CFA SOCIETY OF BRAZIL Student Researchrecommendation on HYPE3. From a three-stage DCF analysis, the...

CFA SOCIETY OF BRAZIL

Student Research

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CVM nº 388 de 30 de abril de 2003.

Consumer Goods

52 Week Price Range BRL 37.5 - 9.7

Average Daily Volume 0.28M

Beta 0.5898

Average Daily Volume (3 months) -

Shares Outstanding 223.1M

Market Capitalization 7,585.4M

Book Value per Share BRL 9.59

Debt to Total Capital 35.50%

Return on Equity -1.04%

S o urce: Gro up's Es tim ates , Capital IQ

Market Profile

Ticker: HYPE3 Recommendation: Buy

Price (10/23/2009): BRL 34.00 Price Target: BRL 41.46

Mar. Jun. Sept. Dec. Year P/E Ratio

2008 -0.03 0.17 -0.57 -0.59 -1.05 N/A

2009E 0.38 0.67 -0.56 -0.5 -0.12 N/A

2010E 0.43 0.75 -0.54 -0.69 -0.04 N/A

2011E 0.62 1.07 -0.38 -0.99 0.31 151.99

Earnings per Share (BRL)

Source: Economática, group’s estimates

Highlights

Valuation: We are beginning our analysis of Hypermarcas (HYPE3) with a buy

recommendation and a YE10 fair value of BRL 41.46 per share. This target price was

reached with a three-stage DCF model, considering higher growth opportunities for

YE10-11. Sensitivity analysis showed upside of 7.98 % even for the worst-case scenario.

HYPE3 is trading at 21.6x TEV/EBITDA, while the industry trades at 10.0x.

Consumer goods industry: The industry is very competitive and demand is barely

affected by the recession. After the financial crisis, it was one of the first Brazilian

industries to come out of recession; it has accelerated GDP expansion and helped Brazil

recover from the crisis on 2Q09. In the past years, the industry has excelled at innovation

and nowadays sees little return on P&D.

The Company: Hypermarcas is a Brazilian conglomerate that develops, produces

and markets consumer staple products. HYPE operates in four business lines: foods,

beauty and personal care, OTC pharmaceuticals, and home care. Its‟ strategy is to acquire

„partially forgotten‟ brands and extend them. Controlling over 160 brands, its prices are

generally 15% lower than competitor‟s. Underpenetrated markets, well established brands

and exposure to growing income classes B, C and D bestow opportunities for high

growth.

Investment Risks: Having substantial goodwill and intangibles accounts, the risk of

impairment cannot be ruled out. The currency exposure and the difficulty to forecast

partial hedges amplify operational risks for the following years. The forecasted

concentration of revenues from OTC and personal care sectors will slightly reduce the

company‟s risk diversification. Finally, strategic movement from multinationals shifting

investment to markets where consumption was quickly restored after the crisis (Brazilian

market) may rough competition.

Hypermarcas S.A.

Luciana Vilar

Marina Trindade

Rodrigo Munhoz

10/26/2009

Source: Capital IQ

CFA Society of Brazil October 26th, 2009

INVESTMENT RESEARCH CHALLENGE STUDENT RESEARCH 2

Investment Summary

We begin our coverage of Hypermarcas, the largest Brazilian maker of toiletries and over-

the-counter medicines that is also in foods and house care markets, placing a buy

recommendation on HYPE3. From a three-stage DCF analysis, the target price in YE10 is

BRL 41.46, a potential upside of 21.94%.

HYPE‟s growth strategy is based on M&A and organic growth. Its modus operandi is to

buy undervalued, forgotten brands and expand their potential. Synergy from acquisitions

(same logistics and distribution channels, cost dilution by using the same administrative

center) grants the lowest SG&A costs in the industry. HYPE is one out of the 3 Brazilian

companies to own their own in-house marketing agency. This competitive advantage

reduces costs by 40% and, along with lean structure and non-bureaucratic decision

process, guarantees the largest margin in the industry. Furthermore, the goodwill paid on

the acquisitions exempts HYPE from income tax payments during 6 years. On the other

hand, goodwill has an intrinsic risk to it that, if concretized, means loss by impairment.

Although the consumer goods industry was not very affected by the crisis, HYPE‟s focus

on lower price products paid off when consumers shifted their preferences to same quality

but lower-priced goods due to a purchasing power reduction. For the past four years,

Brazilian middle-class (HYPE‟s target) has been growing as a consequence of income

concentration reduction policies. On the first semester of 2009, restoring from the crisis,

consumption of non-durables rose. As Brazil emerged from the crisis earlier than many

other countries, there‟s the risk of multinationals (such as Procter&Gamble and Unilever,

HYPE‟s competitors) shifting their investments to the country, which could reduce

HYPE‟s profit margin and market share.

Underpenetrated markets in personal care and food markets, established brands (some are

leaders or vice-leaders in their segments), idle capacity of 60%, growing income classes

B, C and D and the announced strategy to keep up the M&A until 2010, on the amount of

BRL 2bn bestow opportunities for high growth. Because HYPE is a relatively new

company that lives on M&A, its financial demonstrations are unstable. As it matures, it

will solidify its growth (under historical growth) and consolidate itself in the Brazilian

market. When M&A opportunities become less profitable, its growth will become mainly

organic.

