Relaxo Footwear: a wannabe brand play

Stock Opportunities Not-so-Hidden Gems
121

Donald…good that at last someone is talking sense on Relaxo…Last few days, after Prof Bakshi’s post, so many people were so gung-ho about the stock that I was beginning to get scared.

Relaxo has no BRAND power. People don’t look for brand in the 100Rs/pair chappal market!!! I don’t know of anyone who would search around and look specifically for a Relaxo pair of hawaiis. They just buy whichever they get in their neighborhood shoe store, which suits their budget.

The advantage that the co has is that it is operating in a space which is scalable. But, the only way Relaxo can continue to do well is to focus on its distribution. Make its product ubiquitous. So, whichever store (other than probably Bata/Liberty type of single-brand stores) you go to, you will get a Relaxo pair. Otherwise, it will always be a play on raw material.

You also have to think, why is it that we have other large footwear players going into other unrelated businesses? What do they know that Relaxo does not? And when will they find out? How easy is it to build retail presence? So, we need to ask a lot of questions, hard ones at that, before thinking of investing in this.

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Relaxo made operating cashflow net of maintenance capex of 30crore in each of the last two years. It has net debt of 204cr (mar2013) ie 7x annual op-cf. This is high despite 1:1 d/e. Hence, while roe at 28% is high, roce at 18% is not.

On the other hand, it has advantage of low coe (its very low beta stock) and the leverage ensures a very low wacc. Hence, even at roce of 18% it has a nice spread over wacc.

123

In the Rs 100/pair segment, brand is not a big deal. Customers don’t look for much. Even though Prof Bakshi highlights the case of Havaianas, I personally dont see relaxo commanding such price premium anytime soon. People will pay money for flip-flops from Nike/Adidas/Puma etc. It won’t be easy for Relaxo to price its products in that range. As a customer, I will not consider Relaxo or any of its brands at par with a Adidas/Nike and therefore would not pay a premium.

Relaxo operates in an interesting range in Sandals. Sparx for ex, is priced at around Rs 500-600 in the retail stores. Comparable footwear from Nike/Adidas or even other Indian brands like Woodlands would be closer Rs 1500. Here people would prefer known brands. Good distribution backed by aggressive marketing efforts would help relaxo here.

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Hi Guys,

I feel the focus of the project by Prof Bakshi is to bring forward a very interesting case study. I spend close to 2 days to complete the homework he gave, before posting his lecture -http://fundooprofessor.wordpress.com/2013/09/15/the-relaxo-cinderella-project/

It was a superb and a great learning experience. I enjoyed every moment of it.

Doing the homework, one gets to experience a thinking about data differently and understand the actual working of ratios etc with market valuation.

Like Prof starts in his lecture - a stock story is a unfolding movie and not a still photograph!

So the key thing to focus here is - how beautifully the co has evolved over the last 5-7-10 years. They were selling the traditional hawai chappals where the competition was like anything and now over the years, they are moving up the value chain gradually.

The interesting thing for the co is, over last 5 years the co has spend almost 275Cr!! on advertising and selling incentives. Last year the spend was almost 77 Cr!

This is a crazy figure to spend (in contrast to net profit of 50 crores), if one is to believe that there has been no benefit out of this spend. Has this amount gone down the drain??

I believe it needs courage and lot of thought to spend such amounts and the long term plans would be interesting.

So again, the discussion is not that this is the best stock idea available or that this like other branded/fmcg co. Its about the way a small player is scaling up and there may be some very interesting times over much longer term.

I feel thankful to professor for sharing his work.

Regards,

Ayush

125

Ayush,

One will readily concede that if the purpose was only to highlight an improving moving picture case study for Relaxo and let wannabe analysts learn how to spot worth-observing improving trend patterns, this was a good case study.

The good parts of the story as I mentioned before is the beautiful reducing receivables story with growth - that is very nice to have in a business. And the apparently improving gross margin picture. Certainly the Management is seen to beis doing things to get better at the game of managing the vulnerabilities in its business model better.

But that does not mean the business model/quality is pristine - and we start comparing and equating the business with those of brands, with pricing power!

My objections are as follows:

a) this is a case study that fails to mention/highlight any of the easily apparent negatives in the story - slightly unusual for a case study

b) the high RoE is propped up by high Debt. Take Debt out of the equation and you will see at best an RoIC of 13-14% - hardly something to tom tom about - and certainly a clear declining trend from 2010 all of the last 4 years

c) some arguments are stretched too far. Brand-building expenses to be amortised over a number of years…its like arguing let HUL spend on brand building for 5 years, and then stop for next 5 years…since the benefits of spends in earlier years will accrue for a number of years in the future. Even an iconic brand like Dove will not be able to grow for any measure of time, without consistent and higher brand building expenses, every year. That’s the name of the game.

