The Relaxo Cinderella Project

I am experimenting with a new teaching style this year. Every year students work on projects in groups and it turns out no one cares about what happens in other groups. There is no collaboration.

This time, I am asking each group to work on each project. Each project is broken into “chunks.” The deliverables on each chunk will be collated and then the learnings from the project will (hopefully) emerge.

If you want to take a shot at it, here is the link.

There is one problem, however. There are so many experienced value investors who subscribe to this blog, that if they provide all the answers, it will defeat the purpose of teaching in this manner to my students at MDI. So, I will wait for a while before I approve any comment to enable the class to do some original work. Your patience will be appreciated. Thanks!


28 thoughts on “The Relaxo Cinderella Project”

  1. I am always thinking of investment ideas when i’m out. Recently my thoughts veered towards the footwear people were wearing and i thought of Relaxo for some reason. Maybe it was because i had seen the Salman Khan ad recently or i saw someone wearing relaxo i cant recall right now. But i came back and looked at the stock, and i saw it had already done up quite a bit. I figured a lot of others had already “discovered” this stock with not much potential left. I forgot about it until i saw this post. Maybe its time i looked at it again.

    1. Do you think Relaxo will be able to make the transition from a “cheap” to premium brand ?

      Will be interesting to see your thoughts on the low dividend payout of the company, sticks out like a sore thumb.

      1. Kashif, I don’t know the answer to your first question but they are surely trying and so far they have succeeded in moving up the value chain.

        As for low dividend payout, I am not bothered about that at all. Why should I when the company earns 35% return on equity and has opportunity to re-invest earnings retained at high incremental ROE? Indeed, I wish the company skipped dividend altogether and redeployed the money in the business or debt reduction. Indeed, one thing I don’t like about Relaxo is the presence of debt. Even though its small in relation to size of the business and its earning power, it’s there and I wish it wasn’t and one way to cut debt is to cut dividend.

        Sure, there are other very good reasons to continue dividend (the need to be consistent with past practice, the need for income for some investors etc) but I feel they are less important than having a pristine quality balance sheet.

        1. Sir – the high ROE is also partly because of high leverage. High leverage has perked up the returns by around 2 times and as such is necessary for maintaining the high returns. The only other way of increasing returns would be to either increase the margins or the asset turnover. In the future as the company increases in size, its margins and asset turnover should keep climbing because of economies of scale as mentioned by you. But right now the debt is necessary dont you think?

          On a side note, have you looked at companies in the consumer durable (electricals) business such as Bajaj Electricals, Crompton Greaves etc. I’m talking of only about the consumer business of these companies. The businesses have asset turnovers in the range of 20s and returns as high as 100% or even higher. These are essentially cash cows with very little capex requirements as compared to the cash flows. They are growing at rates similar to Relaxo but requiring much lower capital. They too have economies of scale as seen from their increasing margins over the years. And they have brands established over decades.

          BUT (there always is) , they are taking cash flows from this great business and investing in other businesses (capital goods in case of CG and Projects and Engineering in case of Bajaj Electricals). These other businesses are obviously going through a lean patch and are currently quoting at ridiculously low prices IMO. What is your view on these businesses ?

    2. Hello Professor,

      First Congratulations on coming up with such a novel idea. It sure is a brilliant way of crowdsourcing.

      However, some key ideas playing in my mind for some time:
      1. Dexter Shoes problem and Munger
      2. The Ephemeral nature of fashion in footwear: Hush Puppies [Malcolm Gladwell in Tipping Point]
      3. Crocs
      4. Unorganised sector competing with Relaxo.
      5. Organised sector pushing it from above
      6. International brands, if it wishes to upgrade.

      Might be I am missing something


  2. 1. Roughly Rs.5 of market cap created for every Rs.1 retained is very impressive. Its still cheap when compared to projected market growth rate ,

    2. Pre-Tax ROE from 13% in 2003 to around 31% in 2013 seems very impressive. However a caveat , the auditor’s of the firm Gupta & Dua seem to be a related party. I am not saying their earnings are manipulated, but its just one aspect i would like to look at as the earnings are only as good as the validity of the reports.

