pidilite industries - myirisbreport.myiris.com/nfasipl/pidindus_20140117.pdfnomura | pidilite...

Rating From Suspended BuyTarget price From N/A INR 328

Closing price 14 January 2014 INR 282

Potential upside +16.4%

Anchor themesWe remain optimistic on the long-term prospects of spending on construction chemicals and adhesives. Pidilite's ability to identify niche demand and accordingly innovate new products should drive long-term growth.

Nomura vs consensusOur FY15F sales is ~3% lower than consensus as we are building in lower sales growth, due to a slowdown in domestic discretionary consumer spending.

Research analysts

India Consumer Related

Manish Jain - NFASL [email protected] +91 22 4037 4186

Anup Sudhendranath - NSFSPL [email protected] +91 22 4037 5406

Key company data: See page 2 for company data and detailed price/index chart

Pidilite Industries PIDI.NS PIDI IN

EQUITY: CONSUMER RELATED

Brand strength and innovation to the core

Assume coverage with a Buy and TP of INR328

Action: Strong brands and focus on innovation key to market leadership Pidilite is the domestic market leader with ~70% market share in the adhesives and sealants segment in India, with Fevicol being its marquee brand name. Management’s focus on building brands, driving innovation and strengthening distribution has helped Pidilite to achieve leadership positions across the segments in which it operates. While competition from both global and Indian companies does exist, Pidilite has been able to maintain its leadership position, driven mainly by innovation and strong connect with the end consumer. We think these advantages are sustainable in the medium term, which gives Pidilite a unique position of strength in a growing market. We assume coverage at Buy with a TP of INR328, a 16.4% upside potential.

Catalysts: Strong volume growth and stable input prices Volume growth saw a pick-up in Q2FY14, but management’s commentary was cautious on extrapolating similar growth rates for H2FY14. If growth rates hold up at current levels, it will be a positive catalyst for the shares. Input prices have held steady, which should translate into higher margins as in H1FY14F. We see these two as key catalysts for the stock over the next year.

Valuation: Pidilite trades at 24.2x FY15F vs. sector at 27.7x Pidilite trades at 24.2x FY15F earnings vs. the broader consumer sector at 27.7x. This compares with mid-cap consumer companies Dabur (DABUR IN, Neutral) (27.3x), Colgate (CLGT IN, Reduce) (28.1x) and Godrej Consumer (GCPL IN, Neutral) (26.6x), where we project organic growth rates to be lower in FY15F. As well, Dabur and GCPL do not have the kind of market leadership that Pidilite enjoys in its key segment. Given its stable earnings growth (potential for upside surprise) and reasonable valuations vs. the sector and other mid-cap consumer companies, we think Pidilite offers an excellent entry point for long-term investors at current levels.

31 Mar FY13 FY14F FY15F FY16F

Currency (INR) Actual Old New Old New Old New

Revenue (mn) 36,781 41,804 42,302 47,750 48,306 54,485 55,106

Reported net profit (mn) 4,240 5,114 5,073 6,022 5,975 7,030 6,973

Normalised net profit (mn) 4,238 5,061 5,020 6,022 5,975 7,030 6,973

FD normalised EPS na 9.87 9.79 11.75 11.66 13.71 13.60

FD norm. EPS growth (%) na na na 19.0 19.0 16.7 16.7

FD normalised P/E (x) na N/A 28.8 N/A 24.2 N/A 20.7

EV/EBITDA (x) 23.9 N/A 18.8 N/A 15.9 N/A 13.7

Price/book (x) 8.7 N/A 7.4 N/A 6.2 N/A 5.3

Dividend yield (%) 0.6 N/A 1.4 N/A 1.7 N/A 1.9

ROE (%) 28.5 28.3 28.1 28.1 28.0 27.8 27.6

Net debt/equity (%) net cash net cash net cash net cash net cash net cash net cash

Source: Company data, Nomura estimates

Global Markets Research 17 January 2014

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Pidilite Industries 17 January 2014

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Key data on Pidilite Industries Income statement (INRmn) Year-end 31 Mar FY12 FY13 FY14F FY15F FY16FRevenue 31,266 36,781 42,302 48,306 55,106Cost of goods sold -17,403 -20,081 -22,735 -26,122 -29,814Gross profit 13,863 16,700 19,567 22,185 25,292SG&A -9,574 -11,381 -12,766 -14,241 -16,155Employee share expense

Operating profit 4,289 5,320 6,800 7,944 9,137

EBITDA 4,926 6,005 7,586 8,810 10,083Depreciation -637 -686 -786 -866 -946Amortisation

EBIT 4,289 5,320 6,800 7,944 9,137Net interest expense -307 -214 -180 -100 -100Associates & JCEs 27 33 34 34 34Other income 435 705 420 541 753Earnings before tax 4,444 5,844 7,074 8,419 9,824Income tax -1,130 -1,603 -2,051 -2,441 -2,849Net profit after tax 3,314 4,240 5,022 5,977 6,975Minority interests 0 0 0 0 0Other items -3 -2 -2 -2 -2Preferred dividends 0 0 0 0 0Normalised NPAT 3,311 4,238 5,020 5,975 6,973Extraordinary items -67 2 53 0 0Reported NPAT 3,244 4,240 5,073 5,975 6,973Dividends -1,122 -1,535 -2,029 -2,390 -2,789Transfer to reserves 2,122 2,705 3,044 3,585 4,184

