Relaxo Footwear Management Q&A: Feb 2011

Management Q&A

1.       WE ARE VERY IMPRESSED BY THE STRIDES MADE BY RELAXO IN LAST 5 YEARS. 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 PROBABLY 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.

What do you attribute the successes to? Despite several of these advantages like moving up the value chain to high margin products, better working capital management, etc, the RM price volatility seems too much of a drag – dragging down margins drastically. Please comment on margins sustainability and countering the RM challenges going forward.

If you look closely at the company, you will notice that real growth started happening post 2006 when we invested in Flite and subsequently with Sparx. Before that we were only a Hawaii company. With investments going into expanded capacities, branding, opening of company owned retail stores, we started getting known for quality at affordable prices. Customers started asking for our products – retailers needed to start stocking!

Yes, the raw material situation is tough and has worsened in recent quarters. Earlier we needed to effect price changes once a year. We effected a price hike in January 2011, but the last one before that was in April 2010. But with the current situation we will most probably be effecting another hike in Mar 2011. We are watching the situation and moves by competition closely.

There is great brand pull, customers ask for our products and retailers/distributors have to come and get the stock from us. But does that mean we have any real pricing power -No. Our Hawaii slippers will find it difficult to sell at Rs. 2 more (than the Rs 27 currently).

2.       CURRENT CAPACITIES ARE AT 3.35 LAKH PAIRS A DAY. 2 LAKH PAIRS OF HAWAII SLIPPERS PER DAY, 105,000 PAIRS OF FLITE PER DAY AND ABOUT 30,000 PAIRS OF SPARX (SHOES & SANDALS) PER DAY. & FACTORIES SPREAD ACROSS HARYANA, UTTARANCHAL, RAJASTHAN.

What is the current revenue mix and margin contribution from these products? And where is Relaxo’s focus for future growth? What kind of plans going forward on Sparx/Flite. What kind of promotional budgets will be required for this?

What incremental capacities can the current locations take. What is the space available?
Any possibilities of multiple shifts?

35% revenues are from hawaii slippers, 30% is from Flite, another 30% is from Sparx and others bring up the balance 5%. Hawaii slippers are low margin business, while Flite and Sparx bring in higher margins. We are already running 2 shifts. There is enough space for further capacity expansion.
Going forward both Sparx and Flite are our Flagship brands. we will continue to make investments in line with demand.

3.       ALL THREE BRANDS – RELAXO, FLITE AND SPARX ARE QUITE WELL KNOWN AND WELL ACCEPTED IN THE MARKET.

The Relaxo brand is jointly owned with a group company. However no royalty is currently being paid by RFL.  Is this arrangement set to continue or the Management has some plans on consolidating its brand ownership?

The “Sparx” brand is also involved in some trademark infringement suite with Bata? Can you please explain the circumstances and the current status/ What are the threats to the company from this?

The Relaxo brand is jointly owned. The promoters have equal stake in the group entities, so it should not be a problem. Discussions have taken place and there is some progress on assigning a nominal value and bring the “Relaxo” brand within the company fold. The assigned value will not be in Crores for sure, but of the order of a few lakhs.

Bata owns the Sparx brand and operates it in some 27 countries. Yes, it is registered in India since 1978, but has never used it in India!

Relaxo started using Sparx since 2004-5 and since then has been making continual investments in it. Actually the litigation was started by us in 2009, when we came to know of their plans to start using Sparx, and prayed for a direction from courts for the rights of Bata on Sparx to lapse. As per Indian trademark laws, the right to a trademark can lapse, if the firm cannot show any use of the trademark for a number of users. We filed more than 600 documents showing our use of teh brand in Invoicing and the like, while Bata could produce only 2-3 bills dating back to late 70s and nothing after that.

Our legal advice is that we have a strong case and we are pursuing it. We are also hoping for an out-of-court settlement. However these things can go either way, and so we have registered and started using an alternate brand “Spark” with the same styling as ‘Sparx”. That should help us switch with minimum damage.

4.       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.

Please elaborate on the factors contributing to this superlative performance on the working capital front. Is this a result of many factors coming together synergistically or its plain old-fashioned persistent focus on improving operational efficiencies and strategic thinking. How many distributors and retailers. How much of the business is driven thru retail distribution network? What is the role of company-owned stores in this play?

