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Inflation, GST rate hikes continue to hurt the demand 

Relaxo Footwears’ sales declined by 8% YoY however grew 2% on a QoQ basis. Volumes improved modestly over the last quarter after Relaxo decided to roll back the previous price hikes. The volume impact, as we had highlighted in our past notes, has been on account of severe  inflationary  pressure  and  GST  rate  hikes.    Relaxo’s  value  for  money  conscious consumer  segment  continued  to  feel  the  pinch.  Sharp  decline  in polymer  prices  helped gross margins  recover  510bps  on QoQ  basis  (?20bps  YoY)  to  53%. However,  despite  the sharp improvement in GM, EBITDA margin recovery was restrained to 170bps at 10.6% as other expenses as % sales risen sharply. EBITDA/PBT declined by 41/57% respectively. We believe  that  meaningful  demand  recovery  has  now  been  postponed  to  1QFY24. Accordingly,  we  cut  our  EPS  estimates  by  12/13/5%  for  FY23/24/25. We  maintain  ADD rating with lower target price of Rs853 (earlier Rs930) valuing at 60x 1HFY25E EPS.

Meaningful demand recovery and margin normalization postponed to FY24  

Relaxo’s volumes continued to be impacted by severe inflation and GST rate hike (effective  Jan’22). Demand in open footwear continued to remain weak as per our channel checks.  We  also observed downtrading by certain segment of Relaxo’s consumers, hurting the company’s  overall growth trajectory. Our channel checks also suggest Relaxo’s peers were able to offer better value to the end consumers. In order to combat inflationary pressure and avoid market share  losses  Relaxo  rolled  back  the  price  hikes  it  took  in  FY22.  Led  by  this  price  rollback,  volumes have witnessed an improvement sequentially and management expects to achieve better traction with full impact of price cuts from4QFY23 onwards. Once the major portion of the high?cost inventory gets cleared from the distribution channels coupled with the business showing  signs  of  improvement  and  raw  material  costs  stabilising,  the  company  expects  improvement  in  margins  while  regaining  the  market  share  in  the  quarters  to  come. Management  expects  closed  footwear  segment  will  continue  to  show  healthy  growth momentum as wholesale distribution channels and online penetration improve.

Long term secular trend intact 

We remain confident on Relaxo’s long term growth trajectory despite short term hiccups. We believe the current situation of RM price fluctuations accompanied by severe inflationary and  GST  rate  hike  pressure  is  a  black  swan  event.  We  believe  in  Relaxo’s  strong  business fundamentals aided by a wide distribution reach, strong brand recall, a wide variety of SKUs,  solid in?house manufacturing, and better sourcing capabilities. Relaxo is expected to climb up the value chain as its Sparx brand continues to grow stronger. Sparx (shoes and sandals) has been growing at 30% and now contributing ~40% to the company’s total sales. Relaxo has  been consistently investing in building its manufacturing capabilities with current capacity of 1mn pair per day with sport shoes capacity of 50k pair per day. Sport shoes capacity is further to be doubled to 100k pairs per day by April’23.  India’s 80% of footwear pyramid is priced below Rs1,000 – providing a huge play field for Relaxo to grow consistently for a decade.

Valuation  We expect margin improvement to continue its momentum from here led by cooling off of polymer  prices.  We  cut  our  EPS  estimates  by  12/13/5%  for  FY23/24/25  keeping  current inflationary environment in context. We maintain ADD rating with lower target price of Rs853 (earlier Rs930) valuing at 60x 1HFY25E EPS.

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