Jyothy Laboratories Initiation Jun 7breport.myiris.com/MAPESPL/JYOLABOR_20110607.pdf ·...
Transcript of Jyothy Laboratories Initiation Jun 7breport.myiris.com/MAPESPL/JYOLABOR_20110607.pdf ·...
JYOTHY LABORATORIES
Mr. White buys Mr. White
June 7, 2011
Laxmi Deepak, CFA
+91.22.6154.4593
BBG code : JYL IN
Market Data
Rating BUY
Price (6 Jun'11) (INR) 205.9
52 Week Range (INR) 322.8/ 174.8
TP – Mar’13 (INR) 300
O/S Shares (Mn) 80.6
Mkt Cap (INR Mn) 16,602
Mkt Cap (US$ Mn) 371
Daily average volume 183,748
Share Holding Pattern : 31-Mar-2011
Promoter and Promoter
Group
63.16%
FII 15.59%
DII 15.13%
Non-Institutions 6.12%
Relative performance to Sensex
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publicly available information and is not an investment advice. Page 1
Attractive Entry Point for Transformation Story
We initiate coverage of Jyothy Laboratories (“Jyothy”) with a BUY rating. Our March
2013 price target of INR 300 implies 45% return over the next 22 months. Following the
sharp sell-off in the last couple of months due to weak results over the recent quarters
and skepticism regarding the Henkel India acquisition, Jyothy currently trades on a
FY2013E PEG ratio of 0.8 (versus the peer group average of 1.3), on our numbers.
Dependence on Ujala Supreme to come down, Detergents and Dishwash hold the
key. Post the acquisition of Henkel India, we believe Jyothy’s dependence on its
flagship product Ujala Supreme, which dominates a category that is in structural long
term decline, will come down from 31.1% in FY2011 to 18.4% in FY2012E. As a result,
the overall growth profile is likely to improve as we expect Jyothy to drive penetration
and distribution-led growth in detergents and dishwash.
Building blocks in place for a bullish long term thesis. Significantly higher growth and
profitability in a revitalised Henkel India business coupled with continued growth at
Jyothy’s detergent and dishwash brands drives our very conservative price target of
INR 300. Over the last two quarters, the rollback of trade margins for Maxo has driven
a deceleration in volume and a higher advertising spend behind the national rollout of
the detergent brands has resulted in a contraction in operating margins. Further,
investors have not been convinced regarding the suitability of the acquisition of Henkel
India. All these factors have resulted in the share price falling 23.7% YTD compared to
the 10.2% decline in the broader market Sensex and a gain of 4.8% in the FMCG index.
But we believe sentiment could be near a bottom, as the decline in volume growth at
Maxo should moderate and the increased advertising spending will start to result in
detergents gaining traction with increasing volumes in FY2012. So while the market
concerns should be taken seriously, it seems from here that more might go right than
go wrong as we move through FY2012.
We believe the concerns of investors regarding the ability of Jyothy to turnaround the
Henkel India business, while legitimate and well founded, are perhaps running ahead of
the real near and long-term risks, as we show in our analysis in this report.
Transformation drives visible and achievable EPS growth. Jyothy has undergone a
major corporate transformation with its acquisition of Henkel India to become one of
India’s leading FMCG companies. The merger with Henkel India gives Jyothy a portfolio
of well recognised brands like Henko, Mr. White, Fa, Pril, Margo and Neem, entry to
the personal care segment and immediate scale compared to its current operations in
the detergent segment. We project 50% EPS CAGR in FY2012-15E fuelled by: (a) strong
organic revenue growth in both the Jyothy and Henkel India businesses and (b)
substantial margin expansion on the back of cost synergies at Henkel India. We expect
the robust earnings growth to support the re-rating of the stock into FY2012 and
FY2013.
Risks. Integration of the Henkel India acquisition remains a key monitorable.
Initiating Coverage
Securities Private Limited
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Jyothy Laboratories
Sensex index
FY2012E FY2013E FY2014E FY2015E
Revenue 11,289 13,785 16,345 19,171
growth (%) 8.4% 22.1% 18.6% 17.3%
EBITDA 860 1,615 2,134 2,640
margin (%) 7.6% 11.7% 13.1% 13.8%
EPS 6.41 13.05 17.51 21.61
PER (x) 46.8 23.0 17.1 13.9
Page 2
© MAPE Securities Private Limited. For private circulation only. Please read important disclaimers on the last page. This document has been prepared from
publicly available information and is not an investment advice.
FMCG MAPE Securities Private Limited
We initiate coverage of Jyothy Laboratories with a BUY rating. Jyothy has undergone a major
transformation with its acquisition of Henkel India to become one of India’s leading FMCG
companies. It has expanded its presence in the fabric care and dishwash segments and gained
entry to the personal care segment after its acquisition of Henkel India.
Exhibit 1: Product basket post acquisition
Source: Company
We think that the recent sell-off provides an attractive entry point for the stock, which trades
on a FY2013E PEG ratio of 0.8, well below its peer group average of 1.3, on our numbers. We
believe Jyothy offers highly achievable and visible EPS growth over the next three years. The
key EPS drivers are:
• Strong revenue growth (19.3% CAGR in FY2012-15E) fuelled by a) organic growth in the
dish wash and the detergent segments, which are benefiting from national rollout of the
Exo and Ujala Technobright brands respectively b) acceleration of the Henkel India
business driven by new management
• Significant EBITDA margin expansion (615 bps in FY2012-15E) driven by cost synergies
between Henkel India and Jyothy businesses that look achievable to us
We see two main risks to our investment thesis …
• a mature detergent market where growth is modest and competition is intense; and
• integration risks associated with any large merger.
… but the risk-reward trade-off looks highly favourable
Our base case fair value of INR 300 implies 45% upside potential from current levels and
assumes more conservative long-term growth rates and margins relative to management
guidance.
FabricCare MosquitoRepellent DishwashingProducts Personal Care
Product Basket post Acquisi on
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MAPE Securities Private Limited Jyothy Laboratories
Exhibit 2: Company guidance versus our assumptions for Henkel India
FY2013E FY2014E FY2015E
COMPANY GUIDANCE
Sales Growth (%) 47.1% 40.0% 43.0%
EBITDA Margin (%) 10.0% 12.0% 14.0%
Adv/Sales (%) 16.0% 14.0% 12.0%
OUR ASSUMPTIONS
Sales Growth (%) 22.0% 22.3% 15.7%
EBITDA Margin (%) 2.3% 6.0% 6.8%
Adv/Sales (%) 16.0% 16.0% 16.0% Source: Company, MAPE Securities Estimates
Page 4
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publicly available information and is not an investment advice.
