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Serious (but another) attempt on execution improvement (on multiple fronts) – upgrade to HOLD

Bata reported (an in-line) revenue recovery back to pre-Covid level. The recovery though decent, is weaker than most discretionary categories. While some of its key segments (like formals, school-wear) have still not (fully) recovered, the focus on casualization (mainly sneakers) has driven overall recovery.

We like the focus on (1) ramping up omni-channel capabilities, (2) increasing distribution and reach in tier 3-5 towns, (3) capturing semi-urban / rural demand through franchisee stores and (4) brand spends (under-invested for last several years). It has also highlighted renovations in several stores (to modernise). Going forward, improved product mix should also aid margin expansion.

While Bata’s focus on premiumisation, improving brand perception and expanding distribution are steps in the right direction, there will be challenges along the way. That said, the execution seems to be improving and some easy wins will improve the (earnings) trajectory. Bata is also likely to be a key beneficiary of improved mobility as things further normalise (schools, offices). We upgrade to HOLD (from REDUCE) and increase our DCF-based TP to Rs1,850 (from Rs1,750).

* Casualisation drives (in-line) revenue recovery: Q3FY22 revenue was up 37% YoY to Rs8.4bn (1% above I-Sec). We note that Bata’s recovery has lagged other discretionary categories and sales are now back to pre-Covid level; on 2-year CAGR basis, revenue is up 0.7%. In terms of monthly trend, sales in October were 10% below pre-Covid, but were up 2-3% vs pre-covid in November and December. We note that Bata sales still continues to be impacted by continued weakness in schoolwear and formals categories. The recovery in overall sales is led by increased focus on casuals (increased sales mix of sneakers). We note that (1) sneaker studio is being ramped up (current pilot in 15 stores) and (2) higher spends on marketing campaigns (two key campaigns with one focused on sneakers). Some of the recovery was driven by improved omni-channel capabilities (online and omni-channel contributed 11% of overall revenues).

* EBITDA margin continued to be weak: Gross margin expanded 114bps YoY to 52.7% in 3Q (I-Sec: 53%) while it was down 22bps on a QoQ basis. However, EBITDA margin print was much below expectation at 20% (I-Sec: 25.9%) due to 29% rise in staff costs and 58% increase in other opex (as per management, marketing spends were higher by 34%).

* Company initiatives: Bata opened 34 additional franchise stores (total 284 now) in smaller towns and cities. Besides, it is confident of a better growth trajectory going forward on the back of expansion in tier 3-5 towns and growth in e-commerce channels. In terms of distribution, it now covers 1,005 towns (compared to 892 in Mar-20).

* Valuation and risks: We increase our FY23-24 earnings estimates by 9-5%; modelling revenue / EBITDA CAGR of 32 / 88 (%) over FY21-24E. Upgrade to HOLD with a DCF-based revised target price of Rs1,850 (earlier Rs1,750). At our target price, the stock will trade at 46x P/E multiple Sept-23E. Key upside risk is faster-than-anticipated recovery in discretionary demand. Key downside risk is increase in competitive intensity.

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