Brokerage firm Citi Research has started covering Honasa Consumer Ltd, the parent company of D2C unicorn Mamaearth, giving it a ‘buy’ rating. The firm anticipates strong growth driven by the company’s brand positioning and the expansive market opportunity.

Citi has additionally established a price target (PT) of INR 550 for the stock, suggesting a potential increase of nearly 24% from its recent closing price on the BSE.

“We expect growth outperformance led by company-specific initiatives and masstige positioning (business less impacted by demand slowdown),” said Citi analyst Vismaya Agarwal in the research note.

The analyst pointed out that Honasa’s strengthening market position through innovation, accelerating growth by extending distribution reach, entering new sub-categories, and gradually expanding margins are key long-term advantages.

It’s worth mentioning that Mamaearth had a subdued debut at INR 324 on the BSE in November last year. Since then, its shares have risen by 37% and are presently trading at INR 444.

During its most recent quarter, Q3 FY24, Mamaearth witnessed a significant 264% surge in its consolidated net profit, climbing from INR 7.1 Cr in the corresponding period last year to INR 25.9 Cr. Additionally, its operating revenue rose by 28% year-on-year to reach INR 488.2 Cr for the quarter.

Continue Exploring: Mamaearth parent Honasa Consumer sees 250% YoY surge in net profit to INR 26.1 Crore in Q3FY24

Despite experiencing a marginal sequential decline in PAT during Q3, Citi pointed out that the startup’s financial performance is on an upward trajectory as it scales up.

The brokerage projects that Honasa’s consolidated revenue will experience a 25% Compound Annual Growth Rate (CAGR) from FY24 to FY26, surpassing the growth projections of its FMCG counterparts. This growth will be propelled by Mamaearth’s offline expansion and robust growth in other brands.

It’s important to highlight that Honasa, the parent company of Mamaearth, also possesses other beauty and personal care brands such as The Derma Co., Ayuga, Aqualogica, and Dr. Sheth’s.

Analyst Agarwal anticipates that Honasa’s EBITDA will accelerate at a rate of 55% CAGR, propelled by its rationalization of ad spending, enhancement of channel mix, and operational leverage.

“We also expect return metrics to improve gradually driven by improving profitability, a lean balance sheet (asset-light contract manufacturing model, limited capex requirement for company EBOs) and prudent working capital management,” Citi’s Agarwal said.

Continue Exploring: Nuvama analysts bullish on Mamaearth for MSCI Smallcap Index, Nykaa gaining momentum for Global Standard Index

Nevertheless, the brokerage highlighted that the startup, founded in 2016, remains a relatively young company, with its largest brand, Mamaearth, yet to achieve a stable level of profitability.

In fact, Citi has pointed out that one of the key risks to its thesis is Mamaearth’s reliance on contract manufacturers.

It’s worth noting that during its IPO last year, Honasa collaborated with 37 contract manufacturers, a fact that raised concerns for many.

Nevertheless, during that time, Mamaearth founders Ghazal and Varun Alagh explained that manufacturing required significant capital investment, which could potentially limit the company’s resources. They further stated that outsourcing manufacturing would enable the company to swiftly navigate this growth stage.

Additionally, there are other risks to consider, such as increased discounting and competitive intensity, as well as the potential for pre-IPO shareholders of the startup to sell off shares once lock-ins expire.

The six-month lock-in period for Honasa’s pre-IPO shareholders is set to expire in May. Nevertheless, certain shareholders were granted exemptions from this lock-in period based on their percentage of holding.

Continue Exploring: Honasa Consumer sets sights on outpacing industry growth by 2 to 2.5 times; CFO unveils growth strategy for next year

In December last year, Fireside Ventures sold 60.89 lakh shares, equivalent to a 1.89% stake in a bulk deal. Similarly, last month, Stellaris Venture Partners disposed of more than 32 lakh shares, representing 1% of its stake in the company, in a bulk deal.

Peak XV Partners currently holds the largest stake in Honasa, accounting for 18.84% of the company’s shares. Notably, Sequoia Capital Global Growth Fund holds a 4.38% stake in the D2C unicorn, which is separate from Peak XV Partners’ holdings.

“We note pre-IPO private equity players were holding stake in Honasa. After the promoters, Peak XV/Sequoia is the largest shareholder, with 23% stake in the company. The other PE players together own about 19% and have all sold partially in the IPO. We note the risk of excess supply of Honasa shares coming to the market once the lock-ins for these players expire,” the Citi analyst said.

Nevertheless, Citi anticipates additional upside potential for the stock going forward, driven by the possibility of outperforming its peer group.

In fact, the brokerage also pointed out that while some market segments compare Honasa to Nykaa due to similarities in their operations, target audience, and digital-first approach, direct benchmarking might not be suitable. This is because they have distinct business models—Honasa operates more as a brand while Nykaa functions as a marketplace.

Jefferies brokerage also maintains a ‘buy’ rating on Mamaearth shares with a price target of INR 590.