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Focusing on profitable growth

We note that management on the call emphasised on profitable growth. In the fashion segment, it endeavours to improve contribution margins materially. We think this should help allay investor concerns around cash burn. Contribution margin for the ‘Others’ segment also improved to -15.6% in Q4FY23 from -34.8% in Q4FY22, which we think is due to scale benefits (Superstore orders grew to 729k in FY23 up 15x from FY22) and should continue as the business matures. Given improving visibility on profitability, we upgrade our EPS estimates by 8.4%/12.1% for FY24E/25E and upgrade to BUY (from ADD); TP Rs165.

* Strong growth in a subdued demand scenario: Revenue grew by 34% YoY to Rs13bn (largely in line with our expectations). Overall GMV was up 36% YoY (-13% QoQ) to Rs24.5bn driven by 29% YoY and 38% YoY increase for BPC and Fashion business, respectively; Fashion contributes ~26% of GMV. Annual unique transacting consumers grew by 1.24x and 1.4x to 10mn and 2.5mn for BPC and Fashion business, respectively. Nykaa also opened 10 new physical stores (+55% YoY growth in GMV with 8.8% contribution to GMV) in BPC taking total store count to 145 stores across 60 cities (store expansion to be prudent going forward; <50 stores in FY24E). GMV of other business (eB2B business) grew by 1.7x to Rs1.5bn (~5% contribution in FY23). Own brands for BPC business moderated with 13% YoY GMV growth (~12% contribution to BPC GMV) while fashion owned brands grew GMV by 2x (~13% of Fashion GMV). Order conversion to visits (company continues to focus on driving higher order conversion and quality traffic) has improved by 30bps YoY and 10bps YoY for BPC and Fashion business in Q4, respectively. This is visible in Average order value (AOV) which continues to be strong for both the businesses with 5% YoY and 18% YoY for BPC and Fashion business, respectively.

* Gross margin improved due to better brand mix while fulfilment and marketing expenses continue to optimised: Gross margins improved by 50bps YoY to 44.2% due better brand mix. Overall EBITDA margin expanded by 150bps YoY (+10bps QoQ) to 5.4% largely driven by lower marketing & advertising expenses (-130bps YoY) due to focus on better order to visit conversion and fulfilment expenses (- 180bps YoY) due to regionalisation strategy of fulfilment centres (split shipment reduced 1.3 to 1.17). Management highlighted margin expansion will be driven through 1) optimisation of marketing spends as the cohorts of repeat customers increase vs new customer and 2) scale up of eB2B business (focus on servicing in concentric circles around fulfilment centres to drive efficiency). Nykaa continues to invest in the business leading to higher employee cost (incremental investment in technology function, new initiatives, store expansion). Management plans to optimise employee cost with control in hiring of core employees (headcount growth reduced to 4% YoY in Q4 vs 25-27% YoY growth in Q1 and Q2) while stores and sales employee count will be driven by store expansion and scale of eB2B business. Steep increase in depreciation was led by incremental capex on retail expansion (+43% YoY in store area), warehouses (+79% YoY in warehouse capacity) and office space (68% YoY in office space). There will be likely moderation in expansion of store (on this base), warehouse (regionalisation strategy almost completed; likely pause for 12-18 months) and office space.

* Cash flow from BPC business funding other businesses: OCF before working capital adjustment grew by 55% YoY to Rs2.9bn which funded the incremental working capital requirement for other businesses leading to negative OCF of Rs1.4bn (vs negative Rs3.5bn in FY22). FCF came in at negative Rs3.5bn due to incremental capex as discussed above.

* Valuation and risks: We increase our earnings estimates by 8%/12% for FY24E/FY25E. We model revenue and EBITDA CAGRs of 33% and 74% respectively over FY23-FY25E. Upgrade to BUY (from ADD) rating and DCF-based unchanged target price of Rs165. Key risks: (1) chasing growth at elevated levels can be dilutive of gross margin, (2) success in fashion business can be difficult given higher competition in the category. On the upside: Competition in the e-BPC space further weakens.

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