Friday, July 19, 2013

VIP Industries – Packed off by the Rupee

While domestic consumption oriented stocks have generally been having a party of their own in the past 2-3 years, one tribe member they clearly forgot to invite is VIP Industries, the largest seller of branded luggage in the country.
To illustrate, as of the 18th of July, while the CNX Consumption Index has given a return of 33.7% over the last 1 year as against Nifty returns of 13%, the stock of VIP Industries (CMP 49, Mcap ~ 700 cr, EV ~ 750 cr) has lost nearly 40% over the same period.

When it rains it pours!!

In the 6 years till FY12 VIP’s topline grew at a CAGR of nearly 18% to a level of about Rs 850 cr on the back of rising consumerism and increasing travel by Indians. On a year on year basis, revenue grew at between 15% and 30% barring 2009, the year of the global financial crisis, in which it contracted 5%.

FY13 topline (broadly split as:  10% - exports, 25% - CSD , 65% - domestic retail) growth however slowed to less than 2%. Infact even this anaemic growth was a result of pricing while volumes shrunk YoY.

VIPs management explained this as a result of slowdown on all the three segments. Exports slowed due to weak demand in developed markets, while domestic sales were sluggish due to a cut back in discretionary spends on the back of rising inflation also evidenced by the slowdown in air traffic growth. Also, due to some political/ministerial issues, canteen stores were seen destocking during most of the year. A cut back in CSD sales was not specific to VIP but across all product categories but given that it is a meaningful segment for VIP, sales took a larger knock as compared to other consumer names.

Profit margins on the other hand were severely dented largely on account of the free fall in the rupee. The fast growing segment of VIP’s sales is the soft luggage segment (65-70% of revenues) which is almost entirely imported from China. This is not unique to VIP since China is supposedly the sourcing hub for much of the world’s soft luggage requirements. So, Gross profit margins (Gross profit as measured by Net Sales – Raw Material costs) in FY13 fell nearly 300 bps from the previous year to 49% (ranged between 52% and 56% in the previous 4-5 years). While the company took price hikes to offset this margin pressure, they were insufficient due to the extent of the fall in the rupee in FY13 (Average of 13.5% for the year).Inflation in freight, rentals and rebates led to a further fall at the EBIDTA level with margins coming in at 8% a contraction of nearly 600 bps over FY12 (EBIDTA margins between 11-15% in the past 4-5 years other than FY09 wherein it was at 7.5%)

Consequently, PAT for VIP in FY13 was down more than 50% at 31 cr.    

All in all FY13 was a deadly concoction of all the things that shouldn’t happen to any business.

A bit more about the business

VIP claims near 60% share in the branded luggage market (through multiple brands at every price point) where it enjoys a near duopoly with Samsonite. The unbranded market is estimated to be roughly the same size as the branded, pegging the total luggage industry size at 3000-3500 cr. This of course does not include segments like ladies hand bags etc. into which VIP is a recent entrant.

When you look at the demand drivers, the industry enjoys the same tailwinds of the India consumption story as other consumer plays viz. Low penetration, rising per capita incomes, favourable demographics etc... However, since per unit costs are high at between Rs 2000-4000 and spends discretionary, the industry is prone to some cyclicality. While that undeniably weakens the case for VIP as against some consumer staple names, for us it still does not take away from the moats that consumer facing businesses selling brands enjoy. Barring a blip once in a while, we would not be surprised to see sustainable periods of double digit industry growth driven by increasing travel by Indians and additionally helped by replacement demand and the shift to branded luggage as people become more quality and fashion conscious.

Another factor of appeal to us is the simplicity of the business. Unlike many other consumer facing businesses, the luggage industry is not meaningfully exposed to the threat of substitutes (remember the challenge faced by scooters from motorcycles) or any technology led product change (mobiles handsets, Televisions etc.). Shifts in consumer preferences, for eg. from hard to soft luggage, are more likely to be gradual than abrupt. All of which add up as natural moats for incumbents, leaving challengers with little scope for disruptive innovation. With manufacturing increasingly outsourced, pricing, brand building and distribution remain as the primary strategy levers.

