PNVF

PN Vijay Financial Services Pvt Ltd July 13, 2010

Hanung Toys and Textiles Limited

BUY - An Evidence of Higher Yields

Company Overview
13th July 2010
CMP Rs 257
Target Rs 360 India’s largest manufacturer and exporters of
Target Period 12 months stuffed toys, Hanung Toys and Textiles, is also
Potential 43% a key player in mid-high end home textile
upside segment.
52 week 265.45/56
high/low
Avg. daily 350992 shares Established in 1990, the company expanded
volume to 11mn toy pieces in 1996, spread to home
Mcap/Sales 0.73 furnishing in 2002. Manufacturing facilities
I year change 255.15% are located across 2 units in Noida SEZ, those
for textiles are located across 2 units in Noida
SEZ, one unit in Maharashtra and one in
Relative Performance Uttaranchal.

Set up in technical collaboration with South

Korea, Hanung exports 75% of its production
to retail giants all over US, UK, Latin America
and Europe, its major customer being IKEA in
Sweden, Walmart in Latin America and other
retailers in 30 countries across the globe.

Hanung Nifty The company also has 100+ distributors

catering to 3000 retail outlets all over India. It
is the owner of renowned toy brands: “Play ‘n’
Pets” and “Muskan”.
Shareholding Pattern

0.4 In the textile segment, the company

11.8 1.8 manufactures comforters, quilts, bed sheet
sets, pillows, curtains, rugs, cushions, duvets,
5.4 throws and neck rolls. The domestic brand is
“Splash” and key customers include Macy’s,
JC Penny’s, Sears, Bloomingdale’s, Elite,
15.3 Britannica, Vishal etc.
65.3
Gross Sales for the company stood at Rs 8369
mn, a growth of 31% YoY basis. The company
Promoters Public FII's is characterized by strong order book
visibility, steady volume growth and stable
Corporates MF's/ UTI NRI
margins.

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Company Divisions

Toys Division

Industry Perspective

The Indian toy market has been attracting investor curiosity for a while. The market is
valued at INR Rs 40 bn, constituting both organized and unorganized sector. India
also contributes 0.5% to world’s toy production.

The Indian consumer boom has benefited this industry directly. Deeper pockets,
awareness about pre-schools, increased sensitivity towards a growing child’s needs,
preferences for high quality products and several Government initiatives like the
National Programme For Development of Toy Industry, for introducing tax incentives
and higher investments, have set this industry on a natural trajectory.

The Indian organized toy market is expected to grow more than 25% in the next two
years. It is a labour-intensive industry, characterized by small-scale industries. Most
toy manufacturers are located in the Delhi-NCR region of Noida/ Greater Noida and
belts in Maharashtra as this is an SEZ for toy manufacturing.

The biggest threat to the Indian toy industry emanates from China, as large-scale
dumping of toys jeopardizes domestic production. Chinese toys are cheaper hence are
better placed in a competitive market. Also, Indian products are seen as generic in
nature so they lose out in a market where tastes and preferences change overnight.
Obsolete technology used in production processes is again detrimental to the health of
this industry.

However, increased brand consciousness and consumer- inclination towards better

quality products are adversely impacting demand for cheap Chinese products. Parents
understand the impact of educational and recreational toys on a child’s development
and do not hesitate from paying a higher sum for a better product.

Domestic Players include Ok Play India, Funskool India (non-listed) and Hanung Toys
and Textiles.

Position of Company

Hanung has built a strong client base over the last 18 years. 70-80% of its toys are
generic in nature and it boasts of a library of over 5000 designs. Hanung estimates
and pre-orders most of its raw-material requirements and has hence its operating
cycle takes minimal time, a fact reflected in stable margins.

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Revenues in Hanung Toy Division grew by 30% in FY10 YoY to Rs 3.3 bn of which
exports constituted 83% of Sales. EBITDA margin for the division stood at 20.7%.
Sales in toy division constitute 40% of total sales.

Textiles

Indian home furnishing market is one of the fastest growing markets in the world.
Global home textile market is estimated at US$70 billion. Around US$ 30 billion
worth of home textile is imported by the EU and US every year.

Market size of Home Textile in India is US$20 billion including branded and non-
branded turnover. Government intervention and increased quality and
competitiveness through higher investments can help India attain a significant market
share in the global textile market, which is currently dominated by China.

The Indian Textile Industry contributes 14% to industrial production, 4% to GDP and
16.63% to export earnings. 40% of the textiles produced in the country are exported
and it is the biggest employment generator after agriculture. According to the textile
industry, targeted FDI by 2015 is US$ 6 billion, to be invested in green field units in
textile machinery, garment manufacturing and technical textiles.

Indian markets provide various incentives to foreign players like cheaper production
and marketing costs, intellectual rights protection along with 100% EOUs and SEZs.
India also allows 100% FDI in textiles.

