Be bold with fashion not with valuation!
Are you okay not buying a new car and continuing to use your old one until your feel more confident about the revival of your business or feel more secure about your job, post-pandemic?
Most of us will have an affirmative answer to the above question.
But how many people do you think will also postpone buying undergarments and chappals? Sounds bizarre, right?
No wonder markets have recognized that the first-order beneficiaries of unlocking-led-revival will be the companies that deal in essential products. And thus, they still enjoy the lofty valuations.
But here’s a twist
Going purely by current valuations, it seems markets are still betting on dominant players operating in the premium segments. We thought of comparing two companies each from two areas where consumer spending is relatively inelastic—innerwear and footwear.
Bata India and Page Industries trade at premium valuations as compared to Relaxo Footwears and Lux Industries, respectively.
Premium products=premium valuations?
P/E ratio and Return on Equity (RoE) are calculated on TTM basis i.e. on Trailing Twelve Months earnings.
TTM earnings give an idea about stress companies have gone through during the lockdown quarter (Q1FY21)
Note: One can use various valuation parameters to evaluate a company. However, for the purpose of simplicity and better understanding, P/E ratio and RoE are presented—being some of the most widely used parameters.
(Source: ACE Equity)
Are differentials in valuations justified? Are companies catering to mass-markets not well-managed or they are going to face tougher challenges as compared to those operating at the high-end of the market?
First off, let’s not forget this—with its USD 2,100 per capita income, India is still a lower middle-income economy. Economic downcycles—such as the one underway with courtesy to a tiny little virus—are particularly harsh on the low and middle income groups. Thus, India still remains a price-sensitive consumption economy—a trend which may become more pronounced on the backdrop of the on-going pandemic.
This may not work in favour of premium brands targeting first-time-buyers in the post pandemic era.
Q1FY21 numbers suggest that lockdowns had a significantly higher impact on companies selling premium products and primarily focusing on metros. Now the moot question is, will earnings bounce back as fast as they dipped during the lockdown quarter?
One-time blip or a painful road ahead?
(Source: ACE Equity)
On the other hand, companies selling mass-market products have shown resilience in comparison. Was outperformance on earnings merely because of their significant presence outside metros? Or have they silently managed to snatch some market share from smaller companies and those operating in the unorganized sector? Their performance over the coming quarters might answer these questions.
As far the hosiery market is concerned, Page Industries appeared to be under pressure even during the pre-pandemic times. It’s farfetched to assume that mere a week under lockdowns in March 2020 caused margin erosions for the premium brand at a time when its mid-market counterpart reported margin expansions. To be fair, Page Industries has been expanding manufacturing capacities, upgrading technologies and store presence but so has Lux Industries.
(Source: ACE Equity)
Lux Industries has a dominant presence in the economy and mid-priced market. The company has tied-up with Virat Koholi’s One8 brand through which it’s trying to address the Rs 5,400 crore mid-premier innerwear market.
The success of Lux Industry’s foray into the premium segment will be a litmus test, since it may pave the way for future launches, besides it being margin accretive. As against Rs 204 crore spent on branding in FY15, the company’s branding spends expanded to Rs 421 crore in FY20—35% of FY20 revenue.
Over the past 5 years, Lux Industries has recorded a consistent profit growth, thanks to its stringent cost management, which has focused on striking a balance between insourcing and outsourcing. Moreover, it has pared debt over the past two years.
On the other hand, both footwear manufacturing companies—Bata India and Relaxo Footwears reported a strong performance at the EBITDA level. Bata has been aggressively expanding its store tally and franchisee network, alongside revamping the store experience for its customers, which reflects in falling net profit margins.
Moreover, Bata India has been investing in its branding spends to attract youth and women consumers—a move to cautiously reduce its reliance on the formal footwear and school footwear markets.