Unlike some consumer businesses however, the business does not enjoy a float provided by negative working capital. VIP has been able to maintain its net working capital needs at between 2.5-3 months. With the fast growing soft luggage segment almost entirely sourced from China, there has however been relatively small allocation of capital to new capacity expansion. Consequently, dividends have been at between 30-50% of profits for the year (It remains to be seen if this will improve as the company is likely to become debt free by the end of this year). Due to poor profits, while ROEs have been around 12-13% in the last financial FY13, the average 3 year prior ROEs have been 30%. With the business not thirsty for capital, ROEs can thus show consistent improvement if growth and margins were to return to levels as seen in previous years.

Coming to management, whilst being a promoter led concern (part of Dilip Piramal group of cos) we have not seen any glaring instances of capital misallocation. While some may point fingers towards management judgement, on integrity there seem to be no major red flags to our notice. We also draw comfort in the simplicity of the business since the halo effect invariably has a large role in influencing our judgements of management’s decision making abilities.

To sum up while not a VVIP, VIP does look to us as good as its name.

A cyclical low or the new normal??

Given that the rupee has depreciated by nearly 10% already this financial year, FY14 has also started on a challenging note for the company. While Q1 results are not out yet, it is quite likely that the numbers will be muted in spite of a beginning of the year price hike of 5% or so. Infact, given that the first quarter contributes to roughly a third of annual sales, it would probably make it all the more difficult for full year numbers to improve meaningfully, even if things on the rupee front were to stabilise/get better hereon. So is this the new normal or only a cyclical low??

On a near term P/E (FY13/14e) the stock still trades at between 20-25 times, not extraordinarily cheap. But when you start considering the 50-70 cr of PAT that the company managed to achieve between FY10-FY12  the P/E drops to between 10-15 times. The verdict is thus clear. Markets do not seem to be pricing in a return to earnings in the near future. For Mr. Market this is probably the new normal.

While we believe that return to revenue growth is but a matter of time, expectation of margin reversion is not so easily justified. Given VIPs import dependence, any discussion on margins without a discussion on the rupee is fruitless. For starters, we are not about to make a case for Rupee appreciation, what with the continuous challenge the economy faces to fund the unmanageable CAD. The only point of view we have on this subject is that the rupee is unlikely to be allowed to depreciate annually at the same frantic pace as we have seen in the past couple of years. The belief is that the rupee’s behaviour in the last couple of years would likely seem more of an aberration when seen over the longer term. If however, this thesis not be true, then of course we have a lot more to worry about in our portfolios than only VIP Industries J. A more benign 5-6% kind of annual rupee depreciation should not be difficult to pass through to consumers in our view.

The other thing going for reversion in margins is that apparently the entire luggage industry imports from China and thus is equally exposed to the fickleness of the rupee. While we are not certain if the whole industry will have the stomach for a one time price hike given the near term demand challenges, we think VIP should be able to claw back margins in future years. In any case, if the rupee does not fall further, a ~5% price hike should be able to take back VIP to the gross margin levels seen in the past 4-5 years.

The primary risk with mean reversion themes however remains  in the judgement of where the mean lies and the time taken for such reversion. 

Net, Net we think the market is giving us an opportunity to buy a quality business temporarily displaced due to external factors, at interesting valuations. Maybe not in FY14, but we are willing to bet on VIP returning to its earlier levels of profitability in a year of two and growing thereon with healthy ROEs.

Best of Manufactured Luck!!


  1. Hi Abhinav/Niren

    As usual very interesting post. My understanding of business is not very good and entire analysis is based mostly on numbers. My analysis of numbers suggest that historically VIP industries performance was not very consistent and not something which may justify PE multiple of high double digit.

    1) For PE to fall to around 10x, Sales need to grow at around 15% CAGR for next two years and EBITA margin need to improve to around 10% [1999-2000 Average EBITA margin is 7.5% and 2010-12 is 13.3%.] Going by historical performance its NOT IMPOSSIBLE but NEITHER EASY. In last 15 years sales have grown higher than 15% only for 5 years and EBITA margin closer to 10% only in 5-6 years. During 1999-2006, sales grew at a CAGR of only 5%, ofcourse last six years sales grew at a CAGR of 13-14%. I am not sure, whether recent performance [post 2006-07] was an exception or the recent weakness is an exception

    2) Average ROCE and ROE for last 15 years is around 18% [ROCE & ROE more than 20% only in 5 years of out of last 15 years.] Current TTM BV multiple is around 2.7x. To justify a higher BV multiple company needs to earn ROE of much higher than 20%. 2010-12 ROE averaged around 40%. Assuming no more improvement in asset turnover[On the positive side, asset turnover has consistently improved from 1.3 to 2.8, despite increasing working capital requirements over the years], to get back to ROE of 25%+, company need to improve EBITA margin to 13% [assuming full tax rate of 33%, instead of Average cash tax rate for last five years is around 20-22%. I agree that not every company can be valued using BV multiple, but its just a rough indicator.

