EQUITY RESEARCH: ZYDUS WELLNESS LTD.

Zydus Wellness Ltd is an integrated consumer corporation. The Company is engaged within the improvement, manufacturing, advertising and marketing and distribution of health and well-being merchandise. The Company's products include table margarine. Its product portfolio includes brands, along with Sugar Free, Everyuth and Nutralite. Its Sugar Free logo portfolio consists of Sugar Free Gold, which is used as sugar alternative in arrangements, consisting of tea, coffee and fruit juices, and Sugar Free Natura, that is utilized in arrangements, together with cakes, chocolates, blended fruit custard and ice cream. It offers various speciality skincare products below the brand name of Everyuth Naturals, which consists face wash, facial mask (peel off, packs), scrubs, sun blocks, winter care (body lotion and cream), purifier and toner, soaps and men skin care (face washes, sun block, moisturizer and scrub). The Company beneath Nutralite brand gives a table spread, which has poly unsaturated fatty acids and mono unsaturated fatty acids.

ABOUT

Brands like Sugar-Free, Everyuth, and Nutralite, which are industry leaders in their respective categories of skin scrubs/peel-offs, fat-free spreads, and sugar substitutes, respectively, are part of Zydus Wellness Limited's (ZWL) product range. Additionally, the newly acquired products, Nycil and Glucon-D, continued to hold the top spots in the prickly heat powder and glucose powder sectors, respectively. With ZWL Utilising research and development (R&D) capabilities, the company introduced a number of innovative goods to address changing consumer needs including Optimum substitutes. For ZWL's product line, low penetration across categories and expanding distribution reach are positive signs. The corporation has been able to keep a consistent market share for its brands because of its focus on innovation. ZWL has the capacity to launch several Within the established specialty categories itself, there are variations, formats, and extensions. ZWL is constantly promoting the growth of its core brands to boost its market share through innovation, utilizing distribution channels, and diversifying its brand portfolio. This will also enable them to grow their customer base with greater penetration and increase the category size of the brands in which they are the market leader. To fuel growth in the medium term, the company relies on three pillars: speeding the expansion of core brands, establishing an international presence, and considerably expanding scale.

Carnation Health Foods Limited' (CHFL) was the name given to the business when it was founded on November 1st, 1994 as a public limited company. Zydus Lifesciences Ltd. (formerly known as Cadila Healthcare) purchased 61.56% of CHFL's shares on June 8, 2006, converting CHFL into a subsidiary. After that, Cadila Healthcare sold its consumer goods sector and changed the acquired business' name to ZWL. ZWL does business as an integrated consumer corporation that includes the creation, manufacturing, marketing, and distribution of goods for health and well-being. The product line-up consists of acquired brands like Glucon D, Complan, Nycil, and Sampriti Ghee in addition to household names like Sugar-Free, Everyuth, and Nutralite.

SHAREHOLDING PATTERN

CONCALL SUMMARY

1. Sales Performance:

• Q1 FY '24 net sales growth is about 1%
• Portfolio without Glucon-D experiencing closer to double-digit growth
• Unseasonal rains and erratic weather patterns impacted sales of Glucon-D

2. Gross Margins:

• Gross margins for non-milk based portfolio improved by over 100 basis points compared to the same period last year

3. Health Food Drinks Category:

• Complan registered a growth of 12% in terms of number of household usage
• Health food drinks category grew by 2%

4. Market Share:

• Sugar-Free brand maintains leadership with a market share of 96.2%
• Everyuth Scrub maintains a leadership position with a market share of 42.4%
• Everyuth peel-off maintains its number one position with a market share of 78.7%
• Nycil maintains the number one position in the prickly heat powder category with a market share of 35.5%

5. Nutralite Brand:

• Nutralite brand delivered strong growth for the quarter
• The company plans to strengthen its international presence with the Bangladesh subsidiary becoming operational

6. Digital Transformation:

• The company plans to implement data analytics and warehouse management systems as part of its digital journey

7. Financial Performance:

• Net profit was down by 19.4% year-on-year
• Adjusting for exceptional items, net profit was down by 10.9% year-on-year
• The company aims to recover back to 17-18% EBITDA margins in the next two to three years

8. Controversies and Consumer Education:

• The impact of recent controversies around aspartame is uncertain
• The company plans to provide correct information to consumers and educate them about the safety of its products

9. Future Outlook:

• The next two quarters are expected to have lower margins due to seasonality
• The company remains committed to improving profitability
• Aims to achieve double-digit growth over the next three to four years
• Focus on recruiting new consumers and launching new products

10. Revenue Breakdown:

• No specific details were provided about the revenue breakdown by product category

