Equity Research: Honasa Consumer Ltd.

Honasa Looks attractive with higher growth potential and increasing CAGR.

The husband-wife co-founder duo Varun (CEO) and Ghazal Alagh (CIO) have aptly applied their skillsets to sketch this magnificent journey of Honasa. Varun’s experience on various aspects of brand management (sales & marketing, supply chain, distribution & managing innovations) on the back of his professional tenure with FMCG majors (HUL, Coca-Cola India, Diageo India) and Ghazal’s strength in terms of driving consumer relationship and her knowledge about traditional Indian do-it-yourself recipes has been instrumental in the execution prowess demonstrated by the company, Honasa started its journey with the launch of safe toxin-free baby care products under the ‘Mamaearth’ brand in 2016, as the co-founders wanted to solve the problem for babies at that point in time. However, they were quick to realise that it is essential to have broader play across the BPC industry and baby care alone won’t help to drive scalability of the business model. Also, Mamaearth’s brand construct and proposition (toxin-free products with natural ingredients) allowed it to extend into other BPC categories given the rising consumer preference for non-toxic/natural products. Since then, building on the core insight of providing traditional DIY beauty ingredients in modern and convenient formats, the company introduced product offerings in other BPC categories (body, face, hair, cosmetics), successfully transforming ‘Mamaearth’ into an established BPC platform brand. A lot of the success of the brand is led by innovations based on cultural nuances of the Indian consumer, by understanding Indian habits, getting the right ‘hero ingredient’ and translating it into product ranges, like Onion, Ubtan, Multani Mitti, Tea Tree, Rosemary, etc.

With success/experience of Mamaearth, the business playbook is now in place for Honasa. The initial focus is to identify emerging consumer needs and capitalise on the insights to innovate (in Varun’s words “listening to consumers and innovation are core part of our DNA”) to address those needs. This is what powers their innovation engine, which has churned out many differentiated ingredient-based products (Onion, Vit-C, Ubtan range), some of which have themselves become sub-categories. Once the offering is in place, the strategy is to drive discovery of the brand in the online space and scale up in a calibrated manner in the offline channel, which is where their digital-first omni-channel distribution setup comes in play. Innovation and distribution capabilities apart, the founders have also built a formidable professional management team over the years, with varied experience in the consumer sector. Finally, while executing all these aspects, equally important for the company is to ensure it is done in a profitable and capital-efficient manner.

Another key point to highlight is that strong acceptance of certain ingredient-based ranges of Mamaearth has led to some of them becoming sub-categories in themselves (for e.g., onion-based hair oil/shampoo). Since then, many large traditional incumbents (Marico, Emami, HUL) have also introduced their own product ranges based on these ingredients. However, despite entry of competition, Mamaearth remains a dominant player in the onion-based hair care segment (market share >50%) and sales of its existing key ranges (Ubtan, Vitamin C, Onion) have not slowed down. As per a Redseer report, the brand has emerged as the market leader in onion- and ubtan-based beauty products and garnered market share of 8.8% (in revenue terms in CY22) in a highly competitive facewash category, clearly highlighting the strength of the brand and the quality of its offerings.

Shareholding pattern:

Industry Research:

Sized US$20 billion, BPC in India is a large market (6th largest in the world). BPC is significantly underpenetrated in India. Traditionally, Indian households have spent lesser on BPC in comparison to other countries. For instance, in 2022, BPC spends per capita in China were around 3 times of that in India. Even compared to relatively smaller economy like Indonesia, India’s per capita BPC spends are lower, indicating massive growth headroom. The BPC products market in India is undergoing a fundamental re-industrialization owing to the convergence of technology, demographic dividend, and growing consumer aspirations. BPC is expected to grow faster than categories like food, grocery and consumer electronics. This makes BPC one of the most attractive retail categories in terms of growth. India’s per capita spend on BPC products is currently one of the lowest in comparison to some of the other developing countries and is at the cusp of growth as GDP per capita has crossed $2,000, which is a critical inflection point as observed in other developing economies.

