Yashas Bhat yashas_bhat@lkpsec.com +91 22 6635 1220

October 7, 2015

Buy VIP Industries Industry: Luggage and Bags Industry View: Overweight Initiating Coverage

“Evolutionary moves driving this revolutionary business” VIP is the market leader in the organised luggage industry in India with more than 50% market share, manufacturing and supplying a wide range of hard-sided and soft-sided luggage. Established in 1971, it is Asia’s largest and the world’s 2nd largest luggage manufacturer and is an end to end supplier catering to the needs of a diversified customer mix of value for money and mid to high end premium segments. Amongst the most recognized and trusted brands in India with its flagship VIP brand, the company has diversified to other brands as well through green-field and brown-field expansion like Carlton, Caprese, Skybags, Aristocrat and Alfa. VIP also has a moulded furniture business under the brand name Moderna.

Strong brand equity to drive volume growth A combination of continual innovation and extensive advertising has led to the growth of its flagship VIP brand which is synonymous with luggage in India. The company is also developing its youth oriented brands Skybags, Carlton and Caprese which are witnessing exponential growth. This has helped VIP sustain its leadership position in the Indian organised luggage industry.

Evolution of market dynamics offer significant upside potential India has the world’s largest youth population with the median age being ~ 27.3 years. The intense competition between VIP and Samsonite has also led to increased advertising and promotion thereby extending the reach of the 2 brands. Rising consumer preference for branded products coupled with higher visibility of luggage brands is expected to increase the share of the organised market, directly benefiting its market leader VIP.

Skybags and Caprese to begin a new chapter in VIP’s heritage Skybags, targeted towards style conscious youth who desire aesthetics with functionality, has fast grown to be the 2nd most significant contributor after the flagship VIP brand. Caprese is a lifestyle brand that offers a wide range of ladies’ handbags where it is trying to be the first mass handbag player with a nationwide reach. We believe that both these brands are setting the stage for another high growth phase for VIP.

Outlook & Valuation Considering its strong brand equity, market leadership position, potential of Skybags and Caprese, distribution strength, forward looking management and low financial risk with a debt free balance sheet, we initiate coverage on VIP with a BUY rating and a one year target price of ₹ 125 (47% upside), at which the stock will trade at ~ 24X times FY17E earnings of ₹ 5.2. At current levels, the stock is trading at ~ 16X times FY17E earnings.

Stock Data Current Market Price (₹) 85

Target Price (₹) 125

Potential upside (%) 47

Reuters VIPI.BO

Bloomberg VIP IN

Key Data Market Cap (₹ bn) 12

52-Week Range (₹) 130 / 71

Avg Daily Trading Value last 6 mts(₹.mn) 36

Promoters (%) 52.43

FII Holding (%) 2.97

DII Holding (%) 11.56

Public & Others Holding (%) 33.04

Fiscal YE

YE Mar FY14 FY15 FY16E FY17E

Revenues 9,728 10,477 11,419 12,732

EBITDA Margin (%) 8.3% 7.4% 8.4% 9.0%

PAT Margin (%) 5.9% 4.4% 5.2% 5.8%

EPS 4.1 3.3 4.2 5.2

P/E 20.8 25.8 20.3 16.3

P/BV 4.2 3.9 3.7 3.4

EV/EBITDA 15.0 15.5 12.5 10.5

ROCE 22.9% 20.4% 26.2% 30.2%

ROE 20.1% 15.2% 18.0% 20.8%

Dividend payout 48.9% 59.8% 62.5% 63.6%

Relative Price Performance

One Year Indexed (%) 1 Month 3 Months 12 Months

Absolute 18 (13) (21)

BSE Relative 10 (8) (23)

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70

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90

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120

Oct-14 Feb-15 Jun-15 Oct-15

VIP Industries Ltd. S&P Bse Sensex

LKP

Research

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VIP Industries

LKP Research 3

VIP enjoys strong brand equity with its flagship VIP brand and other fast growing brands as Skybags, Caprese and Carlton.

Investment Argument Strong brand equity to drive volume growth VIP manufactured its very first suitcase in 1971. Since then, it has emerged as a category defining brand with its attention to detail and innate ability to be dynamic and progressive. It has never failed to capitalize on its innovations through advertising and promotions as well. Thus, a combination of continual innovation and extensive advertising has led to the growth of its flagship VIP brand which is synonymous with luggage in India. This has helped VIP sustain its leadership position in the organised luggage industry.