Figure 1: Annotated Stock Chart Stock chart with relevant factors to Hypermarcas

Source: Economática, Company

Phase III (up to 3 years)

Increase market share and

marketing efforts; new product

and brand revitalization

Phase II (3-6 months)

Plant restructuring, synergy

from raw material, packaging

and logistics

Phase I (3 months)

Quick gains through:

S&A Reduction and

changes in manufacturing

process

Synergy from Acquisitions

Source: Company








and logistics

Phase I (3 months)


S&A Reduction and


process









and logistics

Phase I (3 months)


S&A Reduction and


process








and logistics

Phase I (3 months)


S&A Reduction and


process


Source: Company



Hydrogen Pompom Olla+Jontex

Price paid 25 300 364

Goodwill 0 270 349

Net Revenues 19 185 90

Gros Profit 13 65 62

Incremental EBITDA 9 40 52

Price/EBITDA 2.78x 5.21x 7x

S o urce: Co m pany

Numbers of Latest Acquisitions (in BRL M)

Valuation

Why we chose DCF Model

We chose three-stage DCF model to estimate the company‟s intrinsic value because we

believe it to be the most adequate valuation model for companies in a rapid expansion

phase. This kind of company has strong sales growth in its initial phase, pass through a

transition period and then reach maturity. Furthermore, the absence of historical data and

negative earnings do not affect DCF model, since it depends only on future performances.

We acknowledge that incorporating M&A in a valuation model can be tricky since there‟s

a lot of uncertainty involved. Nonetheless, ignoring the benefits of acquisitions will result

in an under valuation for a firm like HYPE, that has established a reputation for

generating value from acquisitions. In a conservative way, we decided to compute higher

growth until 2011 because the company has announced its intention to make M&A until

2010 on the amount of BRL 1.5-2bn; while BRL 700M has already been done in 3Q09.

Why we did not use other valuation models

We did not use other valuation models because HYPE’s supernormal growth renders

short-hand valuation approaches, like price-to-earnings and revenue multiples,

meaningless, as they cannot account for the company’s uniqueness. Moreover, the

absence of meaningful historical data and positive earnings to serve as the basis for this

approach also makes it difficult to use other kinds of valuation models within HYPE.

Recommendation

We reached a fair price of BRL 41.46 to HYPE‟s stock in YE10, yielding a growth of

21.94% relative to current price of BRL 34.00 with a buy recommendation.

HYPE‟s expected growth was estimated based on three factors:

Population growth in B, C and D income classes and their shift within classes;

Expected growth of the industries in which HYPE operates, weighted by revenues and

market share growth. This allows us to capture in a better way the elements that affect

the company‟s results;

For 2010 and 2011 we considered a higher growth, as these years will reflect recent

and short-term planned M&A. As we believe that the expansion possibilities through

M&A of forgotten brands tend to decrease after 2011, we forecast the growth to be

mainly organic from this year onwards, resulting in growth rates below the historical

growth.

Figure 2: Growth Projection

Source: BCB, IMF, Group’s estimates

Our forecast is based on a Debt/Capital structure of 35.5%. The cost of long-term debt

varies according to SELIC and exchange rate variation. Based on the fact that HYPE

today uses only 40% of its plant and property capacity, and on our sales forecast, the

installed assets are increased BRL 250M in order to support the expanding production as

of 2013.



The discount rate for stockholders was determined from the perspective of a diversified

global investor using the CAPM model. We used USA variables as a benchmark, and

found its equivalent values in the Brazilian market considering exchange, interest and

inflation rates in both countries.

We used US-Treasury Bond 10 years‟ current value, 3.47% per year, as the risk-free rate.

We believe that this rate will maintain a low standard until U.S. economy recovers from

the crisis. For 2011, we upgraded the rate value to 4.30% per year, a similar level to the

one seen after the .com crisis recovery.

The market risk premium for 2009 and 2010 we used was 6%. From 2011 onwards we

forecast a declination to 4.79%; this represents the geometric mean return of a diversified

portfolio in US dollars (observed between 1928 and 2007) minus the T-Bond rate values

in the same period.

Brazil‟s risk was assessed by the current difference between C-Bonds and T-Bonds,

adjusted by both countries‟ inflation rates. Thus, we estimate a Brazilian risk of 3.38%.

We did not add in our main model specific additional risk to HYPE, as we believe a

diversified investor will diversify systematic risk. Perpetuity estimated growth is 4%,

based on Brazilian GDP growth expectation.

The beta calculation considered the betas of each industry where HYPE is present. Foods

(βf=0.45), Pharmaceuticals (βp=0.60), Personal Care (βpc=0.64) and Household (βh=0.44)

markets. The data was benchmarked from emerging markets‟ industries‟ unleveraged

betas. They were then weighted by their participation on the company‟s revenues. The

resulting beta was levered according to the capital structure (βL=0.59).

For the years after 2012, because we forecast that HYPE will grow in pharmaceuticals and

personal care products, we put a greater weight on those sectors‟ betas to form the new

global beta (βL2 =0.60).

Based on this analysis, the company‟s fair value is BRL 9,248.65M. Hence, as its current

market value is BRL 7,925.43M, we forecast that the stocks have a bullish tendency.

Sensitivity Analysis

Due to market uncertainty, a sensitivity analysis was made to verify the impact of changes

in the key variables of our model. Thus, we created different scenarios with variations on

WACC and growth rate in perpetuity, for 53.95% of company value projected is

ascribable to the stable growth period.

In a primary analysis we found results that we judged unrealistic, given our micro and

macro expectations. For this reason we emphasized the variations with greater probability

of happening (light blue shaded area; GDP growth between 3-5%).

Based on the current capital structure (D/E=6.03%), we have altered the D/E ratio in order

to see the changes in the WACC. Because the cost of capital (Ke) and the cost of debt (Ki)

are so close, changing the capital structure didn't change much the WACC.