    3. That said in terms of a moat, branding and distribution network in India, but barriers of entry is on the lower side, need more reading time to ascertain if market size is more than enough for all players or there is something special that keeps competitors at bay.

    4. Management seems to be be very good at capital allocation and working capital management, they also seem to pay themselves very reasonably. I saw during a year of dipping profit around 2005, 2006 they didn’t pay themselves a commission/bonus

    5. Given projected volume growth of 15% for the next 3 years, 17 pe still seems cheap, but much of the fast growth seems behind it. Volume drivers are

    a. increasing population,
    b. increasing number of pairs per person
    c. Shoes have wear and tear, there has to be a replacement rate for shoes/chappals
    d. South India still seems a market they haven’t made inroads into yet,I like their choice of africa as its probably a cost conscious market like india, europe not so sure
    e. Cost of raw materials like rubber might come down over the years compared to price per pair, that could be a potential driver of margins

  3. I did a small exercise, while on my way to C.P from Rajouri Garden in Delhi metro, I started checking the footwear everybody was sporting. Almost 60-70% of the people I observed had ‘Sparx’. only a handful were wearing Nike, Reebok and beyond while the remaining were the unorganized sector.

    Now I know it is stupid (anchor, recency and availability bias) to draw an inference from such a small sample which must have been skewed demographically. Also on my way back from a vipasana meditation retreat from sohna to delhi, I noticed these big hoardings of salman khan sporting relaxo all over the place. These small villages, and towns seem to be a big draw and it seems Relaxo is a preferred brand for middle and lower middle class set.

  4. a) On 17th Sep 2003, the stock was quoting at Rs.35/-. On 17th Sep 2013, the stock is quoting at Rs.730/-. That makes it a 21 bagger in 10 years (a 35% CAGR over 10 years).
    On 17th Sep 2008, the stock was quoting at Rs.42/-. That makes it a 17 bagger in 5 years (a 84% CAGR). (or more broadly, the stock hardly did anything from 2003-2008)
    Compared to Sensex – Sensex has been a 5-bagger over the last 10 years (16% CAGR), and hasn’t gone anywhere over the past 5 years (6% CAGR).

    Essentially, it beat the pants down of Sensex, albeit the highest increase came through in the last 5 years.

    b) On the Earnings retention test, over the last 10 years, every rupee retained has turned into Rs.4 of market cap. Over the last 5 years, every rupee retained has turned into Rs. 5 of market cap.

    Essentially, management has been a very good capital allocator.

    c) The average return on capital employed over the past 10 years is around 13% and the average over the last 5 years is around 17%. [The average RoE though is 18% and 24% over 10 and 5 years, indicating debt has juiced up returns]
    The AAA bond yield currently is 8.3%. At a very basic level, I would be 100% guaranteed of my capital and 8.3% return on capital if I invested with a AAA bond. That’s say 1 time book. Since Relaxo pays up about 17%, the stock should quote at roughly 2 times book (ignoring all intangibles for now, and assuming book is real, unlike PSUs)

    d) The true economic earnings are higher since they have been ploughing a lot of money into creating brands (sparx and flite), which once created will lead to sustainable pricing and selling power. (look-through earnings from Buffett)

    e) Have markets made it a 20 bagger over the past 10 years just because it’s average RoCE is approx 5% more than AAA bond yield? I don’t think the difference warrants such a re-rating. Although I am jumping ahead with my answers, I think the reason markets re-rated the stock was due to perceived margin improvement due to new higher-priced products (sparx and flite). As we run the numbers, we realize that the EBITDA margins have moved from 6% in 2004 to a peak of 17% in 2010 and returning to 11-12% levels in the past couple of years. The market loves ‘moving-up-the-value-chain’ companies, because it is percieved to bring in higher profits (whether they materialize or not is a different question). In Relaxo’s case, that has been true – profits moved up just 2 times between 2003-08, but moved up 4 times between 2008-13, because of ‘moving-up-the-value-chain’ stuff.

