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Pantaloon Retail India Ltd
Reuters: PART.BO Bloomberg: PF IN Exchange: BSE Ticker: PART
Free cash flow struggle continues. D/G to Hold
Hypermarket and grocery formats struggle to generate positive cash flow
We are downgrading Pantaloon from Buy to Hold due to a) poor cash flow from
hypermarket stores, b) struggling consumer and trade finance business (30% of
balance sheet), and c) weak bargaining power with brand-name suppliers for
consumer staples and durables. We are 42% below consensus on EPS estimates.
We believe the Street is focusing on the core retail earnings and is not factoring in
the financial impact of non-retail subsidiaries. We are lowering our target price
from INR705 to INR250.
Investments in subsidiaries and joint ventures have driven equity dilutions
During the past six years, Pantaloon has raised INR24bn in equity issuances and
an incremental INR40bn in debt. The equity issuances have been via warrants
issued to promoters, enabling the promoters to maintain their equity holdings at
~43% during the period.
Loans and advances—a key end use of the incremental capital raised
Pantaloon’s financial services subsidiary, Future Capital Holdings, accounts for
one-third of its current balance sheet and bloats the interest cost, affecting the
company’s consolidated profit. While core retail earnings growth remains healthy,
the hive off of this business looks unlikely in the foreseeable future.
Downgrading to Hold; cutting target price to INR250
Our earnings estimates factor in a consolidated earnings CAGR of 35% FY11-13E
and our DCF-derived target price of INR250 (using 15.6% CoE and 4.5% tgr)
implies an earnings multiple of 22.8x FY12E (12 months ended June) and an
EV/EBIDTA of 8x FY12E earnings. Downside risks to our view include further
dilutions in the parent company and upside risks include faster-than-expected
growth in top line.
Investment thesis
Outlook
Negative FCF in the mass-market hypermarket and grocery formats, approximately one-third
of Pantaloon’s consolidated balance sheet in financial services, and brand owners maintaining
margins in consumer staples and durables imply an ongoing struggle within a competitive
retail environment. Equity dilutions amounting to 30% of its incremental market capital over
the past six years have curtailed stock returns. While core retail earnings growth remains
healthy, the long tail of subsidiaries (Future Generali, Future Capital, etc.) continues to burn
cash, offsetting the strong growth in the lifestyle retail segment. We also believe that the
hive off of the financial services business still seems some time away. Hold.
Valuation
Our DCF-derived target price of INR250 rests on the following assumptions.
„ Risk-free rate of 6.4%, market-risk premium of 7.2% (we apply a standard estimated riskfree rate and market-risk premium to all the Indian companies we cover) and beta of 1.28
(Bloomberg Finance LP data), implying a cost of equity of 15.6%.
„ Terminal growth rate of 4.5%.
This implies a target P/E of 22.8x FY12E earnings.
Risks
Financial services account for a third of Pantaloon’s current balance sheet and bloat
the interest cost
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the consolidated profit of the company. While core retail earnings
growth remains healthy, the hive off of the financial services business is unlikely in the
foreseeable future. With the asset-management business separating from the group, the
build up of the credit book will likely take time.
Also, we remain skeptical about Pantaloon’s ability to change Indian consumer behavior, such
as Indian consumers buying insurance products from retail, and we believe that the hive off
of the insurance business will be a function of the insurance sector reform.
Backend investment returns remain uncertain
Backend investments remain a sunk cost with an uncertain return on investment, and
Pantaloon has a delicate balancing act in integrating vendor suppliers, improving fill rates and
scaling up distribution centers. With GST likely to be delayed till April 2012, it remains
tempting in the current economic environment to continue investing in the front end and
harvest revenues rather than invest substantially in backend with uncertain ROI implications.
We believe that the logistics arm, Future Logistics, will likely need to tap the equity markets
to scale up its warehousing operations
Equity dilution curtails stock returns
India’s biggest mass-market retailer consolidates – FCF positive
by FY13E
Pantaloon remains the biggest mass-market retail play in India, with 590 stores across food,
fashion, general merchandise, electronics and home improvement. It has consolidated its
retail space to 13.2m square feet as of June 2010 and is in line to add 2m to 2.5m square
feet of space each year during FY11-13. We give below our estimates of space, per square
feet revenues and format-wise revenues during FY11-13E.