Figure 3: WACC variation due to D/E changes Figure 3: WACC Variation due to D/E Changes

D/E Ki Levered Beta Ke in Brazil WACC

61.00% 13.80% 0.796 13.80% 13.81%

28.21% 13.80% 0.673 13.20% 13.34%

13.77% 13.80% 0.619 12.90% 13.05%

6.03% 13.80% 0.59 12.72% 12.79%

Source: Group's Estimates

Source: Group’s estimates

Major changes on WACC happen either when economic scenario or unsystematic risk

change abruptly: that would impact new acquisitions costs. Considering this, we used 0.25

percentage point variation around the current WACC to simulate small adjustments on the

capital structure and 0.5 percentage point variations to simulate more striking changes.

Nevertheless, we believe that WACC‟s future value will be between 12.55 and 13.3%, for

a level lower than 12.55% is inconceivable in the current capital structure.




Figure 4: Risk variation on WACC

Price in BRL

11.80% 12.30% 12.55% 12.80% 13.05% 13.30% 13.80%

0% 37.257 35.409 34.544 33.714 32.918 32.153 30.713

1% 39.079 37.02 36.06 35.143 34.266 33.426 31.85

2% 41.273 38.943 37.864 36.837 35.858 34.924 33.179

3% 43.966 41.28 40.046 38.876 37.767 36.712 34.755

4% 47.348 44.18 42.738 41.397 40.097 38.886 36.652

5% 51.726 47.875 46.143 44.524 43.007 41.583 38.98

6% 57.613 52.743 50.588 48.594 46.742 45.018 41.906

Perp

etu

ity

Gro

wth

WACC


Consequently, we reinforce a buy recommendation, once the worst-case scenario inside

the framework of possibilities grants an upside of 7.98 %.

Value creation through M&A

Despite the fact that growth rate and WACC are extremely important to identify the fair

value, the lack of a detailed study about the future acquisitions possibilities would render

the analysis incomplete, because it has great importance in HYPE future growth.

We drafted three possible future scenarios, HYPE: 1) Stops M&A and grows organically,

2) Continues with aggressive acquisitions in the early years, decreasing slowly over time

due to less desirable opportunities, 3) Maintains the acquisitions until 2011 and, after that,

has mainly organic growth. These simulations take into consideration the investment on

PP necessary to bear the predicted growth in sales.

Figure 5: Growth Scenarios Figure 6: Sensitivity Analysis

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Price

Without M&A 78.00% 28.00% 20.00% 21.00% 22.00% 22.00% 21.00% 17.00% 15.00% 8.00% 35.553

With M&A until 2016 78.00% 40.00% 24.00% 26.00% 25.00% 28.00% 23.00% 19.00% 16.00% 10.00% 47.4

More M&A 2010 / 2011 78.00% 40.00% 24.00% 22.00% 23.00% 22.00% 21.00% 17.00% 15.00% 8.00% 41.455

S o urce: Gro up's Es tim ates

Ex

pec

ted

Gro

wth


Once again we can reinforce a buy recommendation, as the worst-case scenario, not

considering further M&A, shows an upside of 4.57%.

The results near minimum and maximum values of both analyses reinforce that the stock‟s

fair value is between BRL 35.55 and 47.40. Because of our assumptions and

macroeconomic forecast, we believe that the third scenario is the most likely to happen,

thus we defined the stock value BRL 41.46.

Business Description

HYPE is one of the major companies in Brazil‟s consumer goods industry and the most

brand-diversified portfolio, including leader and vice-leader brands. HYPE is present in

the following industries:

Pharmaceuticals: the company has a line of over-the-counter drugs (OTC), which

provide a gross margin of 70-80%. HYPE doesn‟t develop patents; it only

commercializes nonprescription medications with great sales volume. Engov,

Merthiolate, Rinosoro, Tamarine®, Benegrip, Doril, Estomazil and Gelol to name

some principal brands in this segment, which responds for 35% of total evenue;

Personal Care: Monange, Paixão, Bozzano, Risqué and Cenoura & Bronze are the

main brands here. The gross margin is around 50-60% and 35% of HYPE‟s revenues

come from this segment. Hydrogen, Pom Pom, Olla, Jontex, are the recent

acquisitions in 20091, emphasizing the company‟s entry into child and youth markets

and the national condom market;

Food products: HYPE has a gross margin of 35-45% in food products, small margin

when compared to the others. Finn® and Zero-Cal are the main brands in this

segment, which represent 14% of global revenue;

1 Acquisition process not completed up until the closing of this report.



Household and Cleaning Products: Hypermarcas has a gross margin of 35-45%, and

it responds for 16% of total revenues and Assolan is the main brand.

Hypermarcas began its operations in 2001 with household and cleaning products by

acquiring Assolan. The acquisition process in other sectors began in 2006. It has made 26

acquisitions up until today.

The company relies on four distribution centers and six production unities situated in the

states of São Paulo, Goiás and Santa Catarina. The main distribution center is in Cajamar,

SP. Its plants present a lean structure and a capacity to grow in the next years (60% idle).

Growth Strategy

HYPE‟s growth strategy is based on M&A and organic growth. With respect to

acquisitions, the company buys forgotten, undervalued brands to expand its potential,

either extending or creating new product lines. These brands are chosen from companies

with financial or heritage problems, or from multinational companies that are closing their

operations or a specific line in Brazil.

With respect to organic growth, HYPE intends to expand its control of Brazilian market

by expanding product lines and stimulating its low-cost products‟ sale through the

upgrade of distribution channels.

Synergy guarantees lowest SG&A and major gross margin in the industry

HYPE is 3rd place in the consumer goods industry rank and its major competitors are

Unilever and Procter & Gamble. No Brazilian companies are direct competitors, except

for those which operate only in a specific business sector where HYPE operates.

The company achieved synergy gains in distribution channels and cost dilution by using

the same administrative center, which makes it the lowest G&A cost of the industry.

