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Q3 beat leads to earnings upgrade; maintain Buy

ABFRL’s Q3 EBITDA was ~7% ahead of our estimates, largely led by ~150bps jump in gross margins vs. flat expectations. The beat on consensus nos. was higher on both revenue and margin fronts. Higher fresh mix and greater Lifestyle mix led to better margins.

Q3 recovery highlights strong traction in core brands. ABFRL remains aggressive in entering new segments (ethnic/athleisure/D2C) through the inorganic route; it expects to build scale profitably in ethnic, and aims to become a major player in sportswear (Reebok).

Margin improvement appears to be on track, and we expect ~400bps margin gains in FY22-24. In our view, operating leverage arising from strong growth, cost efficiencies and profitability turnaround in new segments should add more to margins beyond FY24E.

We raise FY23/24E EBITDA by 10-13% on strong recovery in the previously impacted Wholesale/Pantaloons and forecast FY20-24 EBITDA CAGR of ~30%. RoIC (ex-goodwill) is expected to improve to ~35% by FY24. Maintain Buy with a revised TP of Rs400.

Strong pick-up in Pantaloons/Wholesale: ABFRL reported a 112% recovery in Q3, aided by a strong 120%+ recovery in Lifestyle and near-full recovery in Pantaloons. Within Lifestyle, Retail/Online channels continued to see strong traction, with 14%/20% CAGRs on a 2-yr basis, while the wholesale channel picked up strongly with 95% recovery vs. 43% in Q2. Nearfull recovery in the previously impacted Pantaloons/Wholesale channel (~60% of pre-Covid sales) is encouraging and was led by healthy demand/secondary sales. Despite disruptions, Innerwear saw strong growth of ~25% CAGR, driven by market share gains, outlet expansion and online traction. ABFRL remained upbeat on both Ethnic/Innerwear, and these businesses are having ~Rs10bn run-rate currently (vs. ~Rs4bn pre-Covid). In addition to partnerships in the luxury ethnic segment, ABFRL opened exclusive EBOs for ethnic women/men brands Tasva/Marigold Lane in the mid-premium space. Store additions in Pantaloons were muted, with ~15 net additions in 9M, leading to ABFRL trimming its guidance by 25 stores for FY22E. ABFRL became net-debt free, aided by WC reduction, but this is not sustainable, in our view

Cost savings to aid structural margin improvement: EBITDA margins, at 19.3%, rose ~140bps, largely led by higher GMs of ~54% vs. 52% a year ago. Higher lifestyle and fresh mix, aided by an improvement in the supply chain, led to better gross margins. The ~330bps improvement vs. pre-Covid era strengthens confidence in continued gains upon full normalcy

Stronger franchise; maintain Buy: Strong recovery trends, aggressive expansion plans and improving margin profile should drive healthy revenue/EBITDA CAGRs of 14%/30% over FY20-24E. RoIC (ex-goodwill) is expected to improve to ~35% by FY24. Retain Buy with a revised TP of Rs400 (28x FY24E pre-IndAS116 EBITDA vs. 30x Dec’23E earlier). The reduction in multiple is due to 3M roll-over and higher WACC.

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