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Beat on all fronts, outlook remains good

* PAG’s 1QFY23 result surprised on the revenue front, leading to a beat on overall estimates, despite a higher than expected pressure on gross margin. The management expects yarn costs to come off by Oct- Nov’22.

* Three year revenue CAGR (compared to pre-COVID levels) remains healthy ~17%. We expect the healthy momentum to continue. The management expects operating margin to be in line with its long-term average of 20-22%.

* While the outlook remains robust, we maintain our Neutral rating on account of its rich valuation.

Sales outperformance led to an overall beat

* PAG reported a sales growth of 167.4% YoY to INR13.4b (est. INR11.3b) in 1QFY23 over a soft base.

* EBITDA grew 8.7x YoY and 11.5% QoQ to INR3b (est. INR2.6b). PBT grew 18.9x YoY and 11.6% QoQ to INR2.7b (est. INR2.3b).

* Adjusted PAT grew 18.9x YoY and 8.7% QoQ to INR2.1b (est. INR1.7b)

* Gross margin contracted by 320bp YoY and 490bp QoQ to 54.5% (est. 58%).

* As a percentage of sales, lower employee/other expenses (fell 1,430bp/ 430bp YoY to 16.1%/16.2%) led to an 1,540bp YoY expansion in its EBITDA margin to 22.2% (est. 22.5%).

* On a three-year CAGR basis, sales/EBITDA/PAT grew 17.1%/16.9%/23.2%

* The Board has declared its first interim dividend of INR60/share.

Highlights from the management interaction

* The company is witnessing good traction in all regions (metro and Tier II/III/IV cities). Premiumization is also healthy.

* Raw material inflation was seen in cotton yarn, logistics, and packaging. The management expects cotton prices to reduce by Oct-Nov’22.

* Price hike: PAG has taken a 3.5-4.5% price hike.

* Capex stands at IN4.5b in FY23. It is investing in digital technology for better efficiency, modernization, assortment planning, and expansion in Odisha.

* It is chosen to raise the number of shifts to increase the capacity. The management said there are no regulatory issues with regard to the same.

Valuation and view

* Strong sales momentum led to an increase in our FY23/FY24 EPS estimate by ~7.5% each, even as near-term challenges with regard to higher material cost persist.

* After a few years of an earnings decline (-4.3% PBT CAGR over FY18-21), its performance in FY22 has been encouraging, resulting in an improved outlook. RoCE revived to over 50% after 15 years, having dipped to the late 30s in recent years.

* PAG’s higher multiples will sustain, driven by healthy revenue and earnings visibility. However, valuations at 60.4x FY24E EPS are rich, which leads us to maintain our Neutral rating.

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