Pantaloon Retail: Buy

Pantaloon Retail appears to be in a sweet spot in the Indian retail sector. Revenue growth continues to be buoyant on the back of rapid store rollouts. Benefits of scale are also beginning to kick in, which is borne out by the expansion in margins in the last couple of quarters.

There is greater confidence on the execution front, as the company has tied up real-estate at lower costs compared to competition. Pantaloon is also building new businesses through subsidiaries that are well placed to raise money independently, thus addressing funding concerns.

The stock has dropped nearly 50 per cent from its January high. The preceding rally was on the back of expectations of “value unlocking” upon the listing of Future Capital Holdings, which now trades at a discount to its offer price. Valuations now appear to be at more reasonable levels.
Valuation

We prefer to evaluate Pantaloon on a standalone basis for now, as its subsidiaries nurture new formats and are unlikely to contribute significantly to profits in the near term.

Its subsidiary Home Solutions Retail is beginning to make a significant contribution to consolidated revenues (15 per cent in the nine months ended March’08, according to updates on the Web site).

We value Pantaloon’s stake in Home Solutions at Rs 46 a share (assuming a market cap to sales ratio of 1 on likely FY08 sales). The market is also likely to continue factoring in Pantaloon’s stake in Future Capital Holdings (FCH), which listed recently, as the group companies derive significant synergies from each other.

We value Pantaloon’s stake in FCH at Rs 113 a share, based on our estimate of its fair value (Rs 507 a share, against current market price of Rs 582). Stripped of the value of Home Solutions Retail and FCH, the stock is trading at about 35 times its likely June 2008 earnings per share.

This appears reasonable as Pantaloon’s stand-alone operation is well placed to record a 35 per cent annualised growth rate over the next five years.

Risks to our buy recommendation would be a significant decline in the stock of FCH, a greater-than-expected slowdown in consumption and delays in break-even of some of its newer retail formats.
Gaining scale

Pantaloon’s revenues increased 57 per cent on the back of expanding retail space and improving performance of existing stores. Same-store sales growth, which measures the performance of stores that have been in operation for at least a year, have slowed down significantly.

In the nine months to March 2008, same store sales of its value retailing format grew by 8.8 per cent, down from 19 per cent a year earlier.

Similarly, same-store growth in the lifestyle format slowed to 10.5 per cent from 23.3 per cent a year earlier. Greater competitive intensity in the metros may be one reason for slowing growth. However, the same-store numbers in the last two months have bounced back to the double digits.

Its home retailing venture, on the other hand, registered same-store growth of 35 per cent in the last nine months. Strong growth in new markets may compensate for any slackening of growth in the more mature formats. In any case, revenue growth is likely to be driven mainly by new store additions. Pantaloon has added 2 million sq.ft in the last nine months and is likely to finish fiscal 2008 with slightly more than 8 million sq.ft under its various formats.

Pantaloon’s earlier target of 30 million sq.ft by 2011 appears a bit difficult to achieve currently, despite the fact that the company has tied up 70 per cent of its space requirement. However, any increase in its pace of execution is likely to buoy revenues significantly.
Margins expand

Pantaloon has surprised with better-than-expected numbers in the last three quarters by recording an expansion in margins.

Margins in the third quarter ended March 2008 expanded by 130 basis points to 8.4 per cent on the back of savings in employee costs and tighter control on other expenses.

While some of the savings in employee costs may be due to transfer of employees to its subsidiaries, the company does appear to be benefiting from its greater scale.

This has compensated for lower gross margins, which is a result of a higher proportion of “value” retailing. Value retailing, which is led by its Big Bazaar hypermarket format, accounts for 70 per cent of its standalone revenues.

Improving profitability of newly opened stores is likely to offset the adverse impact of higher competitive intensity and expansion costs on margins.
Experimenting continues

Pantaloon’s earlier formats — Pantaloons (departmental store), Big Bazaar (hypermarket), Food Bazaar (Food supermarket) and Central (mall) — together accounted for over 250 stores as of March 2008.

In the specialty retailing segment, Pantaloon is witnessing significant growth in the home retailing segment. Home retailing includes formats such as Home Town, Home Bazaar, Collection I, Furniture bazaar and E- Zone. Revenues from this segment have tripled to Rs 711 crore in the nine months ended March.

Pantaloon has carved relatively new formats such as home retailing into subsidiaries, which enables these arms to raise funds for their projects independently.

ICICI Venture has a 15 per cent stake in the home retail subsidiary. Its practice of tie-ups for other specialty retail ventures such as fitness (Talwalkars Fit & Active), Office Products (joint venture with Staples Inc, US) and footwear (Liberty shoes) also reduces the risk to the main operation from new forays.

Pantaloon’s ability to discover new under-penetrated markets remains one of its key strengths and makes it a preferred partner for foreign retailers who are targeting the Indian market.

via BL