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D2C-led transformation gathering pace

* AFL is transitioning into a higher-quality, D2C-led fashion platform under its ‘Arvind 3.0’ strategy, with improving execution, a stronger D2C mix, and margin-accretive growth.

* Execution is improving meaningfully, led by USPA, which has emerged as a key earnings driver in FY26, delivering ~20% growth and improving profitability supported by better inventory quality, faster sourcing cycles, and operating leverage.

* The portfolio mix is improving, with adjacent categories now at ~25% of revenues and growing faster than core apparel, thereby enhancing retail productivity and reducing cyclicality.

* This mix shift toward a more retail- and D2C-led model is improving capital efficiency, with RoCE expanding (to 18.5% in FY26) despite higher inventory intensity, supported by better product mix, stronger margins, and improving cash conversion.

* We expect AFL to deliver ~12% revenue CAGR and ~17% pre-Ind AS EBITDA CAGR over FY26-28, with margins expanding ~70bp to ~9% by FY28E. PAT is expected to expand at a ~21% CAGR, driven by sustained profitability improvement and continued balance sheet deleveraging.

* Despite improving earnings quality and convergence in fundamentals, the company continues to trade at a ~10% EV/EBITDA and ~30% P/E discount versus Aditya Birla Lifestyle Brands (ABLBL), which we view as difficult to justify given its improving growth profile, capital efficiency, and profitability trajectory.

* We have a BUY rating with an SOTP-based TP of 620 (unchanged)

Valuation and view

* AFL is delivering steady operating momentum despite a subdued demand backdrop, supported by consistent execution across retail, online, and brand portfolios. Growth is increasingly driven by direct channels, improving mix, inventory discipline, and margin quality.

* USPA has emerged as the key earnings driver with broad-based traction across channels, while adjacent categories continue to scale profitably, adding a second growth engine without diluting margins and improving overall earnings quality.

* Despite this, the stock has corrected ~25% since Aug’25, with valuation now at ~34x FY27E earnings (vs. ~45x for ABLBL). We see this as an attractive entry point into a franchise with an improving mix, stronger direct channel exposure, and visible adjacency-led growth runway.

* We expect revenue/pre-Ind AS EBITDA CAGR of ~12%/17% over FY26-28, with ~70bp margin expansion to ~9.0% by FY28. PAT is expected to expand at a ~21% CAGR, driven by sustained profitability improvement and continued balance sheet deleveraging.

* We reiterate BUY with an unchanged SOTP-based TP of 620.

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