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Weak quarter with GM recovery the only positive

2QFY23: Revenue print further weakened, down 8% YoY. India braded business’ 16% YoY revenue decline (volumes down 18% YoY) was quite weak with it highlighting a softer demand environment (surprising to us given urban discretionary as a basket continues to perform well in general). There was good improvement in gross margin print (+470-480bps YoY/QoQ) with RM softening. While some uptick from auto segment is expected, the furniture segment demand is slightly sluggish. Australia continues to trend well (was up 11% YoY) while Spain business is weak (-17% YoY) - some near-term headwinds.

Our positive stance on Sheela Foam is based on the long-term opportunities which also embellish the narrative – (a) benefit from China+ strategy of buyers in the US, Europe, (b) opportunity in furniture cushioning and manufacturing (under SleepX brand), (c) sustained acceleration in India business growth (competitive edge through 5,000+ EBO network), (d) consumers realizing importance of good quality mattress and (e) focus on growing e-commerce channel. BUY.

* Weakness across particularly in India branded business: Consolidated revenue performance was muted given 1% QoQ (down 8% YoY) decline to Rs7.2bn, below our estimate. Branded mattresses segment revenue was down 16% YoY with volume decline of 18%. Overall India business was down 9% YoY. Performance of B2B segments in India was mixed: while furniture foam and foam care were down 18-20% YoY, technical foam reported a good 24% YoY growth. Australia business revenue was up 11% YoY while Spain reported a 17% YoY decline.

* Recovery seen in margins: Gross margin recovered 470-480 bps on YoY and QoQ basis to 44.6%. We note that the gross margin print is still down ~5 ppts from the pre-covid level. We note that both key raw materials are showing some signs of softening – TDI at Rs248/kg was up 43% YoY but down 7% QoQ; Polyol at Rs131/kg was down 35% YoY and 25% QoQ. We note that TDI prices have cooled-off after 4- 5 consistent quarters of rising price scenario. EBITDA margin improved sequentially (+180bps YoY) to 10.8% even as it was down YoY with a 27% YoY increase in opex

* Valuation and risks: We cut our earnings estimate by 4% for FY23E; modelling revenue / EBITDA / PAT CAGR of 12% / 31% / 33% over FY22-24E. Maintain BUY with a DCF-based revised target price of Rs3,400 (Rs3,500 earlier). Key downside risks are (1) adverse movement in prices of key inputs and (2) increase in competition from global players/Indian e-commerce.

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