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Pantaloon (PART.BO)
Buy: 1QFY11 - Demand Remains Robust; Margins Disappoint
SSS growth trends encouraging … — Retail demand continues to be buoyant as
same store sales (SSS) growth for lifestyle, value and home remained strong at
22%, 13% and 15% Y/Y respectively. Encouragingly, trends in the key lifestyle
and value businesses were better than 4QFY10 trends. Overall, core retail
(lifestyle+ value + home) revenues rose a healthy 32% Y/Y.
… But, EBITDA margin contraction disappoints — However, EBITDA margin
contraction of 120bps Y/Y to ~8.2% for core retail was below expectations. This
was largely on the back of ~140bps gross margin decline Y/Y. Like-for-like
(lifestyle +value) revenue growth was 22% Y/Y and margins declined 40bps Y/Y to
9.1% during the Q. Mgmt attributed the contraction to seasonality as the festive
sales period was pushed into 2QFY11 (v/s 1Q last year) and margin pressures in
electronics. Usually, the negative impact of the ‘Mahabachat’ program (discount
sales) in August is compensated for with full-price sales during festival season.
Capital structure: Some improvements; more required — While consolidated
debt/equity ratios are a tad better Y/Y, we are concerned with the elevated
capex/sq ft at the consolidated level. Core cash generation will need to improve
through better working capital management to propel growth going forward.
Despite an increase in debt (~Rs3bn), core retail interest was lower by ~9% Y/Y;
primarily on refinancing part of the home business debt at ~200bps lower cost.
by 8-15% over FY11-13E, as we tweak our margin assumptions in line the recent
trends. Our TP is revised to Rs530, valuing core retail at Rs486 (from Rs541), on
25x Mar12E EPS, with almost equal contribution from parent and FVRL. Value
ascribed to other parts (FCH, Future Generali & Future Supply Chain) is Rs44. We
expect continued strength in SSS trends in FY11/12 as the mid cycle establishes
itself. Leverage benefits from lower finance costs, SG&A overheads & better
inventory management should drive operating margin expansion going forward.
Valuation
Our Rs530 target price is based on a sum of the parts approach. We value the
core retail business at 25x Mar12E PE, which gives us Rs486/share - almost
equally split between parent (lifestyle + home retailing business) and value
retail venture, FVRL. Our target multiple is set at around a c40% premium to
the average for the regional peer group, to reflect the higher earnings growth
profile for Pantaloon and its dominant positioning in India. Future Capital is
valued at Rs32/share (current market price, with 20% holding company
discount). We add Rs12/share for the other main subsidiaries (Future Generali
and Future Logistics), at the investment value.
Risks
We assign a Medium Risk rating to Pantaloon instead of Low Risk as suggested
by our quantitative risk-rating system, given issues around high capex/sq foot
(in store + inventory holding costs) and burgeoning working capital
requirements. The main downside risks to our target price include: 1) Initial
trend of encouraging sales growth fades away; 2) Delay in store opening plans;
3) Increase in competitive intensity and/or irrational competition; and 4) Any
pressure on rentals, which could result in lower than expected margins. The
main upside risks to our target price: 1) Value unlocking in subsidiaries
through listing / stake sales, 2) Any significant acquisitions, JVs or partnerships
perceived to be creating value; and 3) Legislative changes that allow FDI in
retail could be perceived as a sentiment positive from a funding perspective.
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