Valuation and ratio analysis

Reported P/E (x) 44.1 33.9 28.5 24.2 20.7Normalised P/E (x) 43.2 33.9 28.8 24.2 20.7FD normalised P/E (x) 44.3 na 28.8 24.2 20.7FD normalised P/E at price target (x) 39.5 na 25.7 21.6 18.5Dividend yield (%) 0.4 0.6 1.4 1.7 1.9Price/cashflow (x) 28.9 na 28.9 25.1 21.6Price/book (x) 10.8 8.7 7.4 6.2 5.3EV/EBITDA (x) 29.4 23.9 18.8 15.9 13.7EV/EBIT (x) 33.7 27.0 20.9 17.7 15.1Gross margin (%) 44.3 45.4 46.3 45.9 45.9EBITDA margin (%) 15.8 16.3 17.9 18.2 18.3EBIT margin (%) 13.7 14.5 16.1 16.4 16.6Net margin (%) 10.4 11.5 12.0 12.4 12.7Effective tax rate (%) 25.4 27.4 29.0 29.0 29.0Dividend payout (%) 34.6 36.2 40.0 40.0 40.0Capex to sales (%) 5.0 4.2 2.8 2.5 2.2Capex to depreciation (x) 2.5 2.3 1.5 1.4 1.3ROE (%) 26.9 28.5 28.1 28.0 27.6ROA (pretax %) 21.4 23.7 27.2 29.6 31.7

Growth (%)

Revenue 17.0 17.6 15.0 14.2 14.1EBITDA 2.7 21.9 26.3 16.1 14.5EBIT 2.1 24.0 27.8 16.8 15.0Normalised EPS 6.3 27.5 17.8 19.0 16.7Normalised FDEPS 6.6 na na 19.0 16.7

Per share

Reported EPS (INR) 6.39 8.32 9.90 11.66 13.60Norm EPS (INR) 6.52 8.31 9.79 11.66 13.60Fully diluted norm EPS (INR) 6.36 na 9.79 11.66 13.60Book value per share (INR) 26.12 32.40 38.15 45.15 53.31DPS (INR) 1.02 1.75 3.96 4.66 5.44Source: Company data, Nomura estimates

Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (INR) -2.4 7.0 29.6

Absolute (USD) -1.2 6.5 14.8

Relative to MSCI India -5.1 4.3 25.1

Market cap (USDmn) 2,348.9

Estimated free float (%) 29.4

52-week range (INR) 314.7/211.1

3-mth avg daily turnover (USDmn)

1.39

Major shareholders (%)

Promoters 70.6

Source: Thomson Reuters, Nomura research

Notes


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Cashflow (INRmn) Year-end 31 Mar FY12 FY13 FY14F FY15F FY16FEBITDA 4,926 6,005 7,586 8,810 10,083Change in working capital -305 159 -1,011 -1,168 -1,303Other operating cashflow 460 -990 -1,571 -1,893 -2,089Cashflow from operations 5,081 5,175 5,004 5,749 6,691Capital expenditure -1,564 -1,558 -1,200 -1,200 -1,200Free cashflow 3,517 3,617 3,804 4,549 5,491Reduction in investments -875 -678 0 0 0Net acquisitions 0 0 0 0 0Reduction in other LT assets 10 98 0 0 0Addition in other LT liabilities

Adjustments 1,870 -869 24 24 24Cashflow after investing acts 4,522 2,169 3,828 4,573 5,515Cash dividends -1,030 -1,120 -2,029 -2,390 -2,789Equity issue 0 0 0 0 0Debt issue -1,626 -1,596 -1,000 0 0Convertible debt issue 0 0 0 0 0Others -172 -678 -180 -100 -100Cashflow from financial acts -2,828 -3,395 -3,209 -2,490 -2,889Net cashflow 1,694 -1,226 619 2,083 2,626Beginning cash 1,038 2,732 1,506 2,125 4,208Ending cash 2,732 1,506 2,125 4,208 6,834Ending net debt 481 -396 -2,015 -4,098 -6,724Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY12 FY13 FY14F FY15F FY16FCash & equivalents 2,732 1,506 2,125 4,208 6,834Marketable securities 909 2,846 2,846 2,846 2,846Accounts receivable 3,952 4,305 4,955 5,662 6,462Inventories 4,541 5,236 5,928 6,811 7,773Other current assets 1,366 1,027 1,027 1,027 1,027Total current assets 13,500 14,920 16,880 20,553 24,942LT investments 74 85 85 85 85Fixed assets 9,129 9,936 10,511 11,006 11,421Goodwill 601 455 386 317 248Other intangible assets 385 357 265 173 81Other LT assets 10 0 0 0 0Total assets 23,699 25,752 28,127 32,134 36,777Short-term debt 2,290 1,110 110 110 110Accounts payable 2,058 2,501 2,832 3,253 3,713Other current liabilities 4,694 5,118 5,118 5,118 5,118Total current liabilities 9,041 8,729 8,059 8,481 8,941Long-term debt 923 0 0 0 0Convertible debt

Other LT liabilities 468 499 499 499 499Total liabilities 10,432 9,227 8,558 8,980 9,440Minority interest 5 10 10 10 10Preferred stock 508 513 513 513 513Common stock

Retained earnings 12,754 16,003 19,047 22,632 26,815Proposed dividends

Other equity and reserves

Total shareholders' equity 13,261 16,515 19,559 23,144 27,328Total equity & liabilities 23,699 25,752 28,127 32,134 36,777

Liquidity (x)

Current ratio 1.49 1.71 2.09 2.42 2.79Interest cover 14.0 24.9 37.8 79.4 91.4

Leverage

Net debt/EBITDA (x) 0.10 net cash net cash net cash net cashNet debt/equity (%) 3.6 net cash net cash net cash net cash

Activity (days)

Days receivable 43.4 41.0 39.9 40.1 40.3Days inventory 90.8 88.9 89.6 89.0 89.5Days payable 39.9 41.4 42.8 42.5 42.8Cash cycle 94.3 88.4 86.8 86.6 87.0Source: Company data, Nomura estimates

Notes

Notes


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Brand leverage: Strong portfolio of brands in adhesives and sealants Fevicol is the leading brand in India’s synthetic glue market, with a ~70% market share (Source: Forbes). The company has been able to establish its brand, Fevicol, as not only the best known brand in its segment, but also among India’s best known brands across sectors. In a market which has competition from both foreign and domestic players, we believe establishing and continuing to dominate the adhesives segment is one of Pidilite’s key positives.

