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Buy Sheela Foam Ltd For Target Rs. 2,500

SFL’s 3Q revenue grew 26%, a significant beat. We like (1) continued growth in branded mattress (+18%) and recovery in foam cores (+23%) and technical foam (+33%) in India, and (2) acceleration in growth in Australia and Spain subsidiaries (+35% and +100% respectively) – the best since IPO. Long-term growth opportunities are DCF-accretive and importantly embellish the narrative as well – (a) benefit from China+ strategy of buyers in US, Europe (grow exports from Spain and India – expect exports to cross Rs1bn in FY22), (b) opportunity in furniture cushioning and manufacturing (under SleepX brand), (c) sustained acceleration in India business growth (competitive edge through EBO network) and consumers realizing importance of good quality mattress. Price hikes in branded mattress and effective cost controls are likely to mitigate pressure from rising input costs. Maintain BUY.

* Strong broad based performance: Consolidated revenue / EBITDA / PAT grew 26% / 53% / 55%. This performance was broad based – branded mattresses (revenue +18%, volume +16%), foam core (+23%) and technical foam (+33%). However, furniture foam grew just 2% and home comfort recovered sequentially (+54%) but declined 26% YoY. Australia business revenue grew 35% YoY. Revenue from recently acquired Spain business doubled. Performance in B2C business was driven by some pent-up demand, change in consumer behavior towards better mattresses and industry formalization. The B2B business growth was driven by good traction in the auto sector.

* Margin expansion despite steep input cost inflation: Comparable gross margin declined 550bps to 43.5% due to input cost headwinds (TDI at Rs211/kg was up 64% YoY; Polyol at Rs216/kg was up 116% YoY). However, EBITDA margin expanded 310bps YoY to 17.4% driven by lower ad-spends, operating leverage and cost savings – lower employee costs (-110bps) and other expenses (-750bps). Australia and Spain business have EBITDA margins of 17.4% (+400bps YoY) and 18% (-200bps) respectively. We note that input costs have eased in Jan’21 – TDI at ~Rs170/kg and Polyol at ~Rs200/kg.

* Valuation and risks: We increase our FY22E earnings estimates by 8%; modelling revenue / EBITDA / PAT CAGR of 17% / 21% / 26% over FY20-23E. Maintain BUY with a DCF-based revised target price of Rs2,500 (was 2,300). At our target price, the stock will trade at 30x P/E multiple Mar-23E. Key downside risks are (1) adverse movement in prices of key inputs – TDI and polyol and (2) increase in competitive intensity from global players or Indian e-commerce.

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