• Date: 4^th Nov 2017
• Industry: Footwear
• CMP: Rs. 581
• P/E: 56.4 and P/B: 11.5 times
• Mid Cap: 7,003 crore mkt cap
• Advice: BUY with a target price of Rs. 905 by May 2019
• We prefer this stock to an IPO open currently.

Summary

• Overview: Relaxo Footwear is a firm into footwear products for over 40 years; is India’s largest footwear maker and sold 13.5 cr. pairs in FY17. RXO offers comfort, style and affordable footwear. 70% of RXO’s sales is from the
• RXO’s revenue in FY17 was Rs. 1,741 cr. and profits Rs. 123 cr. Revenues, EBITDA and PAT have grown at 19.8%, 24.1% and 30.9% CAGR from FY09-FY17.
• Key new trends include growth in non-leather footwear and eCommerce. The firm is going to expand faster using the franchise model. Margins and volumes are likely to improve this year due to reduced interest & tax costs, new value added products and a favorable macro environment. RXO has adapted itself over the years to changing consumer needs.
• Risks: The key risk is a rise in raw material prices could impact margins.

Here is our report on RXO Footwears Ltd. (RXO)

Relaxo Footwear – Description and Profile

• RXO is engaged in the mfg. and sale of footwear products made of textile, rubber, PU (synthetic leather) and EVA (ethylene vinyl acetate). Today RXO is India’s largest footwear firm.
• RXO’s revenue in FY17 was Rs. 1,741 crores and profits Rs. 123 cr. It has 4,855 employees.
• RXO has its HO in Delhi and mfg. at Bahadurgarh (H’yana), Bhiwadi (Raj.) and Haridwar (U’khand).
• RXO stepped into the footwear industry in 1976 when brothers Mukund Lal Dua and Ramesh Kumar Dua started off with the mfg. of slippers and subsequently expanded the range.
• At present, RXO makes 6,75,000 pairs per day with capacity utilization of 60%. Products include slippers, canvas shoes, flip flops, PVC DIP shoes, sport shoes and sandals. The brands are Bahamas, Flite, Casualz, Schoolmate, Sparx, Elena, Mary Jane, Kidz Fun and Boston.
• Unlike Bata and Metro Shoes, RXO has taken a conscious decision to stay away from leather products where the prices may be higher but the market size is much smaller.
• RXO sells its products through 275 exclusive COCO stores {Company Owned and Co. Operated}, large format retail stores and e-commerce. However, the majority of company’s business comes from general trade, with 800 distributors and 50,000+ retailers across the country. 75% of the COCO stores are located in north India particularly in UP, Delhi, Haryana and Punjab.
• As a part of its product positioning, RXO offers a combination of comfort, style and affordable footwear. See Fig 1. RXO has 6,000 SKUs and 400 articles (products).

Fig 1 – RXO Product positioning; Fig 2 – RXO Geographical presence; Fig 3 – Brands  

• RXO brands are promoted by Salman Khan, Akshay Kumar, Shahid Kapoor and Shruti Haasan from the film industry. Fig 3 highlights the positioning and target market of each brand.
• Key Executives are: Ramesh Dua (MD), Mukund Lal Dua (Whole Time Director), Sushil Batra (CFO), Gaurav Dua (ED Marketing) and Ritesh Dua (ED Finance, Exports and HR).
• Shareholding pattern % is: Promoters 74.9, DII 1.8, QFI 4.5, Individuals 5.0 and Others 13.8.

Business Notes, Strategies and Events

• RXO reported a 1% rise in profit YoY at Rs. 37 cr. in Q1 FY18. Revenues grew by 19% to Rs. 483 cr. in Q1 FY18 YoY. Revenue growth was high in Q1 FY18 due to pre-ponement of sales prior to implementation of GST. However, the same kind of growth is not expected in Q2 FY18, but it may revive in subsequent quarters. This PAT growth was flat due to sharp increase in cost of materials by 37.1% YoY.
• Management expects double digit revenue growth (mid-to-high teen) for FY2018 driven by improvement in sales volume and better realization (due to improvement in revenue mix).
• GST has improved prospects as footwear priced up to Rs. 500 is now taxed at 5% (earlier 9.5%) and the rest at 18% (earlier 23.1-29.5%). This is a positive for organized footwear players.
• RXO changed its 40-year old logo in Jan 2017 to stay relevant amid the changing consumer preferences.
• RXO has always owned the resources like land, machinery, factory etc. to keep a check on quality. It has recently adopted the franchise model to accelerate reach in untapped markets.
• In 2009 Bata had filed a case against RXO in the Delhi HC accusing it of infringement of its brand Sparx. The issue was settled out of the court in 2015 in favor of RXO.
• RXO is setting up its 9th mfg. unit in Bhiwadi, Rajasthan with a capex of Rs 100 cr. to make the Hawai brand of footwear as current capacity is fully utilized. This should boost revenues.
• eCommerce is an important channel with an Online Presence with shopatrelaxo.com and Online Shopping Websites like Amazon, Flipkart, Snapdeal, Jabong, etc.

