Relaxo Footwear has garnered many followers on Dalal Street of late. Its stock has delivered a mind-boggling 374% return in the past three years and trades currently at 33x FY17 consensus earnings, closing in on the valuation gap with rival, Bata India, which trades at 36.2x.
This re-rating has been driven by a couple of things: a strong growth in realisation because of a product-premiumisation strategy, and an expansion in its distribution network. But, can this stellar performance continue?
Relaxo has gradually moved up the value chain, increasing its realisation from ₹48 per pair in 2008 to ₹130 per pair currently, but still far lower than Bata’s ₹480 per pair. Yet as its sales continue to come from non-leather products, it makes up for nearly 85% of sales by selling 13.5 crore pairs, as against Bata’s sales of 5 crore pairs.
Since 50% of India’s footwear market still belongs to unorganised players, Relaxo identifies them as direct competitors instead of big players like Bata. Hence, it is still sticking to a lower price point while strengthening its branding to get a greater share of this pie by tapping customers willing to upscale. In line with the strategy, it has not only been innovating on product design, launching about 100 new designs in FY16, but also creating aspirational value by roping in celebrities. In 2012-13, Relaxo roped in Bollywood star Akshay Kumar for its sports brand Sparx, Katrina Kaif for the women category, Flite, and Salman Khan for its newly launched Bahamas collection — Hawaii.
The promotional push is costing the company dearly — Relaxo spends close to ₹9 per pair on branding its products (advertising and promotion) as compared to Bata’s ₹4 per pair. But the expense seems to be worth it. Its RoE moved up from 17.24 % in FY08 to 23% in FY13 to 32% in FY15 before falling to 27% in FY16 because of sluggish demand; and a wage hike in Haryana, where most of Relaxo’s manufacturing takes place. Interestingly, this still compares favourably with Bata, which has a RoE of just 14%.
This low return is due to the fact that Bata is under-investing in its brand while investing more in its retail stores. Says Abhishek Ranganathan of Ambit Capital, “Bata has invested less than 1% of its revenue in the brand over CY08-15. While this will bite into future earnings, the over-investment in stores will cap capital efficiency," he says.
The investment in stores becomes even more questionable considering the way e-commerce is taking off. The convenience factor and cheaper prices are wearing away customers. Plus, competition in high price points is also increasing with the entry of foreign players. These brands have an aspirational value and shift in customer preference can hamper growth in premium categories. Bata does face a major threat, but Relaxo won’t be insulated either as 30% of its volume comes from products priced above ₹500.
What might work to its advantage is that Bata has expanded its presence across 1,200 stores in India as compared with Relaxo’s 250 stores. Relaxo depends on a distribution-led model as compared with Bata that relies heavily on capital-intensive own stores. So despite being a bigger brand with better realisations, its returns are significantly lower. Relaxo’s superior operating margin of 14% as compared with 11% for Bata is because of higher share of leased properties and the 1.1% royalty that Bata has to pay to its parent.
While Relaxo still has a long runway in terms of capturing market share from unorganised players, it could face hiccups in the coming couple of quarters because of the impact of demonetisation. In the first half of current fiscal, the company made an EPS of ₹5.3; assuming a 20% hit on earnings, the company might close the year with an EPS of ₹9.5, which translates into a price-earnings ratio of 42x.
Between FY12-16, the company has grown its volume at 10% along with a 9% annual growth in realisations, translating into an earnings growth of 31%. Even if it grows 20% in FY18, its EPS of ₹11.5 translating into a price-earnings ratio of 34.5x, which is not exactly cheap. On the contrary, Bata has been getting de-rated because of increasing competition in its key markets, closing down of stores (1,200 now, as against 1,400 stores in 2015) and feeble growth in volumes. Analysts do not see much changing over the next couple of years — earnings are likely to remain muted. While the growth prospects look much better for Relaxo currently, it still needs to sustain the growth momentum to reaffirm its brand strength in order to be on par with Bata, which has proved its resilience for many years, in terms of valuation.