FMCG MAPE Securities Private Limited
Jyothy’s acquisition of Henkel India
Acquisition details
On May 6, 2011 Jyothy announced that it had successfully acquired a majority stake in Henkel
India. The acquisition will catapult Jyothy Laboratories into one of the leading FMCG
companies in India. Jyothy currently controls 65.87% of Henkel India and has launched a
mandatory open offer for an additional 20%. Jyothy will pay INR 3,308 million to acquire the
85.87% stake in Henkel India. In addition, Jyothy bought Henkel AG’s outstanding preference
shares for a cash consideration of INR 439 million. The implied Enterprise value works out to
INR 8,042 million as Jyothy has also taken over the debt of INR 4,296 million on Henkel India’s
balance sheet. The implied EV/Sales multiple for the deal is 2x based on Henkel India’s FY2010
revenue. We believe the acquisition of Henkel India by Jyothy has a strong strategic rationale
and leaves room for relevant value creation opportunities.
Our view
In our view Henkel India is a good fit for Jyothy and our analysis suggests that a merger is
appealing on several fronts. While we highlight the benefits below we discuss the details in the
following section:
• The acquisition scales up Jyothy to one of the leading FMCG companies in India with
consolidated proforma FY2011E revenue of INR 10,412 million compared to a standalone
revenue of INR 6,195 million
• The acquisition helps Jyothy pave the way for a more balanced revenue stream by
significantly enlarging the portfolio of products and reduce its exposure to Ujala Supreme.
In our estimates, Jyothy’s exposure to Ujala Supreme would reduce to 18.4% of
consolidated revenues in FY2012E versus 31.1% of standalone revenues in FY2011E
• Value creation through both revenue and cost synergies. We believe the acquisition will
create significant value given the existence of revenue and cost synergies
Consolidated Financials
Jyothy has raised short term debt of INR 6,000 million to fund the acquisition. We have
considered two scenarios in our analysis:
• Scenario 1: This assumes Jyothy funds the acquisition of Henkel India with debt of INR
6,000 million
• Scenario 2: This assumes Jyothy dilutes 15% of its equity at INR 300 per share and uses the
proceeds to repay the debt raised to finance the acquisition of Henkel India
We assign a high probability that Scenario 2 is the likely outcome in FY2012 and our estimates
are predicated on Jyothy raising fresh equity from a private equity placement and returning to
a debt free status.
In this report we have consolidated Jyothy and Henkel India from FY2012E. The combined
entity should generate:
• Revenue - we estimate INR 11,289 million of revenue in FY2012E, of which INR 7,609
million is from Jyothy and INR 3,679 million is from Henkel India. We estimate the
consolidated revenue will be boosted by the turnaround in the Henkel business from
FY2013 onwards.
• EBITDA - we estimate INR 860 million of EBITDA in FY2012E, of which INR 1,099 million is
from Jyothy while Henkel India would contribute a loss of INR 240 million. For the
following years we expect EBITDA to grow much faster than revenue supported by the
benefits flowing through from synergies.
• Net debt - According to our estimates, the consolidated entity will continue to have a
healthy balance sheet in FY2012E with a net cash position of INR 1,582 million.
We opine that the acquisition will be EPS dilutive in the near term as Jyothy makes the
necessary investments to grow the Henkel India business. We note however, that longer term
the incremental earnings potential from this acquisition should be significant once Henkel India
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MAPE Securities Private Limited Jyothy Laboratories
is fully integrated and Jyothy has more time to leverage a larger platform with a more diverse
product offering. Based on our pro forma forecasts, the FY2012E and FY2013E EPS will drop by
49.6% and 16.1% compared to our standalone forecasts but from FY2014E onwards the
acquisition will be increasingly EPS enhancing with an EPS uplift of 9.1% in FY2014E and 13.3%
in FY2015E.
Exhibit 3: Near term dilution but significant long term accretion
INR FY2012E FY2013E FY2014E FY2015E
Standalone EPS 12.72 15.56 16.05 19.08
Consolidated EPS - Scenario 1 3.19 10.48 15.78 20.64
Accretion/Dilution -74.9% -32.7% -1.7% 8.2%
Consolidated EPS - Scenario 2 6.41 13.05 17.51 21.61
Accretion/Dilution -49.6% -16.1% 9.1% 13.3% Source: MAPE Securities Estimates
Page 6
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publicly available information and is not an investment advice.
FMCG MAPE Securities Private Limited
Why Henkel India and Why Now?
Revenue diversified from dependence on Ujala Supreme fabric whitener
Jyothy’s flagship product Ujala Supreme is dominant in the liquid whitener market with a ~72%
market share by value. However, the fabric whitener segment is in structural decline and
Jyothy has been trying to diversify its revenue to reduce its dependence on one single product.
While Jyothy has been attempting to diversify into new product categories by piggybacking on
the Ujala brand name, we believe the brand was getting stretched and in the long term the
brand equity would have suffered. Jyothy extended the Ujala brand into detergents and
entered the Mosquito repellant and dishwash markets through the Maxo and Exo brands. This
has resulted in a decline in contribution from Ujala Supreme but it still contributes 31.1% of
total revenue in FY2011E.
Henkel India’s brand portfolio includes Henko and Mr White in detergents, Pril liquid dishwash,
Margo soap, Fa deodorants, Neem toothpaste and Bref surface cleaners. Jyothy has been
interested in acquiring the Henkel India business for a long time in order to acquire this
bouquet of brands to hasten the process of reducing its dependence on Ujala Supreme. The
biggest standout for Henkel India was that its product offering was the closest in nature to
those of Jyothy and it represented the most natural fit for Jyothy. From a commercial
standpoint, we believe that the transaction will enable Jyothy to reduce its dependence on
Ujala Supreme (Exhibit 4) while complementing the other products offered by Jyothy, namely
detergents (Ujala Supreme and Ujala Technobright), dishwash (Exo) and personal care (Jeeva).
