Description

Zydus Wellness is a consumer-focused health and wellness product company in India that has strong dominance in niche products. With a focus on health increasing with rising disposable income and chronic diseases in India, Zydus is well-positioned to benefit from the structural demand for healthier food alternatives. On the other hand, the acquisition of Heinz India products has more than doubled the addressable market for the company and widened its distribution network for both Zydus and Heinz product portfolios. Additionally, its strong management (led by Taurn Arora) and R&D team (led by Govindarajan Raghavan) of Zydus is capable of turning around the poorly managed Heinz product portfolio to regain its lost market share and launch new relevant products that cater to the changing consumer trend. Finally, merger synergies, operating leverage, and debt reduction should enable earnings to grow at 25%+ cagr for the next 4-5years making this an attractive investment opportunity.  

Company overview and history:

Zydus is a subsidiary of Cadila Healthcare, which is one of India’s largest pharmaceutical company with about $2bn (INR 50b) in revenue and $7bn in market cap. Zydus was listed in 2009 after Cadila carved out its consumer goods business. Zydus has been in the market for over 25 years having launched SugarFree (India’s first zero-calorie sweetener) in 1988. Before its acquisition of Heinz India’s consumer wellness business, Zydus essentially only had 3 brands – SugarFree, Everyuth, and Nutralite (acquired product).

In January 2019, Zydus acquired Heinz India’s consumer business, giving it ownership of popular brands like Glucon-D, Complan, and Nycil (see product details below). Zydus also got access to 2 manufacturing facilities, 800 distributors, and 20k wholesalers across India. The acquisition cost was INR 47b ($625m) funded through equity (26b raised through issuing preferential shares to its sponsor and major shareholders), debt (15b) and internal cash (6b). At the time of the acquisition, Zydus’ core business revenue was just INR 6b ($80m), while Heinz’s revenue was 11b ($150m) and so this was an extremely big acquisition from the company’s perspective.

Heinz’s India operations were not well managed as there was no real focus on brands like Complan, Glucon-D, and Nyclic. One of the reasons for Heinz selling its India business was because globally Heinz has been trying to rationalize its portfolio and focus only on core categories like Ketchup and ready-to-eat breakfast product segments.

Product portfolio: 

Zydus only operates in a few product segments but the company is the market leader in most of these segments. Before Heinz’s acquisition, SugarFree was the biggest brand with 65% revenue contribution, but post the acquisition its revenue contribution from SugarFree has dropped to 19%; Glucon-D is now the top revenue contributor with 31% of total post-acquisition revenues.

Investment thesis:

Consumer portfolio focused on health and wellness: The Company’s entire portfolio is focused on health and wellness. With increasing health awareness and increasing disposable income in India, the portfolio is well-positioned to take advantage of this long-term structural trend. Most of the products are under-penetrated with limited awareness about their health benefits.

Acquisition of Heinz products has increased addressable market opportunity for the company: Prior to the acquisition, Zydus was operating in niche product segments where it was the dominant market leader but the addressable market opportunity was small, given the product awareness among consumers was limited. But with the acquisition of Heinz, the company’s addressable market size has increased 3x from 35b ($450m) to over 120b ($1.6b).  The industry for products like Complan and Nycil is expected to grow at over 10% CAGR despite the reasonably high penetration.

Complan product restructuring: The milk-based health food drink product segment has the highest category size potential for Zydus, but the company’s market share is only 5.5%. This, fortunately, affords the company the best growth opportunity if it is able to fix its legacy issues and regain lost market share. Complan was poorly managed under Heinz’s management in India; product market share dropped from 15% at peak to 5.5% in FY20. Globally, Kraft Heinz was not really focused on this product segment and hence there was hardly any innovation in this product. At the same time, competitors in India were aggressively investing in this product segment and launching new products to cater to changing customer preferences. Despite this, Complan still remains a decent household name in India. Zydus understands that it has a huge potential opportunity to turnaround this product using its strong pharma and R&D experience. Additionally, Zydus plans to leverage its pharma distribution channel to increase its retail touchpoints (beyond modern and general trade).

Sugar alternatives a long-term structural growth opportunity: Currently the market size for the Company’s SugarFree and SugarLite product is only INR 4b ($55m) and this is just about 15% of the actual addressable market of INR 25b or $350m (India’s total sugar industry is over INR 1Trillion or $13.3b x 25% is B2C consumed x 10% organized/branded segment). While the sugar industry in India is probably growing at 2-4% Cagr, the sugar alternative product segment is expected to grow at a much faster rate due to consumers opting for healthier sugar alternatives. India currently has the second-largest diabetic population (77m) and according to the International Diabetic Foundation (IDF) this number is likely to increase to 136m by 2045.

Currently, about 80% of the sales happen through pharmacies and purchased by mainly diabetic patients. The company is investing in changing the narrative to target the product to anyone aspiring for a healthy lifestyle and also making the product available in modern and general trade channels. Currently, the biggest hurdle to the widespread adoption of sugar alternatives is the taste penalty (leaves slight after-taste compared to normal sugar). The company has been working on this and has introduced products like SugarLite, which addresses the taste concern.

New product launch pipeline: In the last 3 years the company has done a very good job at launching new products like SugarFree Green and SugarLite in the artificial sweeteners segment, tan removal & face wash in the facial care segment, and launch of mayonnaise in the Nutralite segment. The new product launches have mainly been driven by their strong R&D team and expertise from the parent Cadila Healthcare. Currently, the Heinz portfolio, which was poorly managed prior to the acquisition, has a lot of white spaces within the products like Complan, Glucon-D, and Nycil. Below are some of the white spaces available in different product segments and we expect the company to fill these spaces over the next few years, which should help the company increase its market share in the product segments.

Strong earnings growth and attractive valuation: The company has demonstrated impressive growth even before the acquisition of Heinz’s portfolio with revenues and earnings growing at 16% and 22% cagr between FY09 and FY19. For the next 4-5 years, I expect the company to grow topline at least at 10% cagr but earnings are expected to grow at 25%+ due to operating margin improvement from 18% in FY20 to about 21% by FY24 due to merger synergies and product mix shift. The company has also recently raised equity capital to reduce debt, which will make the company debt-free by next year, reducing interest expense. The company is trading at 34x FY22 street earnings while the consumer staples and discretionary companies in India trade around 45-60x earnings, which implies potentially both earnings and valuation rerating lead stock price appreciation opportunity.   

Catalyst

new product launches, market share gain in Complan, Glucon-D and Nycil; increasing operating margins