Archies Greetings and Gifts: Hold/Avoid fresh exposures

Recommendation:Hold/Avoid fresh exposures

Aarati Krishnan

THE Archies Greetings and Gifts stock is proof of the volatility inherent in the stock market.

After an IPO at Rs 70, the stock had climbed steadily to touch Rs 1,400 by August 1999. Archies' near-monopoly status in the rapidly expanding domestic greeting cards business and its track record helped sustain the hype surrounding the immense earnings potential for the company.

However, the decline in the company's stock price has been equally dramatic. Since August 1999, the stock has shed 80 per cent of its value and now languishes at Rs 150 per share. Over the same period, the broad market lost just around 14 per cent in value.

The valuation for the stock appears to have been impacted by several factors -- a slowdown in financial performance, the growing threat to the greeting card business from e-cards and Archies' forays into other businesses such as gifts, music and stationery.

The initial years

The stock's steady ascent in the initial years after listing is explained by its impressive financial performance. Over the past four years, the company posted scorching growth rates in sales and net profits. Between 1995-96 and 1999-2000, Archies net profit grew more than ten-fold at a compounded annual rate of 68 per cent, while its sales grew at 26 per cent. Operating profit margins over this period expanded from 10.5 per cent to a phenomenal 31 per cent, while returns on capital employed surged from 46 to 78 per cent.

The stock markets ramped up valuation for the stock as well. After all, over the past four years, the greetings cards business has almost been an analyst's dream come true. With high operating profit margins, low sensitivity to input prices and relative immunity from business cycles, the business appeared to carry few risks. With the organised greeting card industry still in a fledgling stage, rapid expansion of revenues through higher product penetration, appeared easily attainable.

Right strategic moves

Archies, with more than a decade in the business, appeared ideally positioned to leverage these strengths. And it did. Over the past four years, Archies made all the right strategic moves to sustain the rapid expansion in revenues in the greeting card business. It consistently added to its design library by entering into licensing arrangements with the biggest names in card manufacturing worldwide. Archies now has licensing arrangements with several big names -- American Greetings Corporation, Gibson Greetings, Portal Publications, Kingsley Cards and Anne Gedds. The company has also tried to promote product usage by promoting and adverting new occasions such as Father's day, Mother's day, friendship day and Valentine's day. This has helped even out the seasonality of the cards business to some extent. To enhance market penetration, Archies has introduced cards in several regional languages such as Marathi, Hindi, and Gurumukhi.

This has been supported by a rapid expansion in the distribution network, both through new company-owned outlets and the addition of new franchisees to operate Archies Galleries. The number of Archies franchisees has grown from 167 in 1995-96 to 487 by December 2000.

Speed-breakers ahead

But not everything has gone right for the company lately. After registering a rapid pace of growth up to 1999-2000, Archies financial performance slowed down considerably in the first nine months of 2000-01. For the nine months ended December 2000, Archies sales fell by 5 per cent to Rs 53.03 crore, while net profits slumped 15 per cent to Rs 14.68 crore. Though it is difficult to say if this was due to intensifying competition, the company attributes this to the revamping of its distribution system.

Implications of distribution rejig

In 1999, the company initiated a two-year exercise aimed at moving over from a franchisee-based distribution system to one that revolves around company-owned outlets. Earlier, franchisees were required to purchase stocks from Archies and undertook the risk of managing inventory. For the company, this system had its disadvantages. Not only were retail margins high (to compensate franchisees for undertaking business risks), franchisees had the right to determine the product range they stocked, giving the company very little say in what was stocked in the Archies Galleries. The credit extended to franchisees also led to high outstandings.

Under the new system, the company plans to stock stores with its own inventory, with the franchisee only required to bear the cost of maintaining the store. As a result, the company expects to have greater control over the distributors' product range and expects to save substantially on the margins it offers to distributors. The company also plans to source a larger proportion of its turnover from the company-owned Vision 2000 stores. Currently, just around 20 of Archies' 487 outlets are company-owned.

These moves could have their flip side. For one, the shift in the distribution system is likely to sharply enhance working capital requirements. With the company taking inventory on its balance sheet, Archies will have to finance the costs of carrying inventory and sales returns.

Second, investments in real estate, which are negligible in a franchisee-based system, are also likely to multiply. Since the product requires retail outlets in prime urban locations, the investment in real estate can be quite significant.

The company plans to economise on these costs by taking retail space on a lease basis. But there can be little doubt that substantial additional investments may be called for in the transition period. This could increase interest costs and change Archies status as a zero-debt company.

In the long term, Archies hopes that the higher costs of owning the retail infrastructure can be offset by substantial savings in trade margins. In a business where trade margins are as high as 60 per cent, this is believable.

But with both the sales and profit margins suffering a decline in the first nine months of 2000-01, the near term performance may remain lacklustre. Indeed, though Archies has indicated a sales growth target of 15 per cent for 2000-01, it appears unlikely to attain this target, going by its nine-month performance.

New businesses

There are other uncertainties clouding business prospects. Over the past couple of years, Archies has diversified into several other businesses. From vending greeting cards and posters, Archies outlets have moved to vending gifts and stationery too.

Though these require no fresh investments in distribution, gifts and stationery appear to offer lower margins to Archies, since these are outsourced by Archies. With competition from a large unorganised segment, the prospects for these businesses are not as predictable as those for greeting cards. However, Archies has tried to get around this problem by supplying to the corporate gifts market, which provides a more stable source of revenues.

This is not all. Archies has also made forays into two entirely unrelated product lines -- music and perfumes. These could prove to be an entirely different ballgame for Archies. Unlike cards or gifts, where Archies faces little by way of organised competition, in the music and perfumes businesses Archies is pitted against established brands and companies with considerable market clout of the likes of Saregama, Tips Cassettes (music) and Hindustan Lever and Cavin Kare (perfumes). The distribution set-up for these businesses is considerably different from that for greeting cards.

E-cards and competitionFinally, with the advent of e-cards, Archies' core business may also be under threat. The growth of e-cards has not made a significant dent in the earnings of greeting card companies globally. But the small size of the card buying population in India, the popularity of the Internet and the economies of sending cards through the Internet, could limit the growth of players in the greeting cards business.

Archies recently launched its own online venture, archiesonline.com, for vending cards and gifts through the Internet. But with most e-card sites offering free services, it is unclear if this venture will contribute to the holding company's profits in the near term.

The entry of competitors such as Vintage Cards (backed by Hallmark) and Gold Flake Expressions (from ITC) into the greeting cards business may only make things more difficult for Archies in the near future.

Outlook

The overall analysis, given these factors, appears to involve considerable uncertainties for Archies over the next couple of years. Even by the company's expectations, the distribution revamp is likely to hold down growth rates over the next one year. Over the longer term, earnings prospects appear brighter. Though growth rates may not be sustained at the scorching pace of the past five years, the company is likely to return to steady earnings growth.

The Archies stock currently trades at a modest price earnings multiple of 6 times the latest earnings. The downside to the stock from this level looks limited. Therefore, investors with an investment horizon of three years or more could hold on to the stock in light of the expected benefits from the distribution revamp. Fresh investments can be postponed in light of the near-term uncertainties.