Also, the Henko, Fa and Pril brands are players in the premium segment and are well-
positioned in the context of the ongoing consumer shift towards premium brands.
Exhibit 4: Contribution of Ujala Supreme to total revenue falling
30.6% 31.1%
18.4%16.5%
15.1%14.1%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
FY2010 FY2011E FY2012E FY2013E FY2014E FY2015E
Source: Company, MAPE Securities Estimates
Enhanced distribution network
Jyothy has one of the most extensive distribution networks among Indian FMCG companies
with a total reach of 2.9 million outlets through 3500 distributors. However its reach in the fast
growing modern retail channel is limited and modern trade accounts for only 2% of its
revenue. Henkel India on the other hand has only 750 distributors and a total reach of 750,000
outlets but is extremely strong in the CSD and modern trade formats which account for 33% of
its total revenue. Henkel India's predominantly urban presence (70% of sales) neatly
complements Jyothy Lab's semi urban and rural strengths (70% of sales). The Henkel India
acquisition gives Jyothy access to the modern trade distribution network and will also enhance
its skills in marketing and management of modern trade channels, which is relevant in a
changing Indian retail environment. On the other hand the acquisition provides an opportunity
for Henkel India to gain exposure to the large rural and semi-urban market through the
distribution network of Jyothy. Distribution is always a key for success in the FMCG sector and
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MAPE Securities Private Limited Jyothy Laboratories
with Henkel India's distribution network being complementary to Jyothy's own network, the
combined distribution can be leveraged to vend existing brands to new consumers. While the
considerable scope for cross selling opportunities will have a positive impact on sales growth,
we have not explicitly built in any revenue synergies into our estimates, leaving room for
upside to our estimates.
Opportunity to benefit from the turnaround in the business
Another fact that attracted Jyothy to Henkel India was the potential to engineer a turnaround
and reap the benefits. The Henkel India business has been making operational losses since
FY2004 despite revenue growth in the range of 15% per annum and gross margins in the low
30’s. In fact, in 2005 Jyothy and Henkel AG came close to finalising a merger of Henkel India
and Jyothy but the deal fell apart over disagreement about majority control of the combined
entity. However, by 2010 Henkel AG seems to have given up hope that it would be able to
affect a turnaround in the Henkel India business on its own and elected to cut its losses by
selling out.
Substantial merger synergies should significantly accelerate EPS growth
Raw material procurement. Henkel India currently sources the main raw material linear alkyl
benzene (LAB) exclusively from Tamilnadu Petroproducts, who was the JV partner in the
business along with Henkel AG. Prior to the acquisition of Henkel India by Jyothy this exclusive
contract has been terminated and Jyothy will now be able to procure its LAB requirements
from its current suppliers at a much more favorable rate. Jyothy will also benefit in
negotiations with its current suppliers due to the larger scale of the combined entity. The
combined savings from the new sourcing arrangements is expected to be around 2% as per
management guidance. Jyothy uses the same suppliers as its competitors and we believe these
suppliers will not have any capacity constraints to cater to Jyothy’s additional requirements.
Optimisation of manufacturing. Henkel India outsources almost 80% of its production to third
party manufacturers in line with its business strategy of concentrating on marketing and
distribution activities. On the other hand Jyothy prefers to manufacture its products in its “in
house” manufacturing facilities. Post the acquisition Jyothy intends to move Henkel India’s
outsourced production in house leading to a 2 – 4% savings in manufacturing costs. Jyothy
expects to benefit from the savings on an immediate basis without any additional investment.
We believe apart from the production of Fa, which will continue to be the responsibility of
Henkel AG, Jyothy has the spare capacity and the technical knowhow to easily transfer the
production to its own facilities. Jyothy has confidence in its ability to reduce manufacturing
costs as a result of a detailed review the company undertook prior to the acquisition to
benchmark the manufacturing costs of Henkel India’s products at its facilities compared to the
current structure.
Jyothy has stated that it will be able to increase Henkel India gross margins from 32% to 36 –
38% in FY2013E post the changes to the manufacturing and supplier setup. Sustainable gross
margins for the Henkel India business post FY2013 is likely to be in the range of 38 – 40%.
Loss carry forwards. Jyothy’s unit in Uttaranchal enjoys tax exemption status till FY2013
enabling Jyothy to pay only the Minimum Alternate Tax. Once the merger with Henkel India is
complete in the next 6 – 9 months, Jyothy will receive a tax shelter from Henkel India's INR
5,000 million accumulated losses. Jyothy will benefit to the extent of INR 1,500 million and will
be able to extend its tax breaks beyond FY2013.
We also believe that the following additional synergies could be extracted:
• Cost reduction savings from overheads optimisation as Jyothy runs a much leaner business
compared to Henkel India
• Rightsizing the workforce at Henkel India by retaining only the top performers
Page 8
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publicly available information and is not an investment advice.
FMCG MAPE Securities Private Limited
A look at the issues of the day
In our view, there are six key concerns among investors regarding the acquisition of Henkel
India.
#1: Lackluster revenue growth in the Henkel India business
In Henkel India’s most recent FY2010 (December Year ending) results, sales were lower by
9.9% and a loss was recorded at the EBIT and EBITDA level. The deceleration was evident
across product categories with the Detergents & Cleaners segment and the Cosmetics segment
revenue down by 10.1% and 9.3% respectively while the EBIT margins contracted by 420 bps
and 289 bps respectively.
Henkel India has been unable to grow its top line at a sustained rate as shown in Exhibit 4.