The traditional brands of the company such as VIP, Alfa and Aristocrat contributed ~ 69% of its revenues in FY15. In addition to its traditional brands, the company is also looking to develop its youth oriented brands such as Skybags, Carlton and Caprese since these brands are witnessing exponential growth.

The positioning of the brands mentioned is given below: Brand Year Brand Positioning

VIP 1971 Mass mid-premium

Alfa 1971 Mass market targeted to convert consumers purchasing unbranded luggage to VIPs products

Carlton 2004 Premium international brand, targeted towards young professionals

Aristocrat 2007 Value for money

Skybags 1980s, re-launched in 2012 Youth oriented, stylish

Caprese 2012 Mass-premium, targeted towards fashion conscious urban women

We believe that the strong brand equity of all of VIPs brands, its ability to innovate and stay ahead of its competitors and focus on its newer high growth segments would drive volume growth and help support the top-line.

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VIP Industries

LKP Research 7

A 10,000+ point of sale network and improved inventory management expected to economize inventory cost and ensure product availability.

Economic recovery and increasing spend on travel and discretionary products expected to drive volumes.

Currently, the ladies handbag industry is predominantly unorganized with several private labels dotting the competitive landscape. Rising disposable income, increase in the number of working women, widening exposure through internet, development of retailing and specialty stores and growing acceptance of handbags as a lifestyle product presents a significant opportunity for VIP. Even though the brand is at a nascent stage, Caprese is poised to grow into one of the most significant contributors to VIPs top-line and bottom-line. It is the management’s vision to replicate the success it achieved with luggage in the 1970s with its handbags business and develop Caprese into a brand that contributes significantly to its turnover in the foreseeable future. VIP has also brought Alia Bhatt on board as “The Caprese Girl” for establishing its brand with the masses.

Distribution strength and improved inventory management to ensure better demand-supply integration One of the USPs of VIP lies in its distribution strength. Its 10,000+ point of sale network enhances brand visibility and reach for the product range of all its brands.

While its traditional network of dealers has been the foundation of its distribution prowess, the modern markets segment which comprise of hypermarkets and online sales have gained significant momentum in FY15.

Revenues from sales through hypermarkets like Shoppers Stop, Lifestyle, Pantaloons and Central, which comprise ~ 20% of its operational revenues in FY15, have witnessed a growth of ~ 20%. We expect that hypermarket segment will continue its high growth phase as hypermarkets offer comfort, convenience and choice of different products and brands to the consumer with a higher propensity for impulse purchases. In addition to this, online sales have risen ~ 200% in FY15, albeit on a small base, the same being well under 5% of revenues in FY15. VIP has its own E-comm website buytravelbags.com and is also selling its products on all the major online marketplaces like Flipkart, Amazon and Snapdeal. The management identifies the potential of the online marketplace, but has to still finalize its policy on discounting and payment practices in order to keep a check on a possible negative impact of cannibalization on its offline stores.

VIP has also adopted a new inventory management system which is based on the “Theory of Constraints” (TOC). TOC is an overall inventory management philosophy introduced by Mr. Eliyahu M. Goldratt since the 1970s to help organizations continually achieve their goals by better availability of supplies in tandem with demand. We expect that better inventory management of its raw materials and finished stock will help minimize loss of sales enhancing product availability and ensuring optimal inventory costs due to operational efficiencies.

Economic recovery, increasing travel and discretionary spend to spur revenue growth The Indian economy is poised for another high growth phase with GDP growth rates estimated at ~ 7.5-8.0%. We believe that a strong expansion in the country, coupled with favorable oil prices would accelerate growth in India. The economic fundamentals of the country are strong with the government giving a fillip to growth through several initiatives like “Make in India”, clearance of big ticket infrastructure projects, focus on proper governance and adopting measures to ensure ease of doing business. The RBI is also partaking in the efforts to fuel economic growth through policy rate cuts by as much as 125 basis points in the past 3 quarters and working with banks to make sure the benefits of lower rates are passed on to businesses and the public at large.

VIP Industries

LKP Research 8

Economic recovery, better performance of VIP brand, and sustained growth of youth oriented brands to drive revenues.