These competitive advantages, added to the attention on high margin businesses and

efficient supply chain management help HYPE achieve the highest margin in the industry.

We do acknowledge that HYPE‟s biggest competitors are not directly comparable, for

they don‟t have the exact same products (or are in the same segments), nor do they follow

the same accounting principles.

In-house Marketing

Another competitive advantage is that HYPE has its own in-house marketing agency,

which reduces costs by 40% compared to competitors. The policy of investing about 20%

of the net profit in marketing maximizes the return with cost reduction.

Stockholder Structure

Igarapava S.A. is the major stockholder, owning 34.15% of the company‟s stock; while

Maiorem S.A. owns 21.36%. Free float accounts for 30.20% and the remaining 14.29% of

HYPE‟s stocks belong to individual and corporate shareholders. HYPE follows the rules

of Novo Mercado (New Market): with corporate governance, the company improves its

institutional image, presents a low cost of equity and increases its stock demand,

guaranteeing its liquidity and future price growth.

Other Headings Relevant to Company

Financial crisis impact: less than expected

Right before 2008‟s financial crisis, Brazil‟s economy reached its peak; elevated degree of

investment, credit and consumption expansion and sovereign risk lowered by S&P and

Fitch. The crisis reduced external and domestic credit supply, which lead to an abrupt

reduction of growth and macroeconomic uncertainty rose. The economic flexibility,

shown by the quick GDP contraction, along with the absence of financial stress on the

bank system granted a rating upgrade to Baa3 by Moody‟s in September 2009.

However, Brazil was one of the first countries to recover from the global crisis, in 2009‟s

second quarter, because of consumption increase, as a result of monetary, political and tax

policies. Such policies increased minimum wage and reduced inflation and interest rates,

Source: Company

Source: Company

Stockholder Structure 2009



created Bolsa Família (a Brazilian grant aid for poor people) and reduced taxes, such as

automobile‟s IPI (tax on industrialized products).

As a result, the middle class income rose (the reduction of Gini index, which measures

income concentration level). Along with the evolution of income classes E to D and D to

C in the last years2, the consumer goods industry grew, and HYPE did too.

Figure 6: Macroeconomic Indicators

Figure 7: Macroeconomic Indicators

Explanation

2009E 2010E 2011E 2012E 2013E

Selic 8.75% 10.38% 11.00% 10.38% 9.88%

GDP 0.14% 4.69% 4.28% 4.26% 4.22%

IGP-M -0.72% 4.27% 4.50% 4.50% 4.50%

Exchange Rate 1.8 1.78 1.90 1.95 2.00

S o urce: B CB , Gro up's Es tim ates

Source: BCB, Group’s estimates

Government intervention

The National Agency for Sanitary Measures (ANVISA) revisited the resolutions about

medication communication on December of 2008 and medication trade on January, 2009.

Since June of 2009, celebrities cannot take or suggest a nonprescription during the

advertisement and the warning about the implications of the drug must occupy 12 of the

30 seconds for each advertisement.

HYPE‟s revenues depend 35% on OTC. When adapting its marketing strategies to the

2008 law, it lost brand visibility. However, it was not affected by the 2009 law that

obliges the medications to be behind the counter in the drugstores. OTCs may remain

within reach of users because they have therapeutic function and low risk to health.

Law 11.638/2007

HYPE is exempted from income tax payments for 6 years due to goodwill from M&A in

the last years. Although for taxes purposes there is still goodwill amortization, on the

balance sheet it is now differently recognized since January 2009. The last fact doesn‟t

interfere in our valuation, because it merely affects accruals.

Currency risk: opportunities for Hypermarcas

We believe that the exchange rate will maintain a baseline between 1.70 - 2.10 BRL/USD,

below the historical mean of 2.34. Such assumption considers inflation rates and the

increase of foreign capital entrance as Brazil becomes more relevant in the global

framework (commodities exportation, hosting both Soccer World Cup and the Olympics,

tourism, etc.).

HYPE imports between 10 and 15% of its raw material and around 35% of its gross debt

is tied to currency variation. Only debts with maturity within the next 12 months are

hedged. The major currency risk comes from the company‟s expenses. HYPE is only

negatively affected if BRL devaluates. However, as we have forecasted a BRL

appreciation compared to historical data, HYPE shall beneficiate from costs and financial

expenses reduction.

For that reason, the company will consolidate itself: lower production costs can be passed

on to the sale price of HYPE‟s non-leading products; on the products in which HYPE

leads sales, the cost reduction will increase the margin, for their price reduction is not

expected.

2 Classification of Brazilian consumers, according to Credit Suisse: Class E: US$419 per month; Class D: US$420-580 per month;

Class C (Middle Class): US$581-2,508 per month; Classes A and B: from US$2,508 on per month.



STRENGHTS 1. Ability to detect and buy famous, forgotten,

underinvested brands and develop them

2. Risk diversification due to presence in

different product lines and market segments

3. Strong lower cost brands (15% cheaper)

4. Customers diversification

5. Marketing in-house agency

6. Economies of scale (from synergy),

combined with a lean structure and low

SG&A cost

7. Nationwide sales and distribution structure

8. Minor downturns during economic crisis

9. Minimal currency exposure due to hedges

and expected exchange rate

WEAKNESSES

1. Dissociation between the brand and

company name

2. Risks increase because of the tendency

of revenues concentration in only two

segments (OTC and Personal Care)

3. Low appealing to income classes A and

B.

