The Hindu Business Line : Retailers doing a rethink

Stocks of Indian retail players — once darlings of the bourses that enjoyed premium valuations — have been among the worst performers over the past year, with valuations of leading players whittled down to half their earlier levels. Nor have these stocks participated actively in the recent market “recovery”. Persisting hiccups in the retail sector have affected value and premium retailers alike. Smaller players such as Gitanjali Gems and Vishal Reta il have seen their valuations cut down to low single digits, at 4 and 2 times trailing earnings.

As investors turn more defensive, stocks of retailers with less ambitious expansion plans and stronger cash coffers are being preferred to their more aggressive counterparts. This may partly explain the high double-digit multiples enjoyed by Titan (low debt, diversified and branded presence), Pantaloon (restructuring moves, operation across retail lines, wide footprint), Trent (low debt, steady performance, gradual expansion), Koutons (value retail concept holding up, large store network) and Bata India (brand equity, low debt).

The demographic push towards a younger India and a newfound buzz in the real estate sector were key factors that drove investor interest in the retail sector for much of 2005 to 2007. More than eight retailers went in for initial public offers during this time, collectively raising more than Rs 666 crore for expansion and technology investment.

But, of late, the great Indian retail story appears to have fallen victim to the slowdown - indicators such as footfalls, conversion and same-store sales, once used to justify ambitious store rollouts, showing that it is now in the ‘pause’ mode. To compound problems, the expansion binge has left players grappling with a significant funds crunch. So, retailers appear to have gone overboard, and the optimism that to the re-rating of retail stocks in the first place seems to have been belied. What were the factors that kick-started the boom and what’s dragging down the industry now?

Indian consumer, not so resilient

India’s indigenous consumption was thought to be the key factor that would keep retailers in good health even as export-reliant sectors fell prey to the slowdown. As it turned out, the urban population, the main target for leading retailers, was not entirely insulated from global events, and potential job losses, deferring of pay hikes, and a cautious consumer have sent footfalls sliding for most retailers.

These trends became apparent in the December 2008 quarter, with the sales of retailers increasing by a modest 15 per cent, down from the 40 per cent plus growth rates seen in earlier quarters, even with the festival sales bunched up in these months. Cutbacks in spending persisted in 2009 , affecting lifestyle players such as Shoppers’ Stop and the home solutions division of Pantaloon.

Expansion sprees

Driven by the economic boom, real-estate activity had picked up across residential and commercial sectors. With the choice of locations for malls driven more by availability of land than by proximity to consumers, the mall-based model for retail has not delivered as expected. Hectic real-estate activity sent land prices and thus rentals zooming, building a high cost structure into retail expansion.

Players currently fork out about 4 per cent of sales on rentals alone; too high in a sector where operating profit margins are at 8 per cent. Rental rates were fast becoming too high for retailers to find viable and, as the realty sector faced a funds crunch, retailers whose store rollouts hinged on malls saw their capital locked up in these stores.

Organised retail penetration: With only about 5 per cent of India’s retail organised, the vast untapped potential drew retailers. But leading players, such as Shoppers Stop, are concentrated in the metros and Tier I cities, with only a few, for instance, Vishal Retail, penetrating further into Tier III cities, where the bulk of demand is. Organized retailers are also still unable to match the convenience offered by traditional corner-shopretailers .

Credit flows: Rosy demand projections and easy availability of funds (driven partly by a buoyant stock market) led to the charting of aggressive expansion plans. For example, Koutons Retail went from 999 outlets at the time of its IPO in September 2007 to more than 1,400 stores a year later.

Besides IPO funding, retailers took on debt to bankroll expansion. The average debt to equity ratio for retailers was 2.57 for the previous financial year, against the 0.85 times two years before that. Working capital, the life-blood for any retailer, also relied on debt. With faltering growth, servicing of this debt has become a difficult proposition for most retailers.

Margin squeeze: High rentals, high inventory levels and interest payouts together imposed a squeeze on net profit margins of retailers which shrank from 6 to 2 per cent in the quarters between December 2006 and December 2008. Quarterly interest payments for eleven leading listed retailers shot up 80 per cent in just one year – from December 2007 to December 2008.

How they are coping

Cost controls: Retailers are now looking to optimise costs by going in for a supply chain revamp, greater focus on private labels (they offer better margins), closing unviable stores, lowering inventory, and expanding through franchisees. Vishal Retail, for instance, remodelled its distribution system to a centralised version.

The rental front is also looking up, developers now open to negotiation on rentals as well as new models such as a revenue share, an option with which Pantaloon is experimenting.

Propping flagging sales: Same store sales growth was on a decline for most retailers, going negative in some cases such as Shoppers’ Stop and the home solutions division of Pantaloon.

Retailers are now turning to smaller cities, which are less competitive, going in for discount sales to eliminate old stock, launching more offers to attract footfalls, banking on customer loyalty, and so on.

For example, Koutons had an offer giving out five items free for every one item purchased. Westside temporarily lowered bill-size cutoff for its ClubWest membership from Rs 2,000 to Rs 1000, though how far such schemes spur sales may be seen only in the coming quarter.

Expansion cutbacks: A combination of lack of funding, sluggish sales and store delivery delays has forced some retailers, such as Pantaloon, to scale back expansion plans, while others, such as Vishal Retail, are not likely to expand at all. But a few remain optimistic; Bata India plans to open 240 stores in the space of three years. Pantaloon Retail has taken advantage of its presence in multiple retail lines and plans to restructure, transferring its retail and fashion operations into wholly owned subsidiaries, retaining the consumer goods section. The idea is to allow the raising of funds, especially from private equity players, in segments that are money-spinners, without being bogged down by poor performances in Pantaloon’s other segments.

Investment triggers

With multiple challenges, what triggers should investors look out for while choosing between retail stocks? Though value retailers may stand a better chance of weathering the slowdown, in the long term, both value and lifestyle players will see growth, given the nascent state of the retail market in India.

In the short term, however, indicators to look out for are same-store sales growth figures and footfalls — in a climate of scaled back expansion, sales growth will have to come from existing stores. Reach of retail network plays a key role as well. Also important is short-term liquidity and working capital as retailers require quick short-term funding to keep merchandise on shelves. Interest cover is another important measure, as a fair number of retailers have cover of less than five times interest obligations currently.

Retailers’ ability to fundexpansion is another aspect , as credit lines are freezing up and the equity route may not be very well-received in present circumstances. On most, if not all, counts players such as Titan, Pantaloon and Trent may fare better than counterparts.

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Retailers doing a rethink