Industry Outlook

• The total footwear industry is of Rs. 55,000 cr. and organised sector is of Rs. 10,000 cr.
• Relaxo has a 3% market share within the entire industry and 20% of the organized footwear market in value terms, and 5-6% in volume terms. It sold 13.5 cr. pairs of footwear in FY17.
• The domestic footwear market in India is projected to grow at a CAGR of 15% from FY16-20. The key drivers for the footwear segment will be: a) increased adoption owing to versatility in usage, and b) shift from unbranded to branded.
• Men’s footwear dominates this market with 54% share, next is women (37%) and children/ school (9%). But women’s segment will outpace Men’s to take 41% of the market by FY 2020.
• Branded footwear market is expected to grow at a CAGR of 20% to account for 50% of the organized market by FY 2020 from current 40%.
• Footwear market is among the most organized categories in the country with 26% of the organized share with presence of EBOs (Exclusive Brand Outlets). The unorganized pie of 74% will grow at 14% while the organized market will grow at 18% CAGR to account for 29% of the market by FY21. (Source RHP)
• Bata India has the largest store network followed by Khadim’s and Liberty Shoes. See Fig 4.
• 54% of the retail stores sales are under the Rs. 500 category and 30% in the range of Rs. 500-1000. See Fig 5. 70% of Relaxo’s sales is generated from the

Fig 4 – Store network of footwear brands / Fig 5 – Average Selling Price and Shares

Stock Evaluation, Performance and Returns

• The share price has grown at 54.2% CAGR over 5 years and at 34.6% over 2 years. This includes a split in Nov 2013 (FV 5 to FV 1) and a bonus in July 2015 (1:1). See Fig 6.
• The FY17 remuneration of Mukund Dua and Ramesh Dua is high at Rs. 9.12 cr. each. Under Companies Act, the ceiling in pay to key managers is 10% of profits. This limit is being given as remuneration.

Fig 6 – Price History

• Revenues, EBITDA and PAT have grown at 19.8%, 24.1% and 30.9% CAGR from FY09-17. We can see improvements in Operating & Profit margins even as Revenues grew steadily. See Fig 7.
• Dividend growth has been good. RXO has generated positive Free Cash Flow in the last 8 years indicating conservative financial management, Fig 8.

Fig 7 – Quarterly Financials / Fig 8 – Cash Flow 

• The historical average for PE is at 37.6 times of the last 5 years. However in the last 2 years, it has risen to 45.2 times, implying a re-rating. Currently RXO has PE of 56.4 times and is the top quadrant. See Fig 9.

Fig 9 – Price and PE Chart / Fig 10 – Price and EPS TTM Chart

• The earnings of RXO grew 4x from Jan12 – Jan16. In Fig 10, we show the EPS growth in a channel. Employee costs rose sharply from Mar 2016 affecting the EPS growth. Later demonetization also affected business.
• ROCE and ROE are 25.7% and 22.6% respectively which is robust.
• The D/E of the firm has fallen from over 0.96 to 0.38. This is a positive. As per mgmt. in Q1 FY18, RXO’s interest costs fell over 50%. This is likely to drive the margins up.
• However earnings revival will be witnessed now due to benefits arising from GST, fall in interest costs, premiumization of product portfolio and adoption of the franchise model for faster expansion.

Benchmarking and Financial Estimates

We present a benchmarking exercise with listed peers in similar product categories. Since Mirza Intl. is focused on exports, it is not strictly comparable. See Exhibit 11.

• In terms of P/B the valuations appear high. However this is explained by RXO strategy of owning the mfg. plants. P/E appears little high. RXO has good growth and a low D/E ratio compared to the peers.
• RXO leads on margins, which reflects on good sales and costs controls. They are likely to improve as the management continues to focus on premiumization products while also focusing on cost reduction.
• The return ratios are robust with a leading RoE score. The dividend yield is fair.
• In all we can conclude that RXO looks more attractive than Khadim whose IPO is due.

