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Gross profit margin remains depressed

EPL’s Q2FY23 print was a mixed bag with revenue growth of 9% YoY (+14% QOQ) to Rs9.5bn led by growth across regions. However, gross profit margin fell 200bps QoQ to 54% despite softening raw material prices due to high-cost inventory and volatility in currencies (vs USD). Further, investment in Brazil is also adding to cost inflation. EPL believes it will maintain the double-digit revenue growth, and is working to restore EBITDA/tube to pre-covid levels. Personal care segment has started growing strongly again, up 17% YoY, despite flattish revenue in pharmaceuticals while beauty & cosmetics rose 25%. Brazil operations are expected to commence by end-FY23 and should start adding to growth from FY24 onward. Falling freight cost may help improve margins in the coming quarters. We believe the worst is behind for EPL in terms of EPS downgrade, and we assume the company can grow its profits steadily hereon. We cut our FY23E/FY24E EPS by 15%/8% on lower margin assumptions and, accordingly, reduce our DCF based target price to Rs220 (from Rs225). Maintain BUY. Key risks: margin drag in developed countries and geopolitical challenges in China.

* Revenue up 9.0% YoY to Rs9.5bn. Revenue growth was impacted due to mere 1.5% YoY growth in the EAP region as a result of lockdown in certain cities of China. Company believes EAP revenue should see sequential recovery to normalcy. Americas and Europe grew 19.7% and 8.9% YoY respectively on low base. AMESA revenue staged strong growth at 16.9% YoY. Oral care revenue rose 6.7% YoY to Rs4.6bn (up 14% QoQ) and personal care segment was up 17.3% YoY (14% QoQ) to Rs4.2bn. In the personal care business, beauty & cosmetics showed impressive growth of 25% YoY. Pharmaceutical revenue grew only 0.7% YoY and ‘others’ dipped 10.8% YoY. Laminate revenues declined 17% YoY to Rs644mn.

* Gross margin contracted by 200bps QoQ to 54%. Gross profit was up 4.2% YoY (up 9.9% QoQ) to Rs5.1bn. Despite softening raw material prices, the margins were hurt probably due to high-cost inventory and currency volatility. EPL is working to restore absolute EBITDA/tube to pre-covid levels in the next few quarters. EBITDA declined 6.8% YoY (+18.3% QoQ) to Rs1.5bn while EBITDA margin expanded 60bps QoQ to 15.7%. EBITDA continued to be impacted by higher power and employee costs, particularly in Americas and Europe. Net profit was down 8.9% YoY to Rs462mn. Operating cost too was high due to investments in Brazil where EPL is working to operationalise its plant by end-FY23, for which the capex will be ~Rs1.4bn.

* Geography-wise performance. 1) AMESA revenue rose 16.9% YoY to Rs3.6bn; EBITDA was down 2.9% YoY (up 3.9% QoQ) to Rs659mn, and EBITDA margin down 150bps QoQ to 18.3%. 2) EAP revenue was up 1.4% YoY (12.3% QoQ) to Rs2.1bn; EBITDA rose 4.8% YoY to Rs499mn with EBITDA margin growth of 360bps QoQ to 23.0%. 3) Revenue from the Americas increased by 19.7% YoY to Rs2.2bn, but EBITDA dipped 6.0% YoY to Rs267mn. EBITDA margin fell 30bps QoQ to 12%. 4) Europe revenue rose 8.9% YoY to Rs2bn; EBITDA was up 1% YoY (20.2% QoQ) to Rs208mn and EBITDA margin expanded by 140bps QoQ to 10.1%.

* Highlights of earnings call. 1) Brazil operations are expected to start by endFY23 and the company plans to invest Rs1.4bn for the production facility there. The IRR is based on one long-term customer contract; however, the company has seen growing interest from other customers as well, which will only sweeten the IRR. 2) Currency volatility was particularly very challenging during Q2FY23 and partially offset the benefit of softening raw material prices. Currency depreciation in Europe, India and China were significant headwinds. 3) Restoring company profitability in terms of EBITDA/tube is a priority for the company. 4) Raw material prices peaked in Q2FY23 and their stabilisation will benefit margins. 5) Falling freight cost should also support margins.

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