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Sales in line, margin recovery taking longer than expected

* Despite a challenging base of 19% sales growth, PIDI reported a healthy 24% sales growth (in line with expectations) in 3QFY22 as demand remained strong. While Jan’22 has been affected by the third COVID wave, we have seen that demand recovery has also been sharp after the first and the second waves ebbed.

* While there was a significant miss on EBITDA margins in 3QFY22 led by high material costs, the management expects some stability in VAM costs post the Winter Olympics in China. Expensive multiples of ~65x FY24E EPS prevent us from turning positive on the stock. Maintain Neutral.

Sales in line, continued gross margin erosion leads to profitability miss

* Consolidated net sales grew 24% YoY to IN28.5b (in line). EBITDA declined 14.3% YoY to INR5.5b (est. INR6.4b). PBT declined 19.5% YoY to INR4.8b (est. INR5.7b). Adj. PAT declined 20.1% YoY to INR3.6b (est. INR4.2b).

* Overall sales volume and mix growth stood at 9.4% YoY with 9%/13% sales volume and mix growth in C&B/B2B segments.

* Consolidated gross margin contracted 1,120bp YoY to 43.6% despite price hikes amid continued unprecedented RM inflation.

* As a percentage of sales, lower employee expenses (-150bp YoY to 9.8%) and other expenses (-110bp YoY to 14.5%) led to EBITDA margin contraction of 860bp YoY to 19.3% (est. 22.1%).

* 9MFY21 sales/EBITDA/adj. PAT grew +46.6%/+18.6%/+15.9%, respectively.

* Segmental: a) Consumer & Bazaar (C&B) segment revenue was up 22.5% YoY to INR22.6b with segmental EBIT declining 12.7% YoY to INR5.6b. Segmental EBIT margin contracted 1,000bp YoY to 24.9%. b) B2B segment revenue rose 30.2% YoY to INR6.2b with segmental EBIT declining 28.3% YoY to INR400m. Segmental EBIT margin contracted 530bp YoY to 6.5%.

* Subsidiaries’ performances: Revenue from overseas subsidiaries grew 3% YoY to INR1.9b in 3QFY22. EBITDA declined 38.7% YoY to INR146m in the quarter. Revenue from domestic subsidiaries grew 55.1% YoY to INR3.4b, and EBITDA increased 28.5% YoY to INR566m in 3QFY22.

Highlights from the management commentary

* Growth was broad based across C&B and B2B segments with growth in urban geographies outpacing rural geographies.

* VAM cost: currently at USD1,850-1,950 per tonne having corrected from ~USD2,000-2,500 levels in 3QFY22. Consumption cost for 3QFY22 was USD1,968 v/s USD 876 in 3QFY21. Management is seeing some softening in VAM prices in Jan’22 and expects the prices to correct post-Winter Olympics in China as supplies should improve by then.

* Current capacity utilization is about 70-80% in different facilities.

Valuation and view: Expensive valuation; structural growth story intact

* Changes to our model after the significant EBITDA miss in 3QFY22 and likely pandemic impact on 4QFY22 demand have resulted in ~9% cut in our FY22 EPS but there are no material changes to our FY23E and FY24E EPS.

* Topline growth over the past five quarters is a vindication of the latent growth opportunities in the Core, Pioneer, and Growth categories. Once material costs stabilize (unclear for now), earnings growth could potentially be healthy post FY22.

* Nevertheless, while the structural investment case remains intact, valuations are expensive at 76.4x FY23E and 64.7x FY24E EPS. We maintain our Neutral rating, with a TP of INR2,470 (premised on 65x FY24 EPS).

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