Pidilite’s record of consistent revenue growth is a key positive. This is despite having a 70% share in the market, which we believe demonstrates very strong leadership from management. Over the past 10 years, the company has delivered an average 20% revenue growth. This performance compares well with any of the mid-cap consumer names we cover. Also, importantly, most of this growth has been from the domestic business, in which mid-cap consumer companies have made a number of acquisitions over the past 4-5 years. Pidilite is much more of a domestic-focussed company than any of the mid-cap consumer companies we cover. Fig. 1: Consistent revenue growth

Source: company data, Nomura research

The company has also leveraged its Fevicol brand, which has high brand recall both in rural and urban India, by launching a portfolio of new products and brand names resembling Fevicol, as shown below. Fevicol has also enabled the company to develop distribution networks in Tier-3/4/5 towns and cities, which has helped in the launch of new products. Fig. 2: Portfolio of brands across several segments

Products/Brands Application/Use

Fevitite Used for bonding metal, ceramic, marble, asbestos, granite, PVC, Ivory, glass, wood, leather & rubber.

Fevikwik Used for bonding plastics, metal, joining footwear, bonding/sticking paper, thermocole, fabrics and plywood.

Fevicol Marine Waterproofing adhesive.

Fevicol Wudfill Cynoacrylite adhesive is used to fill holes and knots in wood.

Fevicol Vertifix Cladding of vertical walls with marble and granite.

Fevigum Sticking paper to paper.

Fevistick Bonding paper, cardboard, thermocole, fabrics and wood and plywood.

Dr Fixit Silicone Sealant Multipurpose Silicone Sealant.

Fevibond Bond rexine to foam, wood, stick glass to ceramic, PVC tiles to floors.

Source: Company data, Nomura research

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Competitive landscape: market leader in the segment

Adhesives and sealants is a segment which has Pidilite as a major player but also has several smaller players in the market. However, there has been no estimate of market share being put out in open domain either by the company or by an independent third party, which we believe can clearly show how market share trends have evolved in the segment.

However, the company has consistently stated that it is the market leader in the adhesives segment, although published estimates are unavailable. The company’s brands (eg, Fevicol, M-Seal, Fevi Kwik and Dr. Fixit) are the leading brands in the segments in which they operate.

In terms of competition, we believe Huntsman group (USA), Hoechst (Germany), and Indian firms such as Chennai’s Anabond, Delhi’s Jubilant Industries and Mumbai’s Desh Chemicals are the other players which operate in some of the segments where Pidilite is market leader. However, none of these companies have a sizeable share in the adhesives and sealants market as compared to Pidilite. In addition, a significant part of the market is comprised of unorganized players which are low on innovation and only exist in the basic white glue market. As far as market share numbers are concerned, absence of detailed financials for most of them as well any segmental breakdown of revenues makes it difficult to come up with any accurate numbers. However, Fig 3 gives an indication of the major players in the adhesives and sealants segment.

Fig. 3: Key competitors in the adhesives and sealants segment

Company Region Key Brands

Pidilite India Fevicol, Dr Fixit, Fevi Kwik, M-Seal, FeviStik

Huntsman US Araseal, Araldite Karpernter, Araldite builder, Araldite Kwick C

Jubilant Industries India All Rounder, Polystic Hero, and Vambond Excel

Anabond India Anabond series

Source: Company websites

What has helped to build and maintain Pidilite’s market share?

We see three key reasons which have helped the company build and maintain market share over the long term.

– Investment in developing brands: The company has consistently invested in developing the brands over the longer term. As with other consumer companies that have brands with market leading positions (HUL, Asian Paints, Marico), investment behind building brands is necessary in the longer term. Pidilite over the last 5 years have invested INR 4.8bn behind A&P, which is a significant commitment in a segment where company already has a strong market share. While the company has put in money on advertising campaigns, majority of the investment has been towards increasing direct contact with carpenters – who are the end customers. A significant number of activities are below the line which helps it to increase and improve the contact with carpenters.


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Fig. 4: A&P as a percentage of domestic sales has steadily increased


– Consistent innovation pipeline: Over the years, a robust innovation cycle and expansion of distribution have been key pillars on which the company has been able to deliver strong top-line growth. We believe both of these are competitive advantages in an industry that is largely unorganised.

Innovation pipeline over the past five years has been extremely strong with the company launching several new products. In our view, Pidilite’s expanding range of products is evidence of its long-standing ability to gauge consumers’ needs in the segments in which it operates and create new products, eg, Fevicol Marine, Fevistik Blue & Purple, etc. Pidilite’s products have a smaller development phase duration as it does not involve high R&D, nor does it require any major capex, since the company produces from its existing manufacturing plants.