Of Pantaloon’s formats, lifestyle (i.e., Pantaloon and Central), accounting for ~35% of its
revenues, remain relatively profitable. This is partially due to the consumer segments to
which these formats cater and partially due to the relatively higher percentage of private
labels in apparel.
Consumer-staple companies and consumer-durable companies have continued to keep
margins primarily due to their brand strengths, and this is unlikely to change in the
foreseeable future.
The space set up remains Pantaloon’s key competitive advantage in a business where the
real estate pipeline is taking time to build scale. (If the developer does not get land at an
affordable price, the rental cost for a mass-market retailer becomes prohibitive.)
Investment in subsidiaries and joint ventures…
Pantaloon has over the past five years diversified into a consumption play. It invested in 23
subsidiaries and 12 joint ventures/associate companies in varied consumption-related
companies that would require a consumer front-end scale up amounting to a virtuous cycle
that would enable Pantaloon harvest the retail space that it had booked.
…have driven equity dilutions…
Over the past six years, Pantaloon has raised INR24bn in equity issuances and an incremental
INR40bn in debt. The equity issuances have been via warrants issued to promoters, which
has enabled the promoters to maintain their equity holdings at ~43% over the six-year period.
…which have impacted stock market returns
While the market capital for the Pantaloon stock has grown at a 55% CAGR in FY04-10,
approximately 31% of the returns were from new equity dilutions. If one were to strip off
additional equity, the stock has returned a 44% CAGR during FY04-FY10. (These returns were
front ended and peaked by January 2008.)
Loans and advances and inventory have been a key end use of
the incremental capital raised
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the company’s consolidated profit. While core retail earnings growth
remains healthy, the hive off of the financial services business is unlikely in the foreseeable
future.
Earnings and valuation
We have valued Pantaloon on a discounted cash flow basis. Our DCF-derived target price of
INR250 rests on the following assumptions.
„ Risk-free rate of 6.4%, market-risk premium of 7.2% (we apply a standard estimated riskfree rate and market-risk premium to all the Indian companies we cover) and beta of 1.28
(Bloomberg Finance LP data), implying a cost of equity of 15.6%.
„ Terminal growth rate of 4.5%.
This implies a target P/E of 22.8x FY12E earnings. Refer to the next page for DCF valuation
details.
Value per share reduced from INR705 to INR250
We had valued the core business of pantaloon at INR705 per share as we had valued the
core business at
„ INR510/share for the retail business (35x FY09 core earnings),
„ INR165/share for Future capital and
„ Book value of INR30/share for all other subsidiaries.
We are lowering our target price from INR705 to INR250 due to the following reasons.
36% equity dilution over the last two years; overall 127% dilution over the last six years
The equity dilution since 2007 has been to the extent of 36%. Dilution has been a result of
QIPs, preferential allotment to investors and promoters, warrants issued to promoters,
shares issued to shareholders of HSRIL promoters other than the company (explained
below). We believe there is likely to be some more equity dilution as the promoters currently
hold 10m warrants (exercise price of INR400/shr). The 36% dilution by itself reduces the
value of the core business from INR510 to INR375/shr. The cut in earnings estimates is the
driver of reduction in value of INR375 to INR250 per share.
FCH asset management business hived off to Everstone Investment Advisors Private
Limited
The asset management division of Future Capital holdings was transferred to Everstone
Investment Advisors Private Limited. The company now is in the business of retail financial
services, corporate lending, and wholesale credit and trade finance. This division had raised
USD1bn in real estate funds. Funds raised were invested in real estate in 2003-05 – a period
of relatively lower real estate rates. We had valued the real estate funds at INR165 per share
(8% of the value of the AUM).
Pan India Food Solutions Private Limited (PIFSPL)
PIFSPL was a 50-50 joint venture between the company and Blue Foods Private Limited. This
JV used to run the restaurants Cooper Chimney, Noodle Bar, Bombay Blue, Spaghetti
Kitchen, and Spoon - the Food court. During FY07-08, PIFSPL registered income from
operations amounting to INR264.9m and loss after tax stood at INR100.6m.
