Vishal Retail

Value retailers were, for some time, a preferred option among retail stocks based on the belief that they fare better during tough times. But recent numbers from Vishal Retail, a value retailer present in 181 stores across most Indian states, suggest that not all value retailers are well-placed to weather the slowdown.

Despite its very low valuations, investors can consider selling this stock. The company’s sales growth appears set to slow down sharply, as its same-store sales moderate and it scales back on expansion plans.

A slowing topline, given the thin margins and a high debt burden, may lead to a deteriorating profit picture, pointing to earnings uncertainty for the next couple of years. The stock has fallen precipitously from our earlier ‘Book Profits’ recommendation at Rs 689 (June 22, 2008) and now trades at Rs 53. It is valued at a PE of four times its trailing 12 month earnings with an enterprise value of 0.6 times its 12 month sales and 0.5 times its estimated FY-10 sales.

Space addition was aggressively pursued, its store network surging from the pre-IPO 49 to the current 181. Vishal had floated its IPO in mid-2007, raising about Rs 110 crore, primarily to fund space expansion. Of this, Rs 104 crore, besides debt, was employed for the purpose.
Sales slowdown

Successive quarters, post-IPO, saw revenues on the rise, and sales in the quarter ended December 2008 increased 24 per cent over the same period last fiscal. But this is clouded by the fact that sales have been weakening sequentially, shrinking by 5 per cent in June quarter and again by 6 per cent in December quarter of this fiscal.

Vishal’s sales in North India, especially, have been severely affected; its concentration in that region has dealt quite a blow to sales. The company’s focus on Tier-III cities — 139 of its 181 stores — means an overall yield per square foot that is lower than peers. Over 50 per cent of Vishal’s sales come from apparel retailing, where spending has been vulnerable as consumers feel the pinch on their household budgets.
Reliance on existing stores

In the light of slowing consumer spending, and narrowing discretionary spending evidenced by low turnover in the consumer durables segment, Vishal is restricting expansion plans to about 5-10 per cent on a year-on-year basis.

Any addition to retail space will be undertaken through franchisees. Franchise stores currently number 13, and have not contributed significantly to the company’s expenses or margins as yet.

Cutting back expansion means that Vishal will have to rely for its growth on sales generation from existing stores rather than additions as has been the case thus far. The picture on this is not confidence-inspiring, as same-store sales growth for the first two quarters of FY-08 was just 7-8 per cent and then turned negative in the third quarter.

There has also been a drop in daily footfalls on a quarterly basis by about 7 per cent. Vishal has managed a marginal increase in conversion rates, but given an overall slowdown in spending, this aspect offers little cheer.
Narrowing margins

Viewed in relation to its peers, Vishal has performed reasonably well at the operating level, with margins for the past two quarters at 12 per cent. It has been able to bring down operating costs by re-negotiating rentals with landlords; in some cases managing a 40-50 per cent reduction in rates.

Added to this, it has reduced areas in some stores, and cut down on its warehouse space by nearly half. Logistics has been redesigned in an effort to make it more cost efficient. Using the franchisee mode of expansion in place of owning new stores will require almost nil capex requirements and reduced expenses on power and rentals. Such cost controls may not be possible with owned stores.

However, despite these measures, with the deceleration in sales, high interest costs and depreciation have cut net profit margins down to less than 1 per cent in the December quarter. Debt rose by 44 per cent , with interest payouts more than doubling in the past year. Fixed assets increased 34 per cent in FY09, having already doubled in FY08, pushing up depreciation costs by 80 per cent in a year.

Even so, asset turnover has steadily declined in the past three years, a trend mirrored by inventory turnover. Vishal aims at minimising inventory levels by bringing them in line with sales and will attempt clearing out stocks via discounts. While this may unlock working capital, it will have negative margin implications.
Burdened by debt

Vishal’s debt equity ratio is fairly high at 2.6 times. However, it is the interest cover which is more of a concern, having shrunk from seven times to 2.6 times in three years. A portion of debt is due to be repaid this March, and the company has stated that it proposes to roll over debt, for the second time since last year.

Given the more stringent environment now prevailing on bank credit, this may pose challenges, especially given its weak operational cash flows and depleting interest cover. Benefits from extending credit period allowed to it by other creditors may also not improve cash flows significantly.