JPMorgan:: Future Retail Ltd (FRL IN) Stake sale transaction for General Insurance JV with L&T called off

Future Retail Ltd (FRL IN) Stake sale transaction for General Insurance JV with L&T called off		Underweight Price: Rs111.30 21 Apr 2014 Price Target: Rs74.00 PT End Date: 30 Jun 2014

Future Retail has disclosed that it is not proceeding with the earlier announced transaction involving merger of its JV company Future Generali India Insurance Company with L&T General Insurance Company and sale of partial stake to L&T and Generali in the merged entity thereafter. This is due to inordinate delay in finalising the transaction documents and obtaining permissions. Management is hopeful of divesting the stake over the next 12-18 months at likely higher valuation given recent improvement in JV’s financial performance.

· Background. In March 2013, Future Retail had entered into a non-binding agreement with Larsen & Toubro (L&T) and Generali Group for the merger of its insurance JV company, Future Generali India Insurance (FGI) and L&T General Insurance Company. On completion of the merger, L&T and Generali will acquire such number of shares as would result in L&T having a 51% stake, Generali having a 26% stake and the balance (23%) to be held by Future Group in the merged entity. The completion of the transaction was subject to satisfactory due diligence by both the parties, signing of definitive agreements and requisite approvals from IRDA and other regulators. While the company had not disclosed the likely transaction amount, some press reports (Economic Times) at that time had estimated the deal at Rs5bn (implying effective cash inflow for Future Retail at ~Rs4bn).

· Intention to divest stake in insurance venture remains. FRL management has noted that despite non-closure of this transaction, the company maintains its desire to exit non-core businesses and would look to divest stake in general insurance venture over the next 12-18 months. Late last year, FRL had divested 22.5% holding in Future Generali India Life insurance Company for an estimated inflow of Rs3bn. Mgmt further noted that there is potential for realizing higher value for the general insurance venture as the business has turned profitable over FY14 (profit of ~Rs280mn over 9MFY14).

· Focus on debt reduction. FRL has been struggling with high debt levels with high interest costs weighing on the company’s earnings performance. FRL’s core Retail debt is ~Rs51B as of Dec’13 and there is CCDS of Rs4bn.

Larsen & Toubro is covered by J.P. Morgan analyst Sumit Kishore; Generali by Andreas van Embden.

 

Investment Thesis

We have an Underweight rating on Future Retail. Sluggish SSSG rates, lower space expansion, higher debt levels and high working capital intensity would continue to weigh on company’s profitability in our view. We believe a sustained pick-up in discretionary spending and more financial prudence would be needed to help improve free cash flow generation.

Valuation

Our SOTP based Jun’14 PT is Rs74. We use a target EV/EBITDA multiple of 7x for the retail business, and ascribe a Rs50/share value to FRL’s stake in insurance JVs, Future Lifestyle fashion and Future Supply Chain.

Risks to Rating and Price Target

Upside risks to our price target include further significant de-leveraging (aided by more asset sales like logistics and remaining stake in insurance JVs etc at higher valuations), tie-up with a foreign partner at higher valuations (than current levels) and/or significant improvement in underlying business fundamentals.

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