4. Low bargain power compared to

competitors

5. Difficulty to maintain M&A in the long

term

6. High idle capacity (60%)

OPPORTUNITIES

1. Population increase on C and D income classes

2. Development of new distribution channels

3. Brands and product line extensions

4. Growth through new acquisitions

5. Growth through market share gains

6. Growth in segments with higher profit

margins, such as OTC, cosmetics and personal

care

THREATS

1. Brand dilution (over extension)

2. Exposure to regulatory uncertainties

3. Promising Brazilian market attracts large-

scale direct competitors

4. Competition from private label retail

companies

5. Operations in sectors with strong

government regulation

6. Difficulty to manage broad portfolio

Industry Overview and Competitive Positioning

The rapid upturn of Brazil‟s economy can be traced to the internal consumption

development. The non-durable goods consumption rose 19% on the first semester of

2009, according to LatinPanel‟s research, which mainly blamed inflation over the crisis‟

effects on consumption rates. Another factor that positively increased consumption was

the increase of the population in HYPE‟s target income classes (B, C and D).

Figure 7: Evolution of Target Composition Groups % of Brazil‟s population

Source: FGV, Group’s estimates

HYPE‟s sales tagged along this uptrend. While the natural impact on consumption caused

by uncertainty is cost reduction, HYPE had a significant advantage, once its products are

aligned to offer quality at a low price.

The main factors that impact the four markets in which HYPE operates are 1) local and

national economic conditions, 2) real income of target consumers, 3) GDP growth rates.

Sales in all sectors are negatively affected by purchasing power decrease, and positively

affected by the increase of our target consumer income classes (B, C and D).

SWOT ANALYSIS



Figure 8: Income expenditure breakdown Figure 9: Income Expenditure Breakdown

% of income spent on Class B Class C Class D

Food 15.92% 25.65% 29.28%

House Care 0.62% 0.95% 1.14%

Personal Care 1.74% 2.67% 2.70%

Pharmaceuticals 2.12% 3.03% 3.42%

Source: IBGE

Source: IBGE

Household and Cleaning Products Market Analysis

This sector has approximately 30 companies representing 85% of total sales. The

competition is both with large international players and S&M national companies, formal

or informal (prices far below the average). The average real growth of the sector in the

last five years was 5.98% per year.

Sales depend on 1) changes in consumer needs for more practical products, 2) concern for

safe products, 3) precaution against new diseases and 4) search for environmentally

friendly products. In Brazil, ANVISA regulates and registers all the products in this

sector. Regulation and a difficulty to insert new products in the distribution channels

hamper the entrance of new competitors.

Household and cleaning products’ future: stable environment

We estimate a stable environment: the market is mature, there‟s the possibility of market

share expansion as the population begins to choose lower cost products and sales may

increase due to marketing exposure.

However, we do forecast uncertainties. Products are vulnerable to income reduction

because there‟s little differentiation and low consumer involvement. Large

slaughterhouses have adopted growth strategy through vertical integration forward,

extending its product lines to cosmetics and personal care, using the byproduct (tallow) as

raw material.

We believe HYPE will maintain its current position in this sector, but we do not expect

major investments, as it is the most vulnerable segment compared to the others.

Food sector analysis

Food sector is highly competitive and mature, with national companies of all sizes,

international companies and private brands of major retailers. HYPE operates in

“grocery” and “well-being and health” segments, specifically in tomato and „light and

diet‟ products. The sector‟s average real growth in the last five years was 8.22% per year.

HYPE‟s main competitor in tomato products is Unilever, that holds 50% of the market,

while HYPE has only 7%. On the other hand, HYPE is the leader in sweeteners segment,

controlling 65% of sales. Sales are influenced by product practicability, consumer concern

for healthy and nutritious products, time scarcity due to hectic living and women entrance

in the labor market.

The entry barriers for new competitors are the great number of existing products, strict

regulation, and high investment required in distribution channels and marketing.

Food sector’s future: growth opportunities

1) Capturing new consumers, both the ones reducing food expenses without affecting the

amount consumed and the ones who changed their income class and will experiment other

brands, especially those known and at an accessible price.

2) Extending light and diet lines, stimulating that habit on households where people do not

consume this kind of product (especially classes C and D): demand can increase by 65%.

However, we expected few investments in this segment, for much of the marketing efforts

are canceled by competition movements in response of these investments.

The uncertainties we forecast are related to the large number of competitors, the size of

players and the difficulty in reducing production costs (economy of scale) caused by the

high number of products in each product line.

House Care industry

Segmentation

Source: ABIPLA



Pharmaceutical sector analysis

HYPE operates in OTC pharmaceuticals which are regulated by ANVISA to guarantee

quality, efficiency and safety of medications. The sector‟s average real growth in the last

five years was 11.55% per year. In OTC industry the ten major players are responsible for

45% of the sector‟s invoicing. HYPE is the national leader and its main competitors are

multinational companies.

The consumer sensibility related to income improvements is particularly high in this

market; target income classes‟ migration increase OTCs sales. Furthermore, the OTCs

essentiality degree contributes to reduce the negative impacts on sales whenever there‟s a

reduction in consumer income. When that happens, there‟s a substitution process from

expensive drugs to those with the same active principle, but lower price. Nevertheless, the

buying decision for OTC drugs depends not only on price, but also on reputation, image

and history. Thus, a known brand is synonym of consumer trust in product‟s quality and

effectiveness.

Specific factors that influence sales are 1) population aging, 2) acceptance of generic

medications, 3) effectiveness of new drugs, 4) new diseases, 5) disease-prevention drugs

and 7) development of a self-medication culture.

New companies‟ entrance in OTC segment is low because it demands investment in

advertising and technology to develop a strong brand, there‟s strict regulation and there‟s

difficulty to insert new products in the distributors.