Fig. 5: Strong and consistent innovation pipeline has been very successful


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New Products ApplicationFY06Krystalline Capillary waterproofing system for concreteDampfree An injection grout for rising dampnessM-Seal Wet Set M-Seal variant that cures on wet surfacesMotomax Car care productsFY07Dr. Fixit Gapfill Easy to use sealantNewcoat Waterproofing coating for terraceRaincoat Waterproof decorative wall coatingHeatshield Heat reducing exterior coatingFY08Fevicol 1K PUR Special applications in building construction segmentFevicol Vertifix Cladding of vertical walls with marble and graniteFevicol BWP Waterproof adhesiveIn construction chemicals Antibacterial wall and floor coatings for hospitals, hotels, food and pharmaceutical manufacturing unitsFY09Dr. Fixit Waterbar Sealing construction joints in RCC structureDr. Fixit Roofkote Bituminous waterproofing products for terracesDr. Fixit Safeguard Internal waterproofing of the walls of potable water tanksFine Art Colours Provide professional artists with high quality coloursFY10M-Seal Super Versatile epoxy putty meant for DIY applications which can be used in both wet and dry conditionsWoodlok Retail wood working brandFevistik Blue & Purple Coloured sticks, appear coloured when applied but the colour disappears after a few seconds

enabling a person to see & control application of glueFY11Dr. Fixit Pidiproof LW+ Waterproofing compound for concrete and plaster which makes the concrete cohesive and prevents segregationRoff Stoneguard WB Water based penetrating sealer for porous & non porous stones. It protects stone or tile from water as well as stainsFevicol Marine Waterproof adhesive with a new look and an integrated campaignDDL XT Booster An innovative formula to give exterior durability to distemper paint and Wudfin Ezeestain, a water based wood stainerFevicol AC Duct King Adhesive for AC Duct insulation for all residential and industrial projectsFY12Fevicol Wudfill Cynoacrylite adhesive is used to fill holes and knots in wood.Rustolene Maintenance Spray Multipurpose spray for general maintenance, was launched for use in Automotive and Engineering applicationsDr. Fixit Kwikflor Cementitious Flooring Solutions to renovate industrial floors that are exposed to heavy loads and frequent abrasions.Fevicryl Sparkling Pearl Colours Unique sparkling shine to hand painted articles on fabric and non-fabric surfacesFY13RangeelaFevicol PVCFIXFevicol HeatxDr. Fixit Low Energy Consumption (LEC) high end waterproofing coupled with insulation for terraces and walls.Dr. Fixit Extensa A high end puncture-proof waterproof coating for roofs & basements.Dr. Fixit Bathseal Kit A solution for comprehensive and long lasting waterproofing for bathrooms.


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– Establishing connect with channel: Pidilite has a strong network of more than 2,000 distributors servicing more than 400,000 dealers and 4,000 industrial customers. Its distribution network is well entrenched in rural India and Tier-3/4/5 cities, where we believe there is considerable scope for growth owing to rising income levels. Pidilite continues to strengthen its relationship with dealers, carpenters and other channel partners. Every year, it publishes the popular Fevicol Furniture Book, which is widely used by carpenters, households and interior decorators. Pidilite’s Dr. Fixit Institute provides training on the use of waterproofing and construction chemicals to applicators, consultants, builders, architects and civil engineering students.

Long-term demand trends and correlation with GDP

For Pidilite Industries, its two key segments are consumer and bazaar and industrial segment. It is important to understand the demand dynamics in both these segments and how (and if) there is any correlation with GDP growth. For Asian Paints, where demand has a strong correlation to GDP growth, the sales to GDP multiplier of 1.5x to 2x (Sales growth/GDP growth) has held as a rough guide over a longer period of time. For Pidilite, we believe this analysis has been more difficult, with no clear trends emerging.

Since 2004, the multiplier has moved from 0.7x to 2.3x with the average of 1.4x. GDP growth has had less of an impact on demand for Pidilite – a case in point being sales growth over the FY11-13 period where GDP growth slowed from 9%+ to ~5%, but sales growth for the company has held fairly steady at 18.5% (average) in the same time period. In our view, this shows that demand for the company is less prone to fluctuations in GDP growth and is more consistent in the longer term.

Fig. 6: Sales growth vs. nominal GDP

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Sales growth (%) 14.3% 18.1% 19.4% 35.6% 36.7% 16.1% 10.0% 20.7% 17.0% 17.6%

Nominal GDP growth (%) 12.0% 13.2% 14.1% 16.6% 15.9% 15.7% 15.2% 19.0% 15.0% 13.3%

Multiplier 1.2x 1.4x 1.4x 2.1x 2.3x 1.0x 0.7x 1.1x 1.1x 1.3x

Source: Nomura Economics Team, Nomura research


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Business split Pidilite’s business mix is split between consumer and bazaar (C&B) and Industrial segment. The majority of revenues for the company are derived from the C&B segment (81%), while the industrial segment contributes 19% to revenues.

Within the C&B segment, adhesives and sealants contributes to the majority of revenues (63%), while paint chemicals (25%) and art materials and stationary (12%) are other contributing sub segments within the C&B business.

Within the consumer and Bazaar segment, there are three broad sub-segments categorized by the nature of products. Pidilite has a good mix of products across different sub segments.

Fevicol is the company’s largest brand, with a dominant share in the adhesive and sealants segment. Fevicol figures among India’s top brands; eg, as of FY13, it was the third most trusted brand in the household care segment, as per the company.

In construction and paint chemicals, Pidilite has a wide range of products with high growth potential in the new construction and repair and renovation segments. Pidilite is monetizing the first-mover advantage in this segment to build a long-term business.

The art materials and stationary segment is a relatively small but fast-growing sub-segment and Pidilite’s range of products is extensive in this segment and is the preferred brand among users. Brands such as Rangeela, Fevigum, etc, have strong brand recall among users of the products, which is a positive from a longer-term perspective.

Fig. 7: Split of revenues within the consumer and bazaar segment, FY13


The industrial segment is relatively small for the company and contributes 19% to revenues. Within the segment industrial adhesives, industrial resins and organic pigments and preparations – the three sub-segments each contribute a third of the segment revenues.