Like we mentioned before we are in a happy position as far as demand pull for our products are concerned. Quality & Value for money is what we stand for and the brand has got associated in the customers mind. They ask for it by name and distributors are always at our doors for stocking our products.
60% of our business is done in advance today. That has led to the gradual reduction in debtors days. Inventory days has gone up because of moving up in the chain with higher value items. [A hawaii slipper costs Rs 27, an Flite from Rs. 40 onwards, while a Sparx shoe costs Rs. 700 onwards.]
Company owned stores have been playing a big part in helping change consumer perception. That we are not just a hawaii slipper company, but have a very wide range of offerings with lightweight slippers and sports shoes, canvas and sandals. They help drive demand for our products. We are in line to have 125 company owned stores by March 2011. Company owned stores typically break-even by 18-24 months, with new stores added every year. Till the time they break even they work to a clearly defined loss-budget (apportioned from the promotional budget for the year).

5.       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.

What kind of capacities are now dedicated to exports? Will export markets grow to be a significant contributor in the near future, by when? Are margin realizations higher in export markets?

We are a leader in the domestic market and will continue to focus there. We are doing some exports to increase our presence and utilise our capacities better. We did 10 Cr last year and this year we may be able to do 20 Cr in exports, so in percentage terms the exports growth is great. However on an absolute basis, exports will probably remain a small segment. The margins are lower in export sales.

6.       The footwear industry needs lot innovation in coming out with new models. This must be quite a complex and constant planning exercise.

How do you currently manage this aspect? What are the in-house capabilities to cater to this? How many models have you introduced since launching Flite & Sparx brands respectively

You are right, the challenges and complexity is very high in this business. Across the 3 brands, we have more than 600-700 different SKUs active at any given time. the total number of SKUs are around 2500.

Designing is done in-house. We have a dedicated team continuously breaking their heads over this. Management plays an active role. The branding modeling is done by us, the uppers mostly sourced from Chinese manufacturers with the soles designed & manufactured by us. The sourcing is long-term relationship based, with exclusivity for the Indian market.

7.       WE HAVE ALWAYS BEEN HEARING BATA’S BUSINESS MODEL IS INHERENTLY DIFFERENT FROM RELAXO’S AND THESE TWO ARE NOT REALLY COMPARABLE.

Can you please educate us more on BATA’s model. What do you see as the strengths or weaknesses inherent in that model versus yours?

Bata has been in the business much longer than us. They used to manufacture everything themselves, but now follow a mostly outsourced model.

8.       RELAXO SEEMS TO BE GROWING AT HIGHER THAN THE FOOTWEAR INDUSTRY GROWTH RATE.

What is the industry growth rate and why are you able to grow at higher rates consistently? Is this due to new users (growing the market), moving unorganized sector customers to yours, or eating into existing branded market share.

Its probably a mix of the above. With rising incomes many new users are coming to us as they associate quality with value for money for our products. Probably the biggest chunk is coming form the unorganised sector as their incomes & aspiration levels allow them to move up to branded products.

9.       RELAXO HAS EARLIER MENTIONED A TARGET OF RS. 1000 CR IN SALES BY FY12.

How do you see Relaxo placed now? Where is this growth going to come from? What will be the profitability and quality of this growth?

Growth will come from the higher capacities in place for Flite and Sparx brands. Flite capacity is now 100,000 pairs a day while for Sparx it is ~25000 pairs a day. Profitability should be higher as these are higher margin products. Contribution will be more ore less same from both brands.

10.   SALES GROWTH OVER THE QUARTERS HAS BEEN PRETTY LUMPY IN FY11. 154 CR IN Q1, 181 CR IN Q2, 153 CR IN Q3.

This is in variance with the pretty consistent quarterly growths achieved in FY10 and earlier years. Kindly explain the reasons behind this, capacity utilization issues, supply/demand issues, or a deliberate shift in strategy?

This was due to a change in our distribution policy that we affected in the past 2-3 quarters. We were seeing that distributors were violating territorial integrity by selling across nearby territories in order to take advantage of bonus terms from us. We have now removed 6-month and yearly bonuses and linked it to weekly targets. This measure should help prevent accumulation.
This was initially resisted by the trade but are now getting around to accepting that as a fair practice for all concerned. We should see this stabilise in Q4.

Disclosure(s)

Ayush Mittal: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
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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;