Saturday, September 26, 2009



Indian Organized Retail (IOR) was in the fast forward mode over the last few years. While scaling up 3x in just three years to USD18bn (40%+ CAGR), caution was thrown to the winds when it came to business economics. However, the first round of casualties (Subhiksha, Indiabulls Retail, etc), and poor profitability as also leveraged balance sheets – exacerbated by growth slowdown – for survivors have forced them to focus on operational efficiency. Importantly, cost pressures have receded with lower competitive intensity and measures are being adopted to enhance capital efficiency. Pace of scale-up has been redefined to align with internal cash accruals as there is no recourse to external capital. This, we believe, would converge to gradual (25% 3-year CAGR) but profitable growth and healthier balance sheets. It is re-rating time for the sector and we bet on Shoppers Stop, Pantaloon Retail and Provogue.

Mad rush for scale at any cost…: IOR, in the rush to capitalize on under-penetration and gain critical mass before influx of foreign competition, took to the path of rapid scale-up over the last few years. However, even as the sector grew 3x in size over FY06-09, profits were elusive. While costs doubled as everyone chased the limited resources, disproportionately higher scale-up of front-ends ahead of back-ends led to capital inefficiency. Leveraged growth became more a norm than an exception.

…giving way to prudent growth: As external capital taps dried up, players have woken up to the imperative of raising capital within to fund future growth. IOR is now in the course correction mode and while the competitive landscape is more settled, employee costs are trending down and lease rentals have corrected 30-50% from the peak. Players are focusing on efficient manning, inventory management, space rightsizing, etc. These initiatives, we believe, would drive margin expansion for retailers even as same store sales are picking up.

Re-rating ahead; we are Overweight: We see significant profitability improvement and healthier balance sheets ahead as retailers adopt a calibrated growth stance using internal capital. This, we believe, would drive a re-rating in sector valuations. Shoppers Stop stands to be the key beneficiary of easing cost structures (570bp margins expansion over FY09- 11E) while Pantaloon Retail, the largest Indian retailer, too would be attractive as its balance sheet gets deleveraged. We maintain our bullish stance on Provogue given Prozone’s value unlock potential. We are Neutral on Titan due to its rich valuations.

To see full report: INDIAN RETAIL