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Higher marketing spend subdues profitability

About the stock: ABFRL combines Madura’s portfolio of leading power brands (Allen Solly, Van Heusen, Louis Philippe and Peter England) with Pantaloons’ forte of largest value fashion retailer. The company has a robust distribution network with 3197 brand stores along with 396 Pantaloons stores.

* ABFRL has charted out growth strategies to become a ~US$2.8 billion entity (| 21000 crore) by FY26E, translating to 15% CAGR in FY20-26E

* It has enhanced focus on ethnic wear (through its recent acquisitions)

Q2FY23 Results: ABFRL reported healthy revenue growth (in line with our estimates) but higher than anticipated marketing spends weighed on profitability. On the balance sheet front, net debt declined to | 243 crore against | 504 crore in FY22 (owing to capital infusion worth | 770 crore by GIC).

* On a favourable base, revenue grew 50% YoY to | 3074.6 crore (three year CAGR: 10%). Revenue grew 33% over pre-Covid levels

* Gross margins improved 170 bps YoY to 55.1% owing to better product mix and sharp markdown reductions. However, other expenses grew sharply by 60% YoY to | 716.8 crore. Subsequently, EBITDA margins were at 12.9% (Idirect estimate: 14.6%, Q2FY22: 15.3%)

* Lower than anticipated EBITDA (miss by ~ | 40 crore) resulted in PAT coming in at | 29.4 crore (below our estimate of | 69 crore)

What should investors do? The stock price of ABFRL has appreciated at a CAGR of ~18% over the last five years.

* ABFRL has strengthened its balance sheet through recent equity infusion with net debt declining sharply from | 2500 crore (in FY20) to ~| 230 crore We remain structurally positive and maintain BUY rating on the stock

Target Price and Valuation: We value ABFRL at | 380 i.e. 2.5x FY24E EV/sales

Key triggers for future price performance:

* ABFRL has aggressive store addition plans for FY23E with 75+ Pantaloons store and 400+ (franchisee) lifestyle brand stores

* Multiple strategic initiatives like entry into footwear by acquiring Reebok’s India operations, acquisition of majority stake in Masaba to foray into beauty category, launch of premium menswear ethnic brand Tasva and setting up a separate platform to build a portfolio of D2C brands to add value over the medium to long term

* Maintaining b/s strength coupled with aggressive expansion would be the focus of ABFRL, going forward (debt/EBITDA: 1-2x)

Alternate Stock Idea: Apart from ABFRL, in our retail coverage we also like Trent.

* Inherent strength of brands (Westside, Zudio) and proven business model position Trent as a preferred pick. BUY with a target price of | 1665

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