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Margin outlook getting better; sales recovery key to re-rating

* Emami (HMN)’s 1QFY22 sales were in line with expectations. Domestic sales grew 5% v/s 1QFY20 levels. While Healthcare and Pain Management have nearly doubled over 1QFY20 levels, the impact of the second COVID wave led lockdown resulted in sharp decline over 1QFY20 in Navratna (in the crucial summer season) and Male Grooming.

* The outlook for the domestic business gradually improved in Jun’21 and Jul’21, after modest growth over a two-year period in 1QFY22. This was partly offset by slower growth in the International business (~12% of sales) due to COVID-related lockdowns, especially in the Middle East.

* Margin performance in 1QFY22 and the outlook were better than expected. The key to a further re-rating would depend on whether sales growth, after a period of extremely weak performance (3.7% CAGR over FY16–20), could revive to the double digits, followed by the mid-teen level on a sustainable basis. Maintain Buy.

Better-than-expected margins lead to earnings beat

* Consolidated net sales grew 37.3% YoY to INR6.6b (est. INR6.4b). EBITDA / PBT / adjusted PAT before amortization grew 38%/48.1%/44.4% YoY to INR1.7b/INR1.6b/INR1.4b (est. INR1.6b/INR1.4b/INR1.2b).

* Domestic volumes increased 38% YoY in 1QFY22.

* The gross margin contracted 50bp YoY to 66%.

* The EBITDA margin expanded 10bp YoY to 25.7% (est. 24.5%) on lower employee costs as a percentage of sales (-340bp YoY), other expenses (- 140bp YoY), and higher ad spends (+420bp YoY).

* Absolute ad spends grew 84% YoY to INR1.1b.

* The overall domestic business grew 42% YoY, 5% v/s 1QFY20.

* International sales grew 17% YoY, but declined 9% v/s 1QFY20.

* The Institutional business (3% of sales) grew 34% YoY, but declined 17% v/s 1QFY20.

* Within domestic, HMN reported YoY sales growth in all categories in 1QFY22: Healthcare (+59% YoY), BoroPlus (+96%), Navratna (+21%), Kesh King (+53%), Pain Management (+70%), Male Grooming (+78%), and 7 Oilsin-One (+93%).

Highlights from management commentary

* Compared with a normal 1QFY20 (unlike 1QFY21, which was affected adversely by the sudden lockdowns), domestic sales growth was 5%. Healthcare and Pain Management nearly doubled over this period, while Navratna / Male Grooming declined 29%/47%. Both Navratna and Male Grooming are discretionary categories. Kesh King reported ~2% growth over 1QFY20 numbers and was affected by the slowdown in discretionary consumption. Jul’21 numbers seem to be much stronger. HMN has gained share from Patanjali and Indulekha over the last few months.

* Over the last two months, the International business has, however, seen some slowdown due to lockdowns on account of the second COVID wave. The management is uncertain about when the International business (12% of consolidated sales in 1QFY22) would recover.

* After a 3.5% price increase YTD and stability now emerging in material costs, the management has stated that the company is likely to have better gross margins v/s the earlier guidance of 66.5–67% for FY22, perhaps even reaching the same levels as last year. However, it further hinted that higher advertising spends in 2HFY22 could check EBITDA margin expansion.

* E-commerce contributed 5% to domestic revenues from 1% a year ago. The management stated it would be very aggressive on this front, targeting 7–7.5% of sales over the next year

Valuation and view

* There is no material change to our FY22/FY23E EPS forecasts.

* While it is too early to call out a structural recovery in sales, before the COVIDled blip on discretionary consumption in 1QFY22, the company had reported three successive quarters of two-year average sales of 7.5–10% – a level we believe HMN can go back to 2QFY22 onwards. This is far better than the 3.7% sales CAGR between FY16–20. If the path to sustainable and strong double-digit sales growth continues, a further re-rating is possible.

* We maintain our Buy rating, encouraged by the following factors: a) inexpensive valuations at 30.3x FY23E EPS, b) a sharp reduction in pledged shares (now at 30% levels), and c) potential tailwinds for HMN over the next few quarters (~50% of HMN's domestic sales comes from rural India) – just like other peers with higher rural salience.

* We arrive at our TP of INR660/share (valuing the company at 32x Sep’23E EPS, a 40% discount to peers).

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