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.