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Thursday, 26 April 2018

CORPORATE STRATEGY : Analyzing the takeover of Atlas by Hemas Holdings

Hemas Holdings PLC

Hemas Group is a 63 year of corporate giant founded in 1948 by Sheikh Hasannally Esufally as Hemas (Drugs) Ltd. From this humble beginnings, Hemas has grown into a 37 billion rupee corporate empire with interests in pharmaceutical manufacturing and retail, hospitals, leisure, travel, transport and logistics and has a large FMCG operation. 

According to the CEOs report, 2015/2016 financial year saw a 20% growth in FMCG sales with 12% operating margins. As per Lanka Market Research Bureau (LMRB), growth of personal care market was 7% and home care was 3% during 2015/2016 period. Therefore, Hemas FMCG operation has done better than the market growth. Healthcare, where Hemas has manufacturing, pharmaceutical import and distribution as well as hospital operations has grown by 16%.

2015/2016 Hemas Holdings Annual Report

FMCG and Healthcare sectors contribute to almost 80% of the groups revenue with FMCG having a 36.6 share of the revenue pie. Therefore any disturbance to these two sectors would create serious problems for the overall performance of the group.

This decline in a critical sector has come to pass as explained in the 2017/2018 Q3 review of the CEO. The FMCG sector posted a revenue of Rs.12.4Bn for the first nine months ending December 31, 2017, indicating a growth of 1.0% over the previous financial year. This is quite poor showing considering the stellar performance less than two years ago. Further, the Bangladesh FMCG operation which was reported as doing well during 2015/2016 financial year is reportedly dragging the group performance down.

While FMCG was stumbling, healthcare has contributed well and the CEO reported in the 2017/2018 Q3 review that consolidated healthcare sector revenue stood at Rs.16.6Bn, a YoY increase of 19.4% whilst operating profit and earnings grew at 14.5% and 19.3% during the past nine months ending December 31, 2017. However, there are concerns about the long-term profitability and growth prospects of the pharmaceutical manufacturing and distribution due to high price controls and other mechanisms which reduces the ability of the industry to set prices and compete in the market.

The negative sentiment Hemas group has on the medium term prospects of the FMCG and Healthcare sectors is confirmed by their disclosure that the entire proceeds from the April 2015 Rights issue of Rs. 4.1 billion to be invested in FMCG and Healthcare businesses have now been used with the acquisition of Atlas Axillia.  Hemas invested Rs.5.7 billion on the Atlas Acquisition.

However, Hemas board seems to have faith in the long-term prospects of the healthcare industry. During the first quarter of 2017, Rs. 1.45 billion was invested in the construction of a new Morison PLC pharmaceutical plant.

AtlasAxillia, formerly Ceylon Pencil Company

Atlas Axilla Company (Private) Limited manufactures and distributes stationery products. It offers books, pens, school stationery products and sporting items, color products, tissues, and office stationery products. Atlas Axillia Co. was founded in 1959 as Ceylon Pencil Company by the Madanayake Family.  The company is the market leader in school stationery and notebooks, pens, pencils and colour products, with products retailed in over 70,000 outlets across Sri Lanka.

The portfolio includes 350 products under 25 categories. Atlas Axillia brands include “Atlas”, “Zebra X”, “Homerun” "Nimex Tissue" and “Innov8”.  The Company employs 1,300 people and operates two production facilities in Peliyagoda and Kerawalapitiya.  The brand “Atlas” has been voted Sri Lanka’s most loved brand 2017. Atlas holds a leading position in School and Office with over 40% market share.

Nirmal Madanayake, Managing Director of Atlas Axillia Co. states that Atlas Axillia is growing and the board was keen to take the organisation “to the next level” by allowing themselves to be taken over by a strong corporate entity. “We went through a rigorous process to find the right partner, and we saw a great business and cultural fit with Hemas,” says AtalsAxillia Managing Director, Mr. Madanayake explaining the boards decision to allow Hemas to acquire 75.1% of the company .

Details of the acquisition

On January 19, 2018, Hemas acquired 75.1% of Atlas Axillia Company (Private) Limited, for  Rs.5.7Bn.  With the acquisition of Atlas, Hemas is consolidating its leadership in Sri Lankan consumer brands and plans to use brand building experience of Hemas to this new category. AtlasAxillia has a strong profit and dividend track record. Atlas will be the third largest business in the Hemas Holdings Group and will operate independently as a subsidiary of Hemas Holdings PLC.

Based on the historic performance of Atlas it is anticipated that Atlas will add approximately 15% to the group revenues.

Acquisition of Atlas is expected to introduce increased seasonality to Hemas Group earnings due to the importance of the back to school season in December / January which is the peak season for school supply purchases by Sri Lankan families with school going children.

Rationale for the acquisition

Market Growth and Sustainability of the schools supplies segment in the Sri Lankan context.

1] Sri Lanka as a nation is heavily focused on education and parents willingly sacrifice other expenditure and spend on their children's education. As a result school supplies have brisk sales even when others goods and services experience a downturn.

2] Sri Lankan children of school going age are brand conscious and have a big say in the purchases of school supplies. Parents willingly buy the brand of school supplies their children ask for. Atlas being voted as the most loved brand in Sri Lanka enjoys massive mind-share and top of the mind recall when it comes to school supplies.

3] Growth of international school sector and massive expansion seen in private sector higher education providers will add to further growth of the sector.

4] Atlas is also a leader in office stationary and growth can seen in this segment as well due to the growth of commercial activities in Sri Lanka.

Internal Factors at Hemas including over exposure to FMCG and Pharma/Healthcare and prospect of stagnation.

1] The group is heavily exposed to Phama/Healthcare and FMCG with 80% revenue contribution from the two sectors 2015/2016

2] FMCG is the weakest link at Hemas and it is most susceptible to economic fluctuations and declining fortunes of the consumer disposable income.As Steven Enderby has rightly stated, people buy hair gel, aftershave and colognes after they have purchased other necessities and paid the critical bills. FMCG contributes a whopping 36.6% to the group (2015/2016). As such the group needs to reduce their exposure to FMCG.

3] The need to seek revenue growth and profit growth. With slowing down of FMCG and troubles with pharmaceutical sector, Hemas need a strong contributor to continue its growth trajectory. Atlas is expected to contribute upto 15% to the group revenue.

Strengths of Atlas with excellent brand recognition, high market-share and extensive distribution network.

1] Atlas and Homerun are very strong brands. Enjoys approximately 40% market-share in school supplies segment.

2] Comprehensive product portfolio that covers the school and office supplies sectors. 350 brands in 25 segments.

3] Products retailed in over 70,000 outlets across Sri Lanka with an extensive distribution network

4] A workforce of 1300

5] Cutting edge modern technology and processes used in two manufacturing plants.

6] State of the art distribution center

7] SAP systems and Sales Force Automation, the company is able to make its products available across diverse channels in the trade. A specialized Institutional team also enables a B2B service model.

Considering the fact that Hemas need reduce their exposure to FMCG and Heath-care/Pharma industries with the prospect of declining or stagnant growth in those two sectors in the medium term, it is logical that Hemas need an acquisition that gives it the revenue, market-share and a product/brand portfolio in an industry which has been having consistent growth. In this context, AtlasAxillia is a perfect fit as in brings practically all the things Hemas could wish for in a neat package and also in an industry that is similar to FMCG markets it is familiar with

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