As on March 31, 2020, Bata India had 1,558 stores including franchisee stores and a network of 400 distributors which primarily cater to non-urban areas. The company has been offering a phygital experience to its customers by ramping up its e-commerce footprint and handling deliveries from over 900 stores. The Company has been eyeing growth, particularly in the working-women space, with its 9 to 9 collection across Bata Comfit, Hush Puppies and Naturalizer. The brand promotion of the company revolves around offering athletic-inspired comfort combined with elevated tailored styling.
On the other hand, Relaxo Footwears relies on its 390 stores and close to 50,000 retailers to sell its products in 85% of large Indian districts. Recognizing the changing market dynamics, Relaxo Footwears has not only been investing in low-cost automation processes but has been growing its e-commerce presence as well. As reported by the company, 70% of its portfolio is available online.
(Source: ACE Equity)
Are valuations in sync with macro-stories and growth trends?
Fashion in brief…
India’s innerwear market is expected to grow at 11% CAGR between 2018 and 2028—from Rs 32,000 crore to Rs 89,700 crore. At present, close to 60%-65% of the market is served by small players fragmented in the unorganized sector.
Companies involved in manufacturing and selling innerwear are banking on four long term macro-economic trends—formalization of the sector, rapid urbanization, rising discretionary incomes and changing consumer preferences.
As the market is becoming brand-sensitive from (just) price sensitive, the focus of brand communications has also shifted from “functionality” to “bold style statement”. In other words, the fifth growth trigger for the industry is likely to be the premiumization of products.
Hence, many brands are expected to make inroads, which could challenge the dominance of established leaders such as Page Industries in the premium segment. It remains to be seen how the mid-tier market players are going to ride the wave of premiumization.
To stay ahead of the competition, leading companies catering to the premium segment are growing their presence in niche categories, such as swimwear, athleisure and accessories, amongst others. These are relatively smaller categories today but are expected to grow at a faster pace.
Footwear market: on the cusp of a huge growth?
India is the second largest producer of footwear and third largest consumer.
At present India’s consumption of footwear stands at approximately 2.1 billion pairs a year—less than 2 pairs a person—lower than the global average.
The sector enjoys tailwinds since the government has increased the import duty on footwear from 25% to 35% and that on footwear components from 15% to 20% in the Budget 2020. Atma Nirbhar initiative might further encourage the manufacturing of footwear in India.
Footwear sector is a capital-intensive business. To stay relevant and competitive, a company has to not only manage cost-equations but has to invest in innovation, technology and branding as well.
Today, footwear has been increasingly becoming a style-centric product not just in urban areas but even in smaller towns. As a result, the brand communications have been shifting from utility or price points to offering style and comfort at affordable price points.
Despite all the noise about online marketplaces, the share of e-commerce in the total sales of footwear is under 10% as of now. That said, leading companies such as Bata and Relaxo are gearing up for changing shopping preferences of Indians. It also remains to be seen if formalization of the footwear industry speeds up post pandemic.
Connecting the dots
Climbing up the ladder of consumption is a function of aspirations and wage growth. For instance, 1/3rd of future demand for footwear is likely to come from aspirational small town consumers.
Until per capita income grows substantially, India may remain a price sensitive market, despite it moving towards product premiumization. Let’s not forget, India’s growth story isn’t really about consumption by the elite; it’s about cost-cautious consumers aspiring to climb one step at a time.
By no standard are the aforesaid companies—irrespective of their market segmentations, cheap. Yet, if investors want to benefit from consumption growth, it would be crucial for them to evaluate growth prospects and valuations, both. In that context, it’s important to find out whether the huge valuation premium enjoyed by companies catering to the premium markets over those serving the mass market is justified—not just in the case of the four companies we discussed, but even otherwise!
No doubt, it’s a horse that wins or loses a race but the weight of a jockey plays a significant role. Why treat market valuations differently?
It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price—Warren Buffet.
Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.
If you are investing in any family run company, besides governance, you may also want to take stock of significant developments in the lives of the promoters. Sometimes, their personal life can overshadow market sentiments.
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We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
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