March 29, 2012

Analysis: Globus spirits

Globus spirit is a 500 Cr spirits company with four divisions. IMIL (India made India liquor) accounts for 50% of the revenue of the company. The company enjoys a dominant market share in this segment in the states of Haryana, Rajasthan and Delhi.
Franchise IMFL (bottling operations for other companies) is the second largest segment with a revenue share of around 20%.  The company has bottling ties up with companies such as Jagajit industries, ABD etc. This segment allows the company to utilize its manufacturing facility fully and thus earn additional return on its fixed assets
The bulk alcohol and IMFL are the other two segments with revenue share of around 10-12%. IMFL is premium alcohol business with brands such as Country club and Hannibal rum. The bulk alcohol business sells ENA to other companies including the fuel companies and is a lower return, commodity business
The company has grown its sales from around 68 Crs in 2005 to around 700 Crs by 2012. This translates into a CAGR of around 40%. The net profits have grown during the same period at around 50% per annum, starting from a low base of 5 Crs in 2006. The company has been able to improve its net margins from 6% level to around 8-10% in 2012.
The company has been able to achieve an ROE of around 18% on average with a low debt equity ratio of under 0.3. The company has been adding to its capacity, which has gone up from 28.8 Million liters to around 84.4 Mn liters in the current year. This capacity addition has resulted in the fixed turns dropping from around 5 to around 1.8 in 2011, as the entire capacity is not being utilized yet.
The company is a consumer products company where the demand for the product is on the rise. In addition, the company has a fairly high market share in the IMIL segment which is a rapidly growing segment with lesser competition. This segment, though price sensitive, is not completely a commodity business.  The company has an established distribution network in the states of Haryana, Rajasthan and Delhi which can leveraged for future launches.
The company has now started expanding in the IMFL segment too with launch of several new brands and is also planning to expand into new states. This segment is however competitive and will require substantial investment in building the brand and distribution network.
Finally the company has added substantial capacity in the last few years which is being used for the franchise bottling (bottling other brands) or for bulk alcohol sale. The company can easily reduce the bulk and franchise bottling sales as the sale of its brands increase (which generate higher margins)
This industry is worse than the sugar, tobacco and possibly real estate in terms of regulations. The government considers alcohol as an evil and over time has had a love hate relationship with the industry. The love part with the industry is due to the high level of taxes (highest after sales tax) and the amount of black money which can be generated via the grant of licenses for manufacturing and distribution. Needles to say, the industry is quite murky in its operations.
In addition to the regulatory risks, the industry has very poor corporate governance standards (think UB group). As a result, it is not easy to trust the published numbers in this sector.
At the company level, Globus is comparatively a new player and hence faces the uphill task of building a distribution network and brands from scratch which is quite an expensive proposition. In addition there is quite a bit of competition, especially in the premium and super premium segment.
Competitor analysis
The industry is dominated by united breweries and united spirits, both owned by the UB group. These two companies account for more than 50% of the entire industry. Inspite of such a dominance, the group has a net margin in the range of 4-5% and measly 10-12% ROE with high debt levels.
 I am not able to understand why the profitability is so poor, inspite of the dominance. The comparable company for United spirits is Diageo, which makes close to 15% margins and has 40% ROE. Clearly alcoholic beverages are a very profitable business globally. Anyway i am not interested in these two companies, due to their corporate governance.
The other player in the industry - Radico khaitan has similar net margins, but a much lower debt equity ratio (0.7) and an average ROE of around 12%.  The fourth largest player which is listed, is tilaknagar industries. The company has a margin in the region of 7-8% and  a similar ROE of 12%. The company had a much higher debt in the past, but has been able to reduce it in 2011 by raising some equity.
You may notice that I have hardly discussed about the brands of the above companies. There are two reasons for it. The first reason is that strong and well known brands are often a necessary, but not a sufficient condition for high returns on capital. Clearly in the case of the above companies, brands such as kingfisher or Bagpiper  though well know, have not added to the profitability. As an investor, I am more concerned about the profitability of the business
The second reason is that I don’t drink now (used to in the past) and hence am not abreast of the latest brands. At the same I don’t think that is a disadvantage to me as an investor, as I also have never used  a textile machine (LMW) or tiller (VST industries) to be able a informed decision on these companies
In conclusion, one would expect the industry to have remarkable economics in a product which is addictive and has brand loyalty, but unfortunately the numbers are even worse than the cement or steel industry (where atleast the leaders are quite profitable)
The valuation in the case of globus is more of a subjective exercise. The company sells at around 6 times earnings and appears cheap by quantitative measures. The  company is cheap only if you believe that the company’s expansion into IMIL and IMFL segment will be successful and the company will do better than the industry (which has lousy economics for varied reasons). If the company can maintain the current margins and continue growing at 20% rate, then it is cheap.
The margins could dip due to higher expenditure in marketing and distribution and the asset turn could drop due to additional capacities for the franchise bottling and bulk alcohol. If the returns trend towards the industry averages, then the company appears to be fairly valued (which is what the market is assuming)
As you can see, I do not have a specific view point on the company.  Although the company operates in an industry with very poor profitability, it has been able to deliver above average performance with low amounts of debt. I am not completely sure if the company will be able to sustain this performance as it is usually quite difficult for companies to rise above the industry economics.
I plan to analyze the performance of the company and track it for sometime before I become more comfortable with it. In the meantime the price could always run up, which is a risk I can live with.
Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog.


