If there is one new tech stock that investors were super-bullish about, it was Nykaa.
Apart from the fact that founder Falguni Nayar had been a successful investment banker, the blue ocean that the beauty and personal care (BPC) space offered, where Nykaa established itself as an unassailable player in quick time, and the way Nayar built the business and scaled it up in a capital-efficient way had investors awestruck about the business.
So, when the stock debuted on the exchanges on November 10, 2021, its price doubled.
Thereon, a combination of factors, like the tech stock carnage following the rate hikes by the Fed, abnormally high stock prices, the inability of digital businesses as well as Nykaa to report profits have conspired to result in a drawdown in the stock price in 2023.
Abnormally high stock prices were a reflection of the excesses owing to the digital boom, after the pandemic.
Can it regain lost glory?
Now hovering at Rs 150, which is 62 percent down from its listing day price, and correcting 54 percent in 2022, can Nykaa gain back its lost glory?
Currently, Nykaa has two business segments –BPC and Nykaa Fashion. It has an omni channel presence, which it launched in 2014, and three store formats -- value, prestige and luxury.
Other minor segments include EB2B launched in April this year. This is a one-stop distributor for all BPC and wellness products, consisting of 45,000 transacting retailers across more than 500 cities and 165 listed brands at the end of June.
Nykaa also offers its own BPC products under Nykaa Cosmetics, Nykaa Naturals and Kay Beauty, available online as well as offline.
It has an inventory business model, procuring products from brands and authentic distributors directly and stored in warehouses.
The market had valued Nykaa highly due to its leadership in the BPC business, its potential to replicate its margin in the fashion segment and the growing TAM (total addressable market) for both BPC and fashion segments.
Recently, its shares have come under more pressure as the lock-in period ended, making 67 percent of its holding open for trading, with several fund houses offloading stake in the company.
Doubts over long-term potential
Coupled with the resignation of its CFO Arvind Agarwal and the issue of bonus shares, concerns are rising over the long-term value for shareholders.
The YoY result of Nykaa in Q2FY23 has shown good growth, with the gross merchandise value (GMV) growing 45 percent to reach Rs 2,345.7 crore and profit growing 344 percent to reach Rs 5.2 crore in Q2FY23.
It reported revenue growth of 39 percent on a yearly basis to reach Rs 1,230.8 crore.
BPC contribution
Margin improved 630 basis points on a YoY basis to 24.1 percent in Q2FY23. EBITDA saw a growth of 112.1 percent YoY to Rs 61.1 crore on the back of reduced marketing and advertising expenses as Nykaa became more prominent and established itself as the primary online BPC marketplace.
The company also continues to expand its physical store network and investment in warehousing. It has expanded its presence across 53 cities, with a total footprint of 121 stores and is planning to open about 300 stores in the next two years in 100 cities.
Nykaa has also partnered with the Apparel group, a global fashion conglomerate in the Middle East, with more than 2,000 stores. This is Nykaa’s first foray into the international market, and it will give the company access to Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE) to build a distinctive GCC (Gulf Cooperation Council) -focused beauty offering.
Not a smooth sail
Although Nykaa is showing profitability, the business fundamentals look all the more challenging because it has competition in the BPC and fashion segments.
Nykaa has made itself at home to become the go-to online destination for BPC products, which now seems to be changing, as more players enter the segment.
As online penetration and the BPC market grow, the scope for volume growth is also bound to increase.
According to consulting firm Redseer, Nykaa has a large BPC market opportunity of Rs 1,12,000 Crore ($16 billion), growing at 12 percent per annum to Rs 1,98,100 crore ($28 billion) in 2025.
Canara Bank Securities expects Nykaa’s BPC segment to have a three-year CAGR of 43 percent, backed by growing industry and online BPC penetration. It estimates Nykaa’s total share in the BPC market to be about 3.56 percent (based on GMV), which is expected to increase by 300 bps by FY2025.
However, Nykaa could still face roadblocks as competition intensifies and ad income, which the BPC segment relies heavily on, decreases. Nykaa directly competes with multiple platforms, physical retail stores and D2C (direct-to-consumer) brands.