FINANCIAL

• ZWL had a difficult FY21 and FY22 because Covid's sales caused the portfolio's 35 to 40% of summer-focused products to perform below expectations. ZWL has launched more goods and expansions as a result of this turbulent time. ZWL reported sales growth of 12.8% YoY in FY23. On the strength of robust volume growth across categories, we anticipate ZWL's revenue to expand at an 11% CAGR from FY23 to FY25.
• Due to the relatively low margins in the acquired brands after the acquisition of HIPL, ZWL's gross margin decreased by 1,320 basis points between FY18 and FY20; however, the EBITDA margin only decreased by 585 basis points as a result of lower ad spending across the Heinz portfolio and early synergy advantages. Gross margins have decreased by 675 bps between FY20 and FY23 as a result of high input cost inflation and an unfavorable product mix. Because of improved operating leverage, the decline in EBITDA margin was less severe. EBITDA margin is anticipated to increase from 15% in FY23 to 16.8% in FY25.
• Due to excise benefits for two of the company's plants in Sikkim and intangible asset depreciation as a result of acquired brands, the company's income tax rates would be zero until FY25.
• The addition of goodwill from acquisitions and the associated dilution of stock have been significant drivers in lowering return ratios. The return rates of ZWL dramatically decreased from 20–23% before the acquisition to 6.2% in FY23. Excluding goodwill, RoE for FY23 was only about 19%. In the future, we predict that RoE will increase from 6.2% in FY23 to 7.8% in FY25.
• Gross margin on net sales was at 52.4% (-165bps YoY) mainly impacted due to unfavorable product mix
• Other expenses grew by 13.6% on a YoY basis mainly on account of the high cost of alternative fuel and statutory wage rate increase which continued to impact overall manufacturing cost
• One-time expenditure of Rs.142 million rupees on account payment towards one-time settlement with workers, legal charges, and provision for inventory write-off for the Sitarganj plant

KEY HIGHLIGHTS

• Glucon-D: Strong comeback with good summer season

To promote the brand's expansion and draw in new customers, the corporation kept up its marketing initiatives. Because of this, the brand experienced strong growth in FY23 and saw its sales increase to pre-Covid levels.

The launch of extensions such as sachets, kachha mango under Immunovolts, and mango under flavored glucose powder shows a continued commitment to innovation.

The market for glucose powder has increased by 10.7%. According to MAT March 2023, the brand Glucon-D continues to hold the top spot with a market share of 60.1%.

• Complan: Supporting brand with activations and focused communication

During FY23, the Health Foods and Drinks (HFD) category had a slowdown, and the brand's performance reflected this. The business was able to act quickly and benefit from a more expansive market play with category parity packs when the category saw a shift in trends from refill packs and jars to sachets and pouches.

Throughout the year, the brand received assistance from 360-degree campaigns that were run across all media, including TV, print, digital, and influencer marketing initiatives.

At MAT level, HFD category growth has decreased by 1.1%. In the category, Complan's market share was 4.5%, according to Nielsen's MAT March 2023 report.

• Nycil: Witnessing strong traction

With a successful summer, the Nycil brand made a significant comeback in FY23.

At MAT level, the Prickly Heat Powder category has increased by 13.4%. With a market share of 35.4% in the Prickly Heat Powder category, Nycil has kept the top spot.

• Sweeteners: Driven by the natural variant of Sugar-Free Green

During FY23, the whole sweeteners portfolio experienced flat growth. On a three-year CAGR basis, the portfolio, however, showed high single-digit growth.

Throughout the year, ZWL continued to expand the Sugar-Free Green brand with aggressive media campaigns featuring Ms. Katrina Kaif as the brand's celebrity brand ambassador.\

• Everyuth – Growing faster than the category

Everyuth brand keeps growing faster than category growth

 continued to support our main line of body lotions, scrubs, peel-offs, and face wash through TV and digital advertisements all year long.

At the MAT level, the Face Scrub category has seen growth of 9.1%. With a 41.9% market share in the area of Facial Scrubs, Everyuth Scrub is still in the lead.

At the MAT level, the Peel-Off category has seen growth of 4.5%. Everyuth Peel Off continues to hold the top spot in Peel Off with a market share of 78.4%.

According to MAT March 2023, Everyuth brand is ranked fifth with a market share of 6.2% in the overall facial cleansing segment.

• Nutralite: Robust growth in the Dairy portfolio

The dairy portfolio for Nutralite Doodhshakti has shown steady double-digit growth.

Celebrity engagements with Shilpa Shetty and Chef Sanjeev Kapoor are specifically targeted to spur portfolio growth for Doodhshakti butter.

• Synergies from the absorption of the Heinz acquisition

While Kraft Heinz's Indian company was nearly twice as large as their then-reported turnover but had lower EBITDA margins, nearly 400 bps lower than their EBITDA margins of 23.6%, ZWL acquired it for Rs. 4595 cr. during FY19. The items had a vast supply network because they were well-liked, filled a niche, and had a long history. Preferential allotment/QIP was used to raise money for the acquisition in January 2019 and September 2020. At a premium of between Rs. 1375 and Rs. 1680 per share, Rs. 3575 crore were raised. Promoters' ownership, which had dropped from 72.54% in December 2018 to 64.82% in September 2020 as a result of fundraising, has since crept up to 67.1% owing to acquisitions.

