Fitch 15 Retail

8/13/2019 Fitch 15 Retail

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www.indiaratings.co.in 15 January 2013

Retailing

2013 Outlook: Indian RetailDeteriorating Domestic Consumption to Squeeze Retailers

Outlook Report

Rating Outlook

Negative Outlook for 2013: India Ratings has maintained a negative outlook on the retail

sector for 2013. This is because of the protracted weakness in consumers discretionary

spending due to higher inflation, marginal real wage growth and low level of macroeconomic

activity. Rapid credit squeeze, high operating costs and falling margins may also impact the

credit profile of retailers.

Ratings Partly Reflect Risk: The rating levels of India Ratings-rated retail companies have

already factored in pressures on margin and revenue; this contributes to the high proportion ofStable Outlooks. Some companies with deteriorated credit metrics also have Stable Outlooks

as India Ratings has already taken sufficient action to accommodate foreseeable stress. While

in some cases, expectation of significant deleveraging is the driver for stable ratings despite

pressure on operating metrics.

Deteriorating Private Consumption Growth:Private Final Consumption Expenditure (PFCE)

is at an eight-year low. The trend is even more worrisome since out of the last six quarters, four

quarters had the lowest PFCE growth rate in the last 34 quarters. While PFCE tends to bounce

back in response to government spending, a sustained recovery in consumption spending

would depend on robust corporate earnings followed by a significant real wage hike and low

consumer inflation. As such, these are less likely to happen in 2013.

Muted Revenue Growth:The sector experienced overall single digit revenue growth in 2012

the first time in its history and is likely to grow at 3.0%-8.0% in 2013. An exception is Shoppers

Stop Limited (SSL, IND A1) which is likely to exhibit double digit revenue growth at a slowing

rate due to a fall in same-store-sales growth (SSSG). Most retailers witnessed a decline in yoy

SSSG, becoming negative for major retailers from March 2012-September 2012. Retailers

focussed on the luxury or premium segment may be worst hit with an expectation of flat-to-

negative growth in overall revenues.

Pressure on Margins: Median EBITDA margins of major players are likely to contract by

50bps-75bps in 2013. To combat slower SSSG, retailers are offering deep discounts which

may generate volumes at the cost of margins. Retailers are also adopting cost-rationalisation

measures such as closure of unprofitable stores, enhancing employee productivity and

moderating new store addition. An increase in lease rentals (20bps-80bps as a percentage ofrevenue) and manpower costs (50bps-140bps) in FY12 over the FY11 levels further

aggravated margin pressure.

Deteriorating Credit Metrics: In 2013, working capital requirements may increase due to

lower inventory turnover and need to support new stores. With cash flow from operations of

retailers already negative and expected pressure on margins, the credit metrics of retailers

would remain under pressure. The industrys working capital cycle shortened in FY12 as

inventory levels reduced due to heavy discount driven sales adopted by most retailers.

However, the need to support new stores led to an increase in overall debt levels in 2012.

Push towards Deleveraging: Retailers inability to boost cash flows immediately and their high

leverage levels may compel them to look for equity funding. Historically, most capital needs

were met through debt. The proposed demerger of Pantaloon Retail India Limited (PRIL, 'IND

A-'/Stable) and the proposed acquisition of a controlling stake of the newly formed entity by

Aditya Birla Nuvo Limited (ABNL) is a case in point. At present foreign direct investment (FDI)

Related Research

Other Outlookswww.indiaratings.co.in.com/outlooks

AnalystsDeep N Mukherjee+91 22 4000 [email protected]

Priyanka Poddar

Rating Outlook

NN EE GG AA TT II VV EE


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based equity infusion is a theoretical possibility given the complex government requirements,

the existing retailers may have to significantly restructure their businesses before receiving

such investments.

What Could Change the Outlook

Improvement in Consumer Consumption Expenditure:A sustained reduction in consumer

price inflation, coupled with a rise in real wages, is likely to restore the discretionary spending

power of Indian consumers. Alternately, a sudden spurt in government spending may have a

temporary beneficial impact on private consumption, ultimately benefitting the sector.

Equity-Induced Deleveraging: Companies in the sector that may be successfully able to

attract equity investors, so as to deleverage their balance sheet significantly are likely to

improve their credit profile.

