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Margin headwinds and soft near‐term growth outlook makes us downgrade to ADD despite seemingly undemanding valuations now

Our view

Nearly flat volumes in Q3FY22 led to lower than expected revenue growth indicating sluggishness especially in rural demand. EBITDA margin came in‐line with estimates driven by a significant reduction in A&P spends and other cost saving measures. With management indicating its endeavor to maintain balance between volume and price growth, we expect a gradual improvement in volume albeit at a slower pace than expected with growth driven by premiumization and mix improvement. While the company has turned more aggressive on new launches and entered new oral care segments, more traction in these segments or entry into new categories would be required to pull up the growth trajectory towards high single digits. Market share should gradually start improving with aggressive marketing spends, traction in rural markets, distribution efforts across channels and strong momentum in Vedshakti portfolio. Personal care under Palmolive brand and toothbrushes should take few quarters to reach scalability potential. We downgrade from Buy to ADD as lower growth and inflation‐led concerns on margins is expected to delay the earnings growth trajectory.

Result Highlights

* Financial summary – Revenue grew 3.9% YoY to Rs12.8bn indicating flattish volumes, gross margins contracted 320bps due to cost inflation and limited price hikes, EBITDA margins declined only 40bps helped by a sharp decrease in A&P spends, PAT up 1.6%.

* Quarter highlights – While flat volumes on a base of 5% growth looks very weak, it could have been worse if the company had taken further price hikes (took only 4% price hike given the intent to balance volumes and revenue leading to GM contraction). A&P spend decreased 24%/19% YoY/QoQ to mitigate margin contraction which was in contrast to recent aggression in marketing investments in both its core portfolio and new launches.  

* Margins – CLGT witnessed inflation of around 8‐10% in RM which was partially offset by lower A&P spends. EBITDA margin came in at 29.7% vs 30.1% YoY. PAT margin came in at 19.7% vs 20.2% in Q3FY21 due to lower margins,

Valuation

Given the sluggishness in volume growth coupled with inflation headwinds restricting aggressive spends behind innovation and new launches; we see a soft near‐term outlook and hence trim our estimates to incorporate lower revenue growth and margins. We now model in revenue/EBITDA/PAT CAGR of 7.1%/6.4%/5.9% over FY21‐ 24E and cut EPS estimate by 3‐4%, leading us to downgrade our rating from Buy to ADD with revised TP of Rs1,584 based on 35x FY24E earnings (40x earlier), in line with the company’s LPA valuation multiple.

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