Nykaa IPO: Should you buy or stay away?

Nykaa (FSN E-Commerce Ventures), a leading omnichannel beauty and personal care multi-brand retailer is coming out with an IPO to raise ₹5,352 crore. This comprises a fresh issue of up to ₹630 crore and the remaining, an offer for sale by the company’s promoters and other shareholders.

The offer will be open from October 28 to November 1, 2021. The IPO proceeds will be spent on enhancing the brand visibility, funding new retail stores and warehouses, and repayment of borrowings.

Incorporated in 2012, Nykaa with a predominantly online presence offers a diverse portfolio of beauty and personal care (BPC) products, and fashion products (launched in 2018). It offers an extensive range of 31 lakh SKUs from over 4,078 national and international brands across its two business segments.

According to a RedSeer Report (exclusively commissioned and paid for by the company for the purpose of the offer) Nykaa is the largest specialty BPC platform in India.

There are multiple positives for Nykaa. The high growth potential of the Indian BPC market is one. According to RedSeer Research, the Indian BPC market is expected to grow at 12 per cent per annum from 2020 to reach ₹1,981 billion by 2025. Nykaa’s wide-ranging product portfolio, rising number of transacting customers and growing average order value are other pluses.

Besides, providing authentic BPC products through an online platform gives Nykaa the ability to reach out to tier-2/tier-3 cities as well, where the market has huge potential, but is under-penetrated in terms of availability in retail stores. But the valuation dims the attraction.

Also read: Nykaa raises ₹2,396 cr from anchor investors ahead of IPO

At the IPO price band of ₹1,085 to ₹1,125 per share, Nykaa’s valuation appear a bit stiff, leaving nothing much on the table for IPO investors. Based on the company’s FY21 sales, the Enterprise Value-to-Sales (EV/Sales) ratio works out to 21-22 times.

While this may appear cheaper compared to other recently listed e-commerce companies such as Zomato (EV/sales of 25 times at IPO and 52 times today) and CarTrade Tech (EV/ sales of 27 times at IPO and 21 times today – stock down 17 per cent since IPO), Zomato and CarTarde are not exactly trading at rational valuations. Secondly, the high valuation of these companies is also a function of the euphoric market conditions today.

Today, Nykaa is valued at about ₹53,200 crore. Going by information from news reports, this is a significant jump from the valuation of $1.2 billion (around ₹9,100 crore) for the company in April 2020 when it raised ₹100 crore from an existing investor, Steadview Capital.

Besides, how all the positives discussed above translate into a more sustainable profitable growth for Nykaa needs to be watched. It turned profitable at the operating (EBIT) level in FY19 and at the PAT level in FY21. It reported revenue of ₹817 crore, EBIT of ₹7.4 crore and net profit of ₹3.5 crore in the June 2021 quarter.

About the business

While present both through online and offline channels, Nykaa’s business is largely online sales driven. Sales via mobile apps, mobile site and the website accounted for almost 96 per cent of the company’s gross merchandise value (GMV) of ₹4,045 crore in FY21. Physical store sales accounted for the rest.

As of August-end 2021, Nykaa had 80 stores across 40 cities in India in three different formats. GMV refers to the monetary value of all orders placed inclusive of taxes and discounts without accounting for product returns or order cancellations.

The company’s BPC business is largely an inventory-led model where Nykaa sources products directly from the brands or their authorised dealers. This helps Nykaa with timely delivery and ensuring authenticity of the products sold by it. The sourcing at wholesale prices gives Nykaa comfortable room for attractive offers to customers and at the same time retain a portion of the margins.

The smaller, fashion segment largely follows a marketplace model where Nykaa earns a pre-agreed commission fee from the sellers listed on its platform on sale of products. In FY21, Nykaa derived 89 per cent of its revenue from sale of products, largely from the BPC segment.

Another 8 per cent was advertising revenue from BPC and fashion-related sellers in both the online and offline channels. The rest was largely from the fashion business in the form of commissions.

Growing rapidly

Nykaa has grown at a fast pace over the last few years as indicated by its key performance metrics. The annual unique transacting customers grew from 35 lakhs to 56 lakhs for the BPC segment and from zero to 6 lakhs for the fashion segment between FY19 and FY21. Alongside, the average order value (AOV) rose from ₹1,433 to ₹1,963 for BPC and from ₹655 to₹2,739 for fashion during the same period.

Aided by this, Nykaa’s GMV grew at a 57 per cent CAGR to ₹4,046 crore between FY19 and FY21. BPC accounts for 84 per cent of the total GMV.

The growing share of existing customers in the BPC segment – from 55 per cent in FY19 to 70 per cent in FY21 – has helped bring down the overall share of marketing costs. Existing customers are those who placed at least one order in any prior financial year on Nykaa’s website or mobile app.

Similarly, the rising AOV has helped lower fulfilment costs (which includes freight and packaging costs) as a percentage of revenue. A higher order value may not lead to a commensurate increase in fulfilment costs. This along with a scale up in operations helped the EBITDA margins rise from 1.85 per cent in FY19 to 6.61 per cent in FY21. During this period, the net profit margins moved from minus 2.2 per cent to 2.5 per cent.

It reported revenue of ₹2,441 crore (up 38 per cent y-o-y), EBIT of ₹94 crore (up 338 per cent) and net profit of ₹62 crore (₹16 crore loss a year ago) in FY21. As of June 2021, the debt-to-equity ratio was 0.4 times.

What next?

The company expects its EBITDA margins to remain at the current levels over the next couple of years and move up, thereafter. This, it expects to be driven by the improving operating leverage (fixed costs getting distributed across higher sales) in the BPC segment with further expansion and the yet to kick-in operating leverage in the relatively new fashion segment.

Apart from this, Nykaa’s expanding portfolio of its own products, too is expected to help. The margins on Nykaa’s own BPC products (which includes Nykaa Cosmetics, Nykaa Naturals and Kay Beauty) are twice as much as those on third party brands. Given that the company’s own products still account for a small proportion (10 per cent of revenue in FY20 and 7.5 per cent in the June 2021 quarter), this may take some time to play out.

Also, while Nykaa may have a strong presence and visibility in the Indian online BPC market, the same may not hold true for its smaller fashion segment. According to Red Seer, the fashion market is expected to grow by 18 per cent per annum (2020-25) to reach ₹8,702 billion by 2025.

The presence of many other fashion-only as also diversified online players in this competitive space (Ajio, for instance) means that Nykaa’s progress in this segment needs a close watch. Nykaa has a formidable competitor here in Myntra (Flipkart), with much more firepower and possibly deeper pockets, thanks to the backing of Walmart.

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