Exhibit 5: Henkel India revenue trends
FY2007 FY2008 FY2009 FY2010 FY2011
Revenue growth 13.5% 15.6% 12.8% 9.7% -9.9% Source: Company
We believe that there were a few fundamental reasons for the below par performance:
• Within the global footprint of Henkel AG, the Indian business represented a very small
portion (~0.6% of total global turnover in FY2010), which resulted in inadequate attention
from the German parent towards the Indian subsidiary
• The budgets and marketing strategy for each product line were driven by the global
headquarters of Henkel AG in Germany with limited input from the team in India
• There was significant churn among the coordinators appointed by Henkel AG for the India
business which resulted in a disruption to the business strategy at periodic intervals
• There was a reluctance to invest behind the brands and on expanding the distribution
network which resulted in a lack of momentum for the business
• In our view, Henkel India adopted a flawed marketing strategy by depending on a
promotions led push strategy to drive sales instead of investing behind the brands through
advertising campaigns to ensure a pull from the consumer end
We believe the Jyothy has the expertise and the right strategy to dramatically alter the
performance at Henkel India due to the following:
• Focused attention on the business as ensuring the success of the acquisition will be of top
priority to management
• Marketing and product positioning strategy to be driven by Jyothy management who have
extensive insights into the behaviour of Indian consumers and the requirements for
brands to succeed in the Indian market place
• Ability to pursue a long term strategy with stable management in place
• Strong distribution network already in place with access to 2.5 million outlets
• A willingness to invest behind the brands with management indicating that they will spend
16% of sales on advertising at Henkel India compared to Jyothy’s current spend of 8% and
an industry average of 8 – 12%
• Significant reduction in the promotions strategy of Henkel India in order to ensure the
premium positioning of the brands among consumers
In our view if volumes are declining for any prolonged period of time, there is clearly
something wrong with the consumer proposition. If fewer consumers are buying the product,
that means either the brand equity is too low, pricing too high or the quality of product isn’t
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MAPE Securities Private Limited Jyothy Laboratories
good enough. In Henkel India’s case we believe the product quality is comparable, if not better,
than competitor products and while there are issues with sub-optimal pricing, the low brand
equity for the various products is the primary reason for the subdued performance. We believe
that the willingness of Jyothy’s management to invest on reviving the brand equities will result
in short term pressure on margins but will pay off in the long term with a healthier and
sustainable business.
#2: Competitive intensity in the detergent segment
The INR 80 billion detergent powder segment is broken down into 3 tiers: the mass tier (80% of
overall volume, 60% of overall value), mid tier (12% volume share, 20% value share) and
premium (8% volume share, 20% value share).
The top three players in each tier are shown below:
Exhibit 6: Top players in the detergent segments
Tier Price range (INR/kg) Value Market Share
Wheel (18.3%)
Ghari (16.9%)
Nirma (7.2%)
Tide (9.8%)
Rin (5.3%)
Sunlight (2.4%)
Surf (11.5%)
Ariel (6.1%)
Henko (1%)
Mass 30 – 35
Mid 65 – 75
Premium 140 - 160
Source: MAPE Securities Estimates
The consolidated entity will be the fifth biggest player in the detergent powder segment
behind Hindustan Unilever, Ghari, Nirma and Procter & Gamble. In our view the established
players are unlikely to change their strategies due to the combination of the Henkel business
with the Jyothy business as Jyothy intends to be a rational player focusing on value share with
no intention to disrupt the market.
We believe the focus of all the major players would be to gain share from the smaller and
regional brands instead of competing amongst themselves. The wildcard among the major
players in the segment is Procter & Gamble who could intensify its focus on gaining volume
share at the expense of margins forcing all competitors to follow suit. We believe that this
scenario is quite unlikely in the future as margins for all competitors have fallen drastically
from historical levels reducing the flexibility to pursue a volume only strategy. We note that
following price cuts in early 2010, Hindustan Unilever hiked Rin prices by 8% while Procter &
Gamble indirectly hiked prices of Tide by 12% in September 2010 in order to protect margins in
the face of rising input costs. Also in a change of strategy under the new Unilever Global CEO
Paul Polman, Hindustan Unilever has decided to focus on maintaining volume share
irrespective of the impact on its margins in case a price war breaks out. The new strategy
reduces the incentive for Procter & Gamble to cut prices to gain market share unlike in earlier
years when it was able to gain market share while Hindustan Unilever concentrated on
maintaining margins.
In the detergent market the mass tier has the maximum competitive intensity due to the
presence of a large number of local players who are price warriors. Jyothy’s exposure do this
segment is through the Chek brand, which we estimate will contribute only 5.9% of Jyothy’s
total detergent revenue in FY2015E. As such, while Jyothy would still have to negotiate a very
competitive environment we believe it will avoid the brunt of the competition by focusing on
the mid-tier and premium segments.
Page 10
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publicly available information and is not an investment advice.
FMCG MAPE Securities Private Limited
We have assumed conservative growth rates for the detergent business and the success of the
acquisition will not be contingent on a rapid increase in market share. We estimate Jyothy will
be able to increase its market share in the detergent segment from 3.6% currently to 4.0% by
FY2015E.
Exhibit 7: Detergent Revenue by Brand
Brand
Revenue
(FY2011E)
(INR mn)
Value Share of
detergents
(FY2011E)
Revenue
(FY2015E)
(INR mn)
Value Share of
detergents
(FY2015E)Henko 1,317 1.60% 1,878 1.50%
Ujala Detergent 722 0.90% 1,497 1.20%
Mr. White 516 0.60% 788 0.60%
Chek 206 0.30% 333 0.30%
Ujala Techno Bright 150 0.20% 497 0.40%
Combined Total 2,911 3.60% 4,993 4.00%
Source: MAPE Securities Estimates
We estimate the Henkel India detergent revenue declined by a substantial 24.7% in FY2011.
The primary reason we believe was the failure of Henkel India to reach out to consumers in the
midst of a price war in the detergent market. The price war began after the entry of Procter &
Gamble into the mass market with its Tide Naturals brand in December 2009. Hindustan
Unilever responded with price cuts across its Rin and Surf Excel brands by 15-30% while
Procter & Gamble cut prices by 12-20% across Tide, Tide Naturals and Ariel. While Henkel India
responded with price cuts of its own, its total advertising spend dramatically declined from INR
573 million to INR 266 million in FY2010. In contrast Hindustan Unilever and Procter & Gamble
followed up the price cuts with aggressive advertising campaigns to battle for mindshare
among consumers. We believe the decision of Henkel AG to exit the India business is also
partly responsible for the dramatic decline due to a reduced focus on the business by the
German parent and management inertia at the Indian business.