The offline channel, which consists of unorganised channels such as general trade, and organised channels such as modern trade and salons, contributed to 84% of the BPC products market in India in 2022 in terms of revenues. Therefore, offline is the largest BPC channel. Also, due to lower customer acquisition costs, sale of BPC products through offline channels tends to be more profitable as compared to online channels. Within offline, the organised channels are growing much faster than unorganised (general trade). However, online is the fastest growing BPC channel. Online has two types of channels – online marketplaces like the horizontal eTailing portals, beautyfocussed vertical marketplaces and DTC– own digital platforms of branded players. The online marketplaces channel is expected to grow at around 25% annually between 2022 and 2027. And DTC is expected to grow at more than 45% annually between 2022-27BPC sales in the online channel is nascent and is growing much faster than the broader BPC market. Pandemic further accelerated its adoption by encouraging trials, while superior consumer experience provided by online players has boosted consumer confidence, driving retention. On the supply side, online is attractive for players as it entails lower cost, infinite shelf space and instantaneous access to actionable data, to note a few of the efficiencies. As a result, even as offline channels witnessed degrowth post pandemic (between 2019 and 2021), online channel grew approximately 60% annually in the same period. Online channel accounted for 2% of the India’s BPC market in 2016 and grew rapidly to account for 16% of the BPC market in 2022. Going ahead, the compounded annual growth rate of the online channel is likely to be up to 27 times as much as that of the unorganised offline (general trade) channel and it is projected to account for 34% of the BPC market by 2027. In India, traditional channels are generally not designed to offer a wide range of products to the tier 2+ cities. E-commerce can help penetrate this market – this is a large structural tailwind. Rising internet penetration and India’s digital payment infrastructure should accelerate growth. The online BPC market is under-penetrated. Compared to the USA and China, where online penetration of BPC is 20-25% and 35-40% respectively, the same for India is around 16%. Further, within Indian eTailing, categories like electronics have close to 50% online penetration. This further underscores the growth headroom for online BPC. With online retail mimicking China’s trend of high online penetration and e-commerce players covering most of the pin-codes, brands have increased access to acquire new customers in tier-2+ cities. Therefore, online BPC is growing fast. It is currently sized as US$3.1 billion and is expected to grow at 29% annually to be around US$11.1 billion by 2027, translating to online penetration of 34%.

Within this online BPC market, Digital-first brands, through technology-led approaches, are changing the Indian BPC landscape. Contributing 26% of the online BPC market and sized at approx. US$800 million as of 2022, Digital-first brands’ revenues have grown at 91% annually between 2020 and 2022, which is almost twice as fast as the other BPC brands who sell products online. In the same period, the number of Digital-first BPC brands in India has doubled. Digital-first BPC brands are democratising distribution by leveraging ecosystem partners like third-party logistics players. Through the support of these partners, Digital-first BPC brands can potentially reach 20,000 pin-codes as of 2022, as opposed to just about 3,000 in 2010. Beyond logistics, Digital-first also leverage enablers like SaaS and payments enablers to drive efficient value chains and seamless customer experience. Traditionally, BPC supply chains were either localised for unorganised players, or piggybacking on the larger retail supply chains of conglomerates. Enabled by ecosystem partners, Digital-first BPC players are much better equipped to serve the evolving consumer needs around personalisation and the required breadth of offerings.

BPC products are generally classified into three price brands - mass, masstige and premium. Mass represents the class of products that are priced lower (the price levels varying across product categories) and are generally accessible to broader population from an affordability standpoint. The masstige segment, is priced at least 10-15% higher than the mass products while the premium category is priced at least 20% higher than masstige. Despite its structural growth, the BPC market is still at an early stage of development and provides significant room for growth. More than 50% of the market is dominated by mass market products. However, masstige is the fastest growing price segment in BPC and is likely to continue being so, going forward. By 2027, this segment is expected to be the largest price segment within BPC. Growth in this segment is being driven by increased disposable incomes, rise in aspirational BPC buying towards more individualised products that solve for specific need-spaces, and demand for better quality products leading to willingness to pay more. While incumbent brands (both domestic and global) continue to dominate the mass category, new-age companies are increasingly focusing on the masstige price point and are introducing high quality products that address consumer’s emerging needs and preferences.

Investment Rationale:

Focusing on distribution expansion in offline channel: The offline channel accounts for 84% of the BPC products market in India. Hence, innovations apart, we see outlet coverage expansion as a massive growth opportunity for Mamaearth. Capitalising on its brand awareness, Honasa is making inroads into the offline channel but in a more calibrated manner. A lot of pin- code level insights, available from the brands website (services 18,640 pin codes) are used to drive a more targeted expansion in the offline channel. Its products are now available in c.166k outlets (vs. just c.10,000 outlets in FY21), of which c.50% of outlets are serviced directly. Going ahead, the company plans to increase overall reach upto c.0.3- 0.4mn outlets over the next 3-4 years. Moreover, the focus is also on quality of distribution; hence, it is expanding primarily in beauty and cosmetics-focused outlets, modern trade (31 retail chains), pharmacies (5,000+ stores) and self-service department outlets. This apart, the company also has a network of 97 Mamaearth EBOs retailing its entire product range and 14 BBlunt salons, which allows it to curate a richer brand experience and build trust amongst consumers.