Recent studies in the global textile trade have revealed that China is losing its
competitive strength in textiles. Yuan deregulation is expected to be another jolt. In
the future, the baton is likely to be passed to other emerging markets like India and
Brazil. Indian textile players also expect to target companies in other sectors like
automobiles, pharmaceuticals etc who were meeting their textile requirements with
now expensive Chinese imports.

Position of Company

Hanung exports 75% of its production to the US. Hanung also prefers to sell to
wholesalers with a storage facility rather than retailers. This strategy can help contain
immediate fluctuations in demand. Hanung also aims to increase installed capacity in
this division by 24%.

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Revenues in the Textile Division grew 30% in FY10 YoY to Rs 5154 mn, of which
exports constitute 68%. EBITDA margin stood at 18.2%. Sales in the textile division
constitute 60% of Gross Sales.

Financial Analysis

Financial statement analysis and projections

FY09 FY10 FY11E FY12E

Sales (Rs mn) 6376 8369 10461.25 13076.56
Toys 2585 3372 4215 5268
Growth (%) 30 25 25
Textiles 3946 5154 6700 8710
Growth (%) 30 29 30
EBITDA 1170 1635 1883 2354
EBITDA margin (%) 16 17 18 18
Depreciation 113 172 198 268
Interest 329 496 580 592
Tax Provisions 93 67 87 120
PAT 635 900 1018 1374
% Of Sales 10 11 10 11

As the company embarks upon a strong period of maturity, from FY10, EBITDA and
PAT margins stabilize at 18% and 11% respectively. Higher depreciation results from
increase in capacity.

Company keeps high inventory in order to reduce operating cycle time, however the
company is taking steps to reduce inventory turnover.

To meet higher working capital and capex requirements the company is expected to
raise fresh equity.

The company’s tax requirements too are stable due to 100% tax exemption, excise
duty exemption, low power tariffs and duty free import of raw material.

Expected Gross Sales for FY11 and FY12 in the toys division are a conservative figure,
taking into effect threats faced by the company by low-cost Chinese products and
erratic economic situation in developed markets where most products are exported.

Gross Sales in textiles are expected to remain stable.

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Future Agenda

o Hanung has entered into an export order with US buyer to export company’s
home furnishing products. The order is worth USD$ 90 million and expected
to be completed by Dec 2012.

o Hanung’s annual capacity for toys is 27.5 mn pieces. For textiles, capacity
for weaving is 6.5mn meters, processing is 41 mn meters. Hanung plans
expand manufacturing facilities by 37% for toys and 24% for home
furnishing respectively over the next 2 years.

o The company is also focusing on geographic expansion.

o The company is interested in inorganic growth. Any such association will

further improve margins due to enhanced synergy.

o The company boasts of an order book visibility of Rs18 billion, Rs 12 billion

for toys and Rs 6 billion for home furnishing.

o There is also an order backlog of Rs6 billion in the toys segment that needs
to be executed within the next 2 years.

o Hanung also aims to expand into newer toy categories, namely plastic toys,
dolls, electronic toys etc.

o Over the next few years, Hanung aims to reduce its exports in order to tap
potential in the domestic market and strengthen its existing share.

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Deterrents

™ China continues to dominate 70% of world’s toy production. Cheap currency

and economies of scale make an assortment of Chinese toys available at a
bargain. Only dissuading factor is their questionable quality.

™ For a company which excessively exports, currency rate fluctuations present a

huge challenge. Hanung aims to hedge its positions through forward contracts
and dealer payments in INR.

™ With growth and demand facing a slight slump in the EU and US, the
company’s main offshore client bases, Hanung is aggressively pursuing new
frontiers and strengthening its domestic base.

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Valuation and Recommendation

DCF Valuations

For estimating the price target, terminal value of Rs9050 mn was calculated using
Gordon Growth Model. The key assumptions are listed below

Risk free return: - 7.65%, 10 year bond yield

Market risk premium: - 8.75%
Beta: - 0.75
Cost of equity: - 14.21%
WACC: - 11%

The DCF valuation yields a value per share of Rs 360

Valuation multiples

FY09 FY10 FY11E FY12E

EPS 25.6 35.8 39 52.4
EPS growth (%) 40 12 34
EBITDA growth (%) 25 40 20.5 25
ROCE (%) 15.4 16 14 15.6
ROE (%) 21 23 22 23
Debt/ Equity Ratio 1.2 1.4 1.35 1
EV/EBITDA 3.65 3.5 3.9 3
Dividend Payout Ratio (%) 6 4.3 3.8 3.8
PEG ratio 0.336 0.15 0.3 0.24
P/E 8.4 5.9 6 6
Cash EPS 30 42 70 88

All valuations are based on historical trends. The company boasts of very attractive
valuations. EBITDA growth is expected to be stable as the company enters a mature
phase FY10 onwards.

Low EV/EBITDA, PEG and P/E suggest that the company may be undervalued.
However, undervaluation is matched with a terrific growth in earnings and cash
availability as demonstrated by high EPS and Cash EPS ratios.

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Hanung is an excellent mid-cap exposure and is attractively priced. We recommend it

for investors who like high growth opportunities with a 12 month target price of Rs
360

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