Expected GDP growth rates for FY16E and FY17E

Source:ADB, WB,IMF

The Indian aviation industry has also seen significant growth since the 21st century. It is the 9th largest civil aviation market in the world which is set out to grow to the 3rd

largest by 2020. Total passenger traffic increased by 12.47% yoy to 190.1 mn in FY15. Rise in income levels, increased utilisation of air travel for business and leisure as well as low fuel costs is expected to help aviation grow at ~ 18-20% till FY17E.

With economic growth expected to be back on track by H2 FY16E, we believe that there would be a rise in discretionary spending leading to growth in demand for branded long haul luggage and short haul products such as handbags and backpacks. We believe there is a high direct correlation between growth in airline passenger traffic and luggage demand. An increase in demand for check-in bags, soft-sided and hard- sided polycarbonate luggage is expected on account of greater domestic and international air travel. This would help drive volumes for VIP thereby improving profitability of its soft-sided and hard-sided luggage brands such as VIP, Aristocrat and Skybags.

Financial Performance Revenues VIPs revenues have grown steadily at a CAGR of ~ 6.7% during the period FY11 -FY15 which experienced muted economic growth. The company experiences seasonality in demand for its product. Historically, Q1 has always been the strongest quarter for VIP with ~ 31% of operational revenues being earned in Q1FY15. This can be attributed to this period coinciding with the peak wedding season and increased traveling due to the holidays. Q3 also is an important contributor to VIP on the advent of the festive season.

We expect revenues from operations to grow ~ 9% and ~ 11.5% in FY16E and FY17E on the back of a turnaround of the Indian economy, better sales performance of its flagship VIP brand and persistent high growth of its other youth oriented brands.

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FY16E FY17E

VIP Industries

LKP Research 9

Rationalising input costs, increased sourcing from Bangladesh plant to help improve absolute EBITDA and EBITDA margins.

Trend of quarterly operational revenues

Source:Company, LKP Research

EBITDA and EBITDA Margins In spite of an uptrend in revenues, a decline has been observed in absolute EBITDA and EBITDA margins in the past half-decade. From EBITDA level highs of ~ ₹ 1.2 bn (~ 15.9%) in FY11, EBITDA has fallen to ~ ₹774.8 mn (~ 7.4%) in FY15.

Rise in input costs has been a major reason for thinning of margins. The proportion of inputs to sales has increased from ~ 46.5% of revenues in FY11 to ~ 54.7% in FY15. The 2 major categories of inputs i.e. sourced soft-sided luggage from China and polypropylene, a primary raw material for hard-sided luggage both exhibited an uptick in prices. There has also been a higher spend on branding due to aggressive advertising and promotion which is expected to continue at 5-7% of revenues. The reorganization of the sales function to 2 teams: traditional channels and modern markets increased employee costs by 17.5% in FY15. This has been done to increase focus and accountability for both traditional and fast growing modern markets segments.

We expect that input costs would rationalise on the back of softening exchange rates, reducing dependency on China for its soft-sided luggage supply due to

increasing production from its manufacturing facility in Mongla SEZ, Bangladesh and cut in polypropylene prices which generally lag to crude oil prices. We estimate absolute EBITDA levels to rise to ~ ₹ 964 mn (~ 8.4%) and ~ ₹ 1,145 mn (~ 9%) in FY16E and FY17E respectively.

Trend in absolute EBITDA

Source:Company, LKP Research

3,107

1,983

2,360 2,275

3,293

2,187 2,532 2,461

3,544

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

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Op. Revenue (₹ mn)

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964

1,145

-

200

400

600

800

1,000

1,200

1,400

FY11 FY12 FY13 FY14 FY15 FY16E FY17E

EBITDA ( (₹ Mn))

VIP Industries

LKP Research 10

Operational leverage, lower depreciation and negligible interest burden expected to improve absolute PAT and PAT margins.

