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Jyothy Laboratories: margins not bright enough

LiveMint logoLiveMint 09-06-2014 Krishna Merchant

Jyothy Laboratories Ltd’s shares have underperformed the S&P BSE FMCG index in the past three months on concerns that high advertisement spending will continue to weigh on margins.

Even the doubling of net profit and a strong 21% sales growth in the March quarter were not enough to improve the stock’s performance. ICICI Securities Ltd, in a note dated 23 May, cut the operating margin estimate for 2014-15 by 153 basis points to 13% due to the company’s higher expenditure on innovations, new launches and marketing communication, which could pull down earnings by 10.5%.

A basis point is one-hundredth of a percentage point.

The management is planning to increase advertisement spending as a percentage of net sales to 12% in the current fiscal year from 11% of net sales in 2013-14, as Jyothy Laboratories continues to focus on brand-building and growing ahead of the industry. That’s up from 7.9% in the preceding three years.

The heavy emphasis on advertising helped the company clock record sales growth of 23% last fiscal year, the best among consumer and packaged goods firms, but the growth came at the cost of depressing margins.

Operating profit margins dropped 186 basis points to 10% in the March quarter. S. Raghunandan, chief executive officer of Jyothy Laboratories, said the company had cut operating margin estimates to 12-13% in 2013-14 from 14% earlier.

“In the March quarter of every year, margins are generally low because of higher sales of lower margin product—mosquito coils—as demand picks up in February and March,” added Raghunandan.

The company has set a sales growth target of 20-25% for 2014-15 on the back of re-launches of products across various segments. Employee expenses as a percentage of net sales increased by 4.4 percentage points to 11.8% and raw material costs as a percentage of net sales also remained elevated at 57%. Jyothy Laboratories is seeing high inflation across segments, which will remain a worry in the current fiscal year.

Despite the turnaround efforts and the company becoming profitable in the past one year with key brand Ujala, and with fabric whitener sales rising 45% from a year ago, the stock is down 5% in the past one year.

While the stock is trading at reasonable valuations of 20 times one-year estimated price to earnings, it may remain under pressure unless margins improve.

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