Nykaa’s fashion foray and pipeline-style biz model worries analysts

• As the Big Boys of online commerce allocate more real estate to beauty and personal care on their platforms, Nykaa is set to face the heat of competition.
  
  
• A new HDFC Securities report says that Nykaa is not a platform at all, as its non-linear sources of income remain limited.
  
  
• Fashion business continues to be a drag for the hybrid retailer with Q2 being a complete washout despite festive cheer.
  

The public listing of Nykaa, the popular online beauty and personal care retailer, may have made its founder Falguni Nayar the poster girl of several billionaire lists, but less than a year after its listing, investors are raising red flags on its model.

Several new-age tech-driven businesses tapped public markets last year with very fancy valuations, as platform businesses have nonlinear growth paths and are, therefore, disruptive. The market is now questioning the very platform status of Nykaa. HDFC Securities has termed Nykaa as an efficient online pipeline rather than a platform.

Nykaa was among the first to retail beauty products online in India, where physical distribution is a huge challenge. A platform business tends to solve such bottlenecks and they also have the ability to layer on multiple revenue streams at very little incremental cost. Analysts now are of the view that the hybrid retailer will not only face competitive intensity but also have to fight for nonlinear income sources like advertising with bigger giants like AJIO, Tata Cliq Palette and Myntra. Nykaa will have to take on the Big Boys with deep pockets if it wants to remain relevant to its core customer cohort.

Not surprising then that in the last one year, shares of FSN E-commerce Ventures (Nykaa’s parent) are down 50.1% from listing day, making the company announce 5:1 bonus shares. Despite the lure of more shares, market experts have warned investors not to rush to buy the stock ahead of the record date for the bonus issue.

Q2 earnings did little to allay fears

The company’s financials for the quarter ended September have done little to allay these concerns, with a mere 3.6% growth in net profit sequentially as its expenses rose. The strongest critique post its Q2 performance came from HDFC Securities, which claims that the company cannot be termed a ‘platform’ due to its pipeline-like business model. While Nykaa continues to be strong in its key vertical – beauty and personal care (BPC) – it is struggling to gain market share in the fashion vertical.

A bigger risk is the emerging competition that Nykaa is expected to face from competitors with much deeper pockets. Amazon and Myntra are allocating more real estate to BPC on their platforms and in marketing communications, says JM Financial. Analysts are hoping that there will be a reversal in the profitability of Nykaa fashion vertical.

What has also come to haunt Nykaa is the meltdown globally in the valuations of tech businesses. HDFC Securities’ report titled ‘Mirror, mirror on the wall, is Nykaa a platform at all’ is the most damning one so far against the beauty and fashion retailer.

“Nykaa clocked 50% CAGR (compound annual growth rate) over FY19-22; its EBITDAM (earnings before interest, tax, depreciation and amortisation margins) expanded around 250 basis points and it has a linear asset turn profile —all akin to an online pipeline. Unlike platforms, pipelines typically lack the ability to build nonlinear cash flow-accretive revenue streams (except perhaps ad income generated from brands if it’s an online pipe),” said the HDFC report.

While platforms have multiple income sources, a pipeline business is an old-style business where inventory is piled at one end and sold at the other. Platforms, the best example of which is YouTube, have multiple monetary sources from both sellers and buyers.

“Nykaa has the potential to be a hybrid, but as of now (85% of net sales value or NSV - inventory-led), it shares more characteristics with a busy, efficient, linear online pipeline than a platform,” the HDFC report said.



Source: BSE


Where are the margins?

Nykaa’s growth, its margin expansion and asset profile show signs of a pipeline – and not a platform that can turn extremely powerful at scale once it attains critical mass – and does not warrant ‘platform valuations’.

Pipelines in general are a low-margin inventory business and while Nykaa does have advertising income where sellers advertise on it – this income is closely tied to its unit economics.

“The BPC (beauty and personal care) segment – Nykaa’s cash cow– while a go-to destination for shopping, is (as of today) heavily reliant on ad/shipping income for its profitability/return ratios” the HDFC report said.

“Product EBITDAM is estimated to be just about profitable now (FY22). Of course, this might change as Nykaa scales its own brand portfolio and order density. However, any dip in the ad income could be a negative counter-balancing factor (not factored in),” the report added.

Moreover, the unique proposition that Nykaa had in the market is fast vanishing with moneyed competitors entering the market. “We decrease our target multiple to factor the recent corrections in new-age internet companies in backdrop of increasing risk premium. The risks of increased competition from some of the large well-capitalised players (Reliance, ABFRL, Tata etc) is key,” said Dolat Capital.

Apart from losing business, the ad revenue of brands might also get distributed between the many emerging players in the business — a key factor affecting Nykaa’s profitability – possibly affecting its journey towards becoming a full-fledged platform.

However, HSBC differs in its opinion on Nykaa’s business model. It believes that it’s a rare combination of profitability and sustainable exponential growth and expects its revenue to double every 2-3 years in the coming decade.

“Augmenting the core e-commerce operation with a growing pan-India store network,raising structural barriers for others and edging up its game in the consumer experience; building a portfolio of its own skin and beauty brands, and extending its overall proposition for other retailer through eB2B SuperStore by Nykaa. This should make Nykaa’s long-term evolution as not just a platform owner but also a formidable brand owner,” said HSBC.

Fashion forward?

Nykaa’s venture into the fashion business too has met with many sceptics in the analyst community – also in the light of intense competition. For the second quarter of the year, the gross merchandise value increased for this business by 43% y-o-y, albeit on a low base, while sequentially it was up a marginal 3%, as per the HSBC report.

Even as its own brands made their way to 39 multi-brand outlets and 503 general trade outlets, Nykaa also has three of its own stores dedicated to this business.

“Management mentioned that they are not pursuing GMV growth for the fashion business, rather they aim to strike a balance between growth and profitability. We adjust our FY23-FY25e estimates post the 2Q FY23 results. We lowered our revenue estimates primarily for the fashion business. We raise our margin assumptions as we expect that the company will be able to control costs given higher efficiencies and operating leverage,” said a report by HSBC.

However, its entry into this business can offer it something that BPC lacks – a strong advertising market. The fashion vertical is gaining a significant share of brands’ digital advertising, said a report by JM Financial.

“While Nykaa generates 6%+ of GMV in BPC ads income, the same number for fashion is lower than 4% currently, though fashion brands allocate a higher percentage to advertising expenses. If Nykaa does become the go-to platform for online fashion purchases in India, we see significant upside from ads income,” said the JM Financial report.

In its journey to become a fashion forward business, Nykaa is hitting the same wall as its BPC segment – intense competition and moreso it also lacks the first-mover advantage that most other established brands already have.

Nykaa’s nascent presence in the market also means that it’s yet to bring in the ability to make multi-stream revenue from the fashion business. “In BPC, NSV to revenue from operations is higher due to advertising revenue. In fashion, the difference between NSV to revenue is due to the inventory model where only commission revenue is accounted,” said Dolat Capital.

The long-term value accretion of Nykaa depends on its ability to drive value through its own brands, multi-stream revenue and also from the fashion business — that’s currently haemorrhaging money and a difficult and overcrowded market to crack.