    In conclusion, I feel stock is still not cheap enough purely on numbers and company need to perform better than its LONG TERM HISTORICAL AVERAGE. My main concern is it has to improve its performance amid increasing competition. Increasing wages in China is a hot topic and not sure to what extent that will impact VIP sourcing cost.

    1. Hi Anil,

      Always great to have regular constructive feedback from you. We agree that judging where the mean is in terms of growth and margins is the key risk to the investment thesis.
      When we consider growth, we think it is also relevant to look at growth in Airline passenger traffic over the years since VIP sales tends to have a high correlation. This might be (just guessing)because air travellers may be more brand/quality conscious as compared to their train/bus counterparts. If you see growth in air traffic over the years, you would notice that it also has a better 5-6 year growth record (post the advent of low cost airlines) as compared to the much longer term. While last year was weak and even this year does not seem great so far for air passenger growth, it might not be unrealistic to bet on higher growth in future years.
      On margins, in any case we are generally not in favor of looking way beyond the past 5-6 years especially during periods of healthy growth. This is because product mix could have changed appreciably over the period. Also, brands could add some pricing muscle over time, not to forget the impact of operating leverage. We think near term 5-6 years of margins is a better judge as compared to the very long term.
      Of course the risks remain as you point out..

  2. It seems like a lot of industry analysis is automatically being applied to a particular stock/business.

    Secondly the article suffers from 'rose tint bias'.

    As Indian travellers get savvier, they are going to buy more and more of foreign/more hip/more stylist brands. VIP is seen as yet another old Indian, thaka-hua brand. It is definitely going to lose market share to global brands.

    Yes, it may improve margins, up the pricing, etc. But if there is a secular decline of market share, revenues will continue to decline or barely hold up and 'mean reversion', on which your case primarily rests, may never happen.

    Nobody shaves with Topaz blades these days - because Gillette is available. At one time Topaz was a leading brand with large market share.

    Brands and distribution networks on their own cannot form a moat. They have to be reflected into market share metrics.

    1. Hi Anon,

      Thanks for your views.

      It would be foolish to think what you are predicting cannot happen. However, it is probably wrong also to be certain that it will happen.

      VIP Industries is not about only the VIP brand but also brands like Carlton, Skybags, Alfa, Aristrocat etc. other than Caprese their latest handbag brand. Other than straddling various price points, multiple brands help brand marketeers overcome brand specific perception issues, if any. Also, while some brands might represent 'old and tired' for some, the same may stand for durability and dependability for others.

      We would not be hasty in jumping to conclusions based on our perceptions.

      Of course competition will always be a worry in any consumer facing businesses and hence always a key monitorable. We so far draw comfort from VIPs successful defense of its market share over the years, but in case it stumbles meaningfully in future years, would be quite willing to change our positive view.

    2. Let's talk #s. If you have actual market share #s (like the FMCG) for this space, please share the same. That will help the analysis.

      I am willing to venture a guess that the duopoly you mentioned is already being challenged by global brands across a wider range, including the top ones like Louis Voutton.

      The brands you mentioned for VIP have no clout or mindshare. Anyone in India can create brands. Even Arvind Mills has brands in apparel. That does not make it a GAP.

    3. Hi Anon,

      Thanks for sharing your thoughts. We have mentioned that the management claims roughly 60% of the organised market in terms of share. Various articles on the industry freely available on the web seem to corroborate that data point, including interviews given by VIPs largest competitor Samsonite.

  3. I checked their operating profit margins in Margin of around 15% was achieved becoz of high sales growth. If growth slows down, taking last 3yrs margins as normal’s is risky as the co has long history of low margins.
    Slowdown in sales growth, increase in costs (prolonged depreciated rupee), high working capital intensity and competition (new and old) are serious factors while low debt is a positive factor. What we are betting here is that management can effectively manage all those risks!

    Circular trading among promoters in sep-2012. Also chk this wrong reporting of promoter holding
    Shares pledged to deutsche investments? 20th march filing to BSE?

    At current price margin of safety may be little less.
    Well this industry is a consumption story but will VIP be the major beneficiary in industry? How have been the market share dynamics in the past? Market growth Vs. market share growth.

