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Weak Q4 on expected lines; gunning for growth now

* Q4 EBITDA exceeded our/street estimates by 12-33% on a 130-190bps beat on margins. Revenue growth was weak at 6% in Q4 with a 14% fall in EBITDA, due to a slower pickup in ethnic (vs. western) and focus on profitable growth with lower discounting.

* Recovery is faster at ~90% in Q1TD, with consumers opting for fashion vs. value spends in the recent past. TCNS has completed tech-based investments in the supply chain and is leveraging its strong balance sheet to invest in network expansion/fresh inventory.

* Store additions were strong at 18/24 in Q3/Q4, with ~100 net additions expected in FY23E. Recent flagship stores are operating at an attractive payback of 12-18 months. It expects a Rs1bn run rate from new launches, Footwear/Elleven, by FY23E from Rs0.4bn currently.

* As women return to work, TCNS would benefit more thanks to its differentiated styles, strong expansion and better online presence. Retain Buy with a revised TP of Rs1,030 on 37x Jun’24E EPS (vs. 38x). We cut TP/multiple due to 25bps high WACC and 3m rollover.

Faster recovery aided by better preparedness:TCNS reported weaker revenue growth (up 6% at Rs2.3bn) than peers in Q4 (on expected lines), due to a slower pick-up in ethnic (vs. western/celebration), focus on profitable growth with lower discounting, and 4-5% growth impact of inventory realignment with online partners to increase the D2C share. However, its post-third wave recovery has been faster, with a ~90% recovery in physical channels in Q1TD. Demand trends are encouraging amid reopening of offices and consumers opting for fashion vs. need-based spends during Covid. From the supply side, all tech interventions (automated replenishment/warehouse integration) are in place and inventory is fresh across all 4,000 points of sales, unlike carry forward inventory during the pandemic. Store addition was robust, with 18/24 net additions in Q3/Q4, and is expected to stay strong with ~100 net additions in FY23E. The expansion would be driven by FOFO EBOs in Tier3/4 towns and by flagship EBOs (COCO) in the coveted retail pockets of India. Online traction (~21% rev mix in FY22) remains strong with ~25% growth expected in FY23, led by ahead-of-the-curve D2C/omni investments (50-60% online mix). Among new launches, footwear is contributing in double digits to sales in ~200 stores, and store additions for Elleven have accelerated with 10/12 store additions in Q4/FY22. TCNS targets a Rs1bn run rate from these forays by FY23E-end.

Operating leverage to drive margin gains: A change in the channel mix optically led to a 1,140bps gain in gross margin in Q4. However, EBITDA margins fell ~200bps to 8.4% due to a one-off receivable loss. Negative operating leverage and investments in growth channels kept EBITDA margins below pre-Covid levels in Q4. We expect margins to see a sharp jump in FY23/24E, led by a recovery in per-store revenues and traction in new growth areas.

Retain estimates; Maintain Buy: TCNS is a leader in the salwar-kameez industry, with design-sourcing edge, 2x-3x penetration potential and a strong online presence. Maintain Buy with a revised TP of Rs1,030 (Rs1,070 earlier) on 37x Jun’24E EPS (38x FY’24 earlier). The multiple reduction was due to 3M rollover and a 25bps increase in WACC.

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