Initiating coverage: Khadim India (Outperformer) - On the right foot

We see Khadim India Ltd (KIL) as a key beneficiary of the untapped potential (58% unbranded market) of India’s US$7.2bn footwear industry. Our estimate of 16% revenue and 21% EBITDA CAGR over FY18-20E is driven by the company’s two-pronged strategy of 1) expanding exclusive retail network (13.4% revenue and 9% store addition CAGR), and 2) ramping up distribution-led  (27% revenue CAGR) business. Over last 5 years, the company has successfully diversified its footwear business through varied regions, channels and product portfolio. KIL has a strong presence in East India and is in the process of unlocking potential in the Southern and western markets through its retail and distribution formats. Healthy revenue growth, mix improvement, operating leverage benefits and lower interest costs will drive 30% earnings CAGR over FY18-20E. The stock is inexpensive at 27x/22x FY19E/20E earnings compared to peers, Bata and Relaxo. Initiate with an Outperformer rating with a target price of Rs967.

Hybrid channel growth strategy: KIL plans to expand its geographical presence by adopting a two-pronged growth model (through exclusive retail and multi brand distributors). The company has adopted a scalable and less capital-intensive business model to operate its retail business. We estimate 7% same store sales CAGR and store scale up in the southern and western markets to result in 10% volume CAGR in retail over FY18-20E. We estimate 16% and 9% CAGR in distributor addition and revenue per distributor, respectively, to drive KIL’s distribution revenue at 27% CAGR over FY18-20E.

Margin and return metrics to steadily improve: Improving product mix across both (exclusive retail led and multi brand distributor led) channels and benefit of operating leverage on overheads will drive 100bp EBITDA margin improvement, implying 21% EBITDA CAGR over FY18-20E. As profitability and capacity utilizations improve, we expect pre-tax RoCE to improve 460bps to 22.5% over FY18-20E, closer to peers like Bata and Relaxo.

Earnings profile and attractive valuations make KIL an attractive play: We believe conversion opportunity from unbranded to branded footwear, along with superior execution and new product introductions will drive KIL’s sales and earnings growth ahead of peers. We expect the company’s discount to peers (Bata and Relaxo) to narrow, as KIL’s strategy leads to 30% PAT CAGR over FY18-20E. KIL currently trades at 37% discount to average PE multiple of the two largest listed players and we value the stock at 27.5x FY20E     earnings (20% discount to average PE multiple of Bata and Relaxo).