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Demand subdued; outlook remains uncertain

* PAG posted a muted 1QFY24 performance due to a slowdown across all categories, resulting in a 23.5% YoY drop in Adj. PAT. There was a strong improvement in QoQ basis. Volume declined 11.5% YoY but grew 31% QoQ.

* GP margin contracted 160bp YoY and 370bp QoQ. EBITDA margin also dropped 270bp YoY but improved QoQ due to low product costs and better overhead absorption. The management expects to maintain EBITDA margins within the 19-21% range.

* The medium-term sales and earnings outlook remains uncertain for PAG. We maintain our Neutral rating on the stock due to elevated valuations.

Miss on estimates but trends improve

* Sales declined 7.5% YoY to INR12,400m (est. INR13,547m) in 1QFY24.

* EBITDA declined 18.8% YoY but increased significantly by 80.1% QoQ to INR2,419m (est. INR2,533m).

* PBT was down 23.5% YoY/up 97.1% QoQ at INR2,100m (est. INR2,263m).

* Adj. PAT fell 23.5% YoY but grew 102% QoQ to INR1,584m (est. INR1,704m).

* Gross margin contracted ~160bp YoY to 52.9% (est. 55.8%).

* As a percentage of sales, higher employee expenses (+70bp YoY to 16.8%) and other expenses (+40bp YoY to 16.6%) led to EBITDA margin contraction of ~270bp YoY to 19.5% (est. 18.7%).

Highlights from the management commentary

* Despite the current market challenges, the management has effectively increased margins by improving the quality aspects of their inventory.

* Volumes reached 55.8mn, up 31% QoQ and down 11.5% YoY.

* The E-commerce channel witnessed substantial growth of 43%.

* Advertising expenses increased to ~2.5% in 1QFY24 from ~1.9% in Q4FY23.

* Inventory duration declined to 105 days by Jun’23 end from 164 days in 4QFY23, in line with the management's annual target.

Valuation and view

* Changes to our model have led to a ~1%/~3% reduction in FY24/FY25 EPS estimates because of lower volume and near-term demand challenges.

* After a few years of an earnings decline (-4.3% PBT CAGR over FY18-21), PAG’s performance in FY22 was encouraging with strong 57.5% EPS growth YoY. This seems to have petered out to a sedate growth of 6.5% in FY23. If demand recovers in the next quarter, we believe that the company can still grow its earnings by ~13% over the next two years.

* PAG’s medium-term earnings prospects have improved because of investments made in distribution, designs, and technology. RoCE is also likely to be ~40%, after falling to the late 30s in FY20 and FY21. However, the valuation at 55x FY25E EPS is expensive; hence, we reiterate our Neutral rating on the stock with a TP of INR39,080.

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