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A Little Gem in the FMCG Sector
Jul 18, 2016

It's a very Indian ritual. Oiling the hair is a tradition that has been passed on for generations. And probably will for many more. It's a tradition that cuts across rural and urban, young and old, poor and rich. Indeed, hair oil companies could potentially sell oil for a billion heads! And that number will only keep growing.

But there are just two companies that have been able to make a meaningful mark in this huge market. One is Marico and the other is Bajaj Corp.

The business model of Bajaj Corp is particularly intriguing since it depends on selling just one product - Bajaj Almond Drops Hair Oil (ADHO). Ninety-one percent of the company's overall turnover comes from this product. The balance comes from the acquired brand 'No-Marks' in the personal beauty segment. A miniscule percent comes from other hair oil variants.

Bajaj ADHO is a market leader in the light hair oil category. The brand has a whopping 60% market share. Meaning that the company has found its niche in this particular segment.

This niche has given them the advantage of being a price setter. In investing parlance, Bajaj Corp has achieved pricing power. In the last four years, the company has increased the prices of ADHO at a compounded annual growth rate (CAGR) of 7%. Now, that's phenomenal.

This pricing power has in-turn led to higher margins - the best-in-class operating margins in the industry. Average operating margins in the last three years has been 33%.

On the other hand, Marico, one of the biggest players in the coconut oil space, has operating margins of 18%. Much lower than Bajaj Corp's.

We also like the company's healthy dividend payout ratios. The dividend payout ratio in the last three years averaged 71%. This high payout provides cushion during bad times.

We recently had the opportunity to meet the top managerial personnel of this company. The conservation made it clear that the company would never foray into unrelated and expensive acquisitions. They have no intention to blow their cash for the sake of diversification. And that means the high dividend payout ratio is likely to stay.

Having said that, the company has significant exposure to rural areas. Of the overall turnover, 42% comes from rural areas. Until lately, that's where the growth came from. But two consecutive years of deficit rainfall have depressed rural wages. This in turn lowered the company's turnover and disposable income.

As you see from table below, people are increasingly buying the lower sized three-milliliter SKUs as compared to the hundred-milliliter SKU. Realizations from three-milliliter SKUs are lower than the larger SKUs, which in-turn impacts profitability

Comparison of 3ml & 100ml SKUs from 2011-16
Sku 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16
3ml 10.00% 13.00% 15.80% 18.00% 20.30% 22.30%
100ml 33.00% 29.00% 28.50% 27.90% 28.30% 24.10%
Source: Annual Report

Further, people are shifting to the low-cost Amla hair oil variants. Amla hair oil is 30-40% cheaper than ADHO. All these factors coupled with the threat from the emergence of Patanjali have led the stock to correct 14% in one year.

However, the company has a strong distribution network. Bajaj Corp has only 30% fewer stockists than FMCG behemoth Hindustan Unilever Ltd.

In addition, the strong operating margins enable the company to spend huge sums of money on advertising and promotion (A&P) activities. The company spends around 18% of sales on A&P activities.

Turnover has been dampened on account of lower rural wages. But this trend could reverse on account of a normal monsoon and government schemes dedicated to doubling the income of farmers by 2022. These could trigger a spurt in the demand going forward.

Now, this is not a recommendation on the stock, as one should study the revenue growth and valuations carefully before buying it. However, the average dividend yield of 2.9% does offer some margin of safety.

Madhu Gupta

Madhu Gupta (Research Analyst), ValuePro has a post graduate degree in both physics and finance. Having worked with India's leading economic research agency, she has a natural flair for numbers and analytics. She brings with her a near-decade long rich experience in the field of finance. A firm believer of the principles of value investing, she looks for robust businesses with durable competitive advantages.

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Nov 10, 2017

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