Relaxo Footwear

Background

Relaxo Footwear Ltd. (RFL) is a part of the “Relaxo Group” which was founded by Late Shri Mool Chand Dua. The company was incorporated in September 1984 as Relaxo Footwear Private Limited and was subsequently converted into a public limited company in March 1993. RFL started off as a marketing company for the Relaxo Group and subsequently ventured into manufacturing of Hawaii slippers in 1995.

The company has established 7 manufacturing plants spanning North India. These are located in Delhi, Bahadurgarh (Haryana) and Bhiwadi (Rajasthan). With a cumulative area of over 120,000 sq. feet, these units have a huge set up enabling massive production. Each manufacturing unit is equipped with world-class machinery and hi-tech product testing laboratories. Current capacity is 3.35 lakh pairs a day resulting in an annual capacity of more than 100 million pairs.

RFL’s key raw materials include Natural rubber (31% by Qty), Synthetic rubber (7%) & EVA (62%). There is a direct co-relation between raw material price rise and operating margins.


Main Products/Segments

RFL produces different products under different brands. It produces Hawaii slippers branded as “Relaxo” whereas the light slippers segment is branded  “Flite”. The school and sports shoes segment is branded Sparx for which brand ambassador is model and actor Neil Nitin Mukesh. All three brands – Relaxo, Flite and Sparx are quite well known and well accepted in the market.

IN FY11, Hawaii slippers could contribute ~35% of sales, Light slippers  ~35% and Sports shoes and sandals and others ~30% of sales.


Main Markets/Customers

RFL caters to the retail footwear industry. It is a key player in the organized slippers market with a wide distribution network, particularly in north India. It also trades into the entire production of group companies.

It also has set up 100 company owned retail outlets covering NCR, Punjab, Haryana, Uttaranchal and Gujarat. This is part of company’s endeavor to create many more one-stop shops displaying thier entire range of footwear. The company believes the roll-out of these retail outlets is directly influencing consumer demand and turnover of the Company.


Bullish Viewpoints

  • Accelerating Sales & Earnings growth – RFL has ramped up nicely in the last 5 years. Sales have gone up form 200 Cr in FY06 to 553 cr in FY10 registering a 29% CAGR over 5 years. Over last 3 years it has registered an even higher 35% CAGR. Earnings have far outstripped Sales growth going up from 3.26 Cr in FY06 to over 37 Cr in FY10 – a more than 10x increase or a CAGR of over 80%. This has been achieved in the backdrop of increasing share of high-margin products, tremendous improvements in Working Capital management over last 5 years, reduction in power costs and a gradual softening in raw material prices over the years. Year on year EPS growth in FY10 was ~165% on the back of huge decreases in RM prices. However the situation has got reversed in FY11 with RM prices hardening significantly and FY11 is set to see EPS degrowth. However this should be seen in the context of a very high base effect.
  • Great Working Capital management – While Sales have gone up more than 2.5x in 5 years, working capital/Sales is just over 5% in FY10 coming down from 7.5% in FY07. Debtor days are at an unbelievable 14 days in FY10, down from 32 in FY06. This shows a management focused on improving operational efficiencies. 90% of the business is driven through its retail distribution network (balance from the company owned stores numbering 100) and this indicates strong acceptance and brand pull in the market.
  • Large player in retail footwear – RFL is one of the largest players in this sector. Other big names in the footwear industry are Bata India, Liberty Shoes and Lakhani Footwear of which Lakhani is not a listed peer. Bata India cannot be compared to the business of RFL as Bata follows a different business model and valuations reflect impact of real estate play. RFL enjoys a very good market share especially in the northern part of the country. RFL has the capacity to manufacture over 100 million pairs per annum, and is second only to Bata India. Its capacity to manufacture 200,000 pairs of Hawaii slippers per day is one of the highest in the footwear industry. A strong network of 350 distributors and 30,000 retailers operating across India ensures good reach.
  • Increasing share of higher margin products – RFL began by manufacturing and selling Hawaii slippers. Over the years it has invested in brand building and added products to its portfolio that contribute more to the bottomline – light slippers and shoes & sandals. In terms of perception of trade, it has moved up the value chain. Design, product development, quality and affordable price – the four cornerstones of footwear business – RFL is well placed in all of these. Light slippers and shoes give RFL a higher margin compared to the hawaii slipper. The recent increase in profitability is partially explained by the higher proportion of shoes and light slippers in the product mix of late.
  • Established, Quality Brands – RFL produces different products under different brands. It produces Hawaii slippers branded as “Relaxo” whereas the light slippers segment is branded  “Flite”. The school and sports shoes segment is branded Sparx for which brand ambassador is model and actor Neil Nitin Mukesh. All three brands – Relaxo, Flite and Sparx are quite well known and well accepted in the market.
  • Relentless capacity expansion – RFL has been making relentless investments in adding capacity to cater to growth. From 2.85 lakh pairs a day in FY09, current capacity is 3.35 lakh pairs a day. RFL currently has 7 own plants, and uses production of 3 plants owned by group companies. These plants of the company are spread across the states of Haryana, Uttaranchal and Rajasthan. Currently, the company has a facility of producing about 2 lakh pairs of Hawaii slippers per day, which is one of the largest in the industry. It has a capacity of producing about 105,000 pairs of Flite per day and about 30,000 pairs of Sparx (shoes & sandals) per day. In FY09, 2 plants manufacturing Flite went into production. Set up at a cost of Rs 55 crores, these units also cater to exports and produce sports and school shoes named Sparx. In FY10 the company increased production capacity by 15,000 pairs per day in existing plants and 10,000 pairs per day by putting up a new Plant at Bahadurgarh, Haryana.
  • Growing share of exports – The company over the last two-years has also shown increase in its exports from just Rs 1.5 crores in FY08 to Rs 7.1 Crores in FY09 to Rs. 10.58 Crores in FY10. The current exports are to Europe (~70%) and the Middle East (~30%). The Company intends to increase its revenue from exports further with the 2 new plants.
  • Good Industry Outlook – The Indian footwear retail market is expected to grow at a CAGR of 18% for the period spanning from 2010 to 2013 as per CARE Research and a few other studies.