To maintain its lead, Relaxo will have to keep spending higher and higher on brand building for a number of years to come. I do not see that scenario changing in any way. its not an asset light model like brands either…Asset turns have never crossed 3x. It will have to keep spending on Capex to get to that 200 million slippers picture…and we haven’t even provisioned for the bad RM years in this otherwise pretty picture.

Yes,its a high-risk medium gains strategy that may well pay off in the long run …given the considerable lead Relaxo has built, and the entry barriers in this business…but I cant concede anything more than that:). And yes, it will make for a good ride when its grossly undervalued - I cannot make that case either, at current prices.

I submit again for the benefit of ValuePickr readership, this is NOT a balanced picture, its not telling the whole truth, which must be the objective of every analysis piece - how else do we remove analyst/author bias.

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Talking about the products, the Rs 100/pair segment is not a game changer. Because people will buy whatever available or premium brands like nike,adidas. But I think their sparx range of sandals and shoes has a very good potential. I haven’t used them. But I was talking a store manager and he spoke highly of it. It looked nice too. One risk is there may not be repeat customers because they might look to buy more aspirational brands like nike, adidas.

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hi ayush/donald,

I too went through the presentation on Relaxo and was impressed with the kind of the progress the company has made in past few years.

The problem is that hardly 10%-20% of the readers would have considered it as a discussion whereas rest of the 80-90% would have considered this as a stock recommendation.

Coming to the business of Relaxo the only thing that struck me as impressive is that the margins per pair of slippers are so thin… I think something like Rs 5 per pair which Relaxo makes would deter other players wanting to enter the fray as that would entail a lot of capital to build the capacities that Relaxo has…

But there’s nobody to stop a Bata to enter the fray with complete outsourcing and sweating their Bata brand and network to increase sales…

I have been seeing this brand endorsements by Salman Khan, Katrina Kaif and Akshay Kumar and not impressed with the quality of ads.

What I feel is that there are some products that are amenable to brand building whereas others which are not… Slippers or flipflops I feel are not products which are amenable to brand building… One doesnt go searching for Relaxo brand of slippers too far… If one gets some other good quality slippers at a nearby outlet, then the buying gets over within no time. So the superstar’s brand pull comes nowhere. Personally I feel it is going to be money down the drain.

Quality wise Relaxo is not far superior as compared to others and so it does not score too well on that front. e.g Page products like Jockey brand of underclothings, track pants, and other many products definitely score over competitors in terms of quality and comfort.

These days on the online shopping platforms you get good quality branded nike/adidas/lee cooper slippers at very attractive prices post discounts…With the growth in online shopping these would be much preferred to Relaxo.

Coming to the last few years, one can see that in 2010, the OPM was 16.5% whereas in 2012 and 2013 it was around 10.9% and this is a big drop. . Only goes to re inforce the argument made by donald about impact of raw materials costs on profitability.

So while one can continue to monitor the Prof’s blog for further updates on Relaxo, one needs to keep it clear in one’s mind that it is currently an academic discussion only and not an investment argument.

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Something, I personally took out of the case study, is to use it to evaluate other Businesses.

I am trying to apply it on Page (Jockey).

As Hitesh Sir says, take this as a business study and not a stock recco.

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Hitesh,

1). I would think an academic discussion paper first, needs to be holistic - it cannot leave out the negatives completely - atleast that’s what I think. I have reacted strongly since as you rightly mentioned there was a huge hype about the Relaxo branding success story - many emails and calls focused on this - like Abhishek mentioned too, and you must have been inundated too:)

It’s not as if Prof is not unaware of his cult following. If I were in his place, I would make sure the negatives were equally discussed and dealt with in sufficient detail e.g. on RM impact

2). RM Impact - situation has improved over the years. Gross Margins have actually gone up from 40% in 2009 to 50% in 2013. That’s an overall improving trend in RM volatility handling - no denying that. But take any bad RM year - like 2011 which has happened before and will happen again, and you can punch holes in the brand, pricing power, RM sensitivity de-linking,etc theory.

As Abhishek pointed out, Relaxo’s case looks better because of the overall benign RM situation post 2011, not so much because of other things as is being made out. EBITDA has reduced in recent years because of increased spend on sales & marketing overheads, not because of RM.

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Overall the case gave me some very good points to add to my framework of studying a stock story. I improved my template on screener to incorporate few things from the case, and it’s still a work in progress.

Beyond that I wasn’t very impressed by the celebrity led brand theme either and in the same camp as Donald that branding expense have to be carried out for a longer period to create the kind of brand pull where pricing power will come and sustain over long period.

We have seen branding via film stars in case of undewears too, like lux etc… But those have fizzled out. And I won’t read too much into the past branding efforts.

I think Donald has a good point, the case study could have done a better job on highlighting the possible negatives.

131

Thanks for bringing some attention to this aspect - additional pointers for stock/business analysis framework - which Ayush was also trying to mention.