    f) Revenue 10yr CAGR is 50%, 5 yr CAGR is 107%. PAT CAGR is 26% for 10yrs and 33% for 5 yrs. Till 2006-07, the entire revenue and profits came through volume growth of hawaii slippers. Post that, it has been a combination of product mix changes and pricing power due to product mix changes (and hence the disproportionate increase in profits)

    g) The possible sources of volume growth are – a) increase in geographical presence due to distributors (46000 as of last AR) b) setting up and increasing the number of Relaxo-branded stores (156 as of last AR). Of course, they were dominant in North and North east. Now, they are moving to West and East of India.
    Isn’t the expansion very similar to automobile industry – setting up branded stores and distributor-led stores? All I can think of is all kinds of retail only stores.

    h) The company, very significantly hasn’t diluted its equity even once since its IPO in 1994. Holds very good signs for the equity investor. However, their debt levels have increased of late, but as a percentage of equity (equity+retained earnings), it is below 1 and hence manageable. Reducing debt might make earnings more attractive going forward.

    i) The net margin has increased from 1.8% in 2005 to a peak of 7% in 2010, before tumbling down to 5% over the past 2 years. The asset turns have meanwhile remained steady over the past 10 years, at an average of 2.5. Not sure if we can derive how a competitor can steal a business from these guys. They are already operating at razor thin margins (subject to a lot of raw material volatility – in fact, earnings have a very high correlation to rubber and EVA) and primarily driven by volume. Other than the brand recognition and recall, there is literally nothing stopping any competitor with enough money to flood the market with hawaii slippers.

    j) From what I can analyze, if Relaxo wants to grow big, the profits over the next couple of years would be very critical to track. The last 2 years have been very mild (and current valuations in my opinion too optimistic) and if they want to expand at the same rate, by investing significantly in branding and retail stores, we should be looking at increase of debt/dilution of equity in the next year or two. If rubber/eva prices increase, then I would increase the probability of a significant increase of debt very soon (although, given the state of the auto sector, not too sure if rubber prices will increase anytime soon)

    h) Not too sure why this company is not paying down debt, instead of paying dividends. The dividend payout ratio has been 18% over the past 5 years. But then again, in India, dividend payout is more than a signaling phenomena – the market in India will believe a company’s earnings only when it pays dividends. So, maybe, a 18% avg. dividend payout is not bad, considering the debt is still conservative compared to equity

    i) The comparison with Bata is unfair, as Bata is miles ahead of Relaxo. Anyway, from an aspirational basis, Relaxo can hope to be a Bata one day. The reasons Bata is far and away from Relaxo are 1) RoE and RoCE of Bata is much higher than Relaxo 2) Bata is a debt free company 3) Bata’s management bandwidth in successfully scaling to 1500 stores (branded stores, apart from some distributors) is proven beyond doubt, while Relaxo’s major revenues (>80%) still come through distributors and they have only 150 odd stores. 4) Bata enjoys a higher pricing power than Relaxo simply because Bata has a wide range of brands along with volume. Relaxo right now is still in the volume game and trying to move up the ladder through sparx and flite. (Given all these advantages, compare Bata’s mkt cap to Relaxo’s and we’d get an idea of why Relaxo might just be overpriced at these levels)

    j) I think Relaxo, if it keeps its head to the ground and doesn’t increase debt dramatically for rapid expansion has a long way to go. There are multiple triggers available – 1) India – demographics – large population – willing to buy – chappals are essential, enough said 2) Product expansion both within the category (hawaii, flite, sparx, abc, def etc.) and across categories (shoes, handbangs etc.). However, we need to be cautious since RM volatility still hits them badly (esp. due to hawaii slippers accounting for 70% of volume growth) and they need to move quickly onto the brand bandwagon (which they are doing, by doing star-endorsements) if they have to sustain above-normal profits. As I said earlier, the scale of opportunity is massive. Execution will go a long way in this being a multi-bagger. But till I see a decisive shift in sparx and flite numbers (or any other value-added product numbers), at these valuations, I wouldn’t enter the stock.

    (I know this was only about the quality of the business, but old habits die hard. Valuation for me is like a parallel thought process along with evaluating a busiess). Management quality – well, except for the Bata run-in on Sparx, I couldn’t find much (and I will not pre-empt any answers, since I am guessing that would be your next activity for your students).

