Pantaloon Retail India

Retail major Pantaloon Retail India, operating in both value and lifestyle retail, is among the preferred exposures in the Indian retailing sector.

However, investors in the stock have to brace for the stock underperforming markets over the next few quarters, given the challenges relating to curtailed consumer spending, low ability to add debt and poor performance from subsidiaries. At Rs 126, the stock trades at 15 times its trailing 12-month standalone earnings per share.

Though this is at a substantial premium to the overall market, it is at a discount to the historic valuations enjoyed by the stock. Enterprise value stands at 0.50 times its estimated standalone FY10 revenues.
Growth in question

Pantaloon has a retail portfolio addressing almost every consumer need, placing it at an advantage over most peers. It operates apparel chain, Pantaloon Fresh Fashion, hypermarket major Big Bazaar, lifestyle chain Central, discounter Brand Factory, home product provider Home Solutions and lesser-known food chains such as Blue Sky. Private brands include names such as John Millers, Bare Casuals, Umm, Agile, and others.

Over a three-year period, Pantaloon’s sales registered a 70 per cent annual growth, before slowing in the current fiscal. Sales grew 24 per cent in the December 2008 quarter over last year, moderating from the 39 and 35 per cent in the preceding quarters.

Flat sequential December quarter sales were disappointing – given that this was a key period for festival and New Year sales. After hovering above 10 per cent for most of 2008, same-store sales growth was negative in the last two months of 2008, before moving back to positive territory in January at 5 per cent. The latter may have been aided by continual discounts.

With macro indicators showing discretionary purchases on the wane, caution may rule spending for some time yet, which may curb Pantaloon’s growth in the next few quarters.
Subsidiary pressures

Pantaloon has built an army of subsidiaries, such as Whole Wealth to source international products, Future Logistics to provide end-to-end logistics and others. Future Capital Holdings, a 55 per cent subsidiary, is a financier and investment advisor and now the highest contributor to subsidiary profits. The home products subsidiary, Home Solutions Retail, incurs the most losses, though it may break even this financial year. Of the ten operational subsidiaries, only two are profitable, thus pulling Pantaloon to a loss on a consolidated level for 2007-08.

With many of these businesses in a nascent stage (Pantaloon disbursed Rs 1,500 crore to associates and subsidiaries last year), and credit markets drying up, Pantaloon may have to put off expansion plans, which could have enabled them to unlock their potential; subsidiaries may, therefore, continue to weigh on the parent’s profits.
Trials in expansion

Unlike many retailers, Pantaloon’s expansion plans are still on, with the company proposing to reach 15 million square feet across formats from the current 11 million. Funding these plans may be difficult , since the company has accumulated an estimated Rs 2,800 crore debt. Though the debt-equity ratio of 1.6 times is not particularly high in the retail space, the steadily depleting interest cover, (from 3.4 times in 2006 to its current 1.7 times), is a concern. Pantaloon may have the upper hand in negotiating rental properties and is looking at rent control through a revenue-sharing models with developers.

Margin squeeze

Gross margins have been maintained above 10 per cent in the last three quarters, an improvement over the 8.5 per cent averaged in the preceding four quarters. Margin improvement was mainly on account of a control on employee expenditure and other expenses.

But interest — which jumped 52 per cent in the June 08 quarter — and depreciation hammered net margins to less than 2.5 per cent consistently over the past four quarters. Net margins were lower in the December and September 2008 quarters compared to the same period in 2007.

Given the quantum of debt, interest costs may remain quite substantial. Increasing share of value retail, at the expense of lifestyle retail, in overall sales may pinch margins further. Discounts to attract customers may pressure margins as well.