by the Patel family headed by Mr. Pankaj R. Patel, Group
CMD. The Zydus Cadila group, which has interests in Pharmaceuticals, Diagnostics, Herbal Products, Skin Care
Products and OTC Products was founded by Late Mr. Ramanbhai Patel in 1952. Group posted revenues of Rs. 86bn in
FY15. ZWL has institutional holding of 12.85% (30th Sep’15) with marquee investors such as LIC (3.54%), Matthews
India Fund (4.28%) and Baring India PE Fund III (1.66%). FIIs own 7.53% stake while DIIs own 5.32%.

Key Drivers to growth

Product Details
Sugar Free  With 92% market share, Sugar-Free is a near monopoly with strong brand recall. It has become synonymous with artificial
(Sugar Substitute) sweeteners in India.
 Other two players in this category currently are Equal and Splenda which constitute remaining 8% market.
40% revenue  India is the global diabetes capital with more than 65mn diabetes patients currently, projected to increase to 109mn by 2035
contribution (Indian Heart Association).
Market Share – 92%.  Given this number and low penetration of artificial sweeteners in India, there is enormous potential for growth of Sugar-Free
brand provided it is marketed and positioned correctly.
 Going ahead, Sugar-Free would benefit from growing health conscious young Indian populace. With rapid growth in
per capita income, preventive medications such as Sugar-Free would gain in importance over longer term.
 ZWL recently launched Sugar-Free Stevia (extracted from leaves of plant Stevia Rebaudiana) that has several times the
sweetness of sugar with negligible effect on blood sugar.
EverYuth  ZWL was an early entrant in scrubs and peel-offs category where it enjoys market leadership (market share more than 30%
(Peel-off, Face Wash and 90% respectively).
and Face Scrub)  As per Nielsen data, these two categories have been growing between 10% and 15% annually over past couple of
years.
25% revenue  However, face wash is a relatively crowded category where EverYuth has only 2% market share with low single digit growth.
contribution  We feel that peel-offs and scrubs will continue to see robust growth going ahead given the strong hold that ZWL has over this
Market Share – 30% in category.
scrubs, 90% in peel-offs  However, ZWL would have to invest heavily in advertisement and promotion of its face wash category due to
and 2% in Face wash. crowding in this space. This may restrict any major expansion in EBITDA margins in near term.
 ZWL has introduced new products under EverYuth brand such as Tulsi-Turmeric FaceWash, Advanced Hydroactive Walnut
Apricot Scrub and Advanced Refreshing Facewash.
Nutralite  ZWL’s Nutralite is a butter substitute that is claimed to be free of cholesterol and hydrogenated fats.
(Margarine; i.e.,  As per company data, Nutralite is a leader in its category with market share of ~40% and growing in higher single digits.
Butter Substitute)  Despite its market leadership, Nutralite has been facing competition from Amul’s offerings – Lite and Delicious, priced
considerably lower than Nutralite.
35% revenue  Given Amul’s dominance and brand loyalty in milk and milk products, and low awareness in margarine category (as
contribution demonstrated by low rate of growth for category), ZWL will have to invest continuously in advertisement, promotion
Market Share – 40%. and innovation of Nutralite brand.

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Risk Factors

1. Failure of new launches, stiff competition in existing categories: ZWL has launched several products such
as Actilife and Sugar Free D’lite which have not captured market attention. Surge in competition in existing
categories, especially artificial sweeteners, could have detrimental effect on revenue growth and margins.
2. Adverse regulations or studies: Any adverse regulations or studies could have a bearing on artificial
sweetener categories and hence on ZWL as a whole.
3. A sharp rise in input cost: An adverse commodity cost environment could affect operating margins for the
company.

Key Financial Parameters

Parameter FY11-15 Commentary and Outlook

Revenues – CAGR 6% Net Sales has grown at only 6% CAGR due to intense competition seen in face wash category
and low growth for Sugar-Free and Nutralite brands. However, company continues to be market
leader in Sugar-Free and Nutralite and has seen 10-15% growth in the scrubs and peel-offs
category. Hence, with the right kind of investments into advertisements and promotions, ZWL can
boost overall revenue growth. Also, growth in newly launched products would be a key
monitorable going ahead.
EBITDA – CAGR 4% EBITDA has grown at slower pace than sales due to rapid increase in A&P expenses (17%
CAGR) & employee costs (16% CAGR) over FY11-15. RM costs have slowed to 3% CAGR due
to weak commodity cycle. Going ahead, we feel that company will have to deal with increasing
EBITDA Margin (%) (Avg) 23.7% competitive intensity and hence continue to invest heavily into brand promotion but will benefit
from lower RM costs and reduction in employee costs due to completion of rationalization of
distributor structure.
Interest + Depreciation – CAGR 48% After staying constant at 1.2% of sales during FY12-14, depreciation reported a 66% YoY jump in
Interest + Depreciation as % of sales (Avg) 1.2% FY15 as ZWL changed method of providing for depreciation to “Straight Line Method” during the
year. Interest charges remained negligible during the period due to near debt-free status of the
company. ZWL has not incurred any major capex during the period except capex totaling
Rs.211mn over FY11 and FY12 for expansion of Nutralite facility, which was financed from its
internal accruals.
PAT – CAGR 16% PAT growth was higher than growth in EBITDA owing to lower tax incidence arising from excise
PAT Margin (%) (Avg) 22% duty re-credit received by ZW Sikkim and robust growth in other income (40% CAGR).
Consequently, PAT Margin has grown 760bps over FY11-15.
Dividend Payout (%) (Avg) 29% Company has been a consistent dividend payer with payout in absolute terms growing at ~12%
CAGR over FY11-15.
D/E (xs) - (Avg) 0.00 ZWL has an almost debt free balance sheet which has led to its FCFF growing at 13% CAGR
over FY11-15. This puts the company in a comfortable position as far as providing for capex and
investing in new brand launches is concerned.
ROCE (%) (Avg) 39% Owing to near-zero debt and minimal capex requirements, the company has maintained RoCE at
nearly 40% levels.
ROE (%) (Avg) 39% RoE has averaged nearly 40% over FY11 – 15 due to robust growth in Reserves and Surplus for
the company.
Asset Turnover (xs) (Avg) 3.80 The ratio has averaged between 3xs and 5xs during the period under consideration.

