Kotak Securities: Pantaloon Retail (India)

Future Media. Future Media focuses on advertising at the point of consumption through access to retail space. It currently has exclusive access to all advertising spaces owned by PRIL, which it manages, markets and sells. PRIL has transferred all advertising rights to Future Media. It had total sales of Rs400 mn in 9MFY08.

Future Brands. Future Brands acquires and creates India-centric private consumer labels and endeavors to convert them into well-known brands by building, nurturing and marketing them by leveraging the distribution reach of PRIL.

Future Logistics. Future Logistics focuses on providing cost-effective, integrated, end-to- end logistics solutions to businesses in the consumption-led sector. We expect total warehousing space to increase around 8 mn sq. ft to 0.5 mn sq. ft by FY2011E. PRIL is currently in the process of rationalization of warehouses to around 7-8 mega warehouses from around 25-30 warehouses currently.Future Bazaar. Futurebazaar.com has been designed to address the growing online shopping market by combining the Future Group’s retail capabilities with a technology platform. Future Bazaar had sales of Rs600 mn in 9MFY08.

KEY RISKS Execution and funding will be the key determinant of future rollouts. We expect Pantaloon to only marginally break-even at operating cash level by FY2010E and hence funding will be a challenge. The competitive landscape could also change dramatically as many financially strong competitors have started operations. Current rules prevent meaningful foreign competition but this could change. PRIL is also exposed to the general economic growth in the country and higher inflation affects demand as well as increases input costs, especially in realty. PRIL could also get significantly impacted by any changes in policy on organized retail.

Execution could get delayed due to unforeseen circumstances. We believe theexpansion plans of PRIL are aggressive and will challenge the execution skills of themanagement. While we believe PRIL’s management’s historical expertise in managinggrowth will hold it in good stead, we are also circumspect of the many unknown variables which tend to plague real estate projects in the country and lead to inevitable delays.

We highlight that we have built a 10% lower expectation of rollout as compared to themanagement’s estimates. As seen in Exhibit 15, a 20% lower-than-expected execution from management estimates would result in a 10% decline in FY2010E PAT (standalone) from our estimates.Capex requirements are substantial over the next 3-4 years. We estimate PRIL’s(standalone) capex requirement to be around Rs34 bn (including working capital and rental deposits) between FY2008 and FY2011E. While a part of this will get funded through conversion of warrants (around Rs12.6 bn has already been pledged by promoters and a few financial investors), we expect the remaining to be funded by debt (we estimate fresh debt of Rs3 bn between FY2008 and FY2011E) and internal proceeds, including possible stake sale in subsidiaries. We ignore the positive effect on working capital due to locked-in retail space as we believe the company will continue to actively acquire retail space for future needs. We also expect the company (standalone) to begin showing operating cash profits from FY2010E.

Current competitive scenario could alter with regulatory changes. Pantaloon has a significant first-mover advantage of ‘locked-in’ retail space. This will help the company overcome the problem of sourcing of prime locations for its retail operations for the next 3-4 years. However, we expect significant competition to increase within the next 2-3 years, given the stated retail plans of its major competitors such as Reliance Retail, Bharti group, Birla group and the Tata group. This will lead to increasing competition for inputs, including manpower and back-end resources, and thus lead to increased costs.

A recent example of the effect of competition was Marks & Spencer’s shift to Reliance Retail from Planet Retail (a 49% JV of PRIL and M&S). We believe such deals will become more frequent in the future and companies which have a large national footprint will be the beneficiaries of this trend.

In addition, the current regulatory framework does not allow foreign companies to have majority stakes, except in single-brand outlets. Any changes in these regulations would be a negative for PRIL’s operations.General economic slowdown could impact sales, especially in the lifestyle segments. Organized retail growth is, like all retail plays, sensitive to overall economic growth and affected by any economic slowdown. We believe the lifestyle segment could be more severely impacted in such a scenario. However, we believe the secular migration to organized trade from unorganized will continue and hence should mitigate some of the fall- outs of any such slowdown.