PAT and PAT Margins The adjusted PAT for FY14 is ₹ 419 mn in FY14 excluding profit of ₹ 158 mn from sale of old investments and property in Bhandup. Similarly, in FY15, the sale of Jalgaon plant also led to an exceptional income of ₹ 43 mn, the adjusted PAT being ₹ 423 mn. The flat trend in adjusted PAT in FY15 was mainly on account of high depreciation which can be attributed to the commissioning of the Bangladesh plant. Going forward, improved operational performance together with lower interest and depreciation burden is expected to improve PAT and PAT margins to ₹ 591 mn (5.2%) and ₹ 737 mn (5.8%) in FY16E and FY17E respectively

Trend in absolute adjusted PAT

Source:Company, LKP Research

Risks • The flagship VIP brand is currently experiencing a phase of sluggish growth and

cannibalization from its fast growing Skybags brand. Since it contributes ~ 50% of revenues, a slow pace of growth for VIP brand would hurt the operational performance of the company. With the rising prominence of Skybags, the company is attempting to support the heritage VIP brand by its repositioning as a go to aspirational travel brand with its new TVC ad campaign.

• VIP faces intense competition from its rival Samsonite through its Samsonite (high end premium), American Tourister (mass premium) and AT (value for money) brands. Safari is also gaining momentum in the value for money segment. As regards to short haul products like backpacks there are several branded and unorganized players like Wildcraft, Tommy Hilfiger, Delsey, Nike etc. Since strong competitive forces exist in each segment, both from the unorganized and organised markets, VIP faces the risk of losing volumes to competitors as well as margins to increasing discounts in order to protect its leadership position.

• The traditional dealer network which includes own stores, dealers, franchisees and CSD segments has faced a sub optimal yoy growth in FY15 which was under 5%. Since ~ 75% of sales come from the traditional segment, stagnation in these channels may significantly impact the top-line. In order to mitigate this risk, VIP is in the process of introducing new models of Skybags and VIP in the CSD segment which would help regain the ground it lost to Safari in CSD. The reorganization of its sales team into traditional and modern markets segments is also expected to help sales teams focus and accountability in both these segments

889

676

315

419 423

591

737

-

100

200

300

400

500

600

700

800

900

1,000

FY11 FY12 FY13 FY14 FY15 FY16E FY17E

Adj PAT o( (₹ Mn)

VIP Industries

LKP Research 11

• With forex outgo 3.6X times its forex earnings, VIP is not naturally hedged and

exchange rate variation is a significant concern for VIP which may adversely affect it operational margins. In addition to currency volatility, rising manpower cost is impacting the cost of soft-sided luggage sourced from China. In order to reduce dependency on Chinese imports, VIP commissioned its Bangladesh facility which is expected to run at 85%-90% capacity in FY16E. The Bangla operations broke even and started earning profits in Q4FY15.

Outlook & Valuation Considering its strong brand equity, market leadership position, potential of Skybags and Caprese, distribution strength, forward looking management and a debt free balance sheet, we initiate coverage on VIP with a BUY rating and a one year target price of ₹ 125 (47% upside), at which the stock will trade at ~ 24X FY17E earnings of ₹ 5.2. At current levels, the stock is trading at ~ 16X FY17E earnings.

VIP Industries.

LKP Research 12

Financials (consolidated) Income statement YE Mar (₹ Mn) FY14 FY15 FY16E FY17E

Revenues 9,728.2 10,476.9 11,418.6 12,731.7

Raw Materials Cost 5,323.2 5,727.6 6,162.3 6,839.5

Freight and Forwarding Charges 483.3 562.8 628.0 695.2

Discount and Rebates 307.3 303.4 310.9 347.6

Advertising and Marketing 570.6 629.7 685.1 802.1

Employee Benefit Expenses 933.2 1,096.9 1,151.7 1,209.3

Others 1,307.7 1,381.7 1,516.2 1,693.2

EBITDA 802.9 774.8 964.3 1,144.7

EBITDA Margin (%) 8.3% 7.4% 8.4% 9.0%

Depreciation 170.5 175.2 139.3 127.7

Other Income 25.5 24.9 34.5 54.0

EBIT 657.9 624.5 859.5 1,070.9

EBIT Margin (%) 6.7% 5.9% 7.5% 8.4%

Interest 18.0 12.8 15.0 18.0

PBT 639.9 611.7 844.5 1,052.9

PBT Margin (%) 6.6% 5.8% 7.4% 8.2%

Exceptional Items 157.6 43.2 - -

Tax 221.1 189.0 253.4 315.9

PAT 576.4 465.9 591.2 737.0

PAT Margin (%) 5.9% 4.4% 5.2% 5.8%

Adj PAT 418.8 422.7 591.2 737.0

Adj PAT Margin (%) 4.3% 4.0% 5.2% 5.8%

EPS 4.08 3.30 4.18 5.22

Key Ratios YE Mar FY14 FY15 FY16E FY17E

Per Share Data (Rs)

