What Ails Nykaa? Jefferies Explains; Keeps Buy On Stock

There’s a lack of investor interest in Indian Internet names recently, but FSN E-Commerce Ventures Ltd., operator of beauty and personal care (BPC) marketplace Nykaa, has fallen sharply from its peak, and the stock has underperformed several of its peers, Jefferies said.

The brokerage, which gathered feedback from investors over the past month, reduced its base case target price on Nykaa to 200 rupees from 275 rupees per share on lower multiples to factor in the pullback in valuation for retailers in the context of near-term slowdown concerns.

Jefferies, however, maintained its Buy rating on Nykaa, which recently appointed P. Ganesh as its chief financial officer to further strengthen its financial operations and key long-term business strategies.

"We continue to like the BPC space and Nykaa as a franchise," it said.

Nykaa, which was founded in 2012 by Falguni Nayar, sells beauty, wellness and fashion products across websites, mobile apps and over 100 physical stores.

Key feedback from Jefferies’ interactions with investors on Nykaa are:

Slowdown Worry

• Concerns on urban demand are rising due to factors like high base and slowing IT hiring, and the impact is evident in certain segments. App intelligence firm Sensor Tower data also suggests a year-on-year decline in recent months across key apps, including Nykaa.

Competition

• Nykaa's meteoric rise has attracted a lot of players, both online and offline, to focus on the BPC space. Fashion brands like Myntra and AJio have increased assortments as well as marketing spends.

• Reliance Retail is reportedly set to make an entry through a focused brand, Tira. The Tata Group is also eyeing an opportunity, and Shoppers Stop has unveiled SS Beauty stores with a plan to go online.

Ad Income

• Tight liquidity conditions have pushed start-ups to focus on profitability. This has also impacted the direct-to-consumer (D2C) players who have also been focusing on reducing their cash burn. This may impact brand investments, resulting in lower ad income for Nykaa, which enjoys high margins.

Higher Investments

• With rising investments in retail, business-to-business (B2B) and own brands, there are some investor concerns on the increasing capital intensity. This is because Nykaa needs to build more warehouses, increase inventory levels, extend credit (B2B) and spend on retail stores.

Fashion

• Despite a large addressable market, the right to win for Nykaa is still not clear, given high competition from strong and deep-pocketed players.

Working Capital

• Nykaa saw a sharp 50% jump in working capital days in March 2022, and the number stayed high in September 2022 due to quicker payments to D2C players.

Bonus Share Issue

• The bonus share issue around the lock-up expiry negatively surprised some, particularly due to timing around the lock-in expiry.

Supply Pressure

• There has been an incessant supply in the stock, which has also weighed on the share price. Of the large pre-initial public offering (IPO) holders, nearly a third have fully exited.

BROKERAGE OPINION

Jefferies said Nykaa is a strong play on the Indian Internet as well as discretionary consumption themes. There are near-term pressures due to slowing consumption, which is a concern, as it is for other discretionary stocks, and this will weigh in the near term, it added.

“However, we like the structural growth story,” the brokerage said.

Jefferies said the market will attract more players, but Nykaa enjoys an advantage, given its early move into BPC, strong brand relationship and content platform, among others.

The brokerage said Nykaa has been able to carve out a niche for itself through its focus on BPC, which differentiates it from horizontals (Flipkart and Amazon). The recent years have seen a surge in transacting customers for the company and Nykaa should benefit from the increasing order frequencies and basket values, as the newer customer cohorts mature, it added.

“We expect Nykaa to remain in a hyper-growth phase in the medium-term as the online BPC and fashion penetration ramps up,” Jefferies said.

The brokerage pegs a target price of 260 rupees on Nykaa, based on its upside scenario assumptions. It has a target price of 100 rupees on the stock, based on its downside scenario expectations.

Nykaa rose 2.1% to 140.85 rupees in early Mumbai trading today.