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Margin pressure sustains

Relaxo Footwears sales grew 34% YoY and 3% over 1QFY20 (pre-pandemic quarter) to Rs6.7bn (our est. Rs6.2bn). Sales, though marginally over our estimates, as we had highlighted in our last channel check note published on 6th July’22 that impact of inflation will be felt most for the companies catering to value for money segment including the likes of Relaxo. Gross margins largely remained flat to 54.1% QoQ and YoY. The gross margin profile is in-line to what Relaxo used to make during the pre-pandemic quarters of 1QFY18/FY19/FY20. EBITDA margins contracted by 40bps YoY to 12.9%. The decline however is sharper and at 350bps if compared with 1QFY20. Other expenses shot up to 28.1% of sales thus hurting margins. As a result, PBT and PAT too declined sharply by 30% and 22% respectively over 1QFY20. We would like to wait for one more quarter before we tweak our estimates. We maintain our estimates, ADD rating and target price of Rs1,057 valuing at 60x FY24E.

Expecting demand and margin trend to improve from 3Q

Our channel checks have suggested that the impact of inflation on the consumer base of Relaxo is far higher than the footwear companies targeting the mid-premium to premium segments. We also, observed downtrading by some segment of Relaxo’s consumers hurting the company’s sales. We expect demand trend to improve meaningfully starting 3QFY23 as the festive season approach and price hikes get fully absorbed into the markets. Relaxo had taken cumulative price hikes of 20-25% in 3Q/4QFY22 to mitigate the impact of RM inflation and GST rate hikes. The impact on EBITDA margins this quarter was on account of higher other expenses (28.1% of sales) which largely include – Advertisement & Sales Promotions, Freight cost and Power & Fuel cost. We expect these cost items to normalize on a sequential basis and helping improve margins.

Long term secular trend intact

We remain confident on Relaxo’s long term growth trajectory despite short term hiccups. Company currently boasts manufacturing capacity of 1mn pair per day. Current capacity utilization is at ~65% and expected to pick up over the next two years. Relaxo continues to invest in the brands and its A&P spends have normalized and were back to 4% of the sales during FY22. Apart from this, Relaxo will do capex of Rs1bn in FY23 to strengthen its backend at existing units, build IT infrastructure and some regular maintenance work. Despite the relentless RM pressure, the company continued to maintain its market share and maintains its premium pricing of 5-10% over its peers. Retail footprint expansion of 10k outlets during FY22 followed by cutting down on weaker distributors should help company strengthen its foundation and support long term growth trajectory. Sparx brand will continue to support the ASP growth for Relaxo in times ahead.

Valuation

We maintain our bullish stance on Relaxo in the footwear industry. We expect margin pressure may sustain for one more quarter before improving back. With polymer prices cooling off sharply over the last three months we expect gross margin improvement on a sequential basis. We maintain our EPS estimates, ADD ratings and target price of Rs1,057. We value the business at 60x FY24E.

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