Key Issues

Domestic Consumption to Remain SubduedIndia Ratings expects muted revenue growth in most industries dependent on consumer

spending including retail. A tentative relation exists among nominal wage growth, economic

activity and more specifically the performance of businesses in the economy. The wage growth

in turn impact consumption. Given the corporate profitability levels of FY12 and the expected

profitability levels of FY13, salary hikes are likely to be much muted in FY13 and beyond than

those observed in FY11 and FY12. An analysis of 500 top companies in Bombay Stock

Exchange (BSE) suggests a lagged (one year) impact of salary and wages growth on previous

years profitability.

The PFCE growth rate of 3.68% at end-Q213 is the lowest in the last 34 quarters. The

deterioration in PFCE is becoming a well-entrenched trend. The last six quarters witnessed four

lowest growth rate observations in the last 34 quarters. This is in line with India Ratingsexpectations (refer to Mid-Year 2012 Outlook: Indian Retail, published in August 2012:

http://indiaratings.co.in/Outlook2012).

Government spending on salary and potentially direct transfers are also likely to be subdued.

As such, PFCE is unlikely to show a significant improvement in 2013. While PFCE can

temporarily spike up in response to government spending, a sustained improvement may

require sustained growth in real wages in the economy and low consumer inflation.

Government spending on salary and social spending are also likely to be subdued. . As such,

PFCE is unlikely to show a significant improvement in 2013. Consumer confidence is also at a

three-year low.

Muted Same Store Sales GrowthSSSG deteriorated for retailers in 2HFY12 and 1HFY13. A decline was reported in three out of

the last four quarters. SSL (year-end March) registered deterioration in SSSG of 10%, 1% and

5% in Q4FY12, Q1FY13 and Q2FY13, respectively, while PRIL (year-end June) witnessed

deterioration in its SSSG in some of the formats with negative 0.2% in value, negative 3.5% in

home and positive 10.8% in lifestyle.

Value retailing, generally considered more resilient to economic slowdowns than the lifestyle

retail segment, has observed some pressure in the current period as customers are

downshifting to more unorganised formats. PRILs SSSG decelerated for value and home

retailing segments in Q3FY13 while its lifestyle segment benefitted by offering higher discounts

and a reduction in excise duty on branded apparels to 3.6% from 4.5%.

Retailers such as PRIL, SSL and Trent Limited have increasingly moved towards private label

sales to improve profitability. However, to combat slower SSSG, retailers are providing deep

Figure 1

115

120

125

130

135

Q110

Q210

Q310

Q111

Q211

Q311

Q411

Q112

Q212

Q312

(%)

Source: AC Neilson consumer confidence

index

Decline in Overall

Consumer Confidence

IndexLargest Decline in past 3 years

Figure 2

Figure 3

Related Criteria

Corporate Rating Methodology(September 2012)


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discounts and promotional offers in lifestyle, which may generate volumes at the cost of

margins. Gross margins deteriorated for SSL to 30.9% in September 2012 from 32.6% in June

2012. PRILs margins remained flat at 29.6% while Trents gross margin fell to 46.3% from

47.2% in the same period.

Figure 4

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10

20

30

40

50

60

70

Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12

PRIL - lifestyle PRIL - value PRIL - home Shopper's(%)

No Improvement in SSSG

Source: India Ratings, Company

Figure 5

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40

50

60

70

Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12

PRIL Shopper's Trent Provogue Brandhouse retail(%)

Decline in Q-o-Q Sales Growth

Source: India Ratings, company

Expansion Driven Revenue Growth

SSSG is unlikely to meaningfully improve in 2013. Overall revenue is likely to grow at 3.0%-

8.0% in 2013, with the exception being SSL. SSL is expected to exhibit double digit growth at a

slower pace in 2013. Overall revenue growth for the sector fell to single digit in 2012 from

double digit observed prior to 2012.

Retailers with diversification across the value and luxury segments are likely to remain more

resilient to a downturn. SSLs registered qoq top-line growth of 21.0%, 15.5% and 14.3% inQ4FY12, Q1FY13 and Q2FY13, respectively, while PRIL registered revenue growth of 7.6%,

3.6% and 5.1% in Q3FY11, Q4FY11, and Q1FY12.

In terms of revenue growth, the worst affected would likely be retailers focussing on the

premium and luxury segments. Such retailers may continue to show flat to negative revenue

growth.