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Adhesive & Sealants Paint Chemicals Art Materials & Stationary


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Fig. 8: Split of revenues within the Industrial segment, FY13


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Consumer and Bazaar segment: key growth driver The Consumer and Bazaar (C&B) segment contributes 80% of the company’s top line. This division includes key products such as Fevicol, M-Seal, Fevikwik and Dr. Fixit. Over the past six years, the company has consistently delivered stable growth in this segment. Given the nature of the product, the company’s strong brand strength and an unmatched national distribution network, we believe outlook for this segment continues to be solid.

However, we acknowledge that in the near term, growth will likely be slower than what has been the company’s historical run rate. This is not too different from other consumer companies in our coverage universe, where there is a projected growth slowdown in FY14F followed by a pick up from FY15F onwards.

Over the past five years the company has delivered 17% average revenue growth in this segment, which places it among the top echelons of growth delivery among consumer companies under our coverage. This is driven by strong brands, distribution network, focus on innovation cycle, as well as a consistent strategy of driving top-line growth.

Fig. 9: C&B segment – Revenue (USD mn, LHS) and revenue growth (%, RHS)


Segment profitability has remained strong

Since the steep increase in profitability in FY10, Pidilite’s EBITDA margins have remained largely stable. Despite several new product launches, slowing growth and rising input prices, margins have remained largely stable in the FY10-FY13 period. Pidilite has strong pricing power, given its strength of the brands which has allowed it to keep margins fairly stable in the past four years. Going forward we believe stable margins will continue to be a strong positive, particularly given the current macro environment.

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Fig. 10: Segment margins have held steady, which is a positive


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Industrial segment: steady growth Although the Industrial segment’s performance has not been at the same level as that of the consumer and bazaar segment, it has continued to deliver steady growth. This segment contributes ~19-20% of the revenues. Within this segment, there are three sub-segments:

– Industrial Adhesive: products catering to packaging, cigarettes, stickers, labelings, footwear etc

– Industrial Resins: Specialty chemicals for industries like paints, non-woven and flocked fabrics and leather

– Organic pigments and preparations: Market leader in pigment dispersions for Textile segment.

Industrial segment growth over the past five to six years has been slower than that of the consumer and bazaar segment. A large part of this is on account of slower industry growth with Pidilite continuing to maintain or grow market share with the sub-segments.

While consumer and bazaar has delivered a 17% average top-line growth over the past five years, Industrial segment growth has been more modest at 12% over the same time period. This growth slowed marginally in FY13 to 11%, but given the sharp slowing in industrial activity in the year, we believe management has delivered a reasonable number.

Fig. 11: Industrial segment – Revenue (USDmn, LHS) and revenue growth (%, RHS)


Lower profitability in the segment

While the industrial segment has seen slower growth than that of consumer and bazaar, what is also a cause of concern for investors is that profitability has declined over the past five years. While we do not see a significant decline from current levels, the industrial segment is a drag on profitability for the company.

Sales growth in the industrial segment over the past five years has seen an average of 12%, but EBIT growth was slower at 10% for the same period. This has been an ongoing concern for management; for the near term, we do not see any signs of a significant turnaround.

Pidilite’s Industrial segment, like Asian Paints’, has an inherently lower profitability for the industry. One reasons is that pricing power is less evident than in the consumer and bazaar segment. Management mentioned this as one reason for lower profitability in the most recent quarter. While it is not possible for the industrial segment to record

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profitability levels similar to the consumer and bazaar segment, it is feasible that there is scope for some margin expansion in the medium term in this segment.

Fig. 12: Industrial segment profitability is lower than C&B segment


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International business Pidilite also has a sizeable international presence, with business in more than 70 countries either directly selling in those markets or exporting to countries. The company has significant manufacturing and selling activities in the US, Brazil, Thailand, Singapore, Bangladesh, Egypt and Dubai.

However, performance for the division has not been as strong as the domestic business with sales CAGR over the past five years of ~12%. This is significantly lower than the 18% growth in the C&B segment in the same time period. What is also a cause of concern for investors is the variability in the growth rates across the regions – indicating that the company has not been able to establish a stable steady business like it has in India.

In terms of profitability, clearly apart from south and southeast Africa, most regions are loss-making or have very low profitability. One key reason for this is that the company is not an established name in those markets, which takes away some of the competitive advantages that it has in India.

Management’s outlook for the international business is for slow and steady progress. In some markets, such as Brazil, the company has a new management team in place and expects a turnaround in profitability – FY13 reported a loss of INR151mn. Overall for the international business in FY13, revenues grew steady at INR3.67bn but the division recorded a loss at the operating level of INR33mn.

Fig. 13: International business performance


North America

Sales 1,111 1,181 1,227 1,276 1,552

- growth 6.3% 3.9% 4.0% 21.6%

EBITDA (43) 26 57 62 54

- margin -3.9% 2.2% 4.6% 4.9% 3.5%

South America

Sales 797 1,023 1,255 1,261 1,242

- growth 28.4% 22.7% 0.5% -1.5%

EBITDA (111) 98 33 (93) (151)

- margin -13.9% 9.6% 2.6% -7.4% -12.2%

Middle East and Africa

Sales 207 236 199 296 293

- growth 14.0% -15.7% 48.7% -1.0%

EBITDA (36) (32) (81) (49) (21)

- margin -17.4% -13.6% -40.7% -16.6% -7.2%

South & South East Africa

Sales 201 255 339 417 583

- growth 26.9% 32.9% 23.0% 39.8%

EBITDA (24) 16 31 45 86

- margin -11.9% 6.3% 9.1% 10.8% 14.7%

Total

Sales 2,316 2,695 3,020 3,250 3,670

- growth 16.4% 12.1% 7.6% 12.9%

EBITDA (214) 108 40 (35) (33)

- margin -9.2% 4.0% 1.3% -1.1% -0.9%

Source: Company data


15

Financials: we see steady growth ahead

Volume growth has bottomed

There has been a slowdown as measured by volume growth in FY13. Q1FY14 saw volume growth of 8% y-y, which was a four-year low. However, there seems to be some revival in volume growth in Q2FY14; we expect volume growth to be more buoyant in the medium term. Management noted on the Q2FY14 call that it did not expect the current quarter’s run rate to continue in the near term – which partly reflects the company’s cautious stance and partly on account of a one-time spike in the growth rate for the industrial segment.

