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Category leader seeking dominance in the nascent luxury watch retail; Initiate with BUY

Ethos Limited (Ethos) is India’s leading luxury watch retailer. Ethos has a ~15% market share by value (Emkay estimate for FY22), thanks to its pan-India physical presence (50 stores in 17 cities) and a distinguished online presence. India is at the cusp of exponential growth in luxury watch sales; we expect: i) 0.9mn HNWIs in India by FY35E [0.3mn at FY22-end], implying 9% CAGR over FY25-35E. Our forecast may be conservative, as extrapolation of trends witnessed in Brazil/China suggests 12% FY25- 35E CAGR; ii) ~4% realization CAGR, led by brands’ pricing power + premiumization + INR depreciation. Hence, we see potential for 13-14% industry revenue CAGR over FY25-35E. Ethos has no pan-India rival, and we reckon the company will achieve its targeted ~30% market-share in each micro-market (vs. 15% overall share) leveraging its balance sheet, flagship stores and exclusive brand partnerships.

We forecast FY22-25E EBITDA CAGR at 47% for Ethos, on: i) 30% revenue CAGR over the same period, led by 13% SSG in new watch retail, 10% increase in average store count, and 5% growth contribution from certified pre-owned (CPO)/new segments; and ii) average annual increase of 110bps in EBITDA margin, buoyed by operating leverage. We expect stable gross margin, as higher mix of exclusive brands would completely offset the impact of higher CPO mix. We expect pre-tax RoICs to improve to 23% by FY25E from 14% in FY22, largely led by margin gains. We initiate coverage on Ethos with a BUY rating and a Sep-23E TP of Rs1,400, based on 24x Sep-24E EV/EBITDA, derived from a two-stage Gordon growth model. Our target multiple implies a 5-30% valuation discount vs. other retail formats, to account for the lower RoIC. (Note: Unless stated otherwise, EBITDA and margins are on pre-IndAS basis)

New watch segment has potential for high-teen revenue CAGR over FY25-35E, led by market-share gains: Ethos’ market share has increased by ~700bps over FY15-20, within the top-8 retailers. It aims to achieve 30% share in each micro-market (vs. 15% overall share in FY22) by offering better experience through flagship stores and differentiated assortment via exclusive brand partnerships. Further, Ethos has created a unique marketing platform that has helped it to enter exclusive partnerships with 33 brands. Ethos offers niche features like live chat with luxury watch consultants and digital content creation with a 70-member team. Ethos has a consumer database of ~0.3mn HNWIs, which it leverages for efficient marketing.

CPO business, other new segments to help drive overall rev. CAGR of ~20%: Improved affordability, sustainability-focus, and limited new watch supply are key drivers of the CPO market. Globally, CPO has grown faster (than new watch sales), to account for 1/3rd share of new luxury watch sales in CY20. We model the Indian CPO market at 35% of new watch sales by FY35E (vs. 1% in FY20). Organized players should account for 80-90% of the CPO market over the long term (vs. 30% in FY20) in our view, as they offer authenticity, warranty and a fair price-discovery. We model CPO/new segments contributing an incremental revenue CAGR of 3%/1%, taking Ethos’ overall revenue CAGR to ~20% over FY25-35E.

Key upside/downside risks: Upside risks are entry of high-end luxury brands into India (ASP of >Rs2.5mn), faster growth in HNWI population, and quicker margin expansion. Downside risks are slower development of luxury malls and failure to manage working capital. Based on these, our Sep-23 fair value in bear/base/bull case scenarios is Rs1,100/1,400/1,750, resp.

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