We forecast a further decline in revenue of 10.2% in FY2012E while the merger with Jyothy is
in process. However, to put our medium term estimates for the Henkel India detergent
business into context we believe we should compare our forecasts with the revenue Henkel
India managed to achieve in FY2010. We believe FY2010 was the last year when the Henkel
India business was running under a business as usual scenario and the revenue generated
could be a sustainable base for the business over the long term. Jyothy has targeted achieving
the FY2010 revenue in FY2013 but we have been conservative and forecast that Jyothy would
be able to get to the FY2010 level only in FY2015.
Exhibit 8: Forecast revenue growth of Henkel India detergent brands
(INR mn) FY2010 FY2011E FY2012E FY2015E 3 yr CAGR 4 yr CAGR 5 yr CAGR
Henko 1,656 1,317 1,186 1,878 16.6% 9.3% 2.5%
Mr. White 722 516 439 788 21.6% 11.2% 1.8%
Chek 401 206 185 333 21.6% 12.8% -3.6%
Total 2,779 2,040 1,810 3,000 18.3% 10.1% 1.5% Source: Company, MAPE Securities Estimates
#3: Need for huge advertising budget to revive demand for Henkel brands
FMCG companies account for their revenue net of trade discounts, rebates, sales taxes and
excise duties. However Henkel India accounts for the cost of the company's products given free
as incentive with the sales of various other products under marketing expenses instead of
netting out revenue. On our estimates Henkel India had a marketing budget of INR 1,281
million in FY2011. Due to Henkel India’s strategy of using a very high level of promotions to
ensure volume takeoff, 80% of the marketing budget is accounted for by promotional spend
leaving an advertisement budget of only INR 266 million. On a like for like comparison with
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MAPE Securities Private Limited Jyothy Laboratories
other FMCG companies the estimated advertising spend works out to only 6.3% of total
revenue. This compares unfavorably with peers which spend 10 – 12% of their revenue on
advertising.
The lack of advertising spend by Henkel India has resulted in low brand equity for its products
among consumers. In order to enhance consumer perception and recall of the Henkel product
portfolio, Jyothy will change the mix of the marketing budget to focus primarily on advertising.
While we expect that a reduction in promotions could negatively affect volumes and revenue
in the short term, the new strategy will enable Jyothy to spend 16% of Henkel India’s revenue
as advertising expenditure despite a reduction in overall marketing spend.
Exhibit 9: Marketing expense forecasts for Henkel India
(INR mn) FY2011 FY2012E FY2013E FY2014E FY2015E
Reported marketing expenses 1,388 589 718 879 1,016
Promotional expenses 1,122 0 0 0 0
Advertising expenses 266 589 718 879 1,016
as % of sales 6.3% 16.0% 16.0% 16.0% 16.0% Source: Company, MAPE Securities Estimates
Over the medium and long term we believe consumers will adapt to the withdrawal of the
perennial promotions on the Henkel products and Jyothy will be able to drive volume growth
as a result of the enhanced brand equity from well funded advertising campaigns.
#4: Control of the international brands Pril and Fa
As part of the acquisition Jyothy gets the ownership rights to all the Henkel brands, except Pril
and Fa, for India, Bangladesh and Sri Lanka. The international brands, Pril and Fa, will be
licensed to Jyothy in return for a 2% royalty payment under a contract with Henkel AG that is
renewable every 5 years. In case Henkel AG decides not to renew the contract after 5 years it
will have to compensate Jyothy at an independently arrived amount.
Jyothy is mandated to follow Henkel AG’s global strategy regarding brand building, quality and
design for the international brands. Jyothy also get the rights to Henkel AG's future launches
under these brands and the option to introduce new products from the brands’ current
portfolio into India. We do not foresee any issues with Henkel AG interfering with product
launches by Jyothy in these brands due to the symbiotic nature of the relationship.
We estimate the Fa brand currently generates only INR 221 million in revenue down from
around INR 350 million in FY2009 despite the strong growth in the cosmetics and personal care
segment in India. Jyothy believes that Fa has the potential to become a INR 1000 million brand
within the next 3 – 4 years. The current Fa portfolio in India comprises deodorants, men’s
shaving products and body talc. The global portfolio also encompasses shower gels and liquid/
bar soaps. The Fa range of soaps have a high coconut oil content and we believe that Jyothy
could see significant potential for the range in the Kerala market to begin with due to
abundant supply of coconut oil and consumer preference in the state for coconut and
vegetable oil based soaps like Medimix and Chandrika.
#5: Management
The senior management team at Jyothy consists of Mr. M. P. Ramachandran, Chairman and Mr.
Ullas Kamath, Managing Director. While Mr. Ramachandran founded the company in 1983, Mr.
Kamath has been associated with Jyothy for the last twenty years. We believe that it would be
difficult for the current management team to effectively run an enterprise with a turnover of
INR 12 billion and a multitude of brands in the absence of other supporting senior
professionals. As per our conversations with management they recognise the fact that it
would not be possible for them to oversee the expanded business with the same intensity as
before. We believe Jyothy is actively looking to hire experienced senior managers to bolster
Page 12
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FMCG MAPE Securities Private Limited
the management bandwidth at the company and would view any news in the near term on
recruitment positively.
#6: Need to service the interest costs on debt raised to fund the acquisition
We estimate Jyothy has around INR 3,364 million of cash on its balance sheet at March 2011.
The total cost of acquiring the 85.87% stake in Henkel India works out to INR 7,723 million. To
fund the acquisition Jyothy has raised INR 6,000 through a) non convertible debenture from
Kotak Mahindra Bank for INR 4,500 million and b) working capital loans from various banks for
INR 1,500 million. The non convertible debenture is a zero coupon bond with a tenure of a year,
a 10% rate of interest and an option to be redeemed at a premium every 90 days. The
premium will be payable out of Jyothy’s reserves and will not have an impact on the P&L.
Jyothy plans to dispose unutilised assets primarily in the form of real estate worth INR 1,500 –
2,000 million to reduce the debt burden to INR 2,000 – 3,000 million within the next 3 to 6
months. Reaching this disposal target would require a sale of the Karaikal manufacturing
facility of Henkel India. We assign a low probability that the facility can be sold in the near term.
However we believe Jyothy Laboratories can dispose the real estate assets in Ambattur
(suburb of Chennai) and Bhubaneshwar in relatively quick time for a combined value of INR
600 million and have assumed the same in our estimates.