IN FY09, the company terminated its joint venture arrangement with Pan India Food Solutions
Private Limited.
34% balance stake in subsidiary Home Town bought out at expensive valuation.
The subsidiary HSRIL (Home Solutions Retail [India] Limited) (66.86% holding) was bought
out from the other shareholders. The 33.14% stake was bought by paying 5.9m shares (value
INR2,183m at INR370/shr) and 6.3m CCPS with FV 100 630m valuing the division at
INR8,488m. The sales for the division in FY09 totaled INR10.7bn and the PAT was a loss of
INR57.3m.
Assigning zero value to JV’s instead of the book value as expected scale up in business
did not happen
Pantaloon has invested INR10,246.5m (excluding Future Value Retail which is the core
business) in JVs and subsidiaries ranging from financial services to insurance to knowledge
services. As of FY10, the cumulative PAT of all JVs was a loss of INR422m and for
subsidiaries was a profit of INR229m. We have now assigned a nil value to all the
investments as the expected scale up of the businesses has not happened and
divestment/hive off of JV’s/subsidiaries is still some time away.
Where are we vs. consensus?
We are broadly in line with consensus on sales and EBITDA numbers. However, we are 35-
42% lower than consensus on PAT. We believe the street is only factoring in the core retail
earnings and is not factoring in the interest cost on account of the non-retail subsidiaries.
We believe that the financial lending part of the business is an integral part of the company’s
plans to drive retail. Also, with the mass-market formats being housed in a 100% subsidiary,
consolidated numbers will likely need to be examined.
Risks
Financial services account for one-third of Pantaloon’s current balance sheet and bloat
the interest cost
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the consolidated profit of the company. While core retail earnings
growth remains healthy, the hive off of the financial services business is still 12 months
away. With the asset-management business separating from the group, the build up of the
credit book will likely take time.
Also, we remain skeptical about Pantaloon’s ability to change Indian consumer behavior, such
as Indian consumers buying insurance products from retail, and we believe that the hive off
of the insurance business likely will be a function of insurance-sector reform.
Backend investment returns remain uncertain
Backend investments remain a sunk cost with uncertain return on investments, and
Pantaloon has a delicate balancing act in integrating vendor suppliers, improving fill rates and
scaling up distribution centers. With GST likely to be delayed till April 2012, it remains
tempting in the current economic environment to continue investing in the front end and
harvest revenues rather than invest substantially in a backend with uncertain ROI
implications. We believe that the logistics arm, Future Logistics, likely will need to tap the
equity markets to scale up its warehousing operations.
Company background
Pantaloon Retail Limited is India’s leading retailer, with 13m square feet retail space. It
operates multiple retail formats in the value and lifestyle segments of the Indian consumer
market. The company has more than 1,000 stores across 73 cities in India and employs more
than 30,000 people.
The company’s leading formats include Pantaloons, a chain of fashion outlets; Big Bazaar, a
uniquely Indian hypermarket chain; Food Bazaar, a supermarket chain that blends the look,
touch and feel of Indian bazaars with aspects of modern retail such as choice, convenience
and quality; and Central, a chain of seamless destination malls. Some of its other formats
include Brand Factory, Blue Sky, aLL, Top 10 and Star and Sitara. The company also operates
an online portal, futurebazaar.com.
Future Value Retail Limited is a wholly owned subsidiary of Pantaloon Retail (India) Limited.
This entity has the company’s value retail business, led by its format divisions, Big Bazaar and
Food Bazaar. The company operates 120 Big Bazaar stores, 170 Food Bazaar stores, among
other formats, in more than 70 cities across the country, covering an operational retail space
of over 6m square feet.
