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Operating performance disappoints, margin outlook better for 2HFY23

* HMN reported a weak set of 2QFY23 earnings. Consolidated sales grew 3.2% YoY, despite the consolidation of Helios (which contributed 3.5% to net sales) in 2Q and Dermicool in 1QFY23. Overall volumes fell 1% YoY in 2QFY23 v/s our expectation of 7% growth. HMN’s rural salience (the highest among its peers) is adversely affecting growth. There was also a doubledigit YoY fall in Pain Management/Healthcare/Kesh King sales in 2QFY23.

* The management guided at a better EBITDA margin in 2HFY23, led by a reduction in material costs.

* It is heartening, though, that HMN is investing in growth. Its ad-spends-tosales ratio is increasing and investments in Project Khoj (to augment rural distribution) will also continue.

* While sales growth continued to be unimpressive for a company of its size (with a five/three/two-year CAGR of 5.1%/5.8%/9.7%), the trend is getting gradually better. HMN's valuations are also inexpensive. Hence, we maintain our Buy rating.

Overall performance weak

* Consolidated net sales was flat YoY at INR8,138m (est. INR8,953m). EBITDA/PBT fell 29.5%/27.3% YoY to INR1,954m (est. INR2,373m)/ INR2,111m (est. INR2,325m). Adjusted PAT before amortization fell 17.9% YoY to INR2,079m (est. INR1,958m).

* Domestic volume fell by 1% YoY.

* Gross margin contracted by 220bp YoY, but expanded 400bp QoQ, to 66.6%. (est. 63.5%). EBITDA margin too contracted by 1110bp YoY, but expanded by 170bp QoQ, to 24% (est. 26.5%) due to higher ad spends/other expenses/employee costs (up 400bp/390bp/110bp YoY).

* Absolute ad spends grew 34.3% YoY to INR1,415m.

* Sales grew 9.8% YoY to INR15.9b in 1HFY23. EBITDA/adjusted PAT declined by 17.5%/10.7% YoY to INR3.7b/INR3.5b.

* International sales grew 17% YoY, driven by MENA.

* Domestic segmental revenue performance YoY in 2QFY23: Navratna (-5%), Pain Management (-13%), BoroPlus (+17%), Kesh King (-10%), Male Grooming (flat), and Healthcare (-16%).

Highlights from the management commentary

* Unprecedented RM cost pressures and a weak product mix (Pain Management, which is a high margin business, declined YoY) led to a YoY decline in gross margin. However, the management stated that the pressure on input costs have started to ease.

* The second half of the fiscal usually constitutes 55% of full-year EBITDA. The management guided at an EBITDA margin of ~27% for FY23.

* Amortization expenses of INR235m per quarter will continue going forward.

* The tax rate was lower because of a MAT credit in 1HFY22. The same in FY23/ FY24 will stand ~10% each.

Valuation and view

* A significant miss on our expectations and the improbability of a sharp revival led to a reduction of ~8% each in our FY23/FY24 EBITDA forecast. However, due to the 10% tax rate guidance for FY23/FY24 v/s its earlier estimate of 17.5%/18%, there is no material change at the EPS level for both fiscals.

* HMN's sales CAGR of 9.7% over FY20-22 was far better than the 3% sales CAGR over FY16-20. If this trajectory leads to a sustainable and strong double-digit sales growth, a further re-rating could be on the cards.

* We maintain our Buy rating on the stock, led by its: a) inexpensive valuations at 21.1x FY24E EPS (23.2x including amortization), b) increase in ad-spends, and 3) expansion in its rural distribution reach.

* We arrive at our TP of INR550 (valuing the company at 24x Sep'24E EPS, at a 40% discount to its peers on a pre-amortization basis). We maintain our Buy rating.

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