While companies like Godrej Consumer Products, Emami, Nirma and Wipro Consumer Care
had expressed interest in some of Henkel India’s brands during the sale process, Jyothy does
not intend to sell any of the brands it has acquired in order to reduce the debt burden.
In view of uncertainty regarding the funding strategy for the Henkel India acquisition, we have
detailed two scenarios in our financial analysis in Page 14 - debt of 100% and equity dilution of
15% with no debt. We believe that Jyothy’s management has always been conservative and
debt-averse so we assign a high probability that the short term debt will be retired post equity
dilution. Irrespective of the choice of funding we believe the debt levels will be comfortable
compared to the cashflow generation and will not strain the P&L or the balance sheet.
Exhibit 10: Key metrics under debt funding scenario
(INR mn) FY2012E FY2013E FY2014E FY2015E
Cash Flow before Financing (1,614) 368 825 1,258
Capital Inc./Dec. 0 0 0 0
Change in Debt 1,470 (3,000) (1,000) (1,000)
Cash Flow after Financing (144) (2,632) (175) 258
Net Cash/(Net Debt) (3,732) (3,364) (2,539) (1,281)
Net Interest (485) (396) (310) (189)
Net Debt to EBITDA (x) (4.34) (2.08) (1.19) (0.49)
EBIT/Interest (x) (1.38) (3.60) (6.26) (12.92) Source: MAPE Securities Estimates
Exhibit 11: Key metrics under equity dilution scenario
(INR mn) FY2012E FY2013E FY2014E FY2015E
Cash Flow before Financing (931) 1,134 1,607 2,097
Capital Inc./Dec. 3,628 0 0 0
Change in Debt 1,470 (6,000) 0 0
Cash Flow after Financing 3,779 (5,300) 992 1,372
Net Cash/(Net Debt) 191 892 1,884 3,256
Net Interest (105) 71 151 247
Net Debt to EBITDA (x) 0.22 0.55 0.88 1.23
EBIT/Interest (x) (6.39) 19.96 12.87 9.90 Source: MAPE Securities Estimates
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MAPE Securities Private Limited Jyothy Laboratories
Private Equity
The Indian FMCG industry is over INR 1,300 billion in size and accounts for 2.2% of the Indian
GDP. The industry has tripled in size over the last 10 years, growing much faster than in past
decades. Over the next decade robust GDP growth, opening up of rural markets, increased
income in rural areas, growing urbanisation along with evolving consumer lifestyles and buying
behaviours are expected to continue to impact the industry positively. Booz & Company
believes that the FMCG industry will grow at a base rate of at least 12% annually to become an
INR 4,000 billion industry by 2020. Additionally, if policy and supply constraints are eased, Booz
& Company forecasts 17% growth over the next decade, leading to an overall industry size of
INR 6,200 billion by 2020. (FMCG Roadmap to 2010, Booz & Co & CII)
This rising demand for FMCG products in India has led to heightened levels of interest from
private equity players in the sector. Besides, private equity interest in the sector has revved up
after Actis made a good return on its investment in Paras Pharma. Reckitt Benckiser acquired
Paras Pharma for INR 32,600 million in December 2010 valuing Actis’ 63% stake at INR 20,538
million. Actis had invested approximately INR 6,690 million to obtain its 63% stake in Paras
Pharma in 2008 and exited the investment with an annualised return of 42%.
There have been numerous reports in the media mentioning that Jyothy is also in talks with
private equity firms to raise fresh equity to retire the short term debt it raised to fund the
Henkel India acquisition. While Jyothy’s management has indicated that they are not currently
in talks with any PE player we believe that Jyothy could strike a deal within the next 6 months
and return to being a debt free company. Jyothy has had a positive experience with private
equity players as partners. CLSA, Actis and Baring Private Equity Partners were shareholders in
Jyothy in the 2000 – 2007 timeframe. While the private equity players made impressive
returns on their investment, they in turn helped Jyothy improve its internal controls and
management information systems. We believe private equity firms are positive on investing in
Jyothy based on its track record of rewarding investors handsomely. On the other hand, Jyothy
will seek a partnership with a private equity firm not only to pay back the debt but to also gain
strategic and operational expertise.
Exhibit 12: Historical returns of private equity players in Jyothy
Investor
Investment
Date
Amount
(INR mn)
Exit
Date
Amount
(INR mn) CAGR
Barings India Jun-00 159 Nov-03 363 27.3%
Actis (CDC) Nov-03 664 Nov-07 1,220 21.2%
CLSA Nov-03 664 Nov-07 1,220 21.2%
ICICI Jun-06 1,362 Nov-07 1,978 30.1%
Under the terms of the acquisition Henkel AG also has an option to buy up to 26% in Jyothy in
five years, which we believe could pave the way for a decent PE exit.
In August 2010 Jyothy had raised INR 2,279 million through a 10% dilution via a Qualified
Institutional Placement (QIP) process at an issue price of INR 282.62. We believe any private
equity placement that Jyothy finalises will have to take into account the desire of some of the
QIP investors to exit through a simultaneous secondary sale at a reasonable profit. Press
reports have indicated that Jyothy is seeking to sell fresh equity at INR 300 - 330 per share. A
share sale at INR 330 and INR 300 would generate a 17% and 6% return respectively for the
QIP investors. Since the QIP, Jyothy’s share price has fallen 26.4% while the Sensex is up 1.3%
and the FMCG Index is up 16.8%. In case of equity dilution we believe Jyothy will try and
provide returns to its QIP investors comparable to the FMCG Index but we have been
conservative and assumed a share sale at INR 300.
Page 14
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FMCG MAPE Securities Private Limited
Quarterly Update
Jyothy reported its Q4 FY2011 results on May 30, 2011. Net revenue for the quarter was down
18.2% with the Soaps and Detergents segment revenue declining by 6.8% and the Homecare
segment revenue declining by 33.1%.
The renegotiation of the distribution margins has impacted growth adversely due to the low
take off from distributors while the negotiation process is on. We believe while Jyothy works
on aligning the margins it provides to its current distributors and the Henkel India distributors
that it has gained as part of the acquisition sales growth would continue to be hampered.
Jyothy is reducing the margins it pays is distributors to 6% from the 8% level currently while it
plans to increase the margins paid to the Henkel India distributors from 5% to 6%.