A subsidiary company, Home Solutions Retail (India) Limited, operates Home Town, a largeformat home-solutions store; Collection i, which sells home furniture products; and eZone,
which is focused on catering to the consumer-electronics segment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Pantaloon Retail India Ltd
Reuters: PART.BO Bloomberg: PF IN Exchange: BSE Ticker: PART
Free cash flow struggle continues. D/G to Hold
Hypermarket and grocery formats struggle to generate positive cash flow
We are downgrading Pantaloon from Buy to Hold due to a) poor cash flow from
hypermarket stores, b) struggling consumer and trade finance business (30% of
balance sheet), and c) weak bargaining power with brand-name suppliers for
consumer staples and durables. We are 42% below consensus on EPS estimates.
We believe the Street is focusing on the core retail earnings and is not factoring in
the financial impact of non-retail subsidiaries. We are lowering our target price
from INR705 to INR250.
Investments in subsidiaries and joint ventures have driven equity dilutions
During the past six years, Pantaloon has raised INR24bn in equity issuances and
an incremental INR40bn in debt. The equity issuances have been via warrants
issued to promoters, enabling the promoters to maintain their equity holdings at
~43% during the period.
Loans and advances—a key end use of the incremental capital raised
Pantaloon’s financial services subsidiary, Future Capital Holdings, accounts for
one-third of its current balance sheet and bloats the interest cost, affecting the
company’s consolidated profit. While core retail earnings growth remains healthy,
the hive off of this business looks unlikely in the foreseeable future.
Downgrading to Hold; cutting target price to INR250
Our earnings estimates factor in a consolidated earnings CAGR of 35% FY11-13E
and our DCF-derived target price of INR250 (using 15.6% CoE and 4.5% tgr)
implies an earnings multiple of 22.8x FY12E (12 months ended June) and an
EV/EBIDTA of 8x FY12E earnings. Downside risks to our view include further
dilutions in the parent company and upside risks include faster-than-expected
growth in top line.
Investment thesis
Outlook
Negative FCF in the mass-market hypermarket and grocery formats, approximately one-third
of Pantaloon’s consolidated balance sheet in financial services, and brand owners maintaining
margins in consumer staples and durables imply an ongoing struggle within a competitive
retail environment. Equity dilutions amounting to 30% of its incremental market capital over
the past six years have curtailed stock returns. While core retail earnings growth remains
healthy, the long tail of subsidiaries (Future Generali, Future Capital, etc.) continues to burn
cash, offsetting the strong growth in the lifestyle retail segment. We also believe that the
hive off of the financial services business still seems some time away. Hold.
Valuation
Our DCF-derived target price of INR250 rests on the following assumptions.
„ Risk-free rate of 6.4%, market-risk premium of 7.2% (we apply a standard estimated riskfree rate and market-risk premium to all the Indian companies we cover) and beta of 1.28
(Bloomberg Finance LP data), implying a cost of equity of 15.6%.
„ Terminal growth rate of 4.5%.
This implies a target P/E of 22.8x FY12E earnings.
Risks
Financial services account for a third of Pantaloon’s current balance sheet and bloat
the interest cost
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the consolidated profit of the company. While core retail earnings
growth remains healthy, the hive off of the financial services business is unlikely in the
foreseeable future. With the asset-management business separating from the group, the
build up of the credit book will likely take time.
Also, we remain skeptical about Pantaloon’s ability to change Indian consumer behavior, such
as Indian consumers buying insurance products from retail, and we believe that the hive off
of the insurance business will be a function of the insurance sector reform.
Backend investment returns remain uncertain
Backend investments remain a sunk cost with an uncertain return on investment, and
Pantaloon has a delicate balancing act in integrating vendor suppliers, improving fill rates and
scaling up distribution centers. With GST likely to be delayed till April 2012, it remains
tempting in the current economic environment to continue investing in the front end and
harvest revenues rather than invest substantially in backend with uncertain ROI implications.
We believe that the logistics arm, Future Logistics, will likely need to tap the equity markets
to scale up its warehousing operations
Equity dilution curtails stock returns
India’s biggest mass-market retailer consolidates – FCF positive
by FY13E
Pantaloon remains the biggest mass-market retail play in India, with 590 stores across food,
fashion, general merchandise, electronics and home improvement. It has consolidated its
retail space to 13.2m square feet as of June 2010 and is in line to add 2m to 2.5m square
feet of space each year during FY11-13. We give below our estimates of space, per square
feet revenues and format-wise revenues during FY11-13E.
