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Base effect persists; stock fairly priced

Tarsons Products’ (Tarsons) Q2FY23 performance was marginally below our expectations. Revenue declined 6.3% YoY (+3.8% QoQ) to Rs712mn on a high covid-led base (I-Sec: Rs741mn). EBITDA margin declined 470bps YoY to 45.9% (ISec: 46%) on lower gross margin of 76.8% (-230bps YoY). Adj. PAT declined 13.7% YoY to Rs215mn (I-Sec: Rs221mn). Tarsons commands industry-leading EBITDA margin (~51% in FY22) supported by technical expertise and economies of scale. We like the company for its strong domestic presence with favourable industry tailwinds, growing export opportunity and robust financials. However, we believe, near-term growth expectations have been largely captured at current valuations, hence, we maintain HOLD on the stock with a revised target price of Rs755/share.

* Business review: Revenue declined 6.3% YoY on the high covid-led base of Q2FY22. Adjusting for covid-related revenue, we estimate base business would have grown ~44% (on an impacted base) in H1FY23 vs H1FY22. Domestic business fell 15.4% YoY and 8.3% QoQ. We expect the benefits of the price hike and volume growth to support domestic revenues in coming quarters. Export business grew 8% YoY (+35% QoQ) driven by currency tailwinds and volume growth. Elevated raw material prices and product mix change dragged gross margin down by 230bps YoY and QoQ to 76.8%. Additionally, higher costs have pushed EBITDA margin lower by 470bps YoY to 45.9%. We expect the company to maintain healthy margins of ~46-48% over FY23E-FY25E led by improvement in product mix, higher contribution from new products and in-house sterilisation, partly offset by higher costs due to commencement of new plants.

* Key concall highlights: 1) Costs: raw material prices have been largely stable, 2) Panchla: i) 80-85% of the work has been completed, ii) revenue may start flowing in from the facility from Q4FY23, iii) asset turns to be ~0.6-0.65, 3) price hike benefit to gradually play out till Q1FY24. 4) Capex of ~Rs3bn (out of Rs5bn allocated) has been incurred so far.

* Outlook: We introduce FY25E and expect revenue/EBITDA/PAT CAGR of 10.7%/8.5%/6.3% over FY22-FY25E. Revenue will likely be driven by growth in both domestic and export markets, while maintaining margins of ~46-48%. We expect RoE and RoCE of 16.2% and 16%, respectively, by FY25E.

* Valuation and risks: We cut our revenue/EBITDA estimates by ~5%/~7% for FY23E-FY24E to factor slower-than-expected growth in domestic business. We remain positive on the business but we believe near-term growth potential has been largely captured at current valuations, hence, we maintain HOLD on the stock with a revised target price of Rs755/share based on 22xSep’24E EV/EBITDA (earlier: Rs756/share). Key upside risks: Increased market share gains and strong growth in end-user industries. Key downside risks: Intensified competition, disruption in distribution network.

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