We explore business of the leading company in the artificial sweetener space in India as well as other products for the health conscious population, and where it stands in its fight against rapidly growing threat of new entrants.
Statutory Warning: This is NOT an investment advice to buy or sell shares. Please make your own decision, as blindly acting on anyone else’s research and opinions can be injurious to your wealth. I do not own the stock, but my analysis may be biased, and wrong. I have been wrong many times in the past. I, Vishal Khandelwal, am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014 (Registration No. INH000000578).
Zydus Wellness Ltd. (ZWL), part of Cadila group (Cadila Healthcare owns 72% stake), is a consumer company operating in the health and wellness space. ZWL owns four key brands – Sugar Free (sugar substitute), Nutralite (margarine), Everyuth (skin care) and Actilife (health drink).
The company is the market leader in Sugar Free (93.6% market share), Nutralite (40% share) and Everyuth Peel-off (92% market share). Let’s talk a bit about each of the key categories of ZWL.
Sugar Free, ZWL’s biggest selling product and brand, is an artificial sweetener, that is an alternative for sugar consumption and is used majorly by diabetic patients. The product is also increasingly being used by health conscious people to reduce their calorie intake. Sugar Free currently is available in two sub-brands namely Sugar Free Gold (made from Aspartame – a protein derivative; 180 times sweeter than table sugar) and Sugar Free Natura (made from Sucralose – zero calorie sweetener; 600 times sweeter than table sugar).
As a category, artificial sweetener is a Rs 300 crore market in India (as compared to sugar consumption of around Rs 1,200 crore) and has grown at about 18-20% annually, though growth has slowed down in recent years. With increasing number of diabetics and health conscious in the population, the demand for such artificial sweeteners in only going to grow going forward.
Talking about ZWL’s second key business of Nutralite, which is healthy alternative to butter (cholesterol free and does not contain hydrogenated fats), the company has a 40% market share. In terms of clientele, 75% of this product is catered to institutional segment which has competition from unorganised players and yields lower margin. Remaining 25-30% of this business comes from the retail segment, where health conscious buy this product and also pay a premium over butter. This category has also seen some slowdown in the past 2-3 years, though ZWL has seen its market share grow on the back of aggressive marketing and distribution drives.
ZWL’s third key business – Everyuth – has been facing pressure over the last few years, though it revived well in FY16. The peel off category, where ZWL has a 92% market share, has seen increasing amount of competition with entrance of more number of players. Peel off category has seen a decline over the last few years, though ZWL has managed to do relatively well.
Anyways, let me now analyse ZWL using a set of questions to test the underlying business and management quality.
1. Has the company done well in terms of sales and profit growth over the past few years?
Reasonably well. Over the past eight years (FY08 to FY16), ZWL has grown it net sales and profits at average annual rates of 29% and 47% respectively. Growth has however slowed down over the past five years (FY11 to FY16), largely owing to slowdown in the company’s key categories. While sales have grown at a CAGR of just around 5% during the last five years, profits have grown at a rate of 11%. However, without being over-optimistic, the future does look promising for ZWL, especially in the Sugar Free business.
Sugar Free has become a generic in India for the artificial sugar-sweetener sub-segment in much the same way Maggi was to the noodles sub-segment. Such high brand recall reflects the strong brand equity and a near monopoly of the Sugar Free brand in India. What is important is that despite the highly-underpenetrated market, competitors have failed to etch a place in the sugar-substitute market. Key competitors for Sugar Free include Equal and Splenda, which together have less than 8% market share. Even though Sugar Free is available over the counter, ZWL is exploring the doctor advocacy route to generate consumer awareness of such products and their benefits. This is expected to be one of the key drivers, together with the growing health consciousness of Indian consumers.
