100- bp rise likely in margins of brick & mortar stores: CRISIL

Online retailers are focusing on lowering discounts share and losses leading to moderation in growth

Operating margins of organised brick-and-mortar retailers are expected to improve by 100 basis points (bps) from about 6 per cent in the next two years. This is due to the slowdown in discounts by online retailers to reduce cash burn, benefits from the implementation of the goods and services tax (GST), and increase store productivity, said rating agency CRISIL on Tuesday. 

It expects the credit profiles of such retailers to remain steady, driven by better operating metrics and adequate debt metrics, despite the increase in the pace of store expansion over the medium-term.

CRISIL has outstanding ratings on 86 retailers, including 27 large (over Rs 500 crore in revenue), 22 mid-sized (Rs 100-500 crore in revenue) and 37 small ones.

The top three online retailers in the country lost about Rs 30 crore a day - or Rs 11,000 crore in FY16 - because of large-scale discounts and aggressive marketing, it said. “The Department of Industrial Policy & Promotion (DIPP) regulation in March 2016, which restricts discounting and vendor concentration, has been favourable for physical retailers. Consequently, online retailers have been gradually focusing on lowering the share of discounts and losses leading to moderation in their growth,” it added.

Also, under GST, offline retailers can set off service tax on rent against taxes on goods. Rent is one of their largest cost components, ranging between five and six per cent of sales. Physical retailers would also benefit from rationalisation of logistics costs because of flexibility in procurement and seamless movement of goods, facilitated by the implementation of GST.

Revenue growth of the organised retail sector is expected to grow 14-16 per cent annually in the next two financial years compared with the 13 per cent compounded annual growth rate seen between FY15 and FY17. Also, over the past two financial years, annual sales per square feet have increased 15 per cent from Rs12,000 to Rs13,800.

CRISIL believes continuation of this trend would result in better store productivity and improved operating leverage.

Anuj Sethi, senior director, CRISIL said, “We see the profitability of brick-and-mortar retailers improving as competitive intensity (from online rivals) moderates and service tax on rent gets set off. As growth rises, revenue per square feet will improve, which, in turn, will improve their fixed-cost absorption ability. This will provide at least 100 bps positive delta to operating margins.”

As growth and profitability look up, CRISIL expects capital expenditure (capex) of physical retailers to increase by 15-20 per cent over next two financial years. Despite increase in capex, which will be partly debt funded, improving operating metrics and better cash generation will continue to support the credit profiles of retailers. 

Amit Bhave, director, CRISIL Ratings said, "The credit profiles of organised CRISIL-rated physical retailers have benefited from improved scale of business, better cash generation, continued promoter support, and prudent capex in the recent past. For instance, the debt/EBITDA (earnings before interest, tax, depreciation and amortisation) ratio improved to about three times in FY17, compared with four times in FY 2015, supported by a 50-60 bps increase in EBITDA margins and prudent management of debt levels."

The improvement in credit profiles is reflected in the credit ratio (upgrades to downgrades) for CRISIL's rated physical retailer portfolio, remaining above one time in past four financial years; this trend is likely to be sustained over the medium term.