As observed in more recently, new store additions are likely to continue to be the driver of

revenue growth. SSL opened 13 new Shoppers stores in FY12. The company targets to have a

total of 75 stores by end-FY15. PRIL added 41 PRIL stores, while Trent opened seven stores in

FY12. India Ratings expects retailers to continue to open new stores in Tier 2 and Tier 3 cities

as Tier 1 cities become saturated. However, the agency expects retailers to take a longer timeto break even for new stores with a drop in footfall and slowing SSSG.

Figure 6

050

100150200250300350

PRIL Shoppers Trent

FY09 FY10FY11 FY12(Units)


Increase in New Store

Openings Y-o-Y


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Continued Pressure on Margins

India Ratings expects a drag on the sectors profitability in 2013 for most retailers as traction

from new stores remains sub-par. However, the momentum in margin contraction observed in

last several quarters is likely to lessen given the cost rationalisation measures. India Ratings

expects EBITDA margins to fall by 50bps-75bps for the sector in 2013.

On an average, margins fell by 3.4%-8.0% across retailers in quarter ended September 2012

from those in the quarter ended June 2012, with SSLs margins of 2.6%, PRIL 8.7% and Trent

1.9% from 1.5%, 9.3% and 4.7%, respectively.

For major companies, employee costs as a percentage of revenue have crept up and are at a

three-year high. Growth in lease rental has been marginal from the 2011 levels, but is still lower

than the levels observed in 2009 and 2010. This component is unlikely to increase significantly

given the weakness in commercial real estate. Also, retailers are actively and often

successfully exploring options such as revenue share with the real estate provider to reduce

the fixed nature of leasing cost.

Figure 7

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2

4

6

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PRIL Shoppers Trent Provogue Brandhouse retail

FY09 FY10 FY11 FY12(%)


Employee Cost as a % of Revenue

Retailers are adopting cost controls measures to counteract margin pressures. These

measures include boosting labour productivity, better inventory management, increasing supply

chain efficiencies and throughput from the new stores. Retailers may also close unprofitable

stores and rationalise capex by opening new stores in Tier 2 and Tier 3 cities at a smaller

scale. Muted commercial real estate prices in such locations may be a long-term positive.

Figure 8

Figure 9

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12


FY09 FY10 FY11 FY12(%)


Lease Rentals as a % of Revenue


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510

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Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12

PRIL Shopper's Trent Provogue Brandhouse retail(%)

EBITDA Margin Under Pressure


Working Capital Cycle

India Ratings expects working capital cycle to remain under pressure during 2013 as new

stores will generate returns onlyafter 12-15 months and sales will remain slow at the existing

stores. Inventory levels to increase moderately in 2013 on account of slowing sales and newstore openings that would require keeping higher inventory levels in 2013.

Overall working capital cycle improved in FY12 as retailers tried to reduce inventory levels by

offering higher discounts. However, this was partially offset by a lower credit period from

suppliers. PRILs (core retail) inventory days are likely to have halved in FY12 from 162 in

FY11. To free up cash and offload slow moving inventory, the company offloaded its inventory

at the year end. However, SSLs inventory levels increased in FY12 due to slow moving sales

resulting in a negative cash flow from operations.

Figure 10

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60

100

140

180

220

260


FY09 FY10 FY11 FY12(Days)


Inventory Cycle Across Retailers

Strain on Cash FlowsIndia Ratings expects retailers free cash flow (FCF) to remain negative in 2013 due to

deteriorating margins, increased working capital requirements and aggressive expansions.

Retailers have relied largely on debt to fund their expansion plans, which has reduced financial

flexibility and could result in further liquidity strains during the year. Aggressive store

expansions and higher capex led to a stretched liquidity position for most retailers in FY12.

SSLsCFO and FCF turned negative in FY12.

In India Ratings opinion, committed capex plans will further put strain on cash flows and

increase debt. The likely margin contraction, expansion plans, along with increased need for

inventory as retailers open up new stores will lead to increased cash flow needs which are

likely to be debt funded, as it has been in the past. However, companies have been adopting

various strategies to contain debt, including raising equity and sale of certain non-related

assets as well as business segments, which may help in maintaining credit profiles and thereby

trying to contain leverage levels


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The proposed demerger of PRIL and the proposed acquisition of a controlling stake of the

newly formed entity by ABNL is a case in point.