Pharmaceuticals sector’s future: opportunities to explore its competitive advantage

HYPE is bound to invest in this sector because consumer reacts favorably to advertising

and links brand with quality. Thus, there‟s the opportunity to explore even more its low

marketing costs competitive advantage, using advertising to create an effective bond with

consumers, improving their recognition of product‟s quality.

ANVISA‟s resolution, limiting drugs advertisement, may reduce brand visibility for

HYPE, being this is our main concern.

Cosmetics and personal care sector analysis

Despite the great number of competitors, the 15 major companies of the sector are

responsible for 70% of invoicing. An important factor is the number of micro and small

informal companies, reaching 40% out of the 1694 companies operating in this sector.

The sector‟s average real growth in the last five years was 10.6% per year.

In this segment, 78% of consumers are faithful to brands and willing to pay for it. Sales

depend on emotional appeal, marketing, innovation degree, safety and women‟s entrance

in the labor market.

The high number of firms is imputable to low initial investments and to the simplicity of

the production processes. However, when companies wish to gain market share they need

to make high investments in distribution channels, product development and marketing

(brands and packaging).

Cosmetics and personal care sector’s future: the most promising sector

We forecast the sector will receive the majority of HYPE‟s investments, once the

consumer is less sensible to prices variation and more faithful to brands, which reduces

risks. In addition, the sector has growth projections well above GDP growth.

HYPE‟s opportunities will be to use the in-house marketing structure to come closer to

consumers and to focus on products for B and C income classes, which responds for

72.8% of the consumption in personal care sector. Uncertainties arise from the large

number of competitors who may decrease profitability.

What we foresee for Hypermarcas

We believe that HYPE will use its strong brand-revitalization know-how to make new

acquisitions in OTC medications and personal care. These sectors have the biggest profit

margins and historical growth, and their marketing efforts are effective. We also forecast

Personal Care industry

Segmentation

Source: ABIHPEC

Source: Company



investments in diet and light food product lines. Household products will have less

importance on the portfolio, with investments merely intended for activities‟ maintenance.

Figure 9: Attractiveness Matrix Attractiveness Matrix

Source: Group

5.00 3.67 2.33 1.00 Strong Medium Weak

1.00

2.33

3.67

5.00

Low

Medium

High

Ma

rket Attra

ctiveness

Competitive Strength

OTC Food Personal Care Household


Financial Analysis Revenues

Most of the company‟s growth since its beginning comes from M&A. To account for the

current acquisitions, we forecast a major growth for 2009 and 2010, of 78 and 42%,

respectively. The company has announced the intention to continue acquiring brands until

2010, and there‟s still BRL 1.3 bn to spend from the projected amount revealed.

Due to the company‟s strategy showed on recent acquisitions, we expect cosmetics and

personal care product‟s sales to increase its importance at HYPE‟s invoicing. OTC is also

expected to improve its revenues importance. Thus, we estimate that both sectors will

respond for more than 75% of total revenues.

Earnings

Free from financial results, the company‟s EBITDA grows above the industry‟s mean.

EBITDA of BRL 542.5M in 2009 is in line with the company‟s performance, yielding a

robust 27.4% margin with a CAGR 2009-2017 of 20.2%.

Figure 10: EBITDA Margin Evolution

Source: Company, group’s estimates

The high EBITDA margin shows HYPE‟s operational efficiency, supported by the ability

to maintain SG&A expenses under control. Net Income is negative until 2010, but EPS is

forecasted to grow from BRL -.12 in 2009 to 5.10 in 2017, a 59% CAGR.

Net Revenues Breakdown




Gross Margin

The increased focus on light and diet products, along with the new product lines recently

acquired in personal care are expected to increase the margin from 59.5 to 61.1% in 5

years. Pharmaceuticals are expected to have steady but small growth.

We raise our operational margin forecasts due to cost cutting obtained with the synergies

from acquisitions: plant restructuring, cost reduction from shared raw material, packaging

and logistics. Finally, operational margins will improve because of investment reduction

on businesses with mediocre results such as the household products.

Figure 11: Net Revenues and Gross Margin

Source: Company, group’s estimates

Cash Flow

During the financial crisis of 2008, credit scarcity affected suppliers and distributors so

that HYPE had to increase its average day‟s receivable, which became bigger than the

average days payable. As a consequence, sales decreased and inventory built up. For that

reason, free cash flow to firm decreased 29.6% in 2009 to BRL 440.0M.

In order to support the revenues growth in the coming years, production will use all of

today‟s idle capacity and there‟s a need to invest in PP in 2013. The proportional amount

of the investment is BRL 250M, showed on the CAPEX account. The new acquisitions

would also affect CAPEX values, but we cannot exactly forecast their amounts. The FCFF

yield for YE10 is 5.2%.

Balance Sheet

The capital structure for the following years was maintained at 35.5% (debt/capital), for

WACC calculations don‟t show much difference coming from plausible variations on

D/E. Thus, the return on equity for Y10 is 1.64% and the return on investment is 1.55%.

Because HYPE‟s history was made through M&A, the most important account in the

balance is goodwill, representing 83% of LT assets in Y09-10. HYPE‟s market-to-book

ratio is 3.54x, showing that the shares are selling way above the sum of the company‟s

assets‟ book value. However, P/B ratio is influenced by the depreciation and amortization

rates. HYPE‟s conduct on goodwill amortization is 5 to 5.5 years.

Investment Risks

The crisis had a minor and temporary impact on Brazilian companies’ results when

compared to similar companies in emerging countries. Consumption increased due to

Government’s policies and the economy restored how it was before the crisis. The latter

enlarges the possibility of a strategic movement of multinationals shifting investments to

markets where consumption was less affected; that would increase foreign investments in

the sectors where HYPE operates, making them more competitive and risking its high

margins.

