Stock Review: PANTALOON RETAIL

Rising same-store sales growth, retail focus and operational improvements should help the company post robust revenues

The stock of India's largest listed retailer is down 24 per cent since the start of the year over fears that rising interest rates and inflation could impact its margins and sales. Despite the under performance, most analysts have a buy rating on the stock, as they believe the company is likely to sustain astrong double-digit same store sales (SSS) growth across verticals and is attractively valued. Analysts at Religare Capital Markets believe the company's efforts to focus on core retail operations, improvement in working capital efficiency and consequently lower capital deployment could generate value for investors.

SUSTAINING HIGHER VOLUMES

After a disappointing CY09, when the same-store sales growth across segments grew 6-12 per cent, in CY10 it has been in the 12-21 per cent range. Analysts estimate that the overall SSS for the company is likely to be at 14-15 per cent. While the value and lifestyle segments are doing well, the company is struggling to make profits for the home division. Though volumes and SSS are encouraging, rising inflation is a worry. The company increased prices 12-15 per cent from March, which could impact sales growth, believe analysts at Motilal Oswal. Further, the imposition of excise duty on branded apparel can impact sales growth in the high margin apparel segment in the coming quarters. A key concern of the market has been the company's stakes and investments in unrelated subsidiaries. However, with focus on core-retail operations, plans to list some subsidiaries and get new partners should help bring down the incremental capital deployed in subsidiaries. The company is likely to look at a moderate expansion at about 2 million square feet every year, lower than the previous years.

MODERATE DROP IN MARGINS

The company had Ebdita margins of 9.2 per cent in 2009-10 and is likely to end 2010-11 at about 8.8 per cent. According to analysts, margins are likely to drop 8-8.5 due to higher contribution from the value retail business. Unlike lifestyle business (Pantaloon, Central), which fetches Ebidta margins upwards of 15 per cent, the value segment (Big Bazaar, Food Bazaar) earns single-digit margins. With food being the fastest growing business for the company, analysts believe margin expansion in the short-to-medium term is unlikely. In fact, its margins for the December quarter fell 150 bps y-o-y to 8.6 per cent due to inadequate price rises, losses in the electronics business and higher sales of food retailing in the overall mix. In addition to the product mix, the company has to contend with cost inflation both in food as well as other product categories.

FINANCIALS AND VALUATIONS

Analysts believe the company is likely to counter a further increase of prices by raising product rates as well as focusing on faster SSS growth. However, if product prices continue to rise, it is likely to impact demand, especially discretionary spending (apparels, home), as was the case in 2008-09. A sharp rise in prices will also impact the value category that generates over 60 per cent of the company's revenues. While rising interest costs are a worry, they are likely to trend down from an estimated 3.8 per cent of sales in 2010-11 to about 3.2 per cent in 2012-13, believe Religare analysts. This coupled with a strong top-line growth are likely to drive earnings for the core retail business by 27.6 per cent for the period FY 2011-13. Analysts peg the sum-of-the-parts valuation for the company, which includes the core retail and the financial services business, at `360-435. Given the growth prospects and peer valuations, the stock (Rs 281) is reasonably valued at 21 times 2011-12 earnings.