Bagging it Right

VIP has strengthened its lead in the market with a strong, diversified portfolio. As the valuation corrects, it might be worth betting on

Alia Bhatt, Varun Dhawan and Hrithik Roshan. Rohit Sharma and Ravichandran Ashwin. This isn’t the roll call for the next Dharma Productions film. Neither are we referring to the cricketers’ performance in the ongoing Indian Premier League. Instead, the five names listed above are a part of VIP Industries’ concentrated effort to refresh its brand positioning and appeal to an all-new millennial audience through its portfolio of brands. 

The re-branding exercise, which started around 2014, was aimed at reducing the dependency on their flagship brand — VIP — by creating more pillars — Skybags (luggage and backpack), Caprese (handbags), Carlton (premium travel bags) and Aristocrat (entry-level luggage and backpacks), each endorsed by a renowned face. Consequent to these efforts, their sales volumes have seen an upward swing, rising from Rs.9.6 billion in FY14 to Rs.14.16 billion in FY18. The company has also undergone a complete revamp this year with a new logo and has roped in Saif Ali Khan and Kareena Kapoor Khan as brand ambassadors. 

“We have four luggage brands so we had to segment it very well to speak to different consumer segments and ensure they don’t cannibalise each other. That has worked beautifully for us. All our brands are growing in an excess of 30% year-on-year consistently for the first nine months of FY19. Our top line has been growing at 27%-30% in the same period. And that kind of growth is on a large base. The product, pricing and advertising has worked together to generate this growth,” says Sudip Ghose, MD, VIP Industries. 

An Ambit Capital report released in January this year notes that in the commoditised US $3 billion luggage industry, VIP has been able to retain its numero uno position and also transition from luggage company to a brand. VIP has about 50% market share, followed by Samsonite and Safari Industries, which have 36% and 15% respectively, according to a 2019 report by Prabhudas Lilladher.

Strong distribution, product innovation and heavy brandex (~5.5x capex in FY14-18 as compared to ~2.5x in FY09-13) have played a crucial role in this transition, allowing it to charge about 20-30% premium over unbranded players. VIP’s unique selling proposition over other brands is its wider product portfolio in mass and economy segment as well as expansion of premium range (see: Multi-bagger). While VIP faces stiff competition from Samsonite and Safari, the former doesn’t have a stronghold in lower price point and Safari doesn’t have presence in upper price point. “Samsonite, traditionally a premium player, entered the mass segment in 2016 to not lose out on growth opportunity. In contrast, Alfa for VIP, their economy segment offering, was launched in 80s,” says Jinesh Joshi, research analyst - institutional equities at Prabhudas Lilladher.

FY18 was a breakthrough year for the company, notes a June 2018 report by ICICI Securities, with its revenue and Ebitda growing at 13% (adjusting for the Goods and Services Tax or GST, growth would have been 16%) and 46% respectively. 

With the company’s strategy yielding results, investors have rushed to bag the luggage company’s stock. Its stock price has risen more than 600% in the past four years from Rs.92.80 (as of April 1, 2015) to Rs.645.05 in August 28 last year. This marked the lifetime high of the stock. In the same period, its market cap rose from Rs.13.48 billion to Rs.87.24 billion. However, the sharp rise was followed by a correction of 27% to Rs.470 as of April 18; market cap dropped to Rs.66.48 billion. 

Analysts attribute this correction to lower margins in the second quarter of FY19. After the margins peaked to 18% in the first quarter, it dropped to 12.7% in the second. And again in the third quarter, the story repeated with a drop to 8.8%. “While revenues and volumes were strong, margins were lower compared to what the market was expecting. Profit growth was disappointing and Ebitda had declined as compared to last year. This was largely due to higher import prices and a product mix in which lower-margin brands were doing well as compared to higher margin,” says Dhaval Dama, director, Equirus Securities. Essentially, volume growth of 30% was accompanied by value growth of 27%. 

Amit Agarwal, vice president, Kotak Securities, concurs, stating that the poor operational performance was due to significant depreciation of rupee and oil prices rising. “Since they are looking to maintain market share, they couldn’t pass on the rise in input cost to the consumer. That is why they took a hit on operational performance,” he adds. 

But the company has taken corrective measures since then. Banking on its strong brand equity and distribution strength, the company hiked prices by 2-6% across brands. They also undertook a round of price negotiation with their factories in China. “I think the current quarter should start to see some recovery. We should be good in the next two quarters,” adds Ghose.  

