We reinitiate coverage on Pantaloon Retail (PRIL) with a BUY rating and SOTP-based target price of Rs460— 17% upside from the current price. We expect same-store sales to increase to almost 85% of total sales by FY2011E, allaying fears about execution of new projects. We expect a four-fold increase in total retail space to 20 mn sq. ft (PRIL standalone) by FY2011E, which is achievable in our view, given the management quality and the amount of retail space already locked-in by the company.
VALUATIONS: SOTP-BASED TARGET PRICE OF RS460 We use SOTP, given the different nature of various formats and the stage of product cycles for these formats Pantaloon increasingly sees itself as an evolving company in the consumption space, rather than just a large organized retail player. Thus, over the past 1-2 years, it has forayed into ventures encompassing the entire gamut of consumption, including seeding businesses in the consumption space, consumer finance, real estate development, insurance, logistics, etc. These businesses, in our view, need to be valued differently from PRIL’s core business of retailing, given their different dynamics and stage of evolution in the business cycle. Our SOTP-based value of PRIL is Rs460, giving 17% from current levels Our June ’09-based SOTP is Rs460, (see Exhibit 3), giving 17% upside from current levelsWe value the core business of PRIL at a 16X FY2010E EPS, 10% premium to current P/E band We value the core business of PRIL (standalone) at 16X FY2010E EPS of Rs19.9, a 10%premium to the current P/E (ex-FCH), in line with the average P/E of the stock post the listing of Future Capital Holdings (FCH) in Feb ’08 (see Exhibit 4) and 30-40% higher than some of its listed Indian counterparts (see Exhibit 5). We believe PRIL deserves to trade at a premium to its local peers given its diversified presence and scale. We also highlight that our valuations are at 10-20% premium to our projected market multiples for FY2010E, which is justified, in our view, as PRIL will be strategically positioned to capture the full benefit of the growth in organized retail.
Ex-FCH and HSRIL (which we value at Rs139), the core business of PRIL is currently trading at 13X FY2010E EPS, which is almost 25-30% discount to its historical P/E multiples, even after adjustments for FCH listing. We believe one of the reasons for this potential derating of PRIL recently has been the concerns on timely execution of projects, especially since the company is now entering a phase of rapid expansion. While we share the market’s concern regarding future execution of projects (our total retail addition is around 10% lower than management expectation between FY2008-11E), we estimate SSS will form an increasing part of the
overall sales mix (almost 70% currently) thereby allaying fears of execution delays. Moreover, a significant part of execution risk is in land acquisition, which has been considerably reduced by the company’s preemptive move to lock-in around 25 mn sq. ft. We also highlight that scale benefits should also help PRIL manage margins, thereby allowing the company to benefit from rapid store expansion, even post FY2011. HSRIL could also provide upsides as we expect these operations to break even from FY2009E. However, we would like to give HSRIL some more time to achieve its long-term margins of 5-6% before consolidating these operations for valuation purposes.
We exclude value of some important initiatives, which could be important drivers for growth in the near future We highlight that we have not attributed any value from some important initiatives, including Future Ventures, Future Logistics, Future Media and Future Bazaar, pending more visibility. These operations could be significant drivers of value, given the size of opportunity and PRIL’s overall commitment to these verticals. We are positive about the potential of some of these verticals to add to the overall margins of the company. To illustrate, Future Media and Future Bazaar, in our view, could easily generate double digit margins against the 3-4% net margins currently enjoyed by PRIL (albeit with lower revenues) and we expect some of these verticals to begin contributing positively over the next 1-2 years
STRATEGY AND PROFILE—BENEFITS OF SCALE Pantaloon is entering a crucial expansionary phase as it plans to add around 15 mn sq. ft of retail space in the next four years. Execution and funding will be key determinants to expansion efforts while economies of scale should offset increased costs. Pantaloon will enjoy a significant first-mover advantage post execution of the current leg of expansion, helping the company to be the preferred partner of choice for future tie-ups.
Expansion reaches critical phase Pantaloon’s expansion has reached a critical phase and the company has set out anaggressive rollout plan between FY2007 and FY2011E. The company expects to double the cities under coverage to around 120 by FY2011E from around 55 at present. We expect the company to increase its total retail space to 20 mn sq. ft (standalone) in FY2011E from around 5 mn sq. ft in FY2007, a CAGR of 40%. This would be more than 3X the total retail space added by the company during FY2004-07 (see Exhibit 6). HSRIL and Future Logistics will likely add another 4 mn sq. ft and 8 mn sq. ft by FY2011E from around 0.6 mn sq. ft and 2 mn sq ft, respectively, in FY2007.
Pantaloon’s strategy has been to operate in the most diverse range of verticals and be the largest player in each of them. It believes there are significant cross-vertical linkages, which can then be leveraged to provide benefits to the customer and thus retain their loyalty. The key driving force for the company is to achieve critical mass in all its leading formats—food, fashion and general merchandise—on a pan-India basis.
Future growth in mature verticals to come from cannibalization as well as growth of organized retailPantaloon’s growth has predominantly come from the significant conversion to organizedretail from unorganized retail. Historically, most sales for organized players came from being an almost ‘quasi monopolist’ in a catchment, given the nascent nature of the organized retail format. However, increasingly many catchments (especially metros) and some verticals (like apparels) are showing maturity with a high degree of organized retail penetration and hence a part of future growth will be driven by growth in ‘already seeded’ catchments, especially for mature verticals like Big Bazaar and Pantaloon. This has important implications for PRIL, especially on store profitability and SSS growth. On the positive side, it will allow PRIL to leverage operating costs (especially marketing and logistics) and increase customer recall. On the negative side, it would impact SSS due to store cannibalization, as more often than not, PRIL is the most important retailer in most catchments.
We believe cannibalization will be inevitable, given PRIL’s overall expansion plan. While PRIL will be expanding aggressively in Tier II & Tier III cities (it expects to double the number of cities under coverage to 120 by FY2011E), metros and Tier I cities still offer attractive returns, given the overall disposable incomes in these cities and low wallet share of organized retail.
First-mover advantage to help in generating economies of scale and insure against potential future competitionWhile specialist retailers provide competition to Pantaloon’s verticals of food, fashion and general merchandise, the company benchmarks itself against fully-integrated players offering services across verticals and price points. Thus, it is apt to compare Pantaloon against fully-integrated retailers like Reliance Retail, Aditya Birla group and Bharti Retail, rather than specialized retailers like Vishal Retail or Shoppers Stop.