Of Pantaloon’s formats, lifestyle (i.e., Pantaloon and Central), accounting for ~35% of its
revenues, remain relatively profitable. This is partially due to the consumer segments to
which these formats cater and partially due to the relatively higher percentage of private
labels in apparel.
Consumer-staple companies and consumer-durable companies have continued to keep
margins primarily due to their brand strengths, and this is unlikely to change in the
foreseeable future.
The space set up remains Pantaloon’s key competitive advantage in a business where the
real estate pipeline is taking time to build scale. (If the developer does not get land at an
affordable price, the rental cost for a mass-market retailer becomes prohibitive.)
Investment in subsidiaries and joint ventures…
Pantaloon has over the past five years diversified into a consumption play. It invested in 23
subsidiaries and 12 joint ventures/associate companies in varied consumption-related
companies that would require a consumer front-end scale up amounting to a virtuous cycle
that would enable Pantaloon harvest the retail space that it had booked.
…have driven equity dilutions…
Over the past six years, Pantaloon has raised INR24bn in equity issuances and an incremental
INR40bn in debt. The equity issuances have been via warrants issued to promoters, which
has enabled the promoters to maintain their equity holdings at ~43% over the six-year period.
…which have impacted stock market returns
While the market capital for the Pantaloon stock has grown at a 55% CAGR in FY04-10,
approximately 31% of the returns were from new equity dilutions. If one were to strip off
additional equity, the stock has returned a 44% CAGR during FY04-FY10. (These returns were
front ended and peaked by January 2008.)
Loans and advances and inventory have been a key end use of
the incremental capital raised
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the company’s consolidated profit. While core retail earnings growth
remains healthy, the hive off of the financial services business is unlikely in the foreseeable
future.
Earnings and valuation
We have valued Pantaloon on a discounted cash flow basis. Our DCF-derived target price of
INR250 rests on the following assumptions.
„ Risk-free rate of 6.4%, market-risk premium of 7.2% (we apply a standard estimated riskfree rate and market-risk premium to all the Indian companies we cover) and beta of 1.28
(Bloomberg Finance LP data), implying a cost of equity of 15.6%.
„ Terminal growth rate of 4.5%.
This implies a target P/E of 22.8x FY12E earnings. Refer to the next page for DCF valuation
details.
Value per share reduced from INR705 to INR250
We had valued the core business of pantaloon at INR705 per share as we had valued the
core business at
„ INR510/share for the retail business (35x FY09 core earnings),
„ INR165/share for Future capital and
„ Book value of INR30/share for all other subsidiaries.
We are lowering our target price from INR705 to INR250 due to the following reasons.
36% equity dilution over the last two years; overall 127% dilution over the last six years
The equity dilution since 2007 has been to the extent of 36%. Dilution has been a result of
QIPs, preferential allotment to investors and promoters, warrants issued to promoters,
shares issued to shareholders of HSRIL promoters other than the company (explained
below). We believe there is likely to be some more equity dilution as the promoters currently
hold 10m warrants (exercise price of INR400/shr). The 36% dilution by itself reduces the
value of the core business from INR510 to INR375/shr. The cut in earnings estimates is the
driver of reduction in value of INR375 to INR250 per share.
FCH asset management business hived off to Everstone Investment Advisors Private
Limited
The asset management division of Future Capital holdings was transferred to Everstone
Investment Advisors Private Limited. The company now is in the business of retail financial
services, corporate lending, and wholesale credit and trade finance. This division had raised
USD1bn in real estate funds. Funds raised were invested in real estate in 2003-05 – a period
of relatively lower real estate rates. We had valued the real estate funds at INR165 per share
(8% of the value of the AUM).
Pan India Food Solutions Private Limited (PIFSPL)
PIFSPL was a 50-50 joint venture between the company and Blue Foods Private Limited. This
JV used to run the restaurants Cooper Chimney, Noodle Bar, Bombay Blue, Spaghetti
Kitchen, and Spoon - the Food court. During FY07-08, PIFSPL registered income from
operations amounting to INR264.9m and loss after tax stood at INR100.6m.