Joshi notes in his report that Ebitda margin is expected to compress by 120 bps to 12.6% in FY19 amid increase in import duty, adverse product mix (increasing share of mass brand Aristocrat) and inability to take sufficient price hike in line with raw-material cost inflation and rupee depreciation. He expects margins to expand by 90 bps and 70 bps to 13.4% and 14.1% in FY20 and FY21 respectively. 

Coaxing out Growth

The company is looking to expand margins not just with price hikes. In a bid to improve efficiencies and reduce costs, it has set up manufacturing facilities in Bangladesh through a wholly owned subsidiary. These have been set up with an investment of Rs.150 million, raised through internal accruals. Currently, the company manufactures its hard luggage at its factories in India located at Nashik and Haridwar. This constitutes 25% of its sales. The remaining comes from soft luggage, which is imported from China. However, increasing labour costs and strengthening of the yuan versus the rupee was impacting margins. 

Sourcing from Bangladesh is currently negligible at about 10%, but the company plans to take it up to 30% in the next three years. “In China, labour cost is 4x of Bangladesh. Once they shift to Bangladesh, there will be expansion in margins because of lower costs,” points out Joshi. Also, in September 2018, import duty on luggage was increased from 10% to 15% by the Government of India. But analysts note that there is no import duty from Bangladesh, thereby saving cost. 

Also, luggage is typically a low capital-intensive industry. “Capital intensity, which is anywhere between 1-2%, is lower than VIP’s brand spending which is 5-7%. That will help them keep their balance sheet clean. Even if they plan to expand at Bangladesh, that capex is only Rs.200-250 million,” Joshi explains. The company has a debt-free balance sheet and he expects its return on equity (RoE) and return on capital employed (RoCE) to expand by 230 bps and 310 bps respectively over FY18-21E. Its RoE has doubled from 15.72% in FY15 to 28.26% in FY18. RoCE has also improved from 21.43% in FY15 to 42.79% in FY18. 

Identifying Niches

VIP has identified two segments as their key growth drivers – handbags and backpacks. Ghose says that luggage as a product is brought at the age of 30. To tap into a younger consumer base, they launched backpacks under the Skybags brand in 2014. “When we entered, we were the last brand to enter the market but today we are the largest backpack sellers in the country. We sell about 4.5 million units every year,” he says. This is despite the presence of multiple players, including American Tourister, High Sierra, Safari, Wildcraft and Fastrack. 

Similarly, diversifying beyond luggage, VIP forayed into handbags in 2013 with their brand Caprese. Today, it is among the top two brands in the country in terms of absolute turnover, claims Ghose. In the segment, it competes with brands such as Hidesign, Lavie and Esbeda. 

A back of the envelope calculation pegs the backpack market to be at Rs.30 billion of which organised is about 33% or Rs.9 billion and VIP contributes Rs.2.5 billion to it. Meanwhile, handbag market, pegged at Rs.100 billion of which about Rs.70 billion is organised, and Caprese contributes Rs.1 billion to this. 

Analysts believe that the company has placed its bets right. Firstly, backpack as a category is linked to student enrolment in higher education, which has been growing at a CAGR of 4% over FY13-18. It is also linked to the two-wheeler demand in the country, which has seen a CAGR of 10% between FY16-18. The category also has a higher replacement demand as compared to luggage. A new backpack is bought once every two to three years, compared to luggage which is bought every four to five years. Backpack as a category has grown at a CAGR of more than 30% for the past three to four years while handbags have grown at a 47% CAGR since inception. 

As a result, the share of backpacks to total revenue has risen from 12% FY16 to about 15-20% in FY18 and is expected to reach 22.1% in FY21. The growth in this segment is bolstered by the addition of two new brands — Aristocrat and VIP backpack which offer value pricing and premium pricing respectively. 

Meanwhile, handbags as a segment are linked to the growth in the number of women in the work force in the country, which has been growing at around 27% every year since 2013. The company has also lowered the average price point of Caprese. The brand was initially priced in the range of Rs.4,000-5,000 and has now lowered average price to the range of Rs.2,000-Rs.3,000, which increased affordability, notes a Prabhudas Lilladher report released in March this year. They expect Caprese’s share in revenues to rise from 7.1% in FY18 to 9.2% in FY21E (35% revenue CAGR over the next three years). 

Ghose adds that the company is also bullish on Carlton, which is just travel bags and competes in the premium segment with Samsonite. “We launched life-time warranty including airline damage one year back and it has done well for us,” he adds. Increase in production from facilities at Bangladesh and premiumisation of portfolio (via brands such as Carlton and Caprese) are expected to aid in margin expansion over FY18-21E. 

