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VST Industries Q3FY24 print was weakest; revenues grew modestly at 4.8% to Rs3.45bn while EBITDA/PAT declined by 24.1%/32.0% led by higher sales from leaf tobacco exports (27% revenue contribution Vs 15% in FY23). Despite weak base Q3 cigarette volumes cut by ~4% YoY due to persistent weakness in rural demand and weaker RSFT portfolio, yet leaf tobacco exports grew 30%. Higher leaf tobacco and packaging (filter rod) prices resulted in 379bp cut in gross margins to 41.6% (-379bp QoQ). With higher employee/other expenses at 8.5%/19.1% EBITDA margin cut to 19.8% (-753bp), lowest since FY11. Management opined RM prices to remain elevated in Q3 as well, yet it expects some relief through rationalizing cost structure. The company expects gradual recovery in demand to be led by, (1) focus on core markets - UP/WB/Bihar/AP/TG (~70% of sales) to improve volumes, (2) launched Demislim priced at Rs10 under Edition in the RSFT segment, (3) expects rural markets to bounce back, and (4) stable taxation. We cut our FY24E/25E earnings and retain BUY with a revised DCF-based TP Rs3,943 (implying 16.3x avg. FY25E/FY26E EPS). Decline in volumes at 7% as VST’s portfolio tilted towards DSFT, core remains strong

VST’s Q3FY24 revenues grew modestly at 4.8% to Rs3.45bn on the back of moderated growth in core markets such as UP/Bihar/AP/TG/WB which contribute ~70% of sales. Q3 cigarette volumes cut by 4% due to persistent weakness in rural demand and weaker RSFT portfolio, yet leaf tobacco exports grew 30% YoY. The company expects gradual recovery in demand to be led by, (1) focus on core markets - UP/WB/Bihar/AP/TG (~70% of sales) to improve volumes, (2) launched Demi-slim priced at Rs10 under Edition in the RSFT segment, (3) expects rural markets to bounce back, and (4) stable taxation. We believe slower than industry growth may force VST to redraw its growth strategy driven by expanding its RSFT portfolio to expand consumer base as newer consumers now pick up Rs10 price point due to coinage issue.

Sharp erosion in gross/EBITDA margins to 41.6%/19.8% led by change in product mix Gross margins fell sharply to 41.6% - (571bp) (cut by 379bp QoQ) due to higher leaf tobacco and packaging material (filter rods) prices and leaf tobacco exports. With higher employee and other expenses at 8.5%/19.1% EBITDA margin cut to 19.8% (-465bp). We reckon cost saving measures undertaken by VST may show up in the medium term margins to remain under pressure as packaging material (paper, cigarette rods and shippers) remain inflationary. Further, environmental restrictions led the company to consolidate its manufacturing shifting to Toopran unit (outside city limit) which may help in operational synergies in medium term.

Valuation and risks We have been highlighting that the renewed focus for VST was driven by, (1) expanding its direct coverage by investing feet-on-the-street, (2) improve trade visibility, and (3) cut wholesale discounts to strengthen its ‘Total brand’ perception in the trade. However demand recovery in rural underway, its dominant business in DSFT segment saw weaker growth, yet VST is now building its RSFT portfolio launching Demi-slims under Edition brand. We expect rural demand to bounce back with a lag and expect VST to launch more products in RSFT segment other than “Edition”. Though near term demand would improve gradually, higher leaf tobacco exports and packaging material prices put pressure on margins. To mitigate cost pressure, VST has already rationalized trade discounts to settle for low single-digit volume growth in FY24. With erosion in margins we cut earnings for FY24E/25E by 11.7%/0.5% and retain BUY with a revised DCF-based TP Rs3,943 (implying 16.3x avg. FY25E/FY26E EPS). Risks – Changes in cigarette taxation and disruption in supply chain.

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