FDI in Multi-Brand Retail A Long-Term PositiveOn 14 September 2012, the government of India approved FDI in multi brand retail up to 51%

and further simplified FDI in single brand product retail. India Ratings expects international

retailers, especially in the hypermarket format, to establish their footprint in the Indian market

over the next one to two years, subject to the resolution of the associated political issues (refer

to India Ratings: FDI in Retail - Complexities to Undermine Benefits, published in September

2012).

2012 Review

As per India Ratings expectations, most of the issuers credit profiles weakened in 2012. This

was the result of the continued decline in consumers discretionary spending, a fall in real GDP

and a persistent rise in inflation and interest rates that eroded the disposable income in the

hands of consumers. Overall demand shrank as retailers experienced revenue declines across

the life style as well as value-based formats.

Margins contracted as prices declined yoy. This coupled with higher-than-expected new store

openings adversely affected retailers cash flows. SSLs CFOs and FCF turned negative in

FY12. India Ratings believes that new stores will generate returns only after 12-15 months,

while inventory is blocked upfront. As a result, retailers will continue to face cash flow

pressures and negative FCF over the medium term, until expansion rates moderate. In 2012,

India Ratings took negative rating action on SSL due to its greater-than-expected liquidity

issues and a higher-than-expected decline in its credit profiles.

India Ratings expects the retail outlook for India to remain negative in the short term. However,

with the liberalisation of FDI in multi-brand retailing this could translate into a positive impact on

the capital structure and liquidity profile of companies in the next two to three years.


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Annex 1

Figure 11Select India Ratings-Rated Retail CompaniesIssuer Long-term rating Outlook Short-term rating

Pantaloon Retail (India) Ltd IND A- Stable IND A1Shoppers Stop Ltd - IND A1Future Value Retail Limited IND A Stable IND A1Tristar Retail IND BB- Stable IND A4+Blues Clothing Company Limited IND BB+ Stable IND A4+

Source: India Ratings


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Annex 2

Figure 12Retail Companies Profile for FY12

PRIL (consolidated) SSL (consolidated) Trent (consolidated)

Presence cities 92.0 20.0 33.0

Formats --Big Bazaar --Departmental stores --Westside--Food Bazaar --Hypercity --Star Bazaar

--Pantaloons --Mothercare --Landmark--Central --Crossroads --Other sp formats

(Sisley)--KB Fair Price --MAC & Estee Lauder--Home Town --Other spec formats

No of stores 316 PRIL Stores, 448FVRL Stores

51 67 westside 15 starbazaar, 19 landmark

and 5 fashion yatraArea 16.7 4.4 2.5

Sales 115,093 27,742 18,449EBITDAR 16,134 3,285 514EBITDA 7,703 909 -571EBITDA margin (%) 6.7 3.3 -3.1Interest 6,291 422 104Total assets 84,897 14,501 20,144Total debt 36,361 4,356 3,013Total adjusted debt 95,376 20,994 10,608Net worth 33,660 5,161 11,639CFO n.a. -475 -748FCF n.a. -1,184 -3,095Adjusted net debt/EBIDTAR 5.7 19.9 6.4EBITDAR/net interest+rent 1.1 1.2 0.4Debtor days 6 9 4Inventory days 82 65 104Creditor days 25 46 55

Net cash conversion cycle 63 28 53

n.a. Not available PRIL results includes unaudited core retail results for FY12Source: India Ratings, company reports


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Annex 3

Figure 13Credit Profile of Retail Companies

FY09 FY10 FY11 FY12

PRILDebt/EBITDA (x) 6.3 4.6 6.3 4.7Adjusted net debt/EBITDAR (x) 6.2 5.5 6.5 5.9Operating EBITDAR/fixed charge (x) 1.2 1.3 1.3 1.1CFO % of sales -4.7 8.8 -6.7 n.a.

SSLDebt/EBITDA (x) 14.3 2.5 2.2 4.8Adjusted net debt/EBITDAR (X) 8.1 5.3 5.1 6.4Operating EBITDAR/fixed charge (x) 1.0 1.5 1.4 1.2CFO % of sales 4.3 5.5 5.0 -1.7

TrentDebt/EBITDA (X) -24.9 19.4 19.3 -5.3Adjusted net debt/EBITDAR (x) 15.0 9.0 8.4 19.9Operating EBITDAR/fixed charge (x) 0.6 1.1 1.0 0.4

CFO % of sales -4.7 -4.3 -3.2 -4.1 PRIL results includes unaudited core retail results for FY12Source: Company reports, India Ratings


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