Distribution Might

One of the hallmarks of VIP is the strong distribution network it has built across the country. The company has about 1,000 dealers and 100 distributors (reaching 1,000 retailers), and 250 exclusive brand outlets, 250 franchisees and 1,000 modern trade outlets. The total point of sales are about 11,000. Such diversity in distribution channel creates a huge barrier for new entrants, notes Joshi in his report. 

Ghose says that there is huge scope to further build this network. “We have about 600 stores and plan to take it to 1,000 stores in three years time,” he says, adding that e-commerce is the fastest growing channel (currently about 6% of sales come from e-commerce). 

They are also looking at expanding their footprint in newer geographies. For now, it exports to countries such as UK, Europe, UAE, Qatar, Kuwait and the Asia Pacific. Though domestic still constitutes 92% of its total turnover, there are plans to tap into newer markets to fuel growth in international markets. Ghose believes that there is a huge opportunity and that they can actually double the company’s growth if they tap into it. “We are targeting anything between 10-12% in next two years and that is quite significant as we are growing our overall business by 25-30%,” says Ghose.

Future Perfect

In addition to strategic changes such as premiumisation and launch of new products that were adopted by the company, favourable policy decisions too have helped organised players in the industry (see: Sky-rocketing growth). Firstly, there is a strong growth witnessed in the overall share of organised luggage market, largely led by the introduction of GST, believe analysts. 

Of the overall luggage industry, organised market was just about 15%. This number has gone up to 25% post GST and is expected to reach 50% in the next three years. “Post implementation of GST, many unorganised players have come into the tax net. This has narrowed down the price differential and helped the entire industry,” says Joshi. A Kotak Securities report notes that VIP has been paying an effective indirect tax of 20% against their estimate of 12% paid by the unorganised players. With GST rates reduced from 28% to 18% in November 2017, the indirect tax situation for organised players has remained stable, but has increased burden on unorganised players, prompting them to undertake a rate hike. 

The slowdown in consumption is also unlikely to affect the luggage industry, which is fairly under-penetrated. Secondly, excluding the current turmoil in aviation sector, the travel and tourism industry in India has mostly seen sunny weather. “The passenger growth has been in strong double digits over the past five years. This points to a strong demand for luggage,” says Manish Gunwani, CIO – equity investments, Reliance Mutual Fund. 

At the same time, certain challenges continue to trouble the luggage industry. Among the most prominent is the fact that its input costs are heavily dependent on crude. The primary raw material for hard luggage includes polypropene and polycarbonate, which are both crude derivatives. For soft luggage, it is nylon or polyester, which is also made from crude derivatives. Any adverse movement in crude price impacts the margins of luggage makers. However, over the past few months, crude has stabilised at $60-70 per barrel from a high of $84 per barrel in October last year. Agarwal states that they believe crude should range within $65-70 per barrel for the next two years. 

Gunwani believes that the real fight is against unorganised market. “Price differential is still around 25-20%. Unorganised players under-bill and don’t advertise. However, it is not something that is insurmountable. The brand pull is still strong,” he adds. 

Value for Money

As VIP continues on its growth trajectory by improving profitability, the stock comes at a cheaper valuation of 25x for FY21. The stock is currently valued below its three year (FY17-19) average of 61x.

It’s also a relatively attractive bet even as compared to its listed peer. Current valuation of 25x for FY21E is at a 17% discount in comparison to other branded discretionary players, according to Ambit. For instance, Safari is trading at a PE of 31.2x for FY20. 

Though margins are expected to remain under pressure for one to two quarters, experts don’t see them as a cause for concern in the long-term. Joshi expects revenue to grow at a CAGR of 23.7% over FY18-21E and profit after tax to grow at a CAGR of 25.1% over FY18-21E driven by a shift towards organised market, premiumisation of product portfolio (rising share of Carlton and Caprese) and increasing share of Bangladesh operations which will improve the profitability profile.

Analysts too believe that the scale of opportunity makes VIP well-poised for high growth, adding that valuations are good for someone who wants to build a portfolio for a longer term. “We expect top line to grow upwards of 25-27% in 2019. That trend is going to continue,” says Joshi. Agarwal says, “Even if VIP maintains their current market share, they will continue to grow at 18-20% at least till 2025.” Dama meanwhile believes that things will fall into place by Q2FY20 as the rupee has strengthened and price hikes have been recently taken to counter the increasing import prices.

The luggage industry should continue growing at about 18-20% every year, with backpacks growing at about 25% and handbags growing at about 15-18%, according to the Ambit report. While the fundamentals improve over the next couple of quarters, it provides an opportunity for the long-term investors to bag it.