Retail Sector

Smiles are back on retailers' faces as tills ring louder
Rebound in consumer confidence; margins to remain static.
Sector Outlook:

Shut out by the paisa-punching consumer during the slowdown years, the retail sector is back in its elements in 2010, building upon the recovery that started in 2009. The rebound was led by the value-for-money category and then moved up to the premium level.

The three quarters ending September 2010 saw a 23 per cent growth in revenues and a near-trebling of net profits for listed Indian retailers, helped in part by a lower base.

Demand promise

Rebounding consumer confidence, a step up in corporate hiring together with salary hikes indicate increased disposable income in the hands of the consumer. This points towards a bright 2011 for retailers, armed as they are with healthier balance-sheets to fund expansion.

Premium and value retail will both see demand pick-ups, as consumer spends rise. With Tier I cities fairly saturated, retailers will move to small towns and cities where growth may be higher. Mall activity, previously beset by delays, is also set to improve. Retailers such as Pantaloon are also looking to tap online buying to supplement revenues.

Hypermarkets will see higher activity next year with players such as Pantaloon, Shoppers Stop and Trent stepping up focus on this format, given the high footfalls they bring in and their position as anchor tenants in malls allowing for lower rents.

Expansion plans

Retailers have, in fact, charted robust expansion plans, against their previous cautious stance. For instance, Titan added 60 stores in the first half of FY-11. Shoppers Stop and Pantaloon plan to add about 60 to 70 lakh sq ft space in the next year.

They are also fairly well-placed to bankroll this expansion. As they sought to reduce debt pressures, collective debt:equity went down from 1 time in FY-09 to a comfortable 0.7 times in FY-10. Interest costs so far in 2010 have reduced by 5 per cent , after a 78 per cent increase in FY09. Retailers have also been able to raise funds through Qualified Institutional Placements.

Exclusivity

Returning investor confidence in retail was evidenced by retail initial public offers, which collectively raised over Rs 500 crore in 2010. Two companies that made a debut were – Jubilant Foodworks in food retail and Talwalkars Better Value Fitness in the health and fitness space.

Their exclusivity afforded them a premium in valuations over other retailers, with trailing valuations of 70 and 57 times, against the 20 to 45 times of other retailers. A younger population with the propensity to spend on food and entertainment, as well as an increasingly health-conscious nation support the prospects of these players.

Margins

The retail segment, while holding promise in revenues, may slip up on the margin front. Operating margins in the first half of FY-11 were helped by a drop in raw material costs.

However, cotton and yarn prices and even synthetic fibre prices are northward bound, and could reverse this saving for apparel retailers. Retailers with backward integration such as Page Industries and Kewal Kiran may manage better margins. Food retail could also see squeezed margins as food inflation lead to spikes in raw material costs.

Two, selling and promotion costs, at 4 per cent of sales are up from the 3 per cent in the year before. Increased competition, especially in the smaller towns where retailers are planning to go, may require higher promotion spends. Operating margins, therefore, currently at 7-8 per cent are not likely to show much improvement.

Finally, as retailers step up expansion, interest cost savings that helped a net margin improvement of 2 percentage points in 2010 is also unlikely to persist, and net margins will remain at 3 to 4 per cent.

The outcome of the much-debated FDI in single brand and multi-brand retail is likely to emerge in 2011.

FDI

Retailers may benefit in partnerships to set up store chains, since 100 per cent FDI in either single or multi-brand retail is hardly likely.

Food and grocery retailers, such as hypermarkets Big Bazaar and Star Bazaar, may additionally benefit from supply-chain expertise foreign retailers bring with them.

Floundering retailers such as Koutons or Vishal Retail could receive a boost from foreign investments, whether by private equity players or foreign retailers looking to benefit from these retailers' massive store chains. Valuations of these stocks may thus see some improvement.