The renegotiation of distribution margins has come as a surprise as we did not expect Jyothy to
have initiated the process before the confirmation of the acquisition of Henkel India. The
proactive strategy has led to inventory de-stocking at the distributor’s end. Super stockists
carry roughly 25 - 30 days of inventory, which Jyothy has tried to bring down to the bare
minimum by the end of FY2011.
Jyothy is also planning a shift in its distribution network by reducing its dependence on the
super stockist model (currently c70% of sales) by moving to a Carrying & Forwarding (C&F)
model which was used by Henkel India. Jyothy has said that sales to consumers have not been
affected as the market share for all the products has remained stable over the period. We
believe the changes to the distribution network are likely to negatively impact sales for the
next quarter as well but we do not believe the changes will have a long term impact on the
revenue generating potential of Jyothy.
.
While the distributor inventory destocking impacted revenue growth for the quarter we
believe some proportion of the decline is linked to lackluster performance of all the brands in
the Jyothy portfolio. The volumes of the Soaps and Detergents segment have been negatively
impacted by the price hikes that Jyothy took on Ujala Supreme and Exo detergent bar in order
to protect gross margins in the face of rising raw material costs. For Ujala Supreme while Q3
FY2011 volumes were flat post the 16% price hike, the full impact was felt in Q4 FY2011
leading to 8 – 9% volume decline. We also believe Jyothy consciously slowed down the rollout
of its detergents as raw material prices have severely impacted margins for all players in the
business. We believe volumes are likely to remain sluggish in Q1 FY2012 but expect Jyothy to
return to an aggressive rollout from Q2 FY2012 as Jyothy has raised prices on its detergents in
June by 5% to improve the margins.
The Homecare segment volumes were dragged down by the continuing decline in Maxo
volumes. Jyothy had decided to reduce its distributor margins to 21% from 28 – 29% in Q2
FY2011. As a result Maxo volumes had declined 16% in Q3 FY2011 and the volume decline
seems to have worsened in the current quarter. Apart from the impact from the reduction in
distributor margins we believe volumes were hit as Jyothy elected to maintain margins by not
replicating the consumer offers for Maxo that were rolled out by Mortein and Goodknight.
Jyothy’s focus on margins has resulted in a 600 bps improvement in gross margins but the
EBITDA margin declined by 620 bps as marketing costs and staff costs rose while revenue
declined. Jyothy was able to improve the profitability of the Soaps and Detergents segment by
258 bps but the overall margins were dragged down by the 1856 bps decline in margins at the
Homecare segment.
The PAT margin was stable at 14.3% despite the decline in EBITDA margins due to the impact
of a lower tax rate as a result of a MAT credit in the quarter and higher interest income from
the proceeds of the QIP in August 2010.
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MAPE Securities Private Limited Jyothy Laboratories
Pro Forma Forecast & Valuation
In the summary forecast table below, we present two scenarios.
Scenario 1: This assumes Jyothy funds the acquisition of Henkel India with debt of INR 6,000
million
Scenario 2: This assumes Jyothy dilutes 15% of its equity at INR 300 per share and uses the
proceeds to repay the debt raised to finance the acquisition of Henkel India
We assign a high probability that Scenario 2 is the likely outcome in FY2012 and our target
price is predicated on Jyothy raising fresh equity from a private equity placement and
returning to a debt free status. The primary reasons we feels Scenario 2 will pan out are:
• Conservative debt averse management
• Provides greater flexibility to maneuver in case turnaround at Henkel India takes longer than
expected
• Positive experience of management with private equity players historically
Our target price of INR 300 is based on FY2013E PEG ratio of 0.8, which is a 40% discount to
peers (Exhibit 14). As a result of the Henkel India acquisition, Jyothy’s product profile has
changed significantly. Ujala Supreme, which contributes 31.1% of net sales in FY2011E, will see
its contribution falling to 16.5% in FY2013E, as per our estimates. This is a key positive from a
valuation point of view as well as Jyothy has traded at a discount to peers due to its
dependence on a single product. With a diversification of revenue post the acquisition, we
believe the valuation gap could close and provide further upside to our valuation.
Exhibit 13: Summary Pro forma Forecast & Valuation Table
Income statement (INR mn)
FY2012E FY2013E FY2014E FY2012E FY2013E FY2014E
Total revenue 11,289 13,785 16,345 11,289 13,785 16,345
EBITDA 860 1,615 2,130 860 1,615 2,130
margin (%)
Net Income 257 845 1,272 555 1,210 1,624
Fully Diluted Weighted avg. shares (mn) 81 81 81 87 93 93
EPS 3.98 12.40 18.09 6.41 13.05 17.51
Net Debt (3,732) (3,364) (2,539) 191 892 1,884
P/E Multiple
19.0x 121.7 248.0 332.7
21.0x 134.6 274.1 367.7
23.0x 147.4 300.2 402.8
25.0x 160.2 326.3 437.8
27.0x 173.0 352.4 472.8
Scenario 1 Scenario 2
Acq funded by debt Acq funded by equity
Implied Share Price
Source: MAPE Securities Estimates
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FMCG MAPE Securities Private Limited
Exhibit 14: Benchmarking Jyothy vs. Peers
PEG Ratio
Company FY2012E FY2013E FY2014E FY2012E FY2013E FY2014E FY2012E FY2013E FY2014E FY2013E
Colgate-Palmolive India Ltd 17.3% 13.7% NM 22.6% 15.1% NM 18.1% 14.9% NM 1.53
Dabur India Ltd 24.2% 15.6% 14.8% 19.5% 16.3% 14.2% 23.3% 17.8% 13.5% 1.35
Emami Ltd 18.8% 18.4% 17.9% -7.9% 16.8% 13.9% 24.9% 18.3% 12.7% 1.09
Godrej Consumer Products Ltd 17.5% 15.6% 17.9% 22.3% 16.2% 14.8% 22.1% 17.9% 12.9% 1.13
Hindustan Unilever Ltd 4.7% 18.4% 17.1% 14.5% 12.2% 18.4% 17.8% 12.9% 16.1% 1.93
Marico Ltd 18.3% 15.4% 17.2% 24.1% 16.2% 29.4% 45.5% 21.3% 23.1% 0.96
Average Peers 16.8% 16.2% 17.0% 15.9% 15.5% 18.1% 25.3% 17.2% 15.6% 1.33
Jyothy Laboratories 8.4% 22.1% 18.6% NM 87.8% 32.1% NM 103.7% 34.2% 0.80
Premium/(Discount) to Average Peers (%) -40%
Sales Growth EBITDA Growth EPS Growth
Source: Bloomberg, MAPE Securities Estimates
Risks
Despite the obvious benefits and synergies that the new entity will enjoy, a merger between
two large groups with established operations and management structures is always a complex
procedure. The key challenge facing the company over the next two years include effectively
integrating the two businesses considering the inherent cultural and system issues that have to
be absorbed. We believe Jyothy’s management recognises the challenge ahead and has
formed a team comprising current employees and new hires with relevant experience to
address all integration issues in order to ensure a smooth transition.