Bearish Viewpoints

  • Recent financial performance (3Q FY11) – There has been a steady decline in margins and profitability over the past 3 quarters. Operating margins have slipped from 13.6% in Q1 to just over 9% in Q3. This is primarily on account of steep increases in RM prices which seem set to continue in Q4. Net margins have been dented badly slipping from 5.6% in Q1 to just over 2% in Q3 on the back of progressively increasing debt burden funding capacity expansions.
  • High Leverage – RFL’s debt on books is about Rs. 167 cr with debt-to equity at 1.32 (Q2 FY11). Judging from higher interest costs Rs.4.45 Cr in Q3 (up 19% from 3.74 cr in Q2) the debt burden has only increased. This could stretch its balance sheet and also increase the company’s exposure to interest rate risk. Higher interest costs coupled with higher raw material costs continue to put severe pressure on margins.
  • Raw material price risk – RFL’s key raw materials include Natural rubber (31% by Qty), Synthetic rubber (7%) & EVA (62%). There is a direct co-relation between raw material price rise and operating margins. Starting late FY10, FY11 has seen relentless rise in natural rubber prices, and RM/Sales has moved up from 41% of Sales in 4QFY10 to 47% of Sales in 3Q FY11. With RM prices (natural rubber) still moving upwards in 4Q FY11, this is a big concern and coupled with higher interest costs margins will be under pressure.
  • Brand Risk – The flagship Sparx brand is involved in a trademark dispute with Bata since 2009. Bata claims to have registered this product in India in 1978 and uses this brand in 27 countries. Relaxo filed a petition praying that the rights of Bata over Sparx should lapse as the company has not used the brand in India at all while Relaxo has been investing in Sparx brand since 2004. They have also started investing in an alternate brand Spark with similar styling. The matter is in the courts and can pose a big risk on teh future of this brand for the company.
  • Forex risk – RFL imports Ethyl Vinyl Acetate (EVA) for the production of FLITE brand. Any depreciation in the rupee would impact the margins of the company. Currently its forex earnings are one-third its imports. (FY10 forex earnings of Rs 10.58 crores vs. forex spend of Rs 31.43 crores)
  • Over-concentration in North India markets – RFL sells almost 65% of its products in the north Indian market thereby creating a very high dependence on the states of north India. It is unable to reap the benefits of a wider market and diversified geographical base as its network in other regions is not as strong.
  • Retail business still losing money – The retail business of the company is currently running into losses. Only 50% of the retail shops have managed to break even while the remaining continues to make losses. RFL currently has 100 retail stores across the country and is in the process of adding another 25 taking the total tally of retail stores to 125 by March 2011. These are mainly spread across Delhi, Punjab, Haryana, Western UP and certain areas in Gujarat. These stores operate from rented premises, have low running costs and typically achieve break-even in 18-24 months. The retail spread helps the company in creating brand awareness and in pushing sales to wholesalers.
  • Relaxo brand not wholly owned – The Relaxo brand is jointly owned with a group company. However no royalty is currently being paid by RFL
  • Related Party Transactions – There are related party transactions such as purchase of goods from the company’s associates that could raise doubts about arm’s length pricing of these transactions. Also certain group companies are engaged in similar business thereby posing a threat as conflict of interest could take place.
  • Low Free-Float & trading volumes – The public shareholding in RFL is 25% of which Corporate bodies have been holding close to 17% over the last 5 years. FIIs hold 1%, another 14% is held VLS Finance & VLS Securities. So effective free float on the stock is less than 8% of the total shareholding. This reduces the scope for further institutional participation. The scrip is listed on BSE and does not generate large volumes on a consistent basis. This could lead to higher impact costs.

Barriers to entry

  • Economies of scale – Total capacity of 3.35 lakh pairs a day, second largest after Bata. It enjoys highest EBITDA & PAT margins in the industry as compared to Bata, Liberty Shoes
  • Wannabe Brand play – Well established brand in North India; slowly making its mark in Gujarat & South India; share of branded footwear on the rise; Sparx/Flite are the main brands advertised on national media. Customers ask for the brands requiring retailers/distributors to stock.

Interesting Viewpoints

  • 60% of the business is done on advance basis. This has brought debtor days to as low as 14 days. While there is not much pricing power with the company, such amazing brand pull augurs well for working capital requirements as the company grows.

Disclosure(s)

Donald Francis: No Holdings in the Company;