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Uncertainty remains; downgrade to HOLD
* Results disappointed with EBITDA and PAT coming in at 28%and 48% below our expectations. Revenue growth of 12% to Rs6.3bn was in line with our expectations, driven by 25% growth in the retail division.
* Management’s new strategy aims at reducing working capital requirements, which are very high, and strengthening the balance sheet. While this will be a positive over the long term, it will drive a reduction in margins and profitability in near term.
* Management’s initiatives to provide the best price, loyalty discounts, and reducing credit sales will continue to affect retail margins. The pressure on processing margins and the rationalization of the channel business are also likely to affect overall margins.
* Management commentary points to continued margin weakness and margins stabilizing at a lower level, resulting in a steep 40%+ cut to our FY19-21 estimates. Despite a 50% correction in the stock price, weak management commentary and uncertainty over margins make us downgrade the stock to a Hold from Accumulate, with a revised target price of Rs1,020 (from Rs2,155), based on 15x FY20 retail EBITDA.
* Revenues in line, driven by retail; headwinds continue in channel business:
Revenues grew 13% to Rs6.4bn – in line with expectations. Retail revenues grew 26%, while channel and enterprise business revenues were flat. Channel revenues declined due to the company’s focus on reducing credit sales. Retail revenues were driven by 18% LTL growth. Management expects a further reduction in channel revenues to reduce its presence in this low-margin and high working capital business.
* Change in business model will continue to affect margins:
Gross margins declined 280bps to 12%. (flat qoq), resulting in an EBITDA decline of 24% to Rs311mn and PAT decline of 47% to Rs91mn Margins were largely impacted by the channel and enterprise business which reported a 69% decline in EBIT with margins at 1.7% vs. 5.5% in 2QFY18. Retail EBIT grew 15% with a margin decline of 80bps to 9.7%. The profitability was also affected by an inventory loss of Rs18mn (due to Kerala floods) and goodwill amortization of 8.7mn for the quarter. Management expects lower processing margins at 4.1% vs. 5.6% on higher competition to impact channel business margins in the near term. Management’s focus on providing the best price in new products and loyalty discounts along with increasing cash sales will also reduce retail margins in the near term.
* Retail expansion plan reduced; working capital and capex remain high:
Despite the decline in product sales in the channel business, capex guidance remains high as the company has already committed on manufacturing capacity expansion. Despite the focus on increasing cash sales and defocus from the channel business, working capital reduction is not visible yet and is likely to be gradual at best.
* Uncertainty over margins remains; downgrade to Hold:
Management commentary points to continued margin weakness, and margins stabilizing at a lower level, resulting in a steep 40%+ cut to our FY19-21 estimates. Despite a 50% correction in the stock price, weak management commentary and uncertainty over margins make us downgrade the stock to a Hold from Accumulate, with a revised target price of Rs1,020 (from Rs2,155), based on 15x retail EV/EBITDA.
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