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With BPC segment expected to be in focus in festive Q3, Nykaa Fashion garnered majority attention in the current quarter. The segment delivered 32%/17% NSV growth on YoY/QoQ basis while also reaching record contribution margin (as % of NSV) of 4.7%. With Indian market increasingly attractive for BPC brands, BPC segment saw higher discounting by brands with Nykaa also seeing reversal of advertising income on the new platform. Overall, the company reported 25%YoY GMV growth with BPC/Fashion/Others growing at 23%/27%/54%, respectively. Consolidated GMV for Q2FY24 was at INR 29.4bn with INR 15.0/15.1bn in NSV / revenue. Gross Margin declined by 221bps YoY due to base effect due to festive season starting early last year. However, EBITDA Margin expanded by 38bps YoY as employee expenses remained stable while declining ~90bps YoY as % of revenue. The company has delivered growth on transacting customers as well as AOVs and we find operating metrics again turning healthy. We reiterate ‘BUY’ rating with TP of INR 210 (~42% upside) as we find strong conviction on earlier than expected profitability in Fashion.

* Enhanced confidence in Fashion, driven by robust revenue and margin expansion: Nykaa Fashion outperformed expectations in 2QFY24 with GMV/NSV growth of 27%/32% YoY. Higher growth of NSV also reflects that the company has been successful in plugging leakages by undertaking line-by-line efforts such as reducing RTOs, minimising returns, churning out abusive customers and pin-codes while increasing cart charges, along with improving assortment and focus on women and premium category. This has resulted in contribution margin (as % of NSV) reaching an all-time high of 4.7%. We expect the segment to turn EBITDA profitable as CM cross 11%. It appears that the segment has turned a corner and is on track to generate incremental value for shareholders.

* BPC growth tad slower due to base effect with margins flat: BPC has been impacted by the shift in festive season to Q3 this year (as compared to Q2 last year), resulting in GMV growth of 23% YoY. Simultaneously, the segment also saw a decline of 173bps YoY in Gross Margin, while Contribution Margin (as % of NSV) declined by just 20bps YoY. However, the quality of transactions and customer cohorts have improved, indicated by increase in AOV to INR 1,916 (INR 1,872 in Q2FY23) and existing customers contributing to 79% of GMV (75% in Q2FY23). We expect a steep rise in the festive Q3 across GMV as well as margins. We postulate that Nykaa retains its competitive edge as the preferred platform for brand launches, with marketing initiatives to provide brand visibility, along with its premium and sticky customer base. Nykaa’s recently commenced ‘Nykaaland’ saw a participation of 80+ brands, 15k+ attendees and 800+ influencers with 2 new launches.

* Reiterate ‘BUY’, Dec’24 TP maintained at INR 210: With Nykaa milking its premium customer base that is willing to deliver high AOVs, we have tweaked our estimates with marginally higher GMV over FY24-28E while retaining EBITDA margin as the company expects to leverage marketing spends. However, we now anticipate Fashion segment to see a faster than anticipated trajectory to breakeven. We reiterate our ‘BUY’ rating with Dec’24 TP of INR 210. Key Risks: Ramp-up in competition and higher marketing needs

* Advertising income recovery imminent: According to the management, the heightened competitive landscape amongst brands has led to an increase in advertising expenditures, subsequently resulting in higher advertising revenue for the company in the current quarter (as compared to Q1) while it is yet to revert to pre ad-tech platform level. As we transition into the festive quarter, we anticipate advertising income to revert with further rise in brand marketing spends on the most dominant BPC platform.

* Others Segment could reach contribution positive by FY26 but operational profits still some way out: Contribution margin in Others segment has reached -14.8% (as % of NSV), a sharp improvement over -33.4% in Q2FY23 and the trend suggests a breakeven over the next couple of years. Nykaa’s eB2B platform, ‘SuperStore’, now delivers to ~130k retailers in 770 cities. However, the business requires almost 7x of current scale in order to deliver operating profits and we forecast that to be achieved only by FY29. Management has previously highlighted that the business can generate 12-15% gross margin and 3-5% EBITDA margin at scale.

* Owned brands growing strongly across distribution channels: As of Q2FY24, owned brands accounted for 12.2%/13.0% of BPC/Fashion GMV, cumulatively accounting for INR 3.4bn+ GMV. Furthermore, these owned brands are also performing better than 3P brands with 12.2%/13.0% GMV contribution for BPC/Fashion actually driving 13.1%/19.2% NSV contribution. The company is seeing these brands perform well not just on Nykaa platforms but also on 3P platforms and offline with 40%+ sales of owned brands happening offline or on 3P platforms. With the company now having a bouquet of 29 owned brands, we expect Nykaa’s house of brands strategy to stay prominent.

* Cost control remains strong: While growth for Nykaa has tapered from the heady days at the time of IPO, the company has exhibited strong discipline on expenses too. With marketing costs as % of NSV in BPC stable in 8-8.5% range, the company is now anticipating reduction in Fashion too. Simultaneously, fulfilment cost per order in BPC has decline to INR 107 in Q2FY24 from INR 136 Q1FY24 with Fashion still struggling to deliver a similar reduction. Additionally, we also observe stabilisation in employee expenses, amounting to 9% of revenue (vs. 9.9% of revenue in 2QFY23). Jointly, these factors should lead to expansion in EBITDA margins across segments gradually.

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