As per its recent presentati0ons and annual reports, ZWL has also initiated major steps towards expanding its reach with some changes in its marketing strategy. It plans to consolidate its distributors which currently stands at 2,500. Given the small size of the sugar substitutes relative to other consumer categories, the level of attention and effort at the distributor end tends to get diluted. Hence, the consolidation would raise the per distributor revenue stake to a higher level. As per the management, the benefits of this strategy are likely to be seen FY17 onward. The company is also in process of doubling its retail touch points, which currently stand at around 270,000. Currently, about 60-65% of retails touch points are through chemist stores, which the company is working to reduce by increasing business share from general/non-chemist stores. Apart from these initiatives, ZWL has been increasing focus towards expanding application of Sugar Free Natura (Sucralose) in cooking. I believe, with growing awareness and rising income levels, the sugar free consumption in this format has potential to increase. If successful, this would provide a strong growth in the volumes for the company in the coming years.
As far as the other two key brands – Nutralite and Everyuth – are concerned, ZWL is trying to grow through introduction of new product variants and strengthening its distribution, though rising competition and slow category growth remain key issues here. So, it’s more of a wait and watch stance that we need to apply here.
2. How profitably have retained earnings reinvested?
ZWL is a debt free company with close to Rs 300 crore cash lying on balance sheet. Apart from the superior gross margin that the company earns (average of 70% over the past five years), the average ROE for past five years stands at over 34%. However, it’s important to look beyond the averages here. ZWL has seen some pressure on ROE over the past five years, with the same declining to 23% in FY16 from 49% in FY11. Reduced asset productivity – as seen from asset turnover – is the culprit here, with the same falling from 1.8x to 0.8x during the same period. And blame the company’s rising cash levels (apart from the slowdown in sales growth) for the decline in asset productivity (see table below). This has negated the benefit that would have flown to ROE from an improved net margin – from 18% in FY11 to 24% in FY16.
How the management utilizes this burgeoning cash is going to be a big question here. Though it suggested in its latest conference call that ZWL is actively scouting for acquisitions in India and abroad, any mismanagement (maybe out of frustration of seeing rising cash levels) should ring alarm bells.
3. Does the business have a durable competitive advantage?
As we have seen in our discussion on ZWL’s key brands above, the company seems to have a strong brand recall and competitive advantage in the artificial sweetener business. The moat in this segment due to this specific brand has only widened in recent years, as seen from the rise in market share for Sugar Free. The company is now getting aggressive in strengthening its distribution reach, which should only add to its brand strength. But this in largely as far as the Sugar Free business is concerned. In Everyuth and Nutralite, despite ZWL’s dominant positions, the fact that the respective categories as a whole have seen demand slowdown even as competition has intensified should keep the management on its toes.
4. How has the management fared?
ZWL’s management has a good, clean reputation and has done well on the execution front in terms of strengthening the various brands of the company over the years, in light of rising competition. The compensation levels of the top management team members are also within reasonable levels.
5. What are the risks to the business?
While the future looks good for ZWL’s Sugar Free business, the key challenges still include rising competition and demand slowdown – largely since health consciousness is still not a large part of an average Indian household mindset and spend. Plus, new alternatives may emerge in the future – as constant research is underway as far as health products are concerned – which may spoil the party for ZWL. Then, as seen from the past 5 years’ performance, the company’s overall revenue performance has been impacted due to decline/muted revenue growth for its Everyuth and Nutralite brands. In an event mainly due to increase competition and slowdown in category growth the revenue may decline in these two segments in the future too, which in turn will impact the revenue growth for the company as a whole.
ZWL’s stock is currently trading at around Rs 790, which implies a P/E multiple of 30x its FY16 earnings of Rs 26 per share. A large part of this valuation captures the success and strength of ZWL’s Sugar Free business, though the stock has seen some hammering over the last one year owing to weakness in its other businesses. You, as an investor, must consider both sides of the case – opportunities and risks – plus ensure sufficient margin of safety in the stock’s price, before making any investment decision.
Statutory Warning: This is NOT an investment advice to buy or sell shares. Please make your own decision, as blindly acting on anyone else’s research and opinions can be injurious to your wealth. I do not own the stock, but my analysis may be biased, and wrong. I have been wrong many times in the past. I, Vishal Khandelwal, am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014 (Registration No. INH000000578).[/show_to] [hide_from accesslevel=’almanack’]
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