Smithkline Consumer: Buy

Recommendation: Buy

Aarati Krishnan

INVESTORS can consider taking fresh exposures in Smithkline Beecham Consumer Healthcare (SBCH), which is presently trading at Rs 390.

Conservative investors may consider the stock by virtue of its potential to deliver a moderate return with low volatility.

With newly acquired brands, Maltova and Viva, contributing to its revenues, the company has turned in a healthy expansion in sales and profits in the first nine months of 2001.

The recent proposal to transfer the OTC (over the counter) pain-relieving brand, Iodex, from GlaxoSmithkline to SBCH, may also add significantly to its revenues. In the circumstances, the stock, trading at around 14 times its latest earnings appears to be a good investment proposition for investors with a three-year investment horizon.

SBCH is the dominant player in the market for malted food drinks. Its portfolio consists of mature but well-established brands such as Horlicks, Viva and Maltova (the last two were acquired in 2000 from Jagatjit Industries). The company's near stranglehold on the market gives its considerable pricing power. SBCH has been in a position to push through price increases on its products at regular intervals.

Despite the sluggish conditions prevailing in the market for malted food drinks, SBCH has managed healthy growth in both profits and sales in the first nine months of 2001. The brand acquisitions undoubtedly contributed quite a bit to the robust sales growth of 16.4 per cent in the first nine months of 2001.

However, the quantum improvement in operating profit margins in the first nine months show that SBCH has leveraged well on the synergies from the acquisitions. In the first nine months of 2001, SBCH managed to increase its operating profit margin from 21.4 per cent to 23.8 per cent. In the first nine months of 2001, SBCH reported a 20 per cent growth in net profits in relation to the previous period.

The recent decision by SBCH's parent, GlaxoSmithkline, to transfer Iodex to SBCH could boost revenues in the coming year. This decision has been taken in order to allow the pharmaceutical company to focus on prescription products.

Iodex is a fairly large brand with the potential to add Rs 70-90 crore to SBCH's revenues (estimates about the size of the brand vary). The transfer is to take effect from January 2002, Therefore, the effect of the transfer will not be felt in the performance for the October-December 2001 quarter.

From a longer term perspective, the limited product portfolio will continue to remain a key constraint for SBCH. With regard to new product launches, it now appears clear that any pharmaceutical launch will be routed through the newly integrated GlaxoSmithkline.

New brands in the consumer products segment have been routed through a wholly-owned subsidiary of the parent over the past couple of years.

Sales growth for SBCH will, therefore, have to come from its core portfolio of malted food drinks. The company has successfully experimented with brand extensions such as Junior Horlicks and Mother's Horlicks, but the possibilities are rather limited now.

However, since malted foods is a low penetration category, there is considerable scope for expansion in the topline if SBCH manages to rope in new consumers.

As the dominant player in the market, SBCH should be in a position to register a steady, though not high growth in sales and profitability over the next three years. The relatively low valuation for the stock (compared with other FMCG peers) makes for limited downside risks.