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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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