    Thanks for all the learning Sir. Looking forward to your answers and any corrections that you’d like to make in my thought process on the analysis.

  5. Hi Sir,

    Tried to analyze the business:

    Wealth Creation – Earning Retention Test
    Over 10 years Relaxo’s MCap rose from INR 43 to 874 CR and ER was 179 CR, implying Delta MC/ER – 4.64 times.
    If we consider all Earnings Retained as cash outflow (corresponding to year of earning) and Delta M.cap over ten years as cash inflow (as of today), the IRR is 75% (different way of looking at the same thing as we understand IRRs better than a multiple, if considered, per se)
    Good business
    The last six years avg pre-tax ROE has been 38.6%! Partly driven by profit margins and partly leverage driven

    Economic earnings – 2013: PAT:44.8 CR + (Depr –Repairs): 14.8 + Advertisement and Publicity: 55 = 114.6 CR!!! Compared to a MCap of 871 CR!
    High pre-tax ROEs are more than proportionately rewarded by the market (to capture future growth potential as brand value rises) as evident in Delta MC/ER – 4.64 times

    Past Growth and Business Volume Analysis
    In the last 5 years total pairs sold grew by 57% whilst price per pair charged grew by ~70%. This was primarily driven by higher end Sparx and Flite brand being added to the product line. Sparx has increased its contribution to volume from a mere 4.2% in FY2008 to 26% in FY2012; on the other hand, Flite has maintained its contribution at ~25-30%. Hawaii, remaining ~ 45 – 50% of volume

    Growth drivers: Price increase per pair, new products launches, Volume growth supported through strengthening brand and wider reach and Export to some extent
    Cap Structure: No equity dilution and falling Debt/NW ratio from 66.5% in 2009 to 51.2% in 2013 as strong ROE (due to leverage, asset turnover and margins support) added to NW growth

    Profit after tax per pair of footwear – Rising from INR 2.3 per pair in 2004 to INR 4.47 per pair in 2013
    Interestingly Advertisement spend per pair was INR 5.5 in 2013 (INR 3.2 in 2012). So the company is making what the Ad ambassadors and other publicity sources are making. However it is at a brand building stage and Ad spend per pair should come down in the next 5 years
    (Ignoring economic earning)

    Margins : Low margins (5 yr avg net margin at 4.71%) but improving with the addition of Flite and Sparx and lower rubber prices. Margins are also lower due to high Ad spend and depreciation. Keeping high volume i.e. higher capital turnover is essential for maintaining ROE (5 yr avg ROE is 26.66%). Lower Margins makes it vulnerable to fluctuating rubber prices/forex.
    Capital turnover: Asset turnover is 1.78 in 2013, down from 1.97 in 2009 as inventory levels are rising. Interestingly total revenue/net asset multiple is falling (3.4x in 2008, down to 2.93x in 2013) so it is mostly Current assets/inventory which is lowering the turnover ratio.

    Economies of Scale
    Branding:10 CR pairs sold in 2013 gives Relaxo muscle to support INR 55 CR in advertisements/publicity.
    Debtors: Branding results in product pull from dealer which has reduced Days of sales o/s from 19.7 in 2008 to 11.8 in 2013.
    Inventory: Also volume and high profitability allows it to support high level of inventory for distribution at Pan India level
    Other generic economies of scale also possible.
    All this creates a good positive feedback loop for fuelling further growth!
    All the above advantages will not be available to a new entrant which if a new entrant tries to match will result in a lot of capital upfront with no visibility of profit thereby amplifying risk!
    These economies are never build intentionally but rather evolves gradually to/with the right player in any industry! (As Taleb said: benefits of decentralization and gradual evolution-correcting things at every stage of growth, nip in the bud)