IN FY09, the company terminated its joint venture arrangement with Pan India Food Solutions
Private Limited.
34% balance stake in subsidiary Home Town bought out at expensive valuation.
The subsidiary HSRIL (Home Solutions Retail [India] Limited) (66.86% holding) was bought
out from the other shareholders. The 33.14% stake was bought by paying 5.9m shares (value
INR2,183m at INR370/shr) and 6.3m CCPS with FV 100 630m valuing the division at
INR8,488m. The sales for the division in FY09 totaled INR10.7bn and the PAT was a loss of
INR57.3m.
Assigning zero value to JV’s instead of the book value as expected scale up in business
did not happen
Pantaloon has invested INR10,246.5m (excluding Future Value Retail which is the core
business) in JVs and subsidiaries ranging from financial services to insurance to knowledge
services. As of FY10, the cumulative PAT of all JVs was a loss of INR422m and for
subsidiaries was a profit of INR229m. We have now assigned a nil value to all the
investments as the expected scale up of the businesses has not happened and
divestment/hive off of JV’s/subsidiaries is still some time away.
Where are we vs. consensus?
We are broadly in line with consensus on sales and EBITDA numbers. However, we are 35-
42% lower than consensus on PAT. We believe the street is only factoring in the core retail
earnings and is not factoring in the interest cost on account of the non-retail subsidiaries.
We believe that the financial lending part of the business is an integral part of the company’s
plans to drive retail. Also, with the mass-market formats being housed in a 100% subsidiary,
consolidated numbers will likely need to be examined.
Risks
Financial services account for one-third of Pantaloon’s current balance sheet and bloat
the interest cost
Financial services account for a third of Pantaloon’s current balance sheet and bloat the
interest cost, affecting the consolidated profit of the company. While core retail earnings
growth remains healthy, the hive off of the financial services business is still 12 months
away. With the asset-management business separating from the group, the build up of the
credit book will likely take time.
Also, we remain skeptical about Pantaloon’s ability to change Indian consumer behavior, such
as Indian consumers buying insurance products from retail, and we believe that the hive off
of the insurance business likely will be a function of insurance-sector reform.
Backend investment returns remain uncertain
Backend investments remain a sunk cost with uncertain return on investments, and
Pantaloon has a delicate balancing act in integrating vendor suppliers, improving fill rates and
scaling up distribution centers. With GST likely to be delayed till April 2012, it remains
tempting in the current economic environment to continue investing in the front end and
harvest revenues rather than invest substantially in a backend with uncertain ROI
implications. We believe that the logistics arm, Future Logistics, likely will need to tap the
equity markets to scale up its warehousing operations.
Company background
Pantaloon Retail Limited is India’s leading retailer, with 13m square feet retail space. It
operates multiple retail formats in the value and lifestyle segments of the Indian consumer
market. The company has more than 1,000 stores across 73 cities in India and employs more
than 30,000 people.
The company’s leading formats include Pantaloons, a chain of fashion outlets; Big Bazaar, a
uniquely Indian hypermarket chain; Food Bazaar, a supermarket chain that blends the look,
touch and feel of Indian bazaars with aspects of modern retail such as choice, convenience
and quality; and Central, a chain of seamless destination malls. Some of its other formats
include Brand Factory, Blue Sky, aLL, Top 10 and Star and Sitara. The company also operates
an online portal, futurebazaar.com.
Future Value Retail Limited is a wholly owned subsidiary of Pantaloon Retail (India) Limited.
This entity has the company’s value retail business, led by its format divisions, Big Bazaar and
Food Bazaar. The company operates 120 Big Bazaar stores, 170 Food Bazaar stores, among
other formats, in more than 70 cities across the country, covering an operational retail space
of over 6m square feet.
A subsidiary company, Home Solutions Retail (India) Limited, operates Home Town, a largeformat home-solutions store; Collection i, which sells home furniture products; and eZone,
which is focused on catering to the consumer-electronics segment.
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