Recommendation:
Particulars (Rs. Mn.) FY15 H1FY16 FY16E FY17E FY18E
Net Sales 4,307 2,094 4,652 5,117 5,731
YoY (%) 6.7% 2.7% 8.0% 10.0% 12.0%
PAT 1,090 486 1,220 1,367 1,531
YoY (%) 13.0% 9.7% 12.0% 12.0% 12.0%
PAT Margin (%) 25.3% 23.2% 26.2% 26.7% 26.7%
EPS (Rs.) 27.33 12.69 30.61 34.29 38.40
P/E (xs) w.r.t CMP Rs.757.70 27.72 59.71 24.75 22.10 19.73
Target PE (xs) 25.00
Intrinsic Value (Rs.) 857
Upside (%) 13%
Note: CMP as on closing of 20th January, 2016.

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While management’s efforts such as improving distribution network, consistent product launches and strong brand
building exercises are expected to benefit ZWL over the longer term, the company could see significant headwinds
over the near term due to increasing competitive intensity, continuous ramp up in A&P spends and low category
growth. Hence, we do not expect any significant margin expansion for the company over FY15-18E. We forecast base
case EPS at ~Rs. 30 in FY16E, ~Rs. 35 in FY17E and ~Rs. 38 in FY18E. The stock currently trades at ~25xs
FY16E EPS, ~22xs FY17E EPS and ~20xs FY18E EPS.

The product categories – especially sugar substitute and margarine, are as yet under-penetrated in India which is
expected to result in robust top-line growth for those categories over the longer term. However, EverYuth and Nutralite
could see rise in competitive intensity in the near term. We arrive at Intrinsic Value of Equity estimate of ~Rs. 860/-
valuing the business at 25xs FY17E EPS. This implies potential upside of less than 15% over next 12 – 18 months.
Given the headwinds that the company is expected to face over the near term, we do not see scope for any PE
multiple re-rating, hence we have retained current PE multiple.

Recommendation scale:

ZYDUS WELLNESS – Sell - 2

Potential Upside Range Recommendation Rating Rationale for the Recommendation Mode of Action
over next 12-18 months
Strong Buy 5 Implies very strong and reliable management track record, Fresh buying strongly
> 50%
extremely robust financials & very strong business outlook recommended
Buy 4 Implies strong management track record, robust financials Fresh buying recommended
30% - 50%
and fairly strong business outlook
Hold 3 Decent Management track record, stable (though not very Hold the stock if it is already
20% - 30% strong) business outlook and moderate financials present in your portfolio but do not
initiate fresh buying
Sell 2 Mixed management track record,unstable business outlook May consider selling and replacing
0% - 20%
and stable (though not very strong) financials with a better recommendation
Less than 0% (downside Completely Avoid 1 Mixed management track record, weak business outlook Selling strongly recommended
expected) and poor financials

Key Market Data Table

Close of 20th January, 2016
Bloomberg Code
Last Price, M. Cap, 52w H/L
Shares outstanding, Face Value
Promoter holding (as on 30th September, 2015)
Institutional holding (as on 30th September, 2015)
Marquee Investors (as on 30th September, 2015)
ZYWL IN
Rs.757.70/- (BSE) – Rs. 29bn/ USD 425mn Rs. 1,130.30/734.85
26.25 mn , Rs. 2/-
Promoter holding at 72.54% (Nil share pledge). Holding unchanged as on 30th September,
2014 and 30th June, 2015.
FII –7.53% (vs 8.59% as on 30th September, 2014 and 8.07% as on 30th June, 2015).
DII – 5.32% (vs 6.62% as on 30th September, 2014 and 5.32% as on 30th June, 2015)
LIC (3.54%), Matthews India Fund (4.28%) and Baring India Pvt Equity Fund (1.66%)

Zydus Wellness Limited - Daily Price Chart for 3 years (BSE)

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