Channel checks point to wider acceptance of Mamaearth brands in offline channel: Channel checks across Class A and Class C outlets to ascertain acceptance of the brand in the offline channel. We saw Mamaearth products occupying decent shelf space with all major product lines available. In-store visibility in modern trade and standalone personal care stores was much better due to the presence of a dedicated beauty advisor, resulting in much higher throughput in these outlets. Most of the retailers we spoke to pointed towards strong brand pull for the key ranges of the brand, despite entry of other players. While channel margins for Mamaearth are higher vs. traditional incumbents, they are lower compared to other D2C BPC brands like WoW science. In fact, the company was able to reduce channel margins by c.100bps without any major disruption in sales, which again points to the strong brand equity of Mamaearth.

Offline channel steadily becoming a more dominant channel and a key revenue driver for Mamaearth: Over FY21-23, offline channel sales have increased 6x, much faster than online sales, resulting in salience of the offline channel in overall revenue mix of the brand significantly increasing from c.16% in FY21 to c.41% of brand sales in FY23. Going ahead, with wider acceptance of the Mamaearth brand, we forecast offline sales to grow at a CAGR of 21% over FY23-26E (>50% of brand sales from offline channel from FY25E onwards) while online is expected to grow at a slower pace (which is part of a conscious company strategy on optimising channel mix and driving profitability).

Bridging portfolio gaps through additions of brands: The experience and success with Mamaearth across key aspects (innovation, distribution, marketing, etc.) of brand-building has helped Honasa develop a brand- building playbook that enables it to replicate that success across newer brands either by incubating brands in-house or by acquiring new engines of growth. Over the years, leveraging the same, Honasa has transformed itself from a single-brand company to a ‘house of brands’ comprising six brands. Over FY20-23, it has launched three in-house brands (The Derma Company, Ayuga, Aqualogica). Moreover, each of these brands has unique propositions, thereby further enhancing Honasa’s overall product offering. While Mamaearth tapped the opportunity arising from increasing consumer demand for natural ingredient-based non-toxic products, there were consumers who were looking for science backed/active ingredient-based product for their specific needs. Honasa was quick to pick up that insight in 2020, when the active ingredients proposition was relatively nascent in India, and launched a separate brand ‘The Derma Company’ given that Mamaearth’s brand construct did not resonate with the active ingredient proposition. Aqualogica is another in-house brand, launched in 2021, based on insight that Indian tropical weather needs light hydration while Ayuga was launched to provide ayurvedic beauty products in easy-to-use, modern formats for Indian millennials. Apart from in-house brand launch, the company also acquired two brands – Dr Sheth (Bio actives based skincare range) and BBlunt (Professional hair care products) in 2022 – again with differentiated propositions, thereby further widening its portfolio offering.

House of brands architecture allows accelerating growth: In our view, having a wider assortment helps capture a consumer’s wallet by catering to different needs even within a single household. Moreover, the success of a flagship brand like Mamaearth acts as a vehicle and helps provide entry to new brands in the channel by leveraging existing relationships with partners. This apart, synergy benefits from other integrated support functions help to scale up new brands at a much faster pace.

Replicating success of Mamaearth through new brands can be a huge opportunity: The benefits are visible with faster scale-up of in-house brands launched after Mamaearth, with three out of five brands having crossed ARR of INR 1.5bn. Leading the pack is The Derma Company where the ramp-up has been pretty strong (from <INR 200mn sales in FY21 the brand is currently clocking ARR of INR 3.8bn). Similarly, Aqualogica was fastest to achieve ARR of INR 1.8bn in just 19 months of launch, which is almost half the time taken by Mamaearth and The Derma Company. Even the acquired brands have seen healthy uptick in revenues from the time of acquisition – Dr Sheth has scaled up 35x post acquisition and is the 4th brand to achieve INR 1.5bn ARR while the product business of Bblunt is up 3x since acquisition. As on FY23, revenue contribution from new brands (excluding service income) has increased to c.16% of overall sales from <5% in FY21. Strong innovation capabilities and online channel expertise apart, we see scope for ramp-up in the offline channel, leveraging existing relationships with distributors/retailers of Mamaearth. We forecast sales from new brands (ex-Mamaearth) to grow at 61% CAGR over FY23-26E, much faster vs. Mamaearth sales (CAGR of 12% over FY23-26E), thereby resulting in revenue contribution from these brands increasing to c.42% of sales by FY26E.

