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Margin headwinds and rich valuations can set in a phase of underperformance; reiterate REDUCE

Result Highlights

* India operations – India business delivered muted topline with 28% growth in beverages (3% volume growth) and 19.6% growth in foods (17% volume growth) led by ~18% growth in salt and robust 12% growth in Sampann on high base (30% 2‐yr CAGR); margins were sharply lower by 960bps/580bps to 11.9%/13.6% in India‐Beverages and foods due to a combination of tea & coffee inflation and increased A&P spends.

* International operations – Growth was impacted by pantry loading in the base quarter further dented by margins contraction; 18% decline in US coffee (16% volume decline) and 3% revenue decline in international tea (9% volume decline).  

* Market share  ‐ Market share gains in both key categories of tea (+170bps) and salt (+370bps) mainly led by distribution expansion and better on‐ground execution.

* Key priorities ‐ With completion of integration of foods business, company aggressively investing in sales and distribution infrastructure, digital, A&P and innovation.

Valuation and view –

While volume growth in core categories of tea and salt was strong, the 4Q margin performance was quite weak as the company did not fully pass on tea inflation and continued its A&P aggression in addition to investing in Sampann business. While the management expects tea prices to start cooling off and tea margins to normalize in 2H, that remains a risk. Salt business growth can also normalize given capacity constraints in near‐ term while Sampann can finally see some acceleration which it has failed to deliver so far. The international businesses might find it difficult to grow on a high base with margins facing some RM headwinds. Starbucks (increased delivery focus) and Nourishco (geographic expansion for Water Plus) should ramp‐up well going forward while the coffee business should have a stable FY22. With commodity inflation expected to settle down in 2HFY22, the company is set for strong EBITDA growth as its growth momentum continues and margins start normalizing in addition to getting the synergy and premiumization benefits. But given the near‐term margin headwinds coupled with rich absolute and relative valuations, we believe the stock is set for a period of underperformance. Despite rolling over to FY24 earnings, we don’t see justifiable upside in the stock and therefore reiterate our REDUCE rating. We model in revenue/EBITDA/PAT CAGR of 11%/15%/23% over FY21‐24E assuming strong margin improvement and increase our SOTP‐based PT to Rs 776, implying 45x FY24E earnings.

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