    Calls like "return to revenue growth is but a matter of time", “rupees recent behavior is more of an aberration” scare me. What can go wrong will go wrong -further cut back in csd sales, drastic slowdown in exports, so on and on- deceleration will exceed acceleration.

    Building a worst case scenario will be of some help. As discretionary spend has high correlation to economy, How a low margin biz will look like in a new normal GDP growth (>5%)?

    You are expecting a muted or bad quarter and stock chart also saying the same hence suggest waiting for sustained uptick in price before buying. Anyways earnings are around the corner.There was earnings downgrade recently for 2014 EPs from Rs. 6.5 to 3.8. (When analyst abandons the ship- margin of safety will be more)

    1. Thanks Jagadish,

      Good to have your thoughts on board

  4. with most of its raw material sourced from China, and China facing a possibel major slowdown, can you share your inputs, how this possible slowdown will impact VIP?

    1. Hi @shwind

      Not sure if it should have any meaningful impact. A slowdown may reduce the bargaining power of the suppliers on one hand. On the other hand they may want to pass through higher interest costs if any. If you force us to take a guess, we will say any major impact is unlikely.

  5. If you want to play discretionary consumption theme why this and why not any auto or AC or appliance company which do not import much and has better governance standards. To me looks like Dollar is in bull market up to End 2015.

    1. Hi JK,

      We agree that one cannot ignore other consumption themes. On a case to case basis we might be willing buyers into auto/consumer durables as well.

      Relative to luggage however, these sectors generally have higher organized competition, risk of technology change leading to high R&D and product development costs and mostly inhouse manufacturing leading to weaker long trend ROCEs.

      Is there anything specific that worries you about VIP's governance?? Would like to hear if you have any major red flags.

      We dont want to prejudge the rupee. Our only hope is that the volatility and extent of movement would be less severe than the recent past giving opportunity for businesses like VIP to react appropriately.

  6. It is an interesting bull case for an investment in VIP. At macro level, it is quite appealing to find a business that is going to ride the coat tails of increasing discretionary consumption story of the Indian middle class. However, if you really want to invest in VIP, my advise would be to also analyze TUMI in the US and Samsonite in Hong Kong. Both are pure-play publicly traded luggage companies and have financial data readily available for the last five years. Samsonite is obviously competing with VIP in India. TUMI will a sense of the margins at the high end.

    My biggest crib with VIP is that they don't do any currency hedging and I am not convinced of the mgt's position on the issue.

    I look forward to your analyses. regards,

    1. Hey Anon,

      Thanks for your inputs. Will certainly look up on Tumi and Samsonite for key learnings on the sector.

  7. Hi ML,

    Wonderful analysis and an interesting case of a company that may benefit from tailwinds & mean reversion. The investing scenario does look good for VIP with reasonable margin of safety, however after going through AR I felt some issues with management, though small ones. Firstly, The W/C cycle doesnt inspire the confidence in management & it seems that either their products doesn't have strong brand pull to command advances or management seems to be a bit lethargic on this front and either of the case is negative.
    Secondly, It seems that due to multiple product/Brand portfolio, their selling expenses are high & will remain so in future. Hence if sales doesnt pick up, certainly their bottom line will suffer substantially. Also, management will have to constantly evaluate the return on marketing expenses for various brands which again is challenging.
    Third, The fact that they are into plastic furniture business, though in nascent stage was a big turnoff for me. They surely justified in AR abt how it is high end product and hence value product, I doubt if they will be able to get high returns from this area. It might just drag their return ratios down.
    For me its a case of a good business in hands of a mediocre management at a lucrative price. Even with above mentioned negatives, Their product portfolio and brands seem to inspire confidence and may help increase in sales as urbanisation increases in future.
    Would love to hear your perspective on above mentioned points.


    Disc: I am invested in VIP.

    1. Hi Vikas,
      Thanks for sharing your thoughts..
      Warren Buffett has been quoted as saying "I like to buy stock in businesses that are so simple that an idiot can run them. Because sooner or later one will". Without jumping to a conclusion on competence of current management, we like VIPs simple business model. The WC cycle is not great due to multiple reasons. Few of them could be 1)products are imported 2)They are not 'fast moving' like consumer staples 3)Company carries inventory in exclusive outlets 4)Large contribution from CSD and increasing reliance on modern trade resulting in higher debtors. However, inspite of a not so favorable WC cycle, ROCE is still healthy due to outsourced manufacturing and low investments in fixed capital creation.
      Brand spends are a neccasity of any consumer facing business and this industry is not unique in that sense. The plastic furniture business does not seem to be a focus area and does not bother us as long as it is not a capital guzzler.