rohitkotewale said...

Hi Rohit,

They have been diluting too much of equity . So profit growth has not been translated into EPS growth. EPS has just gone from 11 in 2007 to 13 in 2011. Isn't this a concern?

Anonymous said...

Tillers is VST Tillers. VST Industries is into cigarettes and what a beautiful business it is.

Piyush Goyal said...

The problem i have with the IMIL business is that it enjoys no pricing power given the profile of the customer. Net net, IMIL cannot provide a sustainable moat. They'll have to crack the IMFL market to get sustainable ROEs which is already a very competitive market. I would keep a tab on how they do on the IMFL front and then go from there.

Rohit Chauhan said...

Hi rohit
i looked at the dilution...the company accquired a group distilerry. valuation seemed to be ok ..though the preference is always cash over stock , especially if stock is cheap

you would expect most management would do this as it increases their shareholding


Rohit Chauhan said...

Hi anon
yes ...thats a typo. its VST tillers


Rohit Chauhan said...

Hi piyush
i differ ...IMIL has a better chance. It has much lower competition - maybe none, larger market and possibly much larger moat. take the example of asian paints - they gained control of market by coming from the rural/ downmarket and then grew into premimum segment

the IMFL segment has large and strong competitors and Globus cannot win there easily. The best option is to build IMIL and other segment and then use those asset to grow in IMFL



Hi Rohit,
Have you been tracking the stock these days? I think the future lies in IMFL market penetration and the company seems to be acting on it becasue the QoQ other expense ratio increased dramatially for Q4 FY12.
Also, it has signed a contract with United Breweries for bottling. Further it is searching and has found minor success in overseas brands for IMFL. Keeping that in mind, how do you feel is the future for the stock? I am thinking about making a token entry.

Anonymous said...

As of March 2013 - equity is going at Rs, 96.

In Jan 2013, Templeton have pumped in 70-90 Crores in this company. Equity convertible at Rs 140.

Have Templeton been taken for a ride?

Anish Jobalia said...

Would like to contribute my thoughts:

1) Country Liquor which is the largest segment of GS does not have pricing power. So branding the products does not generate excess profits.

2) In order to generate high sales growth, there is continuous need for investment into fixed assets because of the need to set up distillation units in each states as per the law

3) Markets get saturated quickly in the Country Liquor segment and it's almost unlikely that government would want IMFL customers to switch to IMIL, the reverse is quite likely

4) After market gets saturated, company grows at industry average. Take the pricing power out of the business and profit growth is just limited to volume growth.

5) GS has 90% distribution penetration and market share of 25%. Only way to deal with this is that GS has to introduce semi premium products or IMFL products which has pricing power

6) Competition is intense in IMFL segment. To gain market share in IMFL is tough

7) Incremental profits on incremental capital employed will fall as more and more greenfield expansion takes place (New distilleries). Cost to set up new distillery is higher than the cost to increase capacity at existing plants.