In addition to the issues related to the creation of the new entity, there are also risks
associated with the business environment in which the company operates. An issue that can
be a source of concern is the possibility of irrational competition in the detergents market,
which would leave limited scope for Jyothy to maneuver. Another factor that needs to be
considered is the additional pressure on profitability by the increasing costs associated with
raw materials, in case Jyothy is unable to increase its selling prices appropriately.
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MAPE Securities Private Limited Jyothy Laboratories
Financial Summary
Income statement (INR mn)
Particulars FY2012E FY2013E FY2014E FY2015E
Net Sales 11,289 13,785 16,345 19,171
growth (%) 22.1% 18.6% 17.3%
COGS (6,432) (7,570) (8,926) (10,501)
Gross Profit 4,856 6,214 7,419 8,669
margin (%) 43.0% 45.1% 45.4% 45.2%
Employee expenses (1,181) (1,289) (1,481) (1,701)
% of sales 10.5% 9.4% 9.1% 8.9%
Distribution expenses (559) (718) (851) (989)
% of sales 4.9% 5.2% 5.2% 5.2%
Marketing expenses (1,197) (1,438) (1,720) (2,010)
% of sales 10.6% 10.4% 10.5% 10.5%
EBITDA 860 1,615 2,134 2,640
margin (%) 7.6% 11.7% 13.1% 13.8%
EBIT 669 1,424 1,943 2,449
margin (%) 5.9% 10.3% 11.9% 12.8%
Net Interest (105) 71 151 247
Profit Before Tax 564 1,495 2,094 2,696
Tax (127) (336) (471) (606)
tax rate (%) 22.5% 22.5% 22.5% 22.5%
Profit After Tax 555 1,210 1,624 2,004
Diluted EPS 6.4 13.1 17.5 21.6
growth (%) 103.7% 34.2% 23.4%
Balance sheet (INR mn)
Particulars FY2012E FY2013E FY2014E FY2015E
Goodwill & Intangible Assets 4,967 4,967 4,967 4,967
Tangible Fixed Assets (Net) 5,064 4,404 4,343 4,282
Total Fixed Assets 9,979 9,918 9,857 9,797
Inventories 1,679 2,006 2,358 2,803
Trade Receivables 1,282 1,566 1,854 2,176
Cash & Cash Equivalents 6,882 1,582 2,574 3,946
Total Current Assets 10,787 6,098 7,731 9,869
Total Assets 20,765 16,016 17,588 19,665
Trade Payables (2,005) (2,397) (2,817) (3,348)
Debt (6,668) (668) (668) (668)
Total Liabilities (10,150) (4,675) (5,239) (5,951)
Share Capital 93 93 93 93
Share Premium 6,952 6,952 6,952 6,952
Reserves 3,062 3,839 4,847 6,126
Total Shareholders' Equity 10,616 11,341 12,349 13,714
Cash flow (INR mn)
Particulars FY2012E FY2013E FY2014E FY2015E
Net cash from Oper. Activities 1,185 1,264 1,737 2,227
Net cash from Inv. Activities (2,116) (130) (130) (130)
Net cash from Fin. Activities 4,711 (6,433) (615) (725)
Net Increase or Decrease 3,779 (5,300) 992 1,372
Free Cash Flow 1,655 1,134 1,607 2,097 Source: MAPE Securities Estimates
Page 18
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FMCG MAPE Securities Private Limited
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Important Information Related to The Research Report The research analysts responsible for content of this report, whether whole or in part, certify that with respect to securities or issuers covered in this report all the views expressed accurately reflect their personal views; and no part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Definitions of Research Ratings
BUY We expect this stock to appreciate by 20% or more over the next 12 months from the price mentioned on the note.
HOLD We expect this stock to stay in the range of -20% to +20% over the next 12 months from the price mentioned on the note.
SELL We expect this stock to go down by more than 20% over the next 12 months from the price mentioned on the note.
Our target prices are on a 12-month horizon basis unless otherwise specifically mentioned.
Investment Banking Disclaimer MAPE Advisory Group Pvt. Ltd. is representing Jyothy Laboratories in its transaction with Henkel India. Disclaimer MAPE Advisory Group Pvt. Ltd. and MAPE Securities Pvt. Ltd. (“MAPE”) are investment bankers, advisors and securities traders on behalf of their clients globally. This report has been prepared by MAPE for its intended recipients only and not for public distribution and should not be reproduced or redistributed without prior approval. Information provided herein with respect to the industry and the competitors has been compiled from publicly available sources, including official publications and research reports, and is given as general information. It has not been independently verified either by MAPE or its Client. Neither MAPE nor its Client or any of their directors, officers, employees, affiliates, representatives and advisors makes any representation or warranty with respect to the accuracy or completeness of the information contained herein. The information contained herein shall not form the basis of any contract. The report may also include analysis and views expressed by our internal research teams which operate independent of the investment banking teams. The report is purely for information purposes and does not construe to be investment recommendation/advice or an offer or solicitation of an offer to buy/sell any securities. The opinions expressed are our opinions as of the date appearing in the material and may be subject to change from time to time without notice. Investors should make their own investment decisions based on their own investigation and analyses of information contained in this report and other sources and they should not solely rely on the information contained in this document. Recipients should not construe any of the contents herein as advice relating to business, financial, legal, taxation or investment matters and are advised to consult their own business, financial, legal, taxation and other advisors concerning any information in the report. MAPE or its affiliates, its clients and/or employees may or may not hold positions in any of the securities mentioned in the document.