Our estimates do not build in a strong recovery in the near term as we expect the macro environment to continue to be weak and Pidilite’s performance to largely reflect the slower growth environment. Our estimates build in ~14% revenue growth pa for the next couple of years, which is lower than the five year CAGR that the company has delivered.

While the long-term growth rate should still be high teens for the company, considering the large unorganised segment, and the competitive advantages that Pidilite has, we believe it is prudent to factor in only a slow recovery over the next couple of years.

Fig. 14: Volume growth in consumer and bazaar segment has seen a slowdown


Steady revenue growth: upside risks

We expect revenue growth to be a steady ~14% over the next couple of years. This will likely be primarily led by the consumer and bazaar segment. We believe the company can continue to leverage its leadership position in the segment and deliver strong growth over the medium term. While there could be some near-term slowdown in the consumer and bazaar segment, that is likely to be restricted to the next couple of quarters rather than the medium term.

EBITDA margins: likely to see some improvement

We expect EBITDA margins to improve in FY14F by 160bps. While there is some risk to that number particularly given depreciation of the INR, the company has the ability to pass on increased costs to consumers by way of price hikes. Our FY15F and FY16F EBITDA margin estimates are more conservative and build in only a marginal improvement. In our view, the company has demonstrated its ability to maintain high

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margins by passing on input cost increases over the past few years; we expect this to continue, given Pidilite’s strong market positioning.

Fig. 15: EBITDA margins should see some improvement in FY14F


Input costs relatively stable

Vinyl Acetate Monomer (VAM) is an important raw material and a crude derivative. Although it constitutes only ~ 14% of total raw materials it is an indicator of the price trend of other major raw materials like HDPE, whose price are also crude linked.

Pidilite imports VAM from international market (which is denominated in USD). We do not see input costs as a major issue in the near term. Given where prices are, margins should continue to see an improvement in H2FY14. However, our estimates are not building in much improvement in FY15-16F, which could be conservative if input prices are stable at current levels.

Fig. 16: VAM prices

Source: Nomura European Chemicals research team

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Strong cash flow

Pidilite has a history of consistently delivering strong free cash flow. FCF has doubled from INR1.72bn in FY11 to INR3.6bn in FY13. We expect FCF to continue to be strong over the next few years as the company generates significantly higher cash than it requires for capex.

Fig. 17: Strong FCF generation (INR mn)


Dividend payout ratio to likely increase

In our view, Pidilite’s low capex requirement and high FCF generation indicate that the company has significant buffer to sustain and even improve its dividend payout level. The company’s dividend payout has been in excess of 30% over the past 10 years. We believe this could rise in FY14F, given the lower capex requirement (INR1.2bn).

Fig. 18: Dividend payout could increase from current levels


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How does Pidilite compare to mid-cap consumer companies?

Pidilite has a strong market position in a growing segment and has been able to deliver consistent earnings growth over the past decade. While its performance has been impressive, it can only be put into context if we compare this with other mid-cap consumer companies. Pidilite and other mid-cap consumer companies operate in vastly different segments. But given some of the similarities (niche position within a segment, market leadership, strong return ratios), in our view, the comparison offers some insights into where the longer-term valuation multiples are likely to settle.

India business growth similar to other mid-cap consumer companies We examine the growth delivered from the India business for mid-cap companies and Pidilite over the past eight years. It is important to separate the performance of the company from what has been achieved in India for all these companies. Consumer companies have made significant acquisitions outside India, while Pidilite also has a significant business outside India along with some acquisitions. For this analysis we only consider the organic India business for all these companies.

Fig. 19: Revenue CAGR (%) for India business, FY05-13


Pidilite compares well with most of the other consumer companies in terms of matching the revenue growth performance in the India business. Pidilite’s India business delivered a revenue CAGR of 17% (vs. 15-18% range for Dabur, Marico, and GCPL) and 26% for Emami. The performance highlights the strong and consistent growth that Pidilite has also delivered over the last decade. While there has been a significant level of focus from investors on the stable growth trajectory of the above consumer companies, we believe performance over the last decade shows Pidilite to be in a similar position.

Looking at the size of the domestic business of the other mid-cap consumer companies and Pidilite, it is interesting to note that Pidilite’s domestic business is ~2x the size of Emami and 1.5x GCPL’s.

Return ratios also comparable Pidilite’s return ratios are comparable to the other mid-cap consumer companies mentioned above over the past five to six years. Since FY09, RoEs for Pidilite have been upwards of 25% on a consistent basis, and we believe they are likely to sustain at current levels over the medium term.

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GCPL Marico Dabur Emami Pidilite


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Fig. 20: RoE (%) profiles for comparable mid-cap consumer companies


Pidilite 17.0% 35.4% 31.7% 26.9% 28.5%

GCPL 47.4% 44.4% 35.6% 23.6% 22.8%

Marico 53.1% 43.6% 30.3% 31.0% 23.2%

Dabur 49.0% 55.2% 47.9% 42.3% 40.0%

Emami 48.7% 38.5% 32.9% 39.0% 43.2%


Having examined the key comparative numbers for Pidilite as well as other domestic mid-cap consumer companies, it is clear that in terms of growth profile and return ratios, Pidilite compares very well. We would also highlight that while growth numbers have been similar for all of the above companies, return ratios are actually declining for many of the mid cap-consumer companies. For Pidilite they have seen an improvement over the past few years. Considering these performance metrics, we believe valuations for all of them should be roughly similar.

