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Good 3Q; Broad-based performance

Q3 witnessed continued growth as gross revenue grew 16% (volume-led), driven by broad-based strong brand performance. We believe the acquisition of Heinz India business is transformational for Zydus Wellness, given the increased consumer focus (COVID-led) on health and wellness – likely accelerated consumer adoption of >70% of the portfolio (Sugar Free, Glucon-D, Nutralite and Complan). We especially like – (1) 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, and (2) expanding direct reach to 0.5mn outlets (0.4mn outlets now) by Mar’21. Deleveraging is likely to drive FCF generation faster. However, we await greater clarity and management’s comments on goodwill not allowed amortization for tax purposes from FY22 as announced in the Union Budget. BUY.

* Gross revenue grew 16%: Reported revenue grew 15% (gross revenue up 16%) while reported EBITDA grew 33% and recurring PAT grew ~3x to Rs359mn (driven by lower finance cost). Revenue growth was driven by strong performance of double-digit growth in Sugarfree and Everyuth and good performance of Glucon-D and Nycil in off season. Nutralite (75% is B2B business) saw sequential recovery. Further, E-commerce business grew by 2.4x.

* Margins expanded as input cost benefits offset by higher ad-spends: Gross margin expanded 260bps to 54.6% due to benefits of deflationary milk prices. However, reported EBITDA margin expanded lower by 180bps to 13% driven by significant step-up in ad-spends (+450bps YoY; +65% YoY) which to some extent was offset by lower staff cost (-260bps) and other expenses (-110bps). However, management stated that they are on track to reach EBITDA margins of 20% by FY22.

* Balance sheet deleveraged: Company successfully bought back non-convertible debentures of Rs11bn by raising equity of Rs3.5bn (preferential issue) and 6.5bn (QIP). However, Zydus had to pay a one-time premium on redemption of NCDs of Rs342mn (categorized as exceptional expense in Q3). The company has further taken a low-cost debt of Rs5.65bn to pay off the balance debt and premium. This led to lower interest cost of Rs99mn (down 72% YoY) in 3Q.

* Valuations and risks: We cut our earnings estimates by 1-2% for FY22-23E. We model revenue / EBITDA / PAT CAGR of 7% / 13% / 39% over FY20-23E – net profit to grow ahead of revenue and EBITDA driven by deleveraging of balance sheet. Maintain BUY with a DCF-based unchanged target price of Rs2,500. At our target price, the stock will trade at 35x P/E multiple Mar-23E. Key downside risks are delays or failures in new product development or inability to expand distribution.

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