Nykaa Shares Gain As HSBC Initiates Coverage With A ‘Buy’

Shares of FSN E-Commerce Ventures Ltd. gained after HSBC initiated coverage on the operator of personal and beauty care products platform Nykaa with a ‘buy'.

The beauty and personal care e-commerce market is India's next big growth story and is expected to grow at an annualised rate of 30% in 10 years, the research house said in a report dated Dec. 1. “Nykaa, a leading and already profitable online business, can dominate the market over the next decade.”

The company, the report said, has proven over the past decade that it can compete in the hyper-competitive e-commerce market with Amazon and Flipkart, among others. It also forecasted three-year earnings CAGR of 81% for the billionaire Falguni Nayar-founded firm, led by strong revenue growth and Ebitda margin expansion of 160 basis points to 8.2% by FY24.

“Nykaa, with its leading scale, huge reach and broad product range, is a rare combination of profitability and sustainable, exponential growth,” the report said. “We expect revenue to double every two-three years in the coming decade, which we see as the chief catalyst for the stock. Marketing costs are likely to remain high for the next two-three years, which could put pressure on margins.”

Shares of FSN E-Commerce gained as much as 3.8% in early trade on Wednesday to Rs 2,535 apiece. HSBC has set a target price of Rs 2,900 apiece on the stock, implying a potential upside of 19%.

Of the three analysts tracking the company, two suggest a ‘buy' and one recommends a ‘sell', according to Bloomberg data. The average of 12-month price targets implies a downside of 2.4%.

Pricey Stock?

Nykaa's stock, according to HSBC, is “hot”.

“The key debate is likely to be around valuation.” After the stock rallied 96% on trading debut, “it's trading at a FY24 estimated price-to-earnings of 317 times on our estimates, or FY24 EV/sales of 14 times”. The research firm, however, expects the stock to still offer a material upside.

“Nykaa offers a strong growth narrative that can span the next two decades, supported by a business model that generates marginal return on capital in the range of 70-100%. If the fashion business turns profitable, this will be a major catalyst for the stock price,” the report said.

A single biggest catalyst for Nykaa, HSBC said, is the trajectory of revenue growth over the next five years. “This will continue to shape the expectations about the amount of value the company can capture. Any material upside from this trajectory would serve as a positive catalyst for the valuation.”

Nykaa has the opportunity, capability, scale, and platform to at least mirror the e-commerce growth rate, it said. “It's still in an exponential growth phase and should remain so for a long time.”

Risks

HSBC listed a few key downside risks to the Nykaa stock:

• Slower adoption of e-commerce: Any normalisation in the e-commerce growth rate will lower the target population for Nykaa.

• Inability to significantly expand its user base: Failure to guarantee product authenticity, increased competition and failure to evolve the product range could impede user base expansion.

• Competition may impact profitability: Competitors are likely to increase marketing expenses and offer higher discounts to attract customers. Such an industry dynamic will increase customer acquisition cost for all companies and adversely impact their profitability.

• Premiumisation trend progresses slower than anticipated: Premiumisation in the beauty and personal care industry may happen at a lower rate, which directly impact growth in average order value for the companies, resulting in lower revenues.

• Fashion business fails to scale up: Online fashion retailing is a highly competitive industry with multiple entrenched players. If Nykaa Fashion fails, it will materially lower the revenue potential of the company.

• Regulatory risks: A formal e-commerce policy is still in the works in India and it will remain a key risk until the final contours of the policy are known.