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Pantaloon Retail (India) Ltd
Overweight
PART.BO, PF IN
Recalibrating expectations
Our recent discussions with PRIL’s management indicate that cost challenges are
likely to increase for the company in the coming quarters in view of inflationary
environment and firm interest rates. We have accordingly moderated our
expectations on earnings growth and cut our FY11-12E EPS by 15-17% and set a
revised Dec’11 price target of Rs465.
• Adverse product mix, firm RM costs and higher employee costs to weigh
on margins. PRIL’s enhanced focus on food & grocery segment coupled with
firm input costs (primarily for their private label led apparel category) will
likely result in moderating gross margins overall (100bp contraction over FY11-
13E we estimate). Pick up in retail activity over the past year will also likely
push up employee costs, which have been stable so far. While we do not see an
immediate inflation in rentals, we would not rule out this cost element
increasing over the medium term in view of limited availability of good quality
retail space. We now forecast EBITDA margins for core retail operations to
moderate from 9.2% in FY10 to 8.6% in FY12E.
• Limited progress on divestment of non-retail investments has not helped
either. There has not been much progress on PRIL's plans to divest its
investments in financial services and other non-core businesses so far and there
is no certain time line being ascribed for the same. This uncertainty has further
delayed PRIL's plans to de-leverage its balance sheet, which implies interest
burden will continue to remain high, particularly in a high interest rate
environment. We have also raised our interest charge estimates by 4-8% in view
of the same.
• SSS growth trends are healthy, though sustained inflation could play a
spoilsport. While we are hopeful that PRIL will post double digit SSS growth,
we fear current inflationary environment could result in consumer downtrading
and moderate growth for more discretionary categories like apparel and
electronics.
• Recent sharp underperformance limits downside. PRIL’s share price has
declined 22% over last two months and this should limit further downside from
current levels. Key risks to our earnings and PT are 1) Higher-than-anticipated
deterioration in product mix and working capital, 2) Weakness in consumer
demand, and 3) Any investments that are earnings dilutive.
Margins likely to moderate
PRIL's operating margins are expected to moderate going forward on account of 1)
Adverse product mix as sales for low margin food & grocery segment grow ahead of
other product categories, 2) Firm commodity costs particularly in case of apparel and
staples which is largely private label, 3) Inability of the company to take on
aggressive price hikes in order to maintain the ‘value’ proposition to the customer
and ensure good footfalls, and 4) Rising operational costs like employee salaries. We
have cut our margin assumptions on back of these reasons and now estimate
EBITDA margins to decline from 9.2% in FY10 to 8.4% in FY13E.
Significant focus on growing share of food & grocery (which currently accounts for
37% of overall sales) would weigh on gross margin profile overall. In our recent
discussions, management noted that they intend to raise the share of Food & Grocery
to c45% in medium term (3-4 years). Further space addition for the value segment
(where Food & Grocery enjoys higher share) will dominate over the lifestyle
segment in the coming years. PRIL has identified seven key cities where it intends to
create food distribution centres, which will manage the supply chain on their own.
For Mumbai city, Food DC is likely to be commissioned in the next few months.
Current inflationary environment is also weighing on margins. Higher prices for
cotton and agri commodities is affecting margins in the apparel and staples segment,
which are largely private label. PRIL’s management noted that though they are likely
to take some price hikes in the coming season for their apparel portfolio, these hikes
may not be aggressive to cover all the cost pressures as they don't want to dilute their
'value' proposition to the customer. Clearly, the company is not willing to sacrifice
consumer footfalls for sustaining margins.
With the revival in the retail sector over past one and half years, we have noticed an
increase in retail expansion by various players and also the entry of some new
players in the market. This has led to higher operational costs particularly staff costs.
Over the last two years, employee costs for PRIL have remained largely stable, but
these are expected to pick up now in view of more competition and general
improvement in retail environment. While we do not see an immediate inflation in
rentals (as PRIL has signed up properties in advance), we would not rule out this cost
element increasing over medium term in view of limited availability of good quality
retail space.
Demand trends are healthy but sustained inflation could
play a spoilsport
PRIL has witnessed healthy sales growth trends so far, with SSS growth continuing
in the double digit range. PRIL has stepped up customer communication using mass
media like TV for thematic based national advertising and doing more of a tactical
communication on a regional basis. PRIL will be focused on four key categories – 1)
Food (driver for topline growth), 2) Fashion (margin driver), 3) General
Merchandise, and 4) Home (including electronics).
