>INDIA RETAIL: From Revolution to Evolution (CITI)

■ What's new? — Our conversations with a clutch of modern retailers reveal that the modern retail sector in India is maturing – the focus has shifted from aggressive revenue growth to a phase where revenue growth, profitability and cash flow objectives have to be balanced.

■ It's all about the balance sheet — Mending damaged balance sheets is the flavor du jour. Retailers are focused on a) closing unprofitable stores and re-calibrating existing stores, b) making supply chains more robust (to lower inventory costs) and c) debt restructuring (in some instances).

■ The large vs. the small: a divergence in trends — i) The big are getting bigger – Players like Pantaloon (PART.BO; Rs374.95; 1M) and Shoppers Stop (SHOP.BO; Rs351.25; Not Rated) are expanding, albeit at a slower pace than in the past. In contrast, smaller players like REI 6Ten (REIS.BO; Rs88.35; Not Rated) and Koutons (KRIL.BO; Rs343.20; Analyzed Not Rated) have scaled down operations. Access to capital remains an important differentiator. ii) Asset light strategies – both 6Ten and Koutons are adopting franchisee based models (at least partially), while both Pantaloon and Shoppers Stop have eschewed this model, preferring to maintain control of stores and customer engagement.

■ Cyclical upsides mitigate structural challenges — The improvement in consumer sentiment and the consequent uptick in discretionary consumption (apparel, footwear), should result in an improvement in profits, and more important, visibility of profits – essential given the capex intensive nature of the industry. Structural challenges such as a) high inventory costs, b) in-store capex costs and c) multiple taxes (service tax, octroi, etc.) will continue to affect returns on capital employed. From a regional perspective, modern retail in India continues to be challenged compared to business models in China/Korea.

■ Pantaloon is best positioned to capitalize on cyclical upsides — PRIL's business model viability is a big positive, and we note that the company's ability to raise equity funds should incrementally improve, given the viability of its business model.

■ SOTP-based target price of Rs456 (raised from Rs370) ----- We value parent PRIL at Rs395 (at 25x June11E EPS, increasing premium to regional peers to 30% from 20%, given a) better visibility, b) PRIL's continued dominance of the sector and c) scarcity premium. Our EPS estimates have been pared 11-12% primarily on account of dilution and some modest (<5%)>

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