SH Kelkar & Company's Q2FY19 results (Outperformer) - Healthy revenue growth, gross margins decline

Q2FY19 results

• S H Kelkar reported healthy revenue growth of 27.7% yoy to Rs2.83m above our estimates of Rs2.44m led by the fragrance division which registered 30%yoy growth to Rs2.53bn, while growth in the flavours business remained soft at 6% yoy to Rs282m.
• Gross margins declined sharply by 583bps to 42.5% (EST 44.5%) on raw material availability issues (fire at BASF, fire at a  domestic aromatic supplier facility, china slowdown etc)
• Stable employee costs and other expenses restricted further decline in EBITDA margins which contracted by 300bps to 13%. (est : 14%)  EBITDA Stood at Rs367m (est : Rs344m), up 3% yoy
• Higher other income (up 420%) and lower tax rate (14.7% vs 36.8% in Q2FY18) led to 50.6% yoy growth in PAT to Rs284m (est : 195m)   

Key positives: strong growth in domestic fragrance business

Key negatives: Gross margins decline sharply

Impact on financials: Cut EPS by 3.5%/12.2% for FY19/20E to factor in decline in gross margins due to higher raw material costs.

Valuations & view

SHK’s performance in the Q2FY19 was impacted due to disruption in raw material supplies despite healthy demand and consumer offtake. We expect SHK profitability normalise 2HFY19E onwards, shored by 1) ameliorating raw material situation, 2) new product launches coupled with price hikes, and 3) capacities coming on stream.  In the long term, SHK’s large revenue exposure to mid-sized domestic FMCG companies that are witnessing faster growth, new client additions (Patanjali, Haldiram and Himalaya) both organically and inorganically and increasing focus on fine fragrance are the key growth drivers. SHK has enunciated a 3x3 strategy, wherein the company expects to focus on 3 fast-growing geographies (India, Indonesia and Italy) for F&F and 3 key product lines - Fine Fragrance, Air care and Fabric care. The company has made several acquisitions which we believe will support its strategy and aid long-term growth (15% revenue CAGR and 20-21% EBITDA margins). Maintain outperformer with revised target price of Rs222.