Aditya Birla Nuvo: Right direction, more to follow?

The fashion retail restructuring would lead to a fall in holding company discount, which could go down further if value unlocking in the financial services vertical is pursued

The restructuring in Aditya Birla Nuvo (ABNL) to create India’s largest fashion retail company has got a thumbs-up from the Street. Shares of listed Pantaloons Fashion and Retail (PFRL), in which the Aditya Birla Group has 72.6 per cent, spurted nearly 20 per cent. Aditya Birla Nuvo (promoter stake 58 per cent) itself was up about 12 per cent.

With demerger of the fashion retail business housed under Madura Garments into Pantaloons Fashion and Retail, shareholders of ABNL will receive 26 shares in PFRL for every five they hold in the company. The exercise, with the exception of the More hypermarket format, brings the retail business of the Aditya Birla Group under one entity, simplifying the retail holding structure. This move is in line with the sectoral trend of a consolidation. Bharti Retail and Future Value Retail are also merging, to achieve scale.

There are