60% upside possible in Nykaa? This broker addresses 5 key investor concerns

JM Financial said Nykaa remains a differentiated player with a rapidly growing and loyal consumer base. “The company’s unique solutions to consumers’ and brands’ pain-points create long-term stickiness that is likely to endure Nykaa’s dominance in beauty and personal care (BPC) while creating a niche positioning in fashion,” it said.

The brokerage has tried to address five key investor concerns on Nykaa:

Do Q3FY22 results imply growth is tapering?

To recall, Nykaa reported a 59 per cent YoY drop in profit at Rs 28 crore. Its December quarter gross merchandise value (GMV) grew 29 per cent sequentially in BPC and 17 per cent in the fashion segment, raising concerns that growth in fashion has started to taper off already.

“However, it needs to be understood that, unlike BPC, the fashion vertical doesn’t see as much seasonality and even 17 per cent QoQ growth implies 119 per cent YoY growth,” said JM Financial.

For comparison, Nykaa’s fashion GMV grew 14 per cent QoQ in the September quarter while growing at 236 per cent YoY in the first nine months of FY22.

“Further, 4 per cent QoQ growth in BPC and 1 per cent growth in unique visitors (fashion) also seems lower on the surface. In comparison, unique shoppers grew at a healthy rate of 9 per cent in BPC and 23 per cent QoQ in fashion. When we compare the two growth rates, it is clear that the company took a strategic call of focusing on conversions rather than enhancing top of the funnel during the festive quarter,” it said.

Is improvement in gross margin and EBITDA margin temporary?
Nykaa’s Q3FY22 gross margin improved 360 basis points QoQ to 46.3 per cent and Ebitda margin by 280 basis points QoQ to 6.3 per cent driven by higher mix of fashion, higher mix of higher-end products in BPC and increasing share of owned brands. This was in fact Nykaa’s highest gross margin ever.

“While we do understand that festive season loosening of purse strings could have resulted in the reason above, the other two reasons would continue to sustain going forward. We would also want to highlight that Ebitda margin comparisons to Q3FY21 are not really fair as the year-ago quarter saw post-Covid revenge spending while the company continued to operate at reduced advertising budget, resulting in Ebitda margin of 13.4 per cent,” JM Financial said.

The brokerage said fashion’s mix in the overall GMV may continue to rise and that GMV to revenue conversion would continue to look lower as revenue only includes take-rate in case of the marketplace business model and fashion segment is predominantly a marketplace.

Realistically, are there enough shoppers for Nykaa to target?
To this, JM Financial said it is forecasting Nykaa to have 2.2 crore unique shoppers in BPC and 1.09 crore shoppers in fashion. For BPC, this implies addition of an incremental 1.41 crore shoppers.

According to BCG, India is expected to have 1.6 crore ‘elite’ households with gross annual income above $30,800 and 3.3 crore ‘affluent’ households with annual income between $15,400 and $30,800 in 2025.

“Assuming 60 per cent penetration in elite households and 40 per cent penetration in affluent households enables over 2.2 crore unique shoppers for Nykaa by FY26. There remains potential upside from incremental users in a household or further penetration,” JM Financial said.

Does omni-channel push implies lack of belief in digital?
Nykaa had 96 stores in 45 cities in India as of December 31, with the company planning to reach 300 stores in 100 cities. Such an aggressive push for omni-channel has raised concerns about a lack of belief in digital and the need for higher capex investments.

“We advocate that Nykaa should continue to pursue omni-channel expansion as that enables the company to provide touch-and-feel experience, acquire customers organically and gain consumer wallet share while digital penetration takes its own time to gain majority. While there are these benefits, physical store expansion will certainly need higher inventory (superb consumer experience implies minimal stock-outs),” JM Financial said.

As Nykaa leases the stores and investments are only needed in electrical, furniture and fixtures, the brokerage said capex investments will continue to be limited. Nykaa too in its IPO papers said that Rs 42 crore is to be utilised for building 87,000 square feet of store area by FY24, implying Rs 4,800 per square feet.

What about competition from large conglomerates ?
Nykaa’s platform with focus on 3Cs – content, curation and convenience with a focus on authenticity – has made it a dominant online BPC platform in the country, JM Financial said.

With Amazon and Flipkart prohibited from carrying inventory by India’s FDI policy and authenticity being tricky to promise in a marketplace model, they continue to focus on low ticket, mass market items only, the brokerage said.

“Meanwhile, large conglomerates that are ramping up their digital presence can certainly become a threat if they dedicatedly decide to pursue this vertical, but we believe they are too distracted by larger categories such as grocery and fashion and BPC still requires a specialised retail capability,” JM Financial said.