Greeting cards and gifts major, Archies, delivered a decent set of numbers for 3QFY06 (December quarter). The company reported an enthusing topline growth, but margin contraction to the extent of 70 basis points clubbed with lower other income resulted in bottomline growing at a relatively slower pace. Had the tax outgo been at the same levels as in 3QFY05, the bottomline picture would have been bleaker.

(Rs m)	3QFY05	3QFY06	Change	9mFY05	9mFY06	Change
Net Sales	239	281	17.7%	558	632	13.2%
Expenditure	195	231	18.6%	463	526	13.7%
Operating Profit (EBDIT)	44	50	13.4%	96	106	10.8%
Operating Profit Margin (%)	18.4%	17.7%		17.1%	16.8%
Other Income	3	1	-61.0%	8	4	-49.9%
Interest	2	2	-5.0%	4	4	8.4%
Depreciation	4	5	16.1%	12	14	21.8%
Profit before Tax	41	44	9.3%	89	92	3.6%
Tax	15	16	6.2%	33	32	-3.9%
Profit after Tax	26	28	11.1%	56	60	8.1%
Net profit margin (%)	10.7%	10.1%		10.0%	9.5%
Effective tax rate (%)	37.0%	36.0%		37.2%	34.5%
No. of Shares (m)	6.5	6.5		6.5	6.5
Diluted earnings per share* (x)					10.0
P/E ratio (x)					17.6
(* trailing 12 months)

What is the company’s business?

Archies is the market leader in the greeting cards space. It also has other social expression products like gifts, posters, etc. The company has a market share of over 50% currently. It set up a music division recently and has been expanding the range of products sold at its outlets. Its competitors are players like Hallmark, Wilson, Ambassador and ITC. Archies greatest strength is its retail reach as the company has around 430 retail outlets spread across over 100 cities in 6 countries. The company added 15 new stores during FY05 and by FY06 the company plans to add 20 more stores.

What has driven performance in 3QFY06?

Gifts continue to steal the show: One of the company’s major contributors to revenues in recent times, the gifts segment, continued to display outstanding performance. Due to its strong growth (up 36% YoY), this business' share in total revenues went up from about 32% in 3QFY05 to over 37% in 3QFY06. While, one must note that this is a low margin business, margins expanded by 230 basis points for this segment during the quarter, which is a big positive.

Greeting Cards: This segment, which contributed to about 45% of the company’s revenues in 3QFY06, continued to be under pressure. Revenues from this segment were down 7% YoY during the quarter. Greeting cards is largely an urban phenomenon. With increasing availability to and accessibility of the Internet, sending greetings via the Internet has become a cost-effective alternative as compared to printed cards. There are many websites that offer free greeting cards, which can be accessed by anyone who has an Internet connection. Though Archies too has an online offering, most of it is paid. Also, entry of aggressive players like ITC into the segment (ITC Expression is already the No. 2 in this segment with a 20% market share), will pose further challenges for the company. Greeting cards and gifts accounted for around 86% of the company’s revenues.

As can seen from the table below, raw material costs have gone down, but if looked closely, this benefit was mainly due to opening stock benefit. However, staff costs and other expenditure increased considerably during the quarter, which led to the company’s margin contraction. Gifts, which accounted for 37% of 3QFY06 revenues, yielded a margin of 17% as compared to the overall business’ 17.7% margin in the quarter.

as a % of net sales	3QFY05	3QFY06	9mFY05	9mFY06
Total Cost of goods	38.4%	33.9%	36.2%	34.6%
Staff Cost	7.2%	8.4%	8.9%	9.4%
Other Expenditure	36.0%	40.0%	37.8%	39.2%
Total expenditure	81.6%	82.3%	82.9%	83.2%

What to expect?

In the last 5 years (until FY05), the company's revenues have grown at an insignificant 2.4% CAGR. There was a time when 'Archies' was considered to be in the right business, when cards were in vogue. The arrival of Internet and new competition has changed all that.

At Rs 175, the stock trades at price to earnings multiple of 17.3 times its trailing 12 month earnings and market cap to sales of 1.4x. Should the company sustain its growth in the gifts business, things may look up for the company. At the end of FY05, the company had outlined plans to add 100 retail stores over the next 5 years (till 2009). This reach may help it improve its volumes, but this may also entail cash flow pressures in the medium to long term. At the current juncture, valuations look stretched and growth sustainability remains a concern.