PRIL is now looking more closely at ‘Fresh’ segment and is planning to deploy
investments in building up supply chain infrastructure to penetrate this segment more
aggressively. The recently introduced Food Right retail format is a step in that
direction. Management is quite excited by the good response to lifestyle formats,
particularly Pantaloon department stores, which they may look to extend to Tier 2/3
cities now.
KB’s Fairprice store is another key format for the group, which focuses on urban
poor segment and is currently being expanded in three metros – Delhi, Mumbai and
Bangalore.
Electronics and Home category is an area where PRIL is trying to improve its
profitability. Electronics segment suffers from issues such as inventory, higher
display space and stiff competition and PRIL's growth in this segment (E-Zone) has
been below their target. Home also suffers from extended working capital cycle due
to the imports and no fixed supply chain. PRIL is trying to make the
electronics/home business asset light (or WC light) and trying to shift the business
model more towards e-retailing.
We forecast retail space addition of c2mn sq ft per annum over FY11-13E and
estimate sales CAGR of 20% over the same period. We fear current inflationary
environment if sustained for a loner time could result in consumer downtrading and
moderate growth for more discretionary categories like apparel and electronics,
particularly in an increasingly competitive environment.
Earnings revision
We build in lower gross margins and higher employee costs for reasons discussed in
sections above. We have also raised interest cost estimates driven by a) higher debt
levels as free cash flows are constrained on account of lower profitability, and b)
higher interest rates (12% vs 11.5% earlier). Depreciation charges are also raised in
line with recent trends. As a result our earnings estimates for FY11 and FY12 are
revised down by 15% and 17% respectively.
Limited progress on divestment of non-retail investments
Since PRIL management stated their plans to divest their investments in financial
services businesses (Insurance and Future Capital) in late 2009, we have seen little
progress on this front. Management has attributed this to delays in certain regulatory
approvals and there is no certain time line being ascribed for the same. This
uncertainty has further delayed PRIL's plans to de-leverage its balance sheet, which
implies interest burden will continue to remain high, particularly in the current high
interest rate environment.
We believe this restructuring exercise (when implemented) will be a key driver of the
stock performance and could trigger stock re-rating as PRIL will then become a pure
play retail company.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Pantaloon Retail (India) Ltd
Overweight
PART.BO, PF IN
Recalibrating expectations
Our recent discussions with PRIL’s management indicate that cost challenges are
likely to increase for the company in the coming quarters in view of inflationary
environment and firm interest rates. We have accordingly moderated our
expectations on earnings growth and cut our FY11-12E EPS by 15-17% and set a
revised Dec’11 price target of Rs465.
• Adverse product mix, firm RM costs and higher employee costs to weigh
on margins. PRIL’s enhanced focus on food & grocery segment coupled with
firm input costs (primarily for their private label led apparel category) will
likely result in moderating gross margins overall (100bp contraction over FY11-
13E we estimate). Pick up in retail activity over the past year will also likely
push up employee costs, which have been stable so far. While we do not see an
immediate inflation in rentals, we would not rule out this cost element
increasing over the medium term in view of limited availability of good quality
retail space. We now forecast EBITDA margins for core retail operations to
moderate from 9.2% in FY10 to 8.6% in FY12E.
either. There has not been much progress on PRIL's plans to divest its
investments in financial services and other non-core businesses so far and there
is no certain time line being ascribed for the same. This uncertainty has further
delayed PRIL's plans to de-leverage its balance sheet, which implies interest
burden will continue to remain high, particularly in a high interest rate
environment. We have also raised our interest charge estimates by 4-8% in view
of the same.
• SSS growth trends are healthy, though sustained inflation could play a
spoilsport. While we are hopeful that PRIL will post double digit SSS growth,
we fear current inflationary environment could result in consumer downtrading
and moderate growth for more discretionary categories like apparel and
electronics.
• Recent sharp underperformance limits downside. PRIL’s share price has
declined 22% over last two months and this should limit further downside from
current levels. Key risks to our earnings and PT are 1) Higher-than-anticipated
deterioration in product mix and working capital, 2) Weakness in consumer
demand, and 3) Any investments that are earnings dilutive.