Exhibit 11 – Benchmarking / Exhibit 12 – Two year Projections  

Financial Projections: We present 2 year financial projections for RXO, see Exhibit 12.

Strengths                                                     

• Key new trends include growth in non-leather footwear and eCommerce. RXO has only a small fraction of leather, and may benefit from this. On eCommerce RXO has its own website and tie ups with popular portals to grow online presence.
• Strong brand equity strength & Celebrity endorsement: RXO has many brands, and has created good brand equity by endorsing celebrities to connect brands with customers, like Salman Khan, Akshay Kumar, Shahid Kapoor and Shruti Haasan. These activities positively impact volume growth.
• GST: 70% of RXO’s sales falls in < Rs 500 price which has been positively impacted by lower GST.
• Improved Financials: RXO has reduced debt over 5 years and current D/E is at 0.2 times, lowering interest costs in Q1 FY18. Along with premiumisation these will improve margins in the medium term.
• RXO is a well-managed firm financially. The return ratios have historically been high and the cash flow management is good. This is a positive from an investment perspective.
• Exports is a priority and will help RXO ramp up volumes in future.
• RXO owns all its mfg. facilities. This allows better quality control and higher returns.
• While the two brothers have been running the firm for 40 years, the next generation appears to have smoothly taken charge along with senior professionals. There should be continuity at RXO.
• Focus on fashion: The key driver at RXO is to be in-sync with changes in fashion for consumers. Many of the new brands, design changes and premiumization initiatives are to tap consumer behavior. The new logo of Relaxo has also been created to appeal to the younger crowd.
• A fall in rubber and raw material costs in recent times has helped RXO to improve margins.
• The initiative around franchisee network growth will help RXO expand reach and availability.
• Capacity utilization at RXO is 60% so there is ample room to grow volumes.

Risks and Challenges

• The IPO of Khadim which is ongoing may throw a spotlight on the sector, and make valuations expensive. RXO has already gained close to 20% in the last 1 month.
• Also some investors in Relaxo may like to exit it and enter Khadims.
• High valuations – at a PE of 56 times, a lot of growth and profitability expectations are baked into the price. Any non-delivery of such performance will result in a big correction of price.
• Any change in Govt. policies, and GST tinkering can affect the company’s performance.
• Rubber and crude oil prices volatility can affect the costs structure and margins. The key raw materials, ethylene vinyl acetate (EVA) etc., are crude derivatives and hence prices follow the crude cycle with a lag effect. A sharp rise in these crude prices could significantly affect input cost.
• Intensifying competition – entry of MNCs such as Nike, Adidas, Puma and many top brands can affect RXO. However our feel is that currently these firm’s products are priced much higher and so will not affect RXO.
• Macro-economic factors like a downturn in the economy, unforeseen political and social upheavals, natural calamities and below normal monsoon can affect RXO.
• Any sharp fluctuations in dollar price can adversely impact the cost of imported raw materials.
• In family owned businesses there is always a risk of breakups and business separation.
• High promoter compensation – it is at prescribed limits.

Overall Opinion, Outlook and Recommendation

• In India the per capita consumption of footwear is 1.66 per year compared to 3 pairs globally and 6-7 pairs in advanced countries. This indicates high potential demand.
• RXO has a positioning of a Value for Money but visible and good quality footwear. There is a massive unorganized sector in footwear. With GST and other tax initiatives, RXO may capture a lot of marketshare vacated by unorganized sector while taking up premiumization and brand strengthening.
• The management is planning to expand faster using the franchise model. FY17 was flat financially on account of demonization and higher employee expenses. The margins and volumes are both likely to improve this year on account of reduced interest & tax costs, introduction of more value added products and a favorable macro environment.
• RXO has adapted itself over the years to changing consumer needs and preferences. This financially reflects well on the company in terms of superior return ratios and good cash flow management.
• Valuations are expensive at P/E of 56.1, but good companies tend to be richly valued for long durations.
• We project a target price for RXO of Rs. 905 by May 2019, a rise of 55% absolute and 33% annualized.
• Investors can BUY this share with a 2 year investment horizon.

Disclaimer

• This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same.
• The basis for the Financial Projections in Exhibit 12 and Target Price are revenue growth per footwear pair at 8% p.a. for FY18-20, volume growth of 11% p.a. for FY18-20, margins at Q1FY18 levels, a P/E target of 50x, management commentary and analyst judgement.
• Punit Jain has no position in Relaxo Footwears. In addition, JM has no known financial interests in Relaxo Footwears or any related group.
• Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of Investments can go down as well. The suitability or otherwise of any Investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com