In contrast to the initial estimate of Rs. 40 cr., ZWL saw synergies from the Heinz acquisition at Rs. 80 cr. The following factors have contributed to the creation of synergies:

(a) increasing trade throughput by combining complementary general trade with the existing pharmacy distribution;

(b) rationalizing various positions within the combined entity and resulting in a 15% reduction in staff;

(c) implementing SAP and analytics software to integrate the Heinz acquisition; and

(d) optimizing the supply chain by reducing warehouses, consolidating CFAs, and reducing distr.

• Continued higher ad spends to drive category penetration

ZWL operates in categories with lower levels of market penetration, necessitating the need to increase market size, improve distribution, and raise customer knowledge of various factors (such as the necessity for the product, its effectiveness, etc.). ZWL's advertising expenditures were about 18% of revenues in FY16, and following the consolidation of the Heinz portfolio, they were down to about 13.5%. The Heinz portfolio has a drop of about 450 bps, although it is due to seasonality (thus the need to spend just during 4-5 months of the year). ZWL has stated that it intends to keep ad spending at 13.5 to 14% through FY25. Holding onto larger ad spends will aid in brand creation as ZWL continues to launch a variety of goods and brand expansions.

• Distribution expansion is a key growth driver

Under the go-to-market plan, Project Vistaar, ZWL is investing in expanding its distribution footprint in the General Trade before the category and enhancing capability and capacity in modern trade. From the current 0.6 million outlets as of March 2023 to 0.7 million outlets in FY24, the corporation would expand its direct reach. Additionally, it plans to raise the number of outlets altogether from the existing 2.5 million to 3.0 million. The sales contribution from e-commerce and modern trade channels increased from 17.5% in FY22 to 19.6% in FY23. The contribution from the same was 21.1% in Q1FY24. In the coming years, these outlets could add 25% to revenues.

• International business can bring in incremental growth

In order to investigate the possibilities of the global market, particularly in the Middle East, Africa, South East Asia, and SAARC countries, ZWL brought in management expertise in FY17. Presently, ZWL exports its goods to 25 nations, with the top 5 markets accounting for 80% of company revenue. 90% of the company's overseas sales are made up of Sugar-Free and Complan. In order to broaden its global reach, the corporation intends to enter new areas with pertinent offerings. Due to the temporary effects of demonetization in Nigeria and supply chain problems in New Zealand, foreign business in FY23 remained flat. However, management anticipates that during the next five years, it will expand by double digits and contribute 8–10% of total revenue. Going forward, the top-line growth will be significantly influenced by the volume expansion brought on by expanding geographical presence. ZWL operationalized a Bangladeshi subsidiary in Q1FY24 to increase its footprint in the Indian subcontinent. Due to listing fees and additional expenses incurred while selling and distributing in overseas markets, the company's international EBITDA margin is lower than the company average. Although it may be 4-5% lower, it is anticipated that with greater scale, it will converge to the company's typical EBITDA margin.

KEY CONCERN

• Raw material price increase: Recent price increases for raw materials like palm oil, packaging materials, and skimmed milk powder (SMP) presented challenges for the company, but it was still able to raise pricing in response. Any persistent increase in the cost of raw materials without a price increase would lead to lower-than-anticipated profitability.
•  Intense Competition: Numerous well-known multinational corporations (MNCs) and local businesses with a presence in several product categories present fierce rivalry for ZWL in the majority of its product categories. While the bulk of its goods has maintained its market share, the "Complan" brand has been steadily losing market share over the past few years (from 12% in FY15 to 6% in FY19 and 4.5% in FY23). The cost of marketing for the organization is anticipated to stay high due to the fierce competition.
• Seasonality: The beginning of a healthy summer season in India is crucial for the sales of Glucon-D and Nycil (around 35% of revenues). Seasonal lag or shifts could have an effect on the company.

VALUATION

ZWL has recently entered the expanding health and wellness sectors, encountering minimal competition from major FMCG companies. ZWL's remarkable market leadership over the past decade underscores the company's strong research and development capabilities and deep customer insights. Thriving in these sectors requires robust R&D capabilities and the introduction of consumer-focused products. Sustained growth can be achieved through increased market penetration and outreach. Another growth driver is the company's international expansion, which currently contributes 5% of revenue but is projected to reach 8% in the coming years. Our forecasts indicate a compound annual growth rate (CAGR) of 20% for revenue, 20% for EBITDA, and 20% for PAT during FY23-25E. Management expects ongoing pressure on operating margins due to rising production costs in the short term, with a gradual recovery to 20% by FY25. We anticipate improved return ratios, increasing from 10% in FY23 to 15% in FY25, driven by a more favorable profit trajectory, effective cost management, and minimal capital deployment. With its extensive product range, market share, and attractive valuations, ZWL is a compelling candidate for partnerships or corporate actions. In our assessment, the stock's bullish scenario suggests a fair value of Rs. 1900.

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