There have been earlier case studies from Prof - which I submit have done a much better job in expanding my thinking like the one on Nestle. This one was actually a curious mix of good points - which make you think - followed by others which don’t stand cursory scrutiny.

It will be a good idea for you/others like Ayush to list what new things you learnt/pointers picked up from this lecture/analysis, and I will add back what I learnt (new to me) from the Nestle exercise, when I read it first.

That might bring some objectivity (I may have become overly-biased(?) by the deluge of calls) and make for some learning for all of us.

132

I think if you look at the long term picture - 10yrs- all this raw material price hike will be passed on to the customers. This may take some time but will eventually be passed on.

So, if your time horizon is 1-2 yrs, you should look at raw material movement closely… Opportunistic Play as we call it here.

But if you want to play for 10 yrs, it should not be that important.

Volume increase + Price hikes + margin improvement should at least give 15% CAGR over a decade… Not great but not that bad given amount of stress involved would be much lesser.

This is the kind of investing which Prof prefers… Very Long term + Good sleep + Decent returns. Hence, maybe he didn’t give much importance to the 3 year margin drop story that we are seeing here.

To me, Relaxo looks like a ‘Wannabe Brand’ as of now & not ‘The Brand’.

PS- Not invested.

And this kind of time frame may not suit all investors. Like- When I am looking at Shilpa Medi story over past 3 yrs, it isn’t attractive. But if we change time-frame to 10yrs (as Ayush pointed), it looks great.

133

Hi all

I feel Relaxo’s is a classic case of a company benefiting from its product moving from the unorganized to the organised sector. Any brand is better than no brand, but an established brand is always better than ‘any brand’. I too agree that no one goes out looking out for the Relaxo name and the quality and perceived impact of their advertisements do not inspire much confidence for the future. Though the other benefit besides it being ‘any brand’ is its distribution network. My sense is that as the story moves along, either the brand will be somewhat established (chances look bleak) or some new players or existing players with their brand extensions will eat into the moat of Relaxo. So my argument is that fundamentally it may do well in the medium term (3 years) but in the long term (10 years), it may or may not succeed.

134

I agree with Ayush that the case study is a very good learning experience. However, there are a few points which needed to be covered better.

  1. For Relaxo, there was absolutely no discussion at all about distribution or retail presence. I found that very surprising. How can you discuss about a manufacturer and not talk about distribution reach.

  2. About the retained earnings exercise, I am not very convinced it really works! I read it when I first started investing in “The Warren Buffet Way” by Robert Hagstorm. But just think about it. If for the last 5 years (say) a company has NOT generated as much per rupee as it has retained, what inference can I make from it? The only inference that is logical is that the market cap has not caught up with the earnings growth. Does it mean it is a bad business or a bad investment? It could mean it is severely undervalued. In Relaxo’s case, I would be very interested to know how they fared before 2003. The retained earnings vs market cap test may be a good choice to see how the market has treated the stock (but then again, you can figure that out by looking at long terms price charts). If anyone can really explain why anyone should do this exercise and what insights can be gained from it, it would really help.

135

Hi Abhishek,

My understanding is, Prof. has clarified that the right way to do the retained earnings exercise is to do it on “5 year rolling basis”, assumption is Mr. Market could be wrong (company is severely under valued) if we just consider a snapshot of 5 years, but if we do the same analysis on a 5 year rolling basis, Mr. Market would have recognized & rewarded the potential of a good business in many of those periods.

136

Hi Raj

What will it tell me that I can’t get just by looking at the price chart for the last 5 / 10 years? This honestly is more a long-term momentum indicator to me :slight_smile:

137

Hi Abhishek,

Looking at the price chart won’t tell us, how much of last x years profit have been plowed back into business vis a vis what has been given out to owners as dividend and how has market cap changed with respect to profit’s plowed back. isn’t it ?

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Relaxo is not the best company out there. Itâs just one business which I think is having some high-quality attributes, which can be useful for students to learn from. – Sanjay Bakshi

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You can learn only by looking at the good things?? You can learn by not looking at distribution strategies for a manufacturing company?? You can really learn by not thinking about disconforming evidences?

Itâs some

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Right, I won’t. But what am I **really **learning by calculating this? I am trying to gauge how the market has treated the stock in the past.

Let’s try to think this through:

Market Cap = Earnings * PE

If I have a company which does not pay a dividend and earns 100 Rs each year. So, all earnings are retained. Ideally over 5 years, I am going to have 500 Rs as retained earnings. Depending on the PE (which is market/investor sentiment driven), I would expect the market cap to go up either more or less than 500 Rs times the PE.

So, if I have a PE of 10, I would expect the market cap to go up by 5000Rs; a PE of 20 would mean 10,000Rs etc.

So, a lot of the market value actually depends on the PE, which is the “speculative component” in valuation.

In the earning retention test, I did not see where we are actually considering the PE. Maybe I am missing something.

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