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Topline below our expectations; increase in ad spends augurs well

*  P&G Hygiene & Health Care’s (PGHH) 3QFY21 sales growth, while healthy at 15.8% YoY, was lower than our expectations, considering: a) the strong momentum in recent quarters; and b) a favorable base, with a 6.2% sales decline in 3QFY20 (June year-ending company).

* There was a steep increase of 73% YoY in advertising spends, translating to ad spends coming in at 17.1% of sales in 3QFY21, much higher than the usual quarterly levels of 9-12% of sales. With gross margin actually above expectations (up 20bp YoY v/s our expectation of a 160bp YoY decline), high ad spends was the key reason for the miss on our EBITDA margin forecasts. The increased ad spends augur well for maintaining the sales growth momentum seen in recent quarters.

* The special dividend of INR150 per share is encouraging. Along with our forecast of 80% dividend payout in coming years, we believe special dividends will be an intermittent feature of the business every 2-3 years, given the healthy cash generation. This also elevates return ratios. Valuations at 47.9x FY23E EPS are not cheap, but best-of-breed structural earnings growth potential and improving RoEs lead us to maintain our BUY rating.

Sales disappoint, margin came in lower on increased ad spends

* Sales in 3QFY21 grew 15.8% YoY to INR7.6b (v/s our estimate of INR8.2b), with EBITDA (adjusted) fell 1.5% to INR1.4b (v/s our expectation of INR2b), PBT (adjusted) declined 1.4% to INR1.4b (v/s our estimate of INR1.9b), and adjusted PAT grew 2.6% to INR1b (v/s our expectation of INR1.5b).

* Reported PAT grew 7.9% to INR983m.

* During 3QFY21, non-current assets held for sale were fully impaired as PGHH was unable to dispose of these assets. Consequently, an impairment loss of INR76.4m has been recognized.  Gross margin expanded 20bp YoY to 66.8% (v/s our estimate of 65%).

* Ad spends grew sharply (73.4% YoY) to INR1.3b, employee expenses grew 13.5% to INR570m, while other expenses (adjusted) rose 6.4% to INR1.8b.

* As a percentage of sales, employee costs/other expenses (adjusted) fell 20bp/210bp YoY to 7.5%/24.3%. Ad spends grew 570bp YoY to 17.1%, leading to a 320bp contraction in EBITDA margin to 17.9% (v/s our estimate of 24.1%) in 3QFY21. In 9MFY21, ad spends were up 14.3% YoY and stood at 11.8% of sales, which is slightly elevated when compared to the last three years, where they have been in the 10-11% range.

* Sales/EBITDA/adjusted PAT grew 17.7%/22.7%/25.8% YoY in 9MFY21.

Highlights from the management commentary

* Feminine Care and Healthcare businesses delivered strong double-digit growth in 3QFY21.

* The company has declared a special interim dividend of INR150/share of INR10 each. This is noteworthy as we were expecting a final dividend of INR150/share.

* The management continues to focus on superior execution, improving productivity, leading constructive disruption, and strengthening its organization and culture.

* The strategies mentioned above have enabled PGHH to deliver consistent results, thus proving that these strategies will deliver balanced growth over the long-term.

Valuation and view

* While there has been a 7.7% reduction in our FY21E EPS estimate (June yearending company) due to: a) sales miss, b) much higher ad spends relative to expectations, and c) as we exercise some caution on sales growth in 4Q due to the ongoing lockdowns, there is no significant change to our FY22E/FY23E EPS estimate.

* Two factors make PGHH an attractive long-term core holding: a) huge category growth potential in the Feminine Hygiene segment (~67% of sales), coupled with potential for market share gains due to considerable moats, and b) potential for higher margin gains from premiumization in the Feminine Hygiene segment over the long term.

* While valuations are not cheap at 47.9x FY23E EPS, strong topline and earnings momentum, best-of-breed structural earnings growth potential, and improving RoEs will ensure premium multiples. We maintain our BUY rating with a TP of INR15,900/share (targeting 55x FY23E EPS)

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