Vishal Retail

Shareholders can consider booking profits in the stock of Vishal Retail. Investors who subscribed to the company’s initial public offer last June are still sitting on a 160 per cent return on the offer price, though the stock has corrected substantially from its highs. The current market price of Rs 689 values the stock at about 25 times its likely FY-09 earnings, assuming the company delivers on its guidance.

The valuation is slightly stiff, in our view, as it factors in sustained ramp up in new stores. We are somewhat sceptical of the company’s ability to meet its expansion target for FY-09, as it is not yet adequately funded for the expansion. Even if it manages to raise equity worth Rs 200 crore through private placement, as proposed, with the balance to be funded by debt, higher interest costs are likely to be a drain on earnings over the next year. As a slower-than-expected pace of rollout could lead to a de-rating of valuations, shareholders can consider booking profits at least partially on the stock.
Progress so far

Vishal Retail operates a chain of stores that sell apparel, FMCG and other consumer products at discounted prices to value conscious customers. The company focuseson small towns and cities where aspirational spending is on the rise.

Vishal Retail reported a 67 per cent growth in revenues and a 62 per cent rise in profits in 2007-08, on the back of a significant ramp up in retail space. Vishal Retail beat its expansion target for FY 08, opening 50 stores as against the proposed 32. It now has over a 100 stores and a retail space of 2.3 million sq ft.

The company’s operating margins improved 1.2 percentage points to 12.7 per cent in FY-08, on the strength of an increasing share of private labels. The company has also managed to improve the share of FMCG sales in the revenue mix (18.6 per cent versus 15 per cent earlier), as part of its strategy to attract footfalls.

Interest costs have, however, jumped to about 3.8 per cent of sales from 2.4 per cent earlier. This may be on account of higher debt used to fund burgeoning inventory costs, now at Rs 2,500 per sq ft. The high inventory poses a strain on working capital requirements and is a cause for concern.

Same-store sales (sales of existing stores, excluding openings) growth has slowed further to 7 per cent in FY-08 from 11 per cent in FY-07. This means that high revenue growth has been driven significantly by store expansion, rather than growth from existing stores. Competitors such as Big Bazaar have managed to maintain at least low double-digit same-store growth.
Ambitious growth plans…

Vishal Retail continues to have ambitious growth plans, targeting 190 stores with over 3.7 million square feet by FY-09 and over 500 stores with 10 million sq ft by FY-11. It also intends to invest in logistics, restaurants and consumer PE fund (similar to that run by Pantaloon).

Expansion is to be led by Tier-3 and Tier-4 towns, which might mean lower ticket sizes and average sales per sq ft, although profitability may remain at the same levels due to lower rent and employee costs.
....but funding a constraint

If the company manages to ramp up retail space at the rate it has in the past, revenues and earnings could grow at a strong pace.

However, funding remains a niggling worry. While funding has not been a cause for concern in the past, we adopt a more cautious view in the current liquidity environment.

To meet its expansion plans for the next three years, Vishal would have to invest about Rs 2,500 crore. The company has little by way of internal accruals. Vishal intends to fund its expansion plans through a 2:1 combination of debt and equity. It is already heavily leveraged and bears an interest cost of 11.75 per cent on its loans. This could go up in a rising interest rate environment. These circumstances call for a moderation in growth expectations.