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In line sales, margin to see a sharp recovery from 4QFY23

* PIDI reported an in line 2QFY23 sales and volume growth. Volume growth in the Consumer and Bazaar segment stood ~1%, which indicates the effect of a high base over the preceding few quarters.

* While the acquisition costs of a key raw material (VAM) have nearly halved in the past few months, considerable high cost inventory, impact of depreciation in the INR and no material reduction in other raw material costs mean that gross and EBITDA margin now appears likely to recover from 4QFY23 onwards.

* While the earnings outlook for 4QFY23 and FY24 remains healthy (35-45% EBITDA growth), steep valuations more than discount this growth and do not leave any room for upside. We maintain our Neutral rating.

Sales in line; higher-than-expected GM pressure

* Net sales jumped 14.7% YoY to IN30.1b (in line).

* Overall gross margin contracted by 440bp YoY to 41% (est. 42%).

* As a percentage of sales, lower employee expenses (down 30bp YoY to 10.1%) and higher other expenses (up 20bp to 14.3%) led to a 430bp contraction in EBITDA margin to 16.6% (est. 17.2%) in 2QFY23.

* EBITDA declined by 9% YoY to INR5b (est. INR5.3b) in 2QFY23.

* PBT declined by 11.3% YoY to INR4.4b (est. INR4.6b) in 2QFY23.

* Adjusted PAT declined by 10.7% YoY to INR3.3b (est. INR3.5b) in 2QFY23.

* Sales/EBITDA/adjusted PAT grew 33.9%/14.7%/16.7% in 1HYF23 to INR61.1b/INR10.3b/INR6.9b.

* Revenue from the Consumer and Bazaar (C&B) segment grew 14.1% YoY to INR24.3b, with segmental EBIT declining by 9.6% to INR5.3b. Segmental EBIT margin fell 570bp YoY to 21.7%. B2B: Revenue grew 17.2% YoY to INR6.2b, with segmental EBIT growing by 88.4% YoY to INR495m. Segmental EBIT margin expanded by 300bp YoY to 7.9%.

Highlights from the management commentary

* Urban demand and Real Estate activity remain good. However, rural demand, which was affected in recent months, needs to return for growth to turn healthy.

* Volume growth was between 1.2% to 1.5% in the C&B segment in 2QFY23 (est. 2%).

* VAM consumption costs stood at USD2,491/t in 2QFY23 v/s USD2,231/t in 1Q. The current ordering rate is much lower at USD1,200-1,300/t, however other RM costs have not reduced. The depreciation in the INR is resulting in much higher RM cost. Its VAM inventory was acquired at reasonably higher levels. EBITDA margin is likely to improve northwards of 20% only by 4QFY23.

* PIDI has not taken any price reduction in the C&B segment in 3QFY23 after the fall in RM costs. It will take it as and when required.

Valuations and view

* Changes to our model have resulted in an FY23/FY24 EPS impact of ~7%/~4% due to the EBITDA miss in 2QFY23 and high-cost RM inventory.

* Nevertheless, a sharp reduction in VAM cost is currently being witnessed and along with good demand will lead to healthy earnings growth from 4QFY23 onwards. While the earnings outlook for 4QFY23 and FY24 remains healthy (35- 45% EBITDA growth), steep valuations more than discount this growth and do not leave any room for upside. We maintain our Neutral rating.

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