    Why Accept: Social proof, visibility, anchoring effect, associating with the brand ambassador, brand endorsement by top actors/actress, value for money, easier choice for customers as brand/visibility helps differentiate for a new customer with other wise limited info to rely on
    Why Reject: Not very stylish (my opinion), want to buy Nike/Adidas/international brands, want to pay more and miss associating lower price with lower quality
    Valuing brand: I don’t know but following factors need to be considered to arrive at value!
    Brand benefits:
    1.Increase sales (wider reach, penetration)
    2.Ability to charge premium for higher value brands
    3.Export potential
    a.The above three factors further assist in launching new products and diversification and ability to invest in innovations
    4.Preferred debtor terms
    5.Assist in attracting and retaining and rewarding talent
    6.Invest in better technology/innovation
    7.Other economies of scale possible only because strong brand assists in building volume
    Finally the above factors can create a positive feedback loop which if supported by surge in share price can in itself fuel further growth and visibility creating a viscous cycle (Soros logic)
    Brand cost:
    1.Annual advertisement and publicity spend
    2.Higher levels of inventory/transportation/distribution cost and other corporate overheads

    Future growth potential and sustainability and capital structure impact
    Growth drivers: Pan India retail stores (but can cannibalize current sales through mutli-brand stores)
    Capture market share form un-organized players and possibly organized players
    Launching new products
    Online retail
    Hawaii – Volume play with limited room to increase price if the intent is to capture un-organized players’ market share
    Other high value brands – Potential to increase price along with volume increase
    Due to multiple avenues to tap growth coupled with limited competition – sustainable growth can be expected by capturing existing market share as well as by tapping into newer markets as well as creating markets/need!!!
    Interesting thing to note: In the last four years sales promotion/incentives spend has gone down and advertisement/publicity spend has gone up which clearly means the strengthening of brand driven by high advertisement spend and that has made it easier to sell products with lower sales promotion/incentive-this confirms future growth potential fuelled by strong brand!
    Growth in the last 5 years has been sustainable as due to high ROE the debt to NW ratio (66.5% in 2009 came down to 51.2% in 2013) has actually improved despite rising absolute debt levels. Interest coverage are also not excessive. So similar growth as witnessed in the past can be sustained with no equity dilution and keeping financing at a pace similar to what is witnessed in the past will actually result in further lower debt to NW ratio.
    Growth potential is immense. Please see this video:Havaianas: The World’s Flip-Flop
    Havaianas – Annual turnover is USD 220 mn and average pair cost 15 USD. And Relaxo sell at an average realization of less than 2 USD

    Bata in comparison with Relaxo
    2013: Bata spent a third on Advertisement, lot higher sales commission, sold 50% less footwear pairs and still earned almost twice the revenue and almost 50% more EBITDA margin!
    Thus Bata is an established brand which targets high end customers and makes healthier margins for every pair sold.
    Both Relaxo/Bata strategy has pros and cons. But at this stage of India’s growth – Relaxo (brand building stage, high volume, low margin, tap untapped markets, tech/innovation focus) has higher chances of growth comparatively as the target market is much wider and remains unaddressed and this makes its strategy defensive as well

    How long will the business of making and selling branded footwear last? – Branded footwear has existed for decades and it should continue to (Taleb said: Things which have existed for 20 years (say for instance) should have high probability of existence for the next 20 years (say for instance))



  6. Dear Sanajy Sir,
    I have great repsect for u and learning from u.
    Just thought of sharing two comments:

    1) Exersize is: “X is Best Company AND now tell me why it is best company”.
    Now since analyasis is subjective matter, its easy to tell show why X is bad company if u asked so.

    As wise man has said, we should also have bad people as Role model to learn what not to do.

    Benjamin Graham- “the combination of precise formulas with highly imprecise assumptions can be used to establish, or rather justify, practically any value
    one wishes, however high, for a really outstanding issue”

    Actually Q. should be “This is company Y which I don’t know if bad or good; Calculate/find these things and tell me if its good/bad company(OR how its balance sheet would look like after 4 years.)

    2)You should have provided Relaxo-like Excel sheet for Bata also, so that we would have come to know that how Relaxo was performing relative to footwear leader Bata


    1. Sameer, Relaxo is not the best company out there. It’s just one business which I think is having some high-quality attributes, which can be useful for students to learn from. I hope you’ll appreciate that. Thanks.

  7. Nice analysis. Can you also tell on how to arrive at the efficiency on retainers earnings on 5 years basis

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