Pidilite’s comparison to Asian Paints – several similarities We find that Pidilite has several factors both in the operating model, business dynamics and return ratios that are very similar to Asian Paints (APNT IN, Neutral). Like Asian Paints, Pidilite has a strong market share in a segment where there is competition from both local and international companies. Innovation has been a strong focus for management in both cases – a strategy which has helped them to maintain or increase market share over the last decade.

Both companies have invested significantly behind brand building, which has helped them to have strong pricing power. There has been strong management focus to improving profitability – a fact that is reflected in strong return ratios over the past few years.

Fig. 21: Consistent sales growth (%)


Fig. 22: Strong RoE (%)


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Valuation: Should Pidilite’s shares trade at a discount to other domestic mid-cap consumer companies?

As highlighted above, Pidilite’s performance compares well with other domestic mid-cap consumer companies under our coverage, both in terms of pace of growth and return ratios. However, when it comes to valuation, the shares of Pidilite trade at a discount to other mid-cap consumer companies. Over the longer term, the stock has traded at 21x one-year forward P/E This is at a discount to consumer average of ~24x over the same time period.

Fig. 23: Pidilite one year forward P/E

Source: Bloomberg, Nomura research

In terms of comparison, we believe it is more prudent to compare Pidilite to mid-cap consumer companies. For this comparison we construct a market cap weighted mid-cap consumer index. Average multiple for the index post GFC is ~25x one-year forward P/E (in line with the valuation multiple we assign for these companies).

Fig. 24: Mid cap consumer P/E


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Target multiple in line with consumer companies

We value Pidilite at 25x one-year forward EPS of INR13.1. Target multiple is similar to the multiple we assign for other mid-cap consumer names in the sector with similar growth profiles and profitability. It is higher than the average multiple the stock has traded at for the past five years, but in line with the current multiple. The stock has seen a rerating upwards over the past few years; we believe the stock will continue to trade at multiples closer to mid cap consumer average over the medium term.

As can be seen from the chart below as well, valuation is in line with mid-cap consumer average vs. >30% discount in 2009. As a result of consistent performance, the stock has seen a rerating upwards over the past few years.

Our DCF-based valuation model also suggests a fair value of INR325. This is based on cost of equity of 11% and terminal growth rate of 4%. Our DCF-based valuation model gives us confidence that the multiple we assign to Pidilite of 25x one year forward earnings is fair.

Fig. 25: Premium/discount vs. mid cap consumer average


TP of INR328 gives 16.4% upside potential from current levels

Our TP of INR328 (25x one-year forward EPS of INR13.1) gives 16.4% upside potential from current levels. We believe Pidilite is a solid long-term story with a strong brand and leadership position in the segment in which it operates. We do not see any disruption to this position of strength in the near to medium term which we believe will allow the company to focus on innovation and help them deliver high teens profit growth CAGR. We assume coverage with a Buy and our TP implies 16.4% potential upside from current levels.

Risks Two key risks for the company are: (1) a sharp slowdown in demand for the products – as part of the portfolio is discretionary in nature; and (2) input costs have been flat for the past few months, but a sharp increase could have a negative impact on margins.

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Fig. 26: Consumer sector valuations

Company Ticker Rating Price INR EPS growth (%) P/E (x) PEG (x)

FY15F FY16F FY15F FY16F FY15F FY16F

Nestle * NEST IN Neutral 5,379 19% 20% 35.8x 29.8x 1.9x 1.5x

GSK Consumer * SKB IN Reduce 4,348 21% 20% 29.3x 24.3x 1.4x 1.2x

Jubilant Foodworks JUBI IN Reduce 1,157 27% 27% 39.3x 31.1x 1.5x 1.2x

United Spirits UNSP IN Buy 2,764 46% 53% 44.0x 28.8x 1.0x 0.5x

F&B Average 37.6x 28.7x

Colgate Palmolive CLGT IN Reduce 1,317 14% 17% 28.1x 23.9x 2.0x 1.4x

Dabur DABUR IN Neutral 172 18% 22% 27.3x 22.5x 1.5x 1.0x

Godrej Consumer GCPL IN Neutral 795 24% 27% 26.6x 21.0x 1.1x 0.8x

Hindustan Unilever HUVR IN Reduce 538 10% 14% 29.2x 25.7x 2.9x 1.9x

Marico MRCO IN Buy 216 22% 21% 22.6x 18.7x 1.0x 0.9x

Emami HMN IN Buy 462 20% 12% 21.8x 19.5x 1.1x 1.7x

HPC Average 27.8x 23.8x

ITC ITC IN Buy 324 19% 18% 23.9x 20.3x 1.3x 1.1x

Asian Paints APNT IN Neutral 487 21% 22% 31.0x 25.4x 1.5x 1.2x

Pidilite Industries PIDI IN Buy 282 19% 17% 24.2x 20.7x 1.3x 1.2x

Titan Industries TTAN IN Buy 221 19% 19% 19.9x 16.7x 1.1x 0.9x

Bata India * BATA IN Buy 1,017 21% 21% 26.9x 22.3x 1.3x 1.1x

Retail Average 21.6x 18.1x

Source: Bloomberg, Nomura estimates. Note: Share prices are as of 14 January 2014. * Indicates calendar year valuations


