Bata Q3 show stellar, but rich valuations restrict scope for multiple re-rating

Gunjan Shah will be at the helm of the brand's operations in India, a statement from Bata India said.

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Krishna Karwa
Moneycontrol Research

Highlights:
- Bata’s Q3 show was impressive
- Store additions and marketing drives will bolster revenue growth
- Margin accretion would depend on rent rationalisation and premium products
- Competition and high ad spends may impact earnings
- Valuations are heady, thus limiting upside
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Bata India has proved its mettle in the third quarter-ended December 31, 2018 on all fronts. Asset-light expansion, a revamped brand portfolio and healthy fundamentals make us bullish on the stock. However, the elevated valuations leave little on the table for a new investor.

Q3 analysis
- Strong top-line growth was seen on account of improved retail coverage and onset of the festive season
- Operating leverage was attributable to approximately 10 percent same-store sales growth year-on-year (YoY), cost controls and an uptick in gross margins
- Profit after tax margins expanded sharply too, aided by a 28 percent YoY growth in other income

Observations
Revenue drivers
- The management plans to open 100-200 new retail stores each fiscal year to augment its network of around 1,375 outlets (as on March 31, 2018)
- To attract more footfalls, store renovations will continue throughout the year. Additionally, experience centres and kiosks will be launched in a phased manner at the outlets
- Spends on promotional activities are anticipated to increase from Rs 40 crore in FY18 to Rs 80-90/100-150 crore by FY19/FY20-end, respectively. Celebrity-backed endorsements would gain momentum as well
- New offerings in select segments (women, youth collections, sports) are likely to be made available in new exclusive brand outlets. Visual merchandising initiatives would complement this move
- To strengthen its omnichannel, the company is investing heavily in developing its website and mobile application. Blogs and posts on social media will be equally pivotal in this regard

Margin drivers
- Stock management processes are being optimised
- The share of high-margin premium products is slated to increase gradually in due course (from 25-30 percent of sales in FY18)
- A major chunk of the capex for new stores will be undertaken by franchise partners
- Rent agreements are under negotiation at a few locations
- Most of the new outlets will be small or medium sized in nature to curtail overheads

Outlook- After a stellar Q3, the stock has set a 52-week high. It has been one of the best performers despite heavy market volatility in recent months
- At 39.7 times its FY21 projected earnings, the rich valuations comprehensively capture all the positives in the short to medium term horizon
- To command such superlative multiples, the company will have to deliver a combination of robust top-line growth and improved margins on a consistent basis (on an already high base). In our view, this could be tough to achieve in an industry where brand loyalty is waning

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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here