Margins likely to moderate
PRIL's operating margins are expected to moderate going forward on account of 1)
Adverse product mix as sales for low margin food & grocery segment grow ahead of
other product categories, 2) Firm commodity costs particularly in case of apparel and
staples which is largely private label, 3) Inability of the company to take on
aggressive price hikes in order to maintain the ‘value’ proposition to the customer
and ensure good footfalls, and 4) Rising operational costs like employee salaries. We
have cut our margin assumptions on back of these reasons and now estimate
EBITDA margins to decline from 9.2% in FY10 to 8.4% in FY13E.
Significant focus on growing share of food & grocery (which currently accounts for
37% of overall sales) would weigh on gross margin profile overall. In our recent
discussions, management noted that they intend to raise the share of Food & Grocery
to c45% in medium term (3-4 years). Further space addition for the value segment
(where Food & Grocery enjoys higher share) will dominate over the lifestyle
segment in the coming years. PRIL has identified seven key cities where it intends to
create food distribution centres, which will manage the supply chain on their own.
For Mumbai city, Food DC is likely to be commissioned in the next few months.
Current inflationary environment is also weighing on margins. Higher prices for
cotton and agri commodities is affecting margins in the apparel and staples segment,
which are largely private label. PRIL’s management noted that though they are likely
to take some price hikes in the coming season for their apparel portfolio, these hikes
may not be aggressive to cover all the cost pressures as they don't want to dilute their
'value' proposition to the customer. Clearly, the company is not willing to sacrifice
consumer footfalls for sustaining margins.
With the revival in the retail sector over past one and half years, we have noticed an
increase in retail expansion by various players and also the entry of some new
players in the market. This has led to higher operational costs particularly staff costs.
Over the last two years, employee costs for PRIL have remained largely stable, but
these are expected to pick up now in view of more competition and general
improvement in retail environment. While we do not see an immediate inflation in
rentals (as PRIL has signed up properties in advance), we would not rule out this cost
element increasing over medium term in view of limited availability of good quality
retail space.
Demand trends are healthy but sustained inflation could
play a spoilsport
PRIL has witnessed healthy sales growth trends so far, with SSS growth continuing
in the double digit range. PRIL has stepped up customer communication using mass
media like TV for thematic based national advertising and doing more of a tactical
communication on a regional basis. PRIL will be focused on four key categories – 1)
Food (driver for topline growth), 2) Fashion (margin driver), 3) General
Merchandise, and 4) Home (including electronics).
PRIL is now looking more closely at ‘Fresh’ segment and is planning to deploy
investments in building up supply chain infrastructure to penetrate this segment more
aggressively. The recently introduced Food Right retail format is a step in that
direction. Management is quite excited by the good response to lifestyle formats,
particularly Pantaloon department stores, which they may look to extend to Tier 2/3
cities now.
KB’s Fairprice store is another key format for the group, which focuses on urban
poor segment and is currently being expanded in three metros – Delhi, Mumbai and
Bangalore.
Electronics and Home category is an area where PRIL is trying to improve its
profitability. Electronics segment suffers from issues such as inventory, higher
display space and stiff competition and PRIL's growth in this segment (E-Zone) has
been below their target. Home also suffers from extended working capital cycle due
to the imports and no fixed supply chain. PRIL is trying to make the
electronics/home business asset light (or WC light) and trying to shift the business
model more towards e-retailing.
We forecast retail space addition of c2mn sq ft per annum over FY11-13E and
estimate sales CAGR of 20% over the same period. We fear current inflationary
environment if sustained for a loner time could result in consumer downtrading and
moderate growth for more discretionary categories like apparel and electronics,
particularly in an increasingly competitive environment.
Earnings revision
We build in lower gross margins and higher employee costs for reasons discussed in
sections above. We have also raised interest cost estimates driven by a) higher debt
levels as free cash flows are constrained on account of lower profitability, and b)
higher interest rates (12% vs 11.5% earlier). Depreciation charges are also raised in
line with recent trends. As a result our earnings estimates for FY11 and FY12 are
revised down by 15% and 17% respectively.
Limited progress on divestment of non-retail investments
Since PRIL management stated their plans to divest their investments in financial
services businesses (Insurance and Future Capital) in late 2009, we have seen little
progress on this front. Management has attributed this to delays in certain regulatory
approvals and there is no certain time line being ascribed for the same. This
uncertainty has further delayed PRIL's plans to de-leverage its balance sheet, which
implies interest burden will continue to remain high, particularly in the current high
interest rate environment.
We believe this restructuring exercise (when implemented) will be a key driver of the
stock performance and could trigger stock re-rating as PRIL will then become a pure
play retail company.
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