      The rupee of ofcourse continues to hurt even more as compared to when we wrote the post :)

  8. Thanks for your views. They do make sense on why W/C cycle might be stretched. Though rupee is more so down, VIP is standing its ground with decent quarterly results. I would request you to have a look into Mastek, a smallcap software company into insurance expertise and annuity based model. Its on a turnaround after posing losses in 2011-12 & has 80% of market cap as Cash on books. Thus it seems to be a graham play with limited downside & substantial upside if business turns out well for future

  9. Rakesh Jhunjhunwala seems to be following your blog. He has bought today.

  10. Hi abhinav/niren
    I am not able reconcile the strong brands with the poor pricing power of the company. Prior to looking at the annual report, i would have thought that the company would be making 8-10% net margins and high ROE/ROC - due to almost iconic brands and the very high market share.
    A 60% market share and duopoly arrangement should have resulted in a very profitable company - look at batteries or sanitaryware or other consumer businesses where individual companies are not as dominant and still have much higher profitability
    Does the management underprice its products due to historical reasons to maintain market shares ?


    1. This comment has been removed by the author.

    2. Hi Rohit,

      Good to have your views as always. Factors which could justify relatively low margins are 1) The need to compete with a large unorganised market which continues to grow at a healthy equal pace 2) Relatively high price points of the products in a price conscious market like India and 3) Value for Money positioning of the bigger brands from the company stable. While battery manufacturers no doubt have better margins inspite of similar challenges, the consumer durables industry for example falters in face of the same challenges.
      Where VIP scores however is healthy return on capital ratios. We tend to focus on ROCE over margins. A good case in point is Britannia where margins are poor at 5-7% but ROCE still healthy.
      We also think that no company however strong, enjoys limitless pricing power. With the extent of challenges that VIP has faced on the Rupee front in the past two years, it would surprise us if there was no margin erosion. Had the FMCG industry faced cost pressures of similar magnitude, we are not sure whether even HUL would have the stomach for annual price hikes of 10-15% in two succesive years as the situation demands in the case of VIP.

  11. The co has been around for a few decades and its track record, in terms of value created for non-promoter shareholders, has been uninspiring to say the least. The only time the stock really outperformed was after 2009 for about 2 years. That huge rally was at least partly driven by the hype created by RJ buying a stake in the co.

    Coming to financials, the critical factor is pricing power and moat. My limited interaction with buyers tells me that except for the really high end segments occupied by Louis Vuitton, Gucci and similar, there is very little differentiation between brands. I don't think anyone buys a VIP in preference to Samsonite or American Tourister. The decades old lead enjoyed by the co over the international brands in establishing a sales network will surely erode over time, and the 60% market share could be under duress.

  12. Hi Guys,

    I have been doing my own research on VIP and stumbled on your post. It does look like a good opportunity at current prices. It is a solid franchise and possesses all the charecteristics of a franchise as specified by Buffer 1) A product that is needed or desired 2) No substitutes 3) Not subject to price regulation. As Buffet says - "The existence of all three conditions will be demonstrated by a
    company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage."

    I do think that management could have done a better job what with only one competitor in the organized segment.

    However I have been thinking about the barriers to entry in the industry. Brand is definitely one, and VIP does enjoy and iconic status. But more MNC brands like Samsonite (any idea which are other big brands apart from Samsonite) are sure to enter India as the size of the pie gets bigger. Given this thought i would like to understand the proportion of revenue VIP earns from different brands. I have tried but have not been able to find this data point. My logic is that these MNCs might want to focus on premium products not compete with VIP in the mass market segment (although Samsonite has launched a product in the 1,000 rs range to compete in this category effectively with VIP).

  13. hello everyone!

    No one has discussed about VIP's new brand or new segment "caprese" or "lady hand bag". They already have a stabilised distribution network and 500 company owned stores, how much revenue/profit they can generate from this. You ask your girl friend, sister, wife or even your mother there is hardly any brand.

    1. Hi Anonymous,

      Thanks for your thoughts. Yes, VIPs management believes that Caprese has great potential and has guided to 50 cr of revenues by next year and break even in next 3-4 years. While the early wins are interesting, let us see how this plays out over the longer term.