Challenges ahead
JM Financial Securities believes competition can impact Nykaa’s business either through technology disruptions, exclusive goods and services offerings, pricing pressure, intense marketing and promotional campaigns, strong leverage of own brand strength or through better relationships with suppliers.
According to HDFC Securities, “The product EBITDA margin is estimated to be just about profitable now. Of course, this might change as Nykaa scales its own brand portfolio and order density. However, any dip in ad income could be a negative counter-balancing factor (not factored in). Ad budgets could potentially get split between more players in the medium to long term.”
It also mentions that increasing competition could lead to an increase in customer acquisition cost, which will impact margins or lead to market share losses and it will be a challenge to maintain the margin with other emerging subsidiaries in its chain.
Signals from the fashion segment
The next major space for Nykaa to watch out for is the fashion segment, which is still at a pretty nascent stage. It currently houses 1,500+ brands and over 1.8 million products.
According to Redseer, the market for fashion is currently at Rs 3,79,400 crore ($54 billion) and it is expected to grow at 18 percent per annum to Rs 8,70,200 crore ($124 billion) in 2025.
The online fashion market in India is fragmented and competition remains a major concern here as well, especially since the fashion segment is already crowded with well-established players, private labels and corporate houses that are seeking to aggressively pursue horizontal/vertical online offerings.
JM Financial lists competition as a major catalyst to keep an eye on. “Nykaa is a relatively new entrant in the fashion industry, which already has heavily capitalised and well-established competition. Therefore, the company may have to make substantial investments in building supplier and brand relationships to improve the brand awareness of its own platform and expand business across new products and categories,” it says.
Myntra, which has a first-mover advantage in the online fashion segment, is a major direct competitor. It currently has over 5,000 fashion and lifestyle brands and is expecting to look at 100 million customers in the next few years.
In its recent Big Fashion festival, it on-boarded a record 1.2 million new customers from across the country. And the competition is only going to get more intense as Myntra steps up its game in the BPC segment as well.
Brokerage recommendations
HDFC mentions that Myntra infused Rs 4,200 crore over FY21-22 to further its growth story and Reliance Retail has invested Rs 1,18,400 crore towards tech stack building for all its online platform businesses and towards assortment across categories (fashion, BPC being key categories) over FY20-22.
It will be tough to consistently compete with a limited wallet with these juggernauts.
“Nykaa is an efficient online business. Its success, in part, is due to the absence of potent competitors (this is gradually changing). Ex-ad income, lack of non-linear monetisation levers force us to realign our valuation compass somewhere between a linear business and a pure platform. Hence, we initiate coverage with a ‘sell’ recommendation and discounted cash flow (DCF)-based target price of Rs 800 (implying 81x Sep-24 EV/EBITDA/5x Sept-24 EV/sales),” it says in its research report.
Elara values Nykaa at Rs 1,431 on a one-year forward EV/EBITDA of 65x/35x for Nykaa’s BPC/fashion segments, banking on the optimism related to BPC margin improvement in the near term as well as the expectation of the fashion segment turning profitable in the next few years.
Nykaa’s BPC segment is trading at fair valuations of 52x basis FY25 EV/EBITDA as the valuation gap with traditional BPC companies have converged slightly in the recent past (gap of 35 percent currently).
“We believe better-than-expected margin in BPC and a faster turnaround in the fashion (moving to profits) segment are the key monitorables that may drive upgrades,” it said.
Largely using a DCF or SOTP (sum-of-the-parts) based valuation through a sales or EBITDA target multiple, Nykaa’s EPS estimates for FY23E average around Rs 2.15, with the price-to-earnings ratio averaging at 750x.
Dolat Capital upgrades Nykaa to a ‘buy’ recommendation from ‘accumulate’ with a target price of Rs 1,420. Overall, it believes in Nykaa’s revenue and Gross Profit growth but is concerned with a moderate EBITDA/PAT as the company tries to balance growth and profitability in a large addressable opportunity with rising competition.
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