Cox & Kings – BUY- High debt depresses earnings::IIFL

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Cox & Kings – BUY
High debt depresses earnings


Cox & Kings reported adjusted earnings growth of 15% YoY in
2QFY11, supported by 32% YoY growth in EBITDA. PAT was below
our estimate, mainly because interest costs spiked on account of the
80% growth in debt since Mar-10 (likely raised to support future
acquisitions). Revenue growth and margins remain well in line with
our expectation, but we are concerned by the hike in debt, well ahead
of any acquisition announcements. We therefore downgrade our
FY11-12 EPS estimates by ~11% to account for the higher interest
cost and the equity dilution following the GDR issuance.


Margins on track: Cox & Kings’s EBITDA margin expansion of 140bps
YoY during 2QFY11 was substantially driven by: 1) lean advertising
expenses (which remained flat YoY); and 2) significant control over
overheads. Staff costs alone rose ahead of topline growth, as the
company took salary hikes after more than a year of flat salaries, keeping
with the improvement in the demand environment. Revenue growth of
28% YoY during the quarter was contributed by equally robust
performance by India and overseas subsidiaries (both registered ~28%
YoY revenue growth).

High debt to fund acquisitions reflected by the balance sheet: The
half-yearly balance sheet indicates that working capital largely remained
under control (net working capital as % of sales flat YoY), which should
assuage some of the investors’ concerns on spiralling working-capital
requirements. Debt levels, however, have risen by ~Rs4bn since Mar-10,
which we believe is substantially on account of long-term debt to support
future acquisition plans of the company. Most of this increase in debt is
reflected in a commensurate increase in cash and investments.

Downgrade earnings due to equity dilution: We downgrade our FY11-
12 earnings estimate by ~11%, of which 3% is due to higher interest cost
burden, and ~8% is due to equity dilution following GDR issuance. That
said, operating earnings should remain intact. The capital infusion will
likely keep return ratios depressed, until the company makes a
reasonable-sized acquisition. This will remain an overhang on the stock in
the near term.