Emami-Strong quarter but margin pressure unlikely to ease – SELL: Religare

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Emami Ltd
Strong quarter but margin pressure unlikely to ease – SELL

Emami has reported Q2FY11 sales/EBITDA/PAT growth of 26%/10%/38%
YoY, which is above our estimates of 20%/4%/16%. The net sales growth of
26% YoY was volume driven to the extent of 22–23%, with the balance 3–4%
being on account of pricing. Gross margins continued to be under pressure,
declining by 560bps YoY due to high menthol and LLP prices. PAT rose 37.6%
YoY, buoyed by one-off forex gains. We expect Emami to witness continued
margin pressures over H2FY11, even though the company plans a 2–3% price
hike in November. We maintain our SELL rating on the stock and roll forward
our valuations to September ’12 earnings. This gives us a revised price target of
Rs 450 (from Rs 415 previously).

Net sales growth of 26% YoY largely led by volumes: Emami’s net sales for
Q2FY11 grew by 26.2% YoY to Rs 2.7bn, 5% above our estimates. The growth
was led largely by volumes (22–23%) with a minimal contribution from pricing
(3–4%). Most of the brands have performed well during the quarter. The
company is contemplating a further price increase of 2–3% in November to
counter the impact of cost inflation in its key input commodities.

Margins hit by inflation in key inputs: EBITDA increased 9.8% YoY to Rs 575mn,
with a 315bps decline in operating margin to 21.1% solely on account of steep
gross margin contraction of 560bps YoY. Prices of key input commodities like
menthol and LLP have increased by more than 30% YoY and remain high going
into Q3FY11. Emami’s raw material cost index has risen by 12% YoY for the
quarter and we expect gross margins to remain under pressure in H2FY11 despite
a likely price hike by the company in November. Emami has managed to counter
the decline in gross margins to some extent by paring other expenses by 170bps
YoY (to 16.3% of sales) during the quarter. Employee costs also declined by
50bps YoY to 6.3% of sales while A&P expenses dipped 20bps to 17.9%.
One-off forex gains push up PAT: PAT registered a robust growth of 37.6% YoY
to Rs 535mn, largely driven by a 10-fold increase in other income to Rs 59mn,
that was entirely led by forex gains. Higher other income and a lower tax rate of
14.6% led to above-estimated PAT for the company.

Maintain SELL with revised price target of Rs 450: We have marginally raised
our earnings estimates for Emami by 2.1% and 1.7% in FY11 and FY12
respectively and have also rolled forward our valuations from March ’12 to
September ’12 earnings. This gives us a revised September ’11 price target of
Rs 450 on the stock. We maintain SELL based on rich valuations.