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Nykaa public issue: Of lipstick effect and bullish markets

IPO valuations are high but given the unique proposition, investors are likely to be excited. The long list of more than 100 anchor investors in pre-IPO allotment reflects the crazy demand.

October 28, 2021 / 12:26 PM IST
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When the times are rough and consumers don’t have enough money to spend on big-ticket luxury items, they tend to opt for smaller indulgences such as lipsticks to make them feel better amid the financial stress.

That’s what we call the ‘lipstick effect’. The term was coined in the early 2000s by former Estée Lauder chairman Leonard Lauder to describe the company’s more-than-usual sale of lipsticks after the global economy was battered by the dot-com bubble burst.

As we gradually return to normalcy post the second covid wave, Nykaa (FSN E-Commerce Ventures Ltd) is expected to benefit from the ‘lipstick effect,’ at least from a near-to-medium perspective. This would help revenue growth outlook to that extent. Of course, if a third COVID wave hits the country and there are restrictions, then the demand may get adversely impacted.

Investor sentiment looks upbeat with a host of start-ups making a beeline to float public issues this year. Never forget that the shares of the loss-making online food delivery firm Zomato Ltd are now trading at around Rs 132 per share on the National Stock Exchange – far higher than its issue price of Rs 76 per share before it went listed.

What’s more, Nykaa can afford to be smug about it being profitable. In the financial year 2021 (FY21), the company has reported an operating margin  (earnings before interest, tax, depreciation and amortisation or EBITDA) of 6.6 percent. A sharp year-on-year decline in marketing and advertising expenses as a percentage of operating revenue is one factor that helped the EBITDA performance last year.

Founded in 2012, Nykaa is a multi-brand beauty and personal care (BPC) platform in India. The company now has a formidable presence in this segment. “Despite competition from horizontal e-commerce majors such as Flipkart and Amazon India, Nykaa has been able to carve out a niche for itself with its ‘loyal’ customer base, backed by focus on content, curation and convenience,” analysts from Jefferies India wrote in a May 28 report. In 2018, the company expanded into the fashion segment under Nykaa Fashion.

Growth and outlook

In FY21, Nykaa’s net profit stood at Rs 62 crore on revenues of Rs 2,441 crore. Over FY19-21, its revenue averaged a compounded annual growth rate (CAGR) of 48 percent. Its gross merchandise value (GMV) averaged 57 percent annual growth during the same period.

In the first quarter this year, a favourable base helped revenues increase as much as 183 percent year-on-year (YoY) to Rs 817 crore. In the corresponding quarter last year, the first COVID wave had brought down its orders and GMV. The pandemic did drive an improvement in the company’s average order value (AOV) in FY21. To be sure, as the pandemic’s impact wanes, one can expect the AOV to taper.

Further, the EBITDA margin for the first quarter of FY22 stands at 3.3 percent, lower than financial year 2021. Analysts reckon the margin outlook is decent.

“Although we expect lower margins in FY22 (lower ad spend in FY21), we expect steady margin expansion led by scale economies as it has already expanded margins from 1.8 percent to 6.6 percent over FY19-21, making it one of the few Ecom players to turn profitable,” Prabhudas Lilladher analysts said in a report on October 26.

The brokerage firm believes Nykaa can sustain a CAGR of about 35 percent in sales and 50 percent in EBITDA over the coming few years with double-digit margins.

Keep an eye on Fashion

Going ahead, one must track how the company's fashion business scales up. A lower base may well help the segment grow faster. The fashion segment accounted for around 25 percent of the total GMV for the first five months of FY22.

Investors should note that fashion is a highly competitive segment. According to Jefferies, “The segment is quite competitive with players like Myntra, Ajio and even brick-and-mortar retailers building online presence.”

Analysts from Elara Securities (India) said in a report on October 26, “Successful execution in the fashion segment is key to valuation re-rating, in mid-to-long term.”

Separately, Nykaa’s high growth outlook can generally lure other companies into the sectors it operates in and that’s a risk, too.

High Valuations

Nykaa’s issue size is Rs 5,350 crore and the price band is Rs 1,085-1,125. The IPO includes fresh issue of shares worth Rs 630 crore and offer for sale of up to 41.9 million shares.

“We believe Nykaa could trade at one-year forward EV/sales of about 6-8 times, purely based on its core BPC offering. However, the issue price is already at 10.2 times FY24 EV/sales, factoring in a premium multiple, backed by growth in the fashion business,” says Elara. EV refers to enterprise value.

As things stand, while high valuations may discourage some, given Nykaa’s unique proposition, investors are likely to be excited about the issue. “When the momentum is on your side, it may not help to question how high valuations are,” an analyst with a multinational brokerage firm said, requesting anonymity. Even so, valuations are likely to taper if growth falls short of the lofty expectations eventually.

The long list of more than 100 anchor investors in the pre-IPO allotment including almost all sizable funds is a testimony to the crazy demand.

Pallavi Pengonda
first published: Oct 28, 2021 11:58 am