EPS 4.1 3.3 4.2 5.2

CEPS 5.3 4.5 5.2 6.1

BVPS 20.3 21.6 23.2 25.1

DPS 2.0 2.0 2.6 3.3

Growth Ratios(%)

Revenues from operations 11.2% 7.7% 9.0% 11.5%

EBITDA 17.3% -3.5% 24.5% 18.7%

PAT 82.9% -19.2% 26.9% 24.7%

Valuation Ratios (X)

P/E 20.8 25.8 20.3 16.3

P/CEPS 16.1 18.7 16.4 13.9

P/BV 4.2 3.9 3.7 3.4

EV/Sales 1.2 1.1 1.1 0.9

EV/EBITDA 15.0 15.5 12.5 10.5

FCF/EBITDA 0.3 0.3 0.4 0.4

Profitability Ratios (%)

ROCE 22.9% 20.4% 26.2% 30.2%

ROE 20.1% 15.2% 18.0% 20.8%

Dividend payout 48.9% 59.8% 62.5% 63.6%

Dividend Yield 2.3% 2.3% 3.1% 3.9%Source: Company, LKP Research

Balance sheet YE Mar (₹ Mn) FY14 FY15 FY16E FY17E

SOURCES OF FUNDS

Equity Share Capital 282.6 282.6 282.6 282.6

Reserves and Surplus 2,587.6 2,774.9 2,996.7 3,264.8

Total Net Worth 2,870.2 3,057.5 3,279.3 3,547.4

Total Debt - - - -

Total Liabilities 2,870.2 3,057.5 3,279.3 3,547.4

APPLICATION OF FUNDS

Fixed Asset 856.1 723.9 634.6 581.9

Investments 0.1 0.1 0.1 0.1

Others 289.4 286.7 276.8 294.6

Current Assets

Cash and Bank 110.9 75.2 111.4 138.0

Inventories 1,756.2 2,268.9 2,447.4 2,721.8

Sundry Debtors 950.1 1,111.0 1,270.4 1,416.5

Current Investments - - 150.0 250.0

Loans & Advances 253.1 241.7 253.6 264.9

Others 260.1 255.7 260.6 285.3

Current Liabilities and Provisions

Current Liabilities 1,355.3 1,705.0 1,821.5 1,988.0

Provisions 225.9 186.3 269.1 372.7

Net Current Assets 1,749.2 2,061.2 2,402.8 2,715.8

Deferred Tax Assets 14.4 31.0 15.0 5.0

Other Long Term Liabilities (39.0) (45.4) (50.0) (50.0)

Total Assets 2,870.2 3,057.5 3,279.3 3,547.4

Cash Flow YE Mar (₹ Mn) FY14 FY15 FY16E FY17E

PBT 639.9 611.7 844.5 1,052.9

Exceptional Items 157.6 43.2 - -

Depreciation 170.5 175.2 139.3 127.7

Interest 18.0 12.8 15.0 18.0

Other income (25.5) (24.9) (34.5) (54.0)

Change in Working Capital (280.1) (355.2) (124.9) (194.2)

Less: Tax (221.1) (189.0) (253.4) (315.9)

CF from Operations (a) 459.3 273.8 586.1 634.6

Capital Expenditure (211.8) (43.0) (50.0) (75.0)

Change in /Investments 3.0 - (150.0) (100.0)

Other income 25.5 24.9 34.5 54.0

CF from Investing (b) (183.3) (18.1) (165.5) (121.0)

Free Cash Flow (a+b) 276.0 255.7 420.6 513.6

Dividend paid (281.7) (278.6) (369.3) (469.0)

Interest paid (18.0) (12.8) (15.0) (18.0)

CF from Financing (c) (299.7) (291.4) (384.3) (487.0)

Net Change in cash and CE (23.7) (35.7) 36.2 26.5

Closing Cash and CE 110.9 75.2 111.4 138.0

VIP Industries.

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