Hanung Toys and Textiles: Buy

Strong revenue and earnings growth, healthy margins and a rising share of domestic market in revenues are positives.

Stuffed toys may seem an unlikely business to invest in, but Hanung Toys and Textiles, which derives 40 per cent of sales from this segment, appears to be a value buy. Home textiles such as pillows, curtains and comforters make up the rest. This blend of toys and home textiles makes Hanung a unique play in the textile sector. Its status as a supplier of toys and home textiles to leading global retailers, strong revenue and earnings growth, healthy margins and an increasing share of domestic markets are the key investment arguments for Hanung Toys. At Rs 149, the stock trades at 3.1 times the trailing 12-month earnings and 2.6 times the estimated earnings for FY-12.

The company does not have a directly comparable listed peer. Investors with a one-to-two year perspective can invest in the stock, but limit portfolio exposure on account of its small cap status.

Export-oriented revenues

Hanung's toys and home textiles are primarily exported, with 74 per cent of revenues (in FY-11) stemming from exports. Consumption in the key market of the US has begun to pick up, with economic recovery setting in. Still, Hanung has broad-based its export basket across regions over the years, with the result that the share of the US markets dropped to 45 per cent from the 56 per cent in FY-08. Other key markets include Europe and Canada. The company has also made inroads in the promising Latin American markets which account for 2 per cent of export revenues.

Hanung further benefits as a good part of its exports supplies to large-scale retailers such as Bloomingdale's, IKEA, JC Penny and WalMart. Such tie-ups allow the company to secure large-sized orders that offer better margins than fragmented small orders or supplies to wholesalers. Another plus is the ability to modify designs or step up production to meet increased requirements according to the retailers' demand.

As retailers looked to consolidate suppliers to reduce costs during the slowdown, Indian textile manufacturers with production capacities and direct relationships managed to weather the export slowdown well. Supplies to established retailers also temper the risk of losing clients. Further, while Hanung does not have long-term contracts in place, it has had a long-standing relationship with these retailers.

Hanung has an annual manufacturing capacity of 30.4 million pieces for toys and 7.68 million sets for home textiles. Plans are on to ramp up capacity as well as move into backward integration to boost margins by setting up spinning plants.

The total planned capex for the next two years for such expansion amounts to Rs 720 crore, funded through internal accruals and bank loans. While debt-equity at end-FY10 is on the high side at 1.4 times, much of the loan is under the Government's Technology Upgradation Fund Scheme resulting in an effective interest rate of 5 per cent.

To help it in its export tie-ups, Hanung recently acquired a controlling stake in a US-based marketing and distribution company in March '11. This move may help it improve operating margins by reducing dependence on third-party middlemen to secure clients.

Improving domestic share

Overseas opportunities aside, domestic markets too hold a lot of potential as the Indian consumer steps up spending, riding on growing income and a bright job market. The share of domestic revenues gradually increased from 20 per cent in FY-08 to 26 per cent in FY-11.

Hanung retails stuffed toys under the names ‘Muskan' and ‘Play-n-Pets', and home textiles under the name ‘Splash'. Products are sold through department store chains such as Lifestyle and Shoppers' Stop, and the company could be an indirect beneficiary of the ramp up these chains are undertaking.

The company currently has a distribution network of over 3000 retail stores and multi-brand outlets across India for toys and 600 retailers for home textiles.

Margin pressure

Revenues clocked a three-year compounded annual growth rate of a healthy 31 per cent to Rs 1,122 crore in FY-11, while net profits grew 26 per cent to Rs 121 crore in the same period. Operating margins have been healthy, at around 20 per cent over the past three years. However, raw material costs such as PSF and cotton have been on the rise; the March '11 quarter saw input costs eating up 72 per cent of sales against 70 per cent in the March '10 quarter.

With prices of cotton and PSF sustaining at high levels, input costs are unlikely to pipe down in the near term. This effect could be tempered to an extent by the company's acquisition of a distribution company in the US, helping it reduce middle-men costs.

Net margins have been at 11 per cent, on account of higher interest costs. With debt taken on to fund further capacity expansion, net margins are unlikely to show significant improvement in the coming quarters. Interest cover, however, stands at an acceptable 3.1 times. The company has also not suffered a lengthening of working capital or inventory cycles over the past three years.

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