Management Profile:

Varun Alagh is one of the Promoters of Company. He is the Chairman, Whole-time Director and the Chief Executive Officer of Company. He holds a bachelor’s degree of engineering (electrical) from the University of Delhi, Delhi and a post-graduate diploma in business management from XLRI, Jamshedpur. He has been associated with the Company as a promoter and a director since September 16, 2016. Previously, he has worked with corporations such as Hindustan Lever Limited, Diageo India Private Limited for over a year and Coca-Cola India Private Limited.

Ghazal Alagh is one of the Promoters of Company. She is a Whole-time Director and the Chief Innovation Officer of Company. She holds a bachelor’s degree of computer applications from Panjab University, Chandigarh and a certification in software engineering from the academic council of the NIIT Academy, New Delhi. She has been associated with the Company as a promoter and director since September 16, 2016.

Ishaan Mittal is a Non-Executive Director of Company and a nominee of Peak XV and Sequoia Capital on Board. He holds a bachelor’s degree of technology in mechanical engineering from the Indian Institute of Technology, Delhi and a master’s degree in business administration from Harvard University, Commonwealth of Massachusetts. He has been associated with the Company as a director since January 3, 2020. Previously, he has worked with the Boston Consulting Group (India) Private Limited for a period of over a year and is working with Peak XV Partners Advisors India LLP (formerly, Sequoia Capital India LLP) for a period of over eight years where he is currently working as “Managing Director”.

Vivek Gambhir is an Independent Director of Company. He holds a bachelor’s degree in arts and a bachelor’s degree of science from the Lafayette College, Pennsylvania. Further, he holds a master’s degree in business administration from Harvard Business School, Commonwealth of Massachusetts. He has been associated with Company as a director since March 24, 2021. Previously, he has worked with Bain & Company India Private Limited for a period of over 11 years where he was last associated as “Partner”, and with Godrej Consumer Products Limited for a period of over 11 years where he was last associated as “Whole-time Director”. He has previously been the co-chair of the Confederation of Indian Industry, National FMCG Committee and served as the president of the Harvard Business School Club of India.

Subramaniam Somasundaram is an Independent Director of Company. He holds a bachelor’s degree of commerce from University of Madras, Madras and is a chartered accountant and cost accountant. Previously, he was the chief financial officer for Titan Company Limited for a decade. Currently he is also an Independent Director on the boards of Teamlease Services Limited, Avanti Finance Private Limited, API Holdings Limited, Landmark Retail FZE (Dubai) and Innoviti Technologies Private Limited. He has worked in the telecom industry for over 11 years as well, as the chief financial officer for BPL Mobile group and chief executive officer for BPL Mobile operations in Mumbai and chief financial officer of the telecom vertical in Essar group. He has also worked earlier in his career with I.T.C Limited, V.S.T Industries Limited in India and Mannai Corporation Limited, Qatar.

Namita Gupta is as Independent Director of Company. She holds a master’s degree of technology in mathematics and computing from the Indian Institute of Technology, Delhi. She has been associated with Company as a director since June 8, 2022. Previously, she has worked with Microsoft Corporation. She has also worked with Facebook Inc. for a period of over five years where she was last associated as “Partner Engineer”. Further, she is also serving as an independent director on the board of directors at Zomato Limited since March 1, 2021 and is the founder and currently on the board of directors of Airveda Technologies Private Limited.

Financials:

Balancesheet

Profit & Loss

Cash Flow

Valuation & Opinion:

Growth remains a key priority for the company, but Honasa has a clear intent to achieve it in a profitable and capital-efficient manner. Honasa’s gross margin is superior to listed FMCG players given its pure-play BPC characteristics and its masstige-to-premium space of operation. Whilst the company has delivered positive EBITDA in each of the last three financial years, its scale was small due to disproportionate investments into brand-building and channel-related spends (c.38- 46% of sales over FY21-23). Honasa clocked strong revenue CAGR of 126% over FY20-23, resulting in c.12x fold increase in revenue from INR 1.2bn in FY20 to INR 15.9bn in FY23. The sales for flagship brand Mamaearth grew by 126% CAGR to INR 12.7bn while sales of newer brands, introduced from FY21 onwards, also grew c.16x to INR 3.1bn by FY23. Going forward, we expect further scale-up in Mamaearth, albeit at a lower pace of 11% over FY23-26E vs. historical rate, owing to higher scale and the company’s focus on optimising channel mix by expanding in the offline channel. However, sales of newer brands are expected to scale up at a much faster pace – 58% CAGR led by innovations and ramp-up across channels. Together, these factors are expected to drive industry leading revenue CAGR of 25% over FY23-26E for Honasa. So the company looks attractive at the current market price.

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