The government is concerned about the effect of organized retail on employment. Political risks have increased in the recent past, with the government concerned about the wider socio-economic impact of organized retail, especially in the food and vegetable segment on unorganized retailing and employment. This has led to some government action (especially at the state level). The recently-submitted report by ICRIER (which was given a government mandate to specifically look into these issues) is a positive for the organized trade but there could still be potentially larger ramifications, given political compulsions.

FINANCIALS We expect Pantaloon’s (standalone) net sales to grow by 44% CAGR in FY2007-11E to Rs139 bn in FY2011Eand total retail space to increase to 20 mn sq. ft (40% CAGR). HSRIL will likely generate Rs38 bn in sales while adding around 4 mn sq. ft of retail space. We expect SSS in leading formats to moderate to single digits as old stores get affected due to store cannibalizations. We expect standalone EBITDA margins to increase 47bps to 7.1% by FY2011E, due to lower gross margins and higher rentals offset by lower operating costs, while net profit is expected to grow 61% CAGR to Rs4 bn by FY2011E.44% CAGR revenue growth during FY2007-11E despite lower same-store salesWe expect standalone revenues of Rs139 bn by FY2011E (44% CAGR growth), driven by40% CAGR increase in retail space to 20 mn sq. ft. We, however, expect SSS to moderate to single-digit growth over the period, affected by cannibalization of old store sales, as the company steps up rollouts within the same catchments.Expect EBITDA margin to increase 47bps between FY2007 and FY2011EWe expect EBITDA (standalone) margins of 8.3%, 7.9%, 7.4% and 7.1% in FY2008E, FY2009E, FY20101E and FY2011E, respectively, as against a 6.7% EBITDA margin in FY2007.

As seen in Exhibit 21, EBITDA margins are expected to increase marginally by around 47bps from FY2007 to FY2011E, primarily on account of lower gross margins and higher lease costs offset by savings in staff and other overheads. Pantaloon’s gross margins have got impacted in recent years as the share of value segment sales (which have lower gross margins) have increased to around 70% in 9MFY08, along with an increasing mix of segments like electronics, which typically have lower margins. We expect value segment sales to continue to increase in importance over the next few years. Similarly, we expect average lease rentals to increase around 8% per year, mainly on properties which have already been leased and which have automatic rental increases.

On the other hand, PRIL will benefit from operating leverage, a trend which was seen in 9MFY08, where EBITDA margins expanded a whopping 200bps from FY2007. We believe incremental growth will come both from large towns and metros as from expansion intonew territories. Thus, we expect the current contribution of top 7-8 cities (around 75-80% of total sales) to be maintained, despite the rapid expansion into other geographies. This will likely lead to a concentration of overheads, especially relating to advertising and logistics and have a positive impact on margins. However, we believe the company will also step up its advertising and promotional reach, especially on its new initiatives which are currently at a nascent stage.

Pantaloon’s valuation of finished goods is at retail price, less markup, which is different from its peers and which tends to inflate overall inventory by around 3-5% (Rs250 mn based on FY2007 numbers). We believe the management is actively looking at aligning this anomaly with that of its peers, but will take a call on final adjustment along with the management. A 5% reduction in inventory, based on our assumptions, will impact margins by around 20-
25bps

Operating cash flow positive from FY2010E We expect Pantaloon (standalone) to become operating cash flow positive in FY2010E,despite the aggressive store rollout as we expect PRIL to manage its inventory in a moreefficient manner. As seen in Exhibit 25, PRIL’s inventory days have typically been higher than its peers, primarily on account of faster store rollouts where typically inventory tends to increase in proportion to sales. However, we expect this trend to decline in the future and expect inventory days to decrease to around 80 days of sales in FY2011E from around 100 days in FY2007

ROCE to increase marginally to around 9% during current phase of expansionPRIL’s historical ROCEs have been between 5% and 9% only, not surprising given the low margins in the business and the constant deployment of funds to fund rapid expansion. We expect the company’s ROACE to improve marginally to around 9% in FY2011E (from around7.1% in FY2008E), on the back of improvement in EBITDA margins due to operatingleverage. However, we do not see ROACEs improving significantly in the short term, given management focus in achieving a national footprint and scale of its ambitions.

  • e-retail

    Thanks for info