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Soft earnings; recovery likely in FY25

* Metro Brands (METRO) reported weak revenue growth of 6% YoY (12% miss) as same-store sales declined 10% due to a high base last year (Covid) and a soft demand and pricing environment. A higher growth contribution of INR3000+ ASP products boosted gross margins, which resulted in adj. EBITDA margin/PAT margin of 33.6%/18% (in line).

* In the near term, we believe that the risk of soft demand, potential losses in Fila, and a moderation in margins could weigh on growth. But, in the long term, healthy store economics, steady store adds and a growth opportunity in Fila/Foot Locker should drive a CAGR of 22%/32% in revenue/PAT over FY24-26. We reiterate our BUY rating on the stock.

PAT down 13% (big miss) dragged by lower revenues and CBL loss

* Consolidated revenues grew 6% YoY to INR6.4b (12% miss) mainly drive by footprint addition as revenue/sqft remained a drag due to higher base.

* Excluding CBL revenue, revenue grew 5% YoY to INR6.3b. ? The company added net 23 stores in 3QFY24 taking the total store count to 840 stores. Excluding FILA, the company added net 31 stores. ? Gross profit increased 7% YoY to INR3.8b while margins saw an expansion of 70bps YoY to 59.9%.

* EBITDA witnessed a decline of 3% YoY to INR2b (17% miss) as the higher Gross margins were offset by higher employee and other expenses. Adjusting for CBL loss, EBITDA was up 3% YoY to INR2.1b with 33.6% margin.

* PAT witnessed a decline of 13% YoY to INR981m (25% miss). However, adjusting CBL loss, PAT remained flat YoY at INR1.1b.

* For 9MFY24, revenues reported a growth of 12% YoY to INR17.7b, while EBITDA grew by merely 1% to INR5.4b dragged by lower margins from Cravatex and higher opex. PAT for 9MFY24 reported a decline of 13% YoY to INR2.6b dragged by losses from CBL.

Key takeaways from management commentary

* Guidance: The management has reiterated its guidance of 55-57% gross margins, +30% EBITDA margin and 15-17% NP margin. Revenue growth would be ~18%, led by store adds and SSSG.

* SSSG could remain weak in 4QFY24: There has not been any economic headwind for target customers. The decline in same-store sales was due to a high base of last year’s post-Covid demand, which could impact 4QFY24 as well.

* Fila inventory stands at INR300m on cost and is expected to be liquidated by Jun’24.

* Foot Locker- Expects the productivity to be similar/higher compared to Metro. The company would open 3,000/5,000 sqft stores in metro and Tier 1 cities.

Valuation and view

* At P/E of 57x on FY26E EPS, METRO trades at rich valuations, considering: 1) a strong runway for growth, largely funded through internal sources, given its strong OCF-to-EBITDA ratio of over 50%; and b) superior store economics reflected in the balance sheet and a healthy RoIC of +50%.

* In the near term, we believe that the risk of soft demand, potential losses in Fila, and a moderation in margins could weigh on growth. But, in the long term, healthy store economics, steady store adds and growth opportunity in Fila/Foot Locker should drive growth.

* We factor in a CAGR of 22%/32% in revenue/PAT over FY24-26 and assign PE of 60x on FY26E PAT of METRO’s existing portfolio. A combination of superior store economics and a strong runway of growth should allow METRO to garner rich valuations going ahead.

* We have not factored in Fila and Foot Locker earnings, but we believe they have revenue potential of INR15-20b over the next 3-5 years (i.e., 30-40% share of METRO). Since both the brands are at the initial stage of investing, we value Fila/Foot Locker at a ~75% discount to the potential value, which creates an option value of INR150 (Exhibit 2), thus arriving at a valuation of INR1,380 per share.

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