Heinz deal to weigh on Zydus Wellness' near-term financials, say analysts

Analysts expect equity dilution, lower margins and increased interest costs to restrict earnings

Shares of Zydus Wellness (Zydus) were trading 7-8 per cent higher in Wednesday’s session amid hopes of improvement in earnings from the acquisition of 100 per cent equity stake in Heinz India Pvt Ltd (Heinz) – a subsidiary of the US-based Kraft Heinz. Zydus deals in fast-moving healthcare food products and owns brands such as Sugar Free, Actilife, Everyuth and Nutralite. However, the stock ended 4.3 per cent lower, even as markets were up 0.55 per cent on Wednesday. Analysts said, even as the deal would be earnings accretive in the longer term, it there are near-term costs for Zydus’ shareholders.

 

Though the management expects the deal to provide various synergies which would add to the company’s overall earnings, the first year from the completion of the deal (FY20) would remain earnings-neutral due to the relatively lower profitability of the business being acquired, said analysts. On the basis of the given information, Heinz’s earnings before interest, tax, depreciation and amortisation (EBITDA) margin is about 20 per cent, which lower than around 28 per cent of Zydus (in the last 12 months ending June 2018). The combined margin is thus pegged at around 20-22 per cent. This, in turn, would lower the return on equity (RoE), which is also a key stock valuation parameter.

 

As informed by the management, the Rs 46 billion deal would be financed through a mix of equity and debt. No doubt, Zydus has a healthy balance sheet as of March 2018 with a debt-to-equity ratio of just 0.04 and the current ratio of 7.5:1, to add more. Current ratio indicates short-term liquidity; the higher the better.

 

Zydus’ net worth stood at Rs 6.9 billion as of March 2018. Analysts said, in case of a higher-than-expect debt funding, finance cost could surge for Zydus. The company (Zydus) is also looking at bringing in private equity investors to fund the acquisition. Even otherwise, a 50-50 funding of the acquisition would also mean significant equity dilution. “If Cadila Healthcare plans to maintain their stake in Zydus Wellness at current levels after the deal, the former will need to infuse capital. This could lead to lower RoE,” said Dhaval Dama, analyst at Equirus Securities. For now, the street is awaiting details of the deal funding.  

 

In the long run, the acquisition will open up new growth avenues for Zydus, Dama adds. Given the strong combined distribution network including Heinz’s over 800 distributors and 20,000 wholesales across 29 states, the larger Zydus should be able to expand market reach for the entire product portfolio. Besides, analysts also believe Zydus will look to improve profitability in the business by bringing in efficiencies, including cross-selling of products.