- With the Big Boys of online commerce allocating more real estate to beauty and personal care on their platforms, Nykaa will have to face the heat of competition.
- A new HDFC Securities report says Nykaa is not a platform at all, as its non-linear revenue sources remain limited.
- Fashion stores remain a drag for the hybrid retailer, with Q2 being a complete washout despite celebratory cheers.
The public listing of Nykaa, the popular online beauty and personal care retailer, may have made its founder Falguni Nayar the star of several billionaire lists, but less than a year after its listing, investors are putting red flags on the model.
Several new-age technology-driven companies have entered the public markets with very nice valuations last year as platform companies have non-linear growth paths and are therefore disruptive. The market is now questioning Nykaa’s platform status. HDFC Securities has called Nykaa an efficient online pipeline rather than a platform.
Nykaa was one of the first to sell beauty products online in India, where physical distribution is a huge challenge. A platform company tends to solve such bottlenecks and they also have the ability to stack multiple revenue streams at a very low incremental cost. Analysts now believe that the hybrid retailer will not only face competitive intensity, but will also have to fight for non-linear revenue sources such as advertising with bigger behemoths such as AJIO, Tata Cliq Palette and Myntra. Nykaa will have to tackle the Big Boys with deep pockets if it is to remain relevant to its core customer cohort.
Unsurprisingly, shares of FSN E-commerce Ventures (Nykaa’s parent company) have fallen 50.1% over the past year from its listing day, prompting the company to announce 5:1 bonus shares. Despite the pull of more stocks, market experts have warned investors not to rush into buying the stock before the record bonus issuance date.
Q2 gains did little to allay fears
The company’s financial data for the quarter ended September did little to allay these concerns, with net profit growing just 3.6% sequentially as costs rose. The strongest criticism after the Q2 performance came from HDFC Securities, which claims the company cannot be called a “platform” due to its pipeline-like business model. While Nykaa remains strong in its core industry – beauty and personal care (BPC) – it struggles to gain market share in the fashion industry.
A greater 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 hope there will be a turnaround in the profitability of Nykaa fashion vertical.
What has also come to haunt Nykaa is the global collapse in technology company valuations. HDFC Securities’ report titled
‘Mirror, mirror on the wall, is Nykaa a platform at all’ is the most scathing yet against the beauty and fashion retailer.
“Nykaa achieved a CAGR of 50% (compound annual growth) over FY19-22; its EBITDAM (earnings before interest, taxes, depreciation and amortization margins) was up about 250 basis points and it has a linear asset turnover profile – all comparable to an online pipeline. Unlike platforms, pipelines typically don’t have the ability to build non-linear cash-flow accretive revenue streams (except perhaps advertising revenue generated by brands if it’s an online pipeline),” the HDFC report said.
While platforms have multiple sources of income, a pipeline business is an old-fashioned business where inventory is piled up at one end and sold at the other. Platforms, of which YouTube is the best example, have multiple sources of money 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-driven), it shares more characteristics with a busy, efficient, linear online pipeline than with a platform.” the HDFC report. said.
Where are the margins?
Nykaa’s growth, margin expansion and asset profile show signs of a pipeline – not a platform that can become extremely powerful on a large scale once it reaches critical mass – and does not justify ‘platform valuations’.
Pipelines are generally a low-margin inventory business and while Nykaa has ad revenue where sellers advertise on it, this income is closely tied to the unit economy.
“The BPC (beauty and personal care) segment – Nykaa’s cash cow – while a favorite shopping destination, (as of today) relies heavily on advertising/shipping revenue for its profitability/yield ratios,” the HDFC said. -report.
“Product EBITDAM is now estimated to be near profitable (FY22). This could of course change as Nykaa scales its own brand portfolio and order density. However, any dip in ad revenue could be a negative counterbalance (which is not taken into account),” the report added.
Moreover, the unique proposition that Nykaa had in the market is rapidly disappearing with lenders entering the market. “We are lowering our target multiple to take into account the recent corrections in new-age internet companies against the background of a rising risk premium. The risks of increased competition from some of the major well-capitalized players (Reliance, ABFRL, Tata, etc.) are critical,” said Dolat Capital.
Aside from the loss of revenue, the advertising revenue of brands could also be split among the many emerging players in the business – a key factor affecting Nykaa’s profitability – potentially impacting its journey to a full-fledged platform.
However, HSBC disagrees on Nykaa’s business model. It believes it is a rare combination of profitability and sustained exponential growth and expects its sales to double every 2-3 years over the next decade.
“Extend the core e-commerce business with a growing pan-Indian store network, erect structural barriers for others and lead the way in consumer experience; building a portfolio of its own skin and beauty brands and expanding its overall proposition to other retailers through eB2B SuperStore by Nykaa. This should make Nykaa’s long-term evolution as not only a platform owner, but also a formidable brand owner,” HSBC said.
Nykaa’s venture into the fashion industry has also met many skeptics in the analyst community – also in the face of fierce competition. For the second quarter of the year, gross trade value for this company rose 43% yoy, albeit on a low basis, while rising a marginal 3% sequentially, according to the HSBC report.
Even as its own brands found their way into 39 multi-brand outlets and 503 general stores, Nykaa also has three of its own stores dedicated to this business.
“Management said they are not pursuing GMV growth for the fashion industry, but that they want to find a balance between growth and profitability. We are adjusting our estimates for FY23-FY25e after the results of 2Q FY23. We have lowered our revenue estimates primarily for the fashion industry. We are raising our margin assumptions as we expect the company to be able to control costs given its increased efficiency and operating leverage,” said a report from HSBC.
However, its entry into this company can provide it with something that BPC lacks: a strong advertising market. The fashion industry gains a significant share of brands’ digital advertising, according to a report by JM Financial.
“While Nykaa generates 6%+ of GMV in BPC ad revenue, the same figure for fashion is currently below 4%, although fashion brands allocate a higher percentage to ad spend. If Nykaa becomes the go-to platform for online fashion purchases in India, we will see a significant benefit from advertising revenue,” according to the JM Financial Report.
In its journey to become a fashion forward business, Nykaa is hitting the same wall as its BPC segment – fierce competition and on top of that it also lacks the first-mover advantage that most other established brands already have.
Nykaa’s emerging presence in the market also means that it does not yet have the ability to generate multi-stream revenue from the fashion business. “At BPC, NSV in revenue from operations is higher due to advertising revenue. In fashion, the difference between NSV and revenue is due to the inventory model where only commission income is accounted for,” said Dolat Capital.
Nykaa’s long-term growth in value depends on its ability to generate value through its own brands, multi-stream revenues and also the fashion business – which is currently a bloodcurdling money and a difficult and crowded market to crack.