23

Appendix A-1

Analyst Certification

We, Manish Jain and Anup Sudhendranath, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Asian Paints APNT IN INR 487 14-Jan-2014 Neutral N/A Colgate-Palmolive (India) CLGT IN INR 1317 14-Jan-2014 Reduce N/A Dabur India DABUR IN INR 172 14-Jan-2014 Neutral N/A Godrej Consumer GCPL IN INR 795 14-Jan-2014 Neutral N/A Pidilite Industries PIDI IN INR 282 14-Jan-2014 Buy N/A

Pidilite Industries (PIDI IN) INR 282 (14-Jan-2014) Rating and target price chart (three year history)

Buy (Sector rating: N/A)

Date Rating Target price Closing price 14-Sep-13 Suspended 239.05 16-Aug-13 254.00 249.50 08-Nov-12 214.00 206.45 08-Jun-12 Neutral 174.40 08-Jun-12 169.00 174.40 09-Feb-12 Buy 146.45 09-Feb-12 174.00 146.45 29-Nov-11 Reduce 153.50 29-Nov-11 142.00 153.50 08-Feb-11 Buy 126.10 08-Feb-11 180.00 126.10

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our target price of INR328 is based on a P/E multiple of 25x applied to the one-year forward EPS of INR13.1, in line with the multiple we assign to other mid-cap conusmer companies. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price Two key risks for the company are: (1) a sharp slowdown in demand for the products – as part of the portfolio is discretionary in nature; and (2) input costs have been flat for the past few months, but a sharp increase could have a negative impact on margins.


24

Asian Paints (APNT IN) INR 487 (14-Jan-2014) Rating and target price chart (three year history)

Neutral (Sector rating: N/A)

Date Rating Target price Closing price 23-Sep-13 435.00 486.10 24-Jun-13 450.00 439.32 21-Jan-13 411.00 428.79 30-Oct-12 380.00 388.795 02-Aug-12 Neutral 365.13 02-Aug-12 346.00 365.13 24-Oct-11 350.00 305.01 28-Jul-11 365.00 312.085


Valuation Methodology Our target price is INR435. We value Asian Paints at 25x one-year forward EPS of INR17.4. Our target multiple of 25x is in line with the past five-year average multiple for the stock and in line with the multiple we assign to the sector.The benchmark index for the stock is MSCI India. We expect the stock to be a market performer and hence our Neutral rating. Risks that may impede the achievement of the target price Increase in input prices or depreciation of the INR vs the USD could mean potential downside risk to our earnings estimates. Pick up volume growth could mean upside risk to our estimates.

Colgate-Palmolive (India) (CLGT IN) INR 1317 (14-Jan-2014) Rating and target price chart (three year history)

Reduce (Sector rating: N/A)

Date Rating Target price Closing price 23-Sep-13 1,120.00 1,263.45 29-Jul-13 Reduce 1,407.85 29-Jul-13 1,270.00 1,407.85 11-Mar-13 Neutral 1,315.75 11-Mar-13 1,300.00 1,315.75 01-Nov-11 825.00 1,041.35


Valuation Methodology We value Colgate-Palmolive at 22x one-year forward EPS of INR 51 to arrive at our target price of INR1,120.The benchmark index for this stock is MSCI India. We expect the stock to underperform the index over the next one year. Risks that may impede the achievement of the target price Upside risk could come from sharp fall in commodity costs. Downside risk could come from heitened competitive activity in the oral care segment which could pose a risk to our numbers.


25

Dabur India (DABUR IN) INR 172 (14-Jan-2014) Rating and target price chart (three year history)


Date Rating Target price Closing price 23-Sep-13 Neutral 167.10 23-Sep-13 174.00 167.10 29-Jan-13 152.00 130.55 24-Jul-12 133.00 118.30


Valuation Methodology Our INR174 target price for Dabur is based on 25x our four rolling forward quarters EPS estimate of INR7. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price Risk to our estimates could come from a faster-than-expected rise in commodity costs and higher advertising and promotional spends.Upside risk comes from strong volume growth.

Godrej Consumer (GCPL IN) INR 795 (14-Jan-2014) Rating and target price chart (three year history)


Date Rating Target price Closing price 23-Sep-13 Neutral 816.00 23-Sep-13 850.00 816.00 12-Dec-12 833.00 720.10 20-Sep-12 800.00 662.70 21-Jul-11 Buy 444.50 21-Jul-11 524.00 444.50


Valuation Methodology Our target price of INR850 is based on a P/E multiple of 25x applied to one-year forward EPS of INR34The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price 1) Underperformance of acquisitions, particularly Megasari and Godrej Household Products business (GHPL), is a risk to our estimates; and 2) rising raw material prices are a risk to our numbers.3) upside risk could come from recovery of margins in Africa.

Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne.

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Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013 The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analyst’s target price is an assessment of the current intrinsic fair value of the stock based on an appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. Benchmarks are as follows: United States/Europe/Asia ex-Japan: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology; Japan: Russell/Nomura Large Cap. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Sectors that are labelled as 'Not rated' or shown as 'N/A' are not assigned ratings. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks

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under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. Target Price A Target Price, if discussed, reflects in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates. Disclaimers This document contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or, with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or identified elsewhere in the document. 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The securities described herein may not have been registered under the US Securities Act of 1933 (the ‘1933 Act’), and, in such case, may not be offered or sold in the US or to US persons unless they have been registered under the 1933 Act, or except in compliance with an exemption from the registration requirements of the 1933 Act. Unless governing law permits otherwise, any transaction should be executed via a Nomura entity in your home jurisdiction. This document has been approved for distribution in the UK and European Economic Area as investment research by NIplc. NIplc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. NIplc is a member of the London Stock Exchange. 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