Such movement is less concerning for consolidated multinationals companies who can

rapidly adapt to strategic changes, because they have well-known national brands, solid

productive structure and distribution channels. Furthermore, some multinationals have

been investing in umbrella brands development, extending known brands to diverse

product lines, reducing the number of brands they work with, the opposite strategy

adopted by HYPE.

From the company’s constitution through acquisitions, it is undeniable the risk arising

from goodwill and intangibles such as brands. Because a great part of its assets is in these

Source: Company



accounts, if that risk concretizes there would be a loss by impairment and not simple

amortization. Nevertheless, stock price might be affected by that risk and also from the

uncertainties of future acquisitions.

Currency exposure combined with difficulty to forecast future exchange rates and partial

hedges may also amplify its operational risks for the next years. Finally, the possible

concentration of HYPE’s results on OTC medications and cosmetics and personal care

can slightly reduce the company’s risk diversification.



Annex 1: Income Statement

In BRL millions 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E

Net Revenues 837.4 1333.0 1979.9 2771.8 3437.0 4193.2 5157.6 6292.3 7613.7 8908.0 10244.2

Cost Of Goods Sold 357.9 534.9 801.8 1113.5 1369.3 1653.8 2023.8 2447.7 2961.7 3465.2 3985.0

% of Net Revenues 42.7% 40.1% 40.5% 40.2% 39.8% 39.4% 39.2% 38.9% 38.9% 38.9% 38.9%

Gross Margin 479.5 798.1 1178.0 1658.3 2067.7 2539.4 3133.8 3844.6 4652.0 5442.8 6259.2

Gross Margin % 57.3% 59.9% 59.5% 59.8% 60.2% 60.6% 60.8% 61.1% 61.1% 61.1% 61.1%

Selling General & Admin Exp. 311.9 509.0 752.3 1053.3 1306.1 1593.4 1908.3 2391.1 2893.2 3385.0 3892.8

Amort. of Goodwill and Intangibles 163.2 332.7 526.0 520.0 518.0 476.0 290.0 87.0 61.0 17.0 4.0

Other Operating Expense/(Income) 8.6 8.3 (8.3) 34.0 56.6 90.0 133.4 184.5 355.8 371.7 421.40

EBIT (4.2) (51.9) (92.0) 51.0 187.0 380.0 802.0 1182.0 1342.0 1669.0 1941.0

EBIT Margin % -0.5% -3.9% -4.6% 1.8% 5.4% 9.1% 15.5% 18.8% 17.6% 18.7% 18.9%

Interest Expense (36.8) (44.4) (65.3) (91.5) (113.4) (138.4) (170.2) (207.6) (251.3) (294.0) (338.1)

Interest and Invest. Income 10.2 48.3 47.9 67.1 83.2 101.5 124.8 152.3 184.3 215.6 247.9

Non-operating Income (Expense) 74.3 (322.1) (29.7) (41.6) (51.6) (62.9) (77.4) (94.4) (114.2) (133.6) (153.7)

Profit Before Taxes 43.5 (370.1) (139.1) (15.0) 105.2 280.2 679.2 1032.2 1160.8 1457.0 1697.2

% of Net Revenues 5.2% -27.8% -7.0% -0.5% 3.1% 6.7% 13.2% 16.4% 15.2% 16.4% 16.6%

Income Tax Expense 16.6 (114.2) (111.3) (5.1) 35.8 95.3 230.9 351.0 449.0 501.0 560.0

35.8 95.3 230.9 351.0 394.7 495.4 577.0

Net Income 58.8 (207.9) (27.8) (9.9) 69.4 184.9 448.3 681.3 711.8 956.0 1137.2

% of Net Revenues 7.0% -15.6% -1.4% -0.4% 2.0% 4.4% 8.7% 10.8% 9.3% 10.7% 11.1%

NOPAT (2.8) (34.3) (92.0) 51.0 187.0 380.0 802.0 1182.0 900.0 1105.0 1284.0

% of Net Revenues -0.3% -2.6% -4.6% 1.8% 5.4% 9.1% 15.5% 18.8% 11.8% 12.4% 12.5%

EBITDA 184.1 309.1 542.5 726.2 890.2 1073.5 1315.2 1566.8 1751.1 2048.8 2356.2

EBITDA Margin 22.0% 23.2% 27.4% 26.2% 25.9% 25.6% 25.5% 24.9% 23.0% 23.0% 23.0%

Source: Company Documents. Student Estimates



Annex 2: Balance Sheet

In BRL millions 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E

Current Assets 469.1 1045.7 985.6 1571.8 2136.8 2770.7 3094.4 4503.1 5419.1 7080.2 9035.2

Cash And Equivalents 99.3 149.8 14.3 235.1 495.2 784.5 666.5 1559.5 1868.2 2924.0 4255.6

Total Receivables 229.5 659.5 657.1 920.0 1140.8 1391.7 1711.8 2088.4 2527.0 2956.6 3400.0

Inventory 118.4 210.1 262.3 364.2 447.9 541.0 662.0 800.6 968.8 1133.5 1303.5

Other Current Assets 21.9 26.3 51.9 52.4 53.0 53.5 54.0 54.6 55.1 66.1 76.1

Long Term Assets 1501.5 2519.7 3160.3 3229.6 3279.0 3295.5 3521.4 3510.1 3561.8 3738.3 4168.9

Net Property. Plant & Equipment 110.8 138.4 147.4 155.4 166.4 179.4 444.4 468.4 488.4 525.4 565.4

Goodwill 1199.5 2017.9 2631.9 2689.8 2724.8 2724.8 2724.8 2724.8 2724.8 2724.8 2724.8

Other Long-Term Assets 191.2 363.4 381.0 384.4 387.9 391.4 352.2 317.0 348.7 488.2 878.8

TOTAL ASSETS 1970.6 3565.4 4145.8 4801.4 5415.8 6066.2 6615.7 8013.3 8981.0 10818.5 13204.1

Current Liabilities 400.6 644.1 1341.9 1913.5 2574.7 3060.1 3212.1 3800.8 4156.4 4761.3 5626.4

Short-term Borrowings 54.3 210.0 380.7 383.6 498.7 693.1 901.1 991.2 1189.4 1427.3 1570.1

Accounts Payable 36.9 115.4 462.6 809.0 1223.1 1449.2 1350.2 1777.0 1936.8 2305.2 2928.5

Curr. Portion of LT Debt 210.6 153.8 185.2 125.5 198.0 197.2 168.2 259.9 277.9 296.4 415.0

Other Current Liabilities 98.8 164.9 313.4 595.4 655.0 720.5 792.5 772.7 752.2 732.3 712.9

Long-term Liabilities 878.6 1004.8 663.8 758.9 643.4 624.8 719.2 945.7 846.1 1122.7 1506.0

Long-Term Debt 822.9 954.2 578.9 657.2 494.9 394.5 400.5 472.6 661.7 926.3 1296.8

Deferred Tax Liability 29.6 5.7 7.7 8.3 35.4 94.6 156.1 300.0 - - -

Other Non-Current Liabilities 26.2 44.9 77.2 93.5 113.1 135.7 162.6 173.1 184.4 196.4 209.2

TOTAL LIABILITIES 1279.3 1648.9 2005.7 2672.4 3218.1 3684.9 3931.3 4746.6 5002.5 5884.0 7132.4

TOTAL COMMON EQUITY 691.3 1916.5 2140.1 2128.9 2197.7 2381.3 2684.4 3266.7 3978.5 4934.5 6071.7




Annex 3: Statement of Cash Flows

In BRL millions

2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016 2017

NOPAT (92.0) 51.0 187.0 380.0 802.0 1.182.0 900.0 1.105.0 1.284.0

(+) Depreciation & Amortization 544.0 555.0 555.0 515.0 295.0 125.0 96.0 35.0 19.0

Free Operating Cash Flow 452.0 606.0 742.0 895.0 1.097.0 1.307.0 996.0 1.140.0 1.303.0

(-) CAPEX (27.0) (43.0) (48.0) (52.0) (250.0) (62.0) (55.0) (55.0) (55.0)

∆ Working Capital 15.0 (80.0) (68.0) (62.0) (61.0) (61.0) (61.0) (61.0) (61.0)

Free Cash Flow to Firm 440.0 483.0 626.0 781.0 786.0 1.184.0 880.0 1.024.0 1.187.0

(+) New Debt Issued / repayments (16.8) (58.1) (57.4) (58.1) (128.8) (65.4) (65.6) (68.6) (72.0)

(+) Equity Raised 281.7 0 0 0 0 0 0 0 0

(+/-) Fin. Res. after taxes and non-op. result

Free Cash Flow to Equity 704.9 424.9 568.6 722.9 657.2 1.118.6 814.4 955.4 1.115.0




Annex 4: WACC Calculation

2009 2010 2011 2012 2013 2014 2015 2016 2017

US-Treasury 10 3.47% 3.47% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30% 4.30%

Risk Premium 6% 6% 4.79% 4.79% 4.79% 4.79% 4.79% 4.79% 4.79%

Brazil‟s risk (Cb - Tb) 3.38% 3.38% 3.38% 3.38% 3.38% 3.38% 3.38% 3.38% 3.38%

Perpetuity growth 4% 4% 4% 4% 4% 4% 4% 4% 4%

Leveraged Beta 0.59 0.59 0.59 0.60 0.60 0.60 0.60 0.60 0.60

Ke 12.48% 12.72% 12.67% 12.56% 12.56% 12.72% 12.72% 12.72% 12.72%

Ki 13.80% 13.80% 13.80% 13.80% 13.80% 13.80% 13.80% 13.80% 13.80%

Debt/Equity 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0%

WACC 12.55% 12.79% 12.74% 12.63% 12.63% 12.79% 12.79% 12.79% 12.79%

US inflation 2.15% 2.15% 2.15% 2.15% 2.15% 2% 2% 2% 2%

Brazil inflation 4.08% 4.31% 4.15% 4.00% 4.00% 4.00% 4.00% 4.00% 4.00%




Disclosures:

Ownership and material conflicts of interest:

The author(s). or a member of their household. of this report [holds/does not hold] a financial interest in the securities of this company. The author(s). or a member of their household. of this report [knows/does not know] of the existence of any conflicts of interest that might bias the content or publication of this report. [The conflict of interest is…]

Receipt of compensation:

Compensation of the author(s) of this report is not based on investment banking revenue.

Position as a officer or director:

The author(s). or a member of their household. does [not] serves as an officer. director or advisory board member of the subject company.

Market making:

The author(s) does [not] act as a market maker in the subject company‟s securities.

Ratings guide:

Banks rate companies as either a BUY. HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater over the next twelve month period. and recommends that investors take a position above the security‟s weight in the S&P 500. or any other relevant index. A SELL rating is given when the security is expected to deliver negative returns over the next twelve months. while a HOLD rating

implies flat returns over the next twelve months.

Disclaimer:

The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable. but the author(s) does not make any representation or warranty. express

or implied. as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice. nor is it an

offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with [Society Name] or the Investment Research Challenge with regard to

this company‟s stock.

CFA SOCIETY OF BRAZIL Student Researchrecommendation on HYPE3. From a three-stage DCF analysis, the...

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