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Weak execution; however, distribution (expansion) and product strategy (appears to be) in place

Q3FY22 was a weak quarter with 2% YoY revenue growth (8.7% on 2-year CAGR basis). Product mix (inferior) and high raw material costs continued to impact margins – EBITDA margin shrank 467bps YoY to 8.3%.

We continue to believe that the acquisition of Heinz India business is transformational for Zydus, given the increased consumer focus on health and wellness – likely accelerated consumer adoption of >70% of the portfolio (Sugar Free, Glucon-D, Nutralite and Complan).

We especially like the new product development strategy aimed to address some key challenges – SugarLite to address the taste penalty, Sugar Free Green is a natural product, Complan Nutrigro to regain lost medical connect of the brand. Zydus also expanded its direct reach which will allow it to participate in larger categories. Deleveraging is likely to drive FCF generation faster. That said, execution improvement and macro tailwinds - in tandem, appear a necessity for business performance (and hence, stock performance). BUY retained for now

Growth slows down: Reported revenue was up 2% YoY. Management highlighted that the slowdown was due to (1) weakness in rural and (2) reduced inventory (also trade). EBITDA was down 35% YoY. On 2-year CAGR basis, revenue print was better at 8.7%. It also achieved good growth in e-commerce – channel contribution has increased from 1% in 2018 to 5% in 2021.

RM pressure weighs on margins: Gross margin was down 637bps to 48.3% with inflationary pressure in select commodities. It has taken price hikes to underpin gross margins. Besides some of the margin improvement (going forward) will also be driven by improvement in product mix. Reported EBITDA margin contracted 467bps YoY to 8.3% (2QFY22: 8%) with a 6% cut in ad-spends while staff costs and other expenses remained flat

Other highlights: 1) The international division is seeing good growth (mainly Sugar Free and Complan) – 7x growth in the last three years and set to cross Rs1bn in revenues next year, (2) Growth in Complan should start picking up on the back of product refresh and NPD supported by marketing spends, (3) Nutralite will also continue to focus on value-added products in dairy (like ghee and butter), (4) focus will be to get 5-6% from NPD on a consistent basis, (5) SugarLite continues to scaleup well and contributes 7-8% of Sugar Free sales, (6) It can look at few bolt-ons to drive growth in the medium-term (high gross margin products)

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