Event update: Shankara Buliding Products (Downgrade to Underperformer) - Evident pressures of a transitioning business model

Shankara building products (SBPL) management hosted a conference call to update on overall business strategy. Key takeaways are:

Focus on consolidating position to entail moderation in store expansion – Over the past few years, SBPL focused on store expansion, upgradation & entering new categories to drive growth. While the long term vision remains intact, management plans to focus on consolidating the position which would entail moderation in store expansion and new category additions. The strategy is to improve store level execution, scale up category by category and ensure payback period of 3 years.

Improving value proposition & reducing cash sales to hurt margins– Apart from strong brand equity, having a strong value proposition is important to drive growth in retail business. While this would drive revenue growth of 25-30% growth in retail sales, EBITDA margins are expected to moderate in near term from ~10% to 6-8%. Further inability to take price hikes in the processing business & reduction in cash sales in channel business, C&E business EBITDA margins is likely to remain weak at ~3-5%. Resultant consolidated EBITDA margins are expected to moderate to 4.5-5% levels in the near term.

Better working capital management & debt reduction – Apart from improving quality of revenue, management also plans to strengthen its balance sheet led by a) reducing overall working capital intensity (reduce inventory & debtors, encourage cash sales) and b) reduction in debt  from ~Rs5.3bn (incl acceptances) to Rs4bn by March 2019.

Valuations & view

Management remains confident on the opportunity size of the business, however, given the nature of the business, it plans to focus on 3 key areas - a) stabilise & consolidate existing operations, b)improve value proposition in retail and c) improve balance sheet strength. While we appreciate the intent of the revised strategy, the steps also point to two key concerns – a) competitive intensity is high as despite having scale & brand equity the value proposition needs to be further improved and b) revenue growth benefit appears to be lower compared to cost involved in terms of margin trade off, thereby impacting the overall profitability. Factoring moderation in store expansion & contraction in EBITDA margins, we have cut our FY19/20E by 12%/35%. Given the evolving nature of the business model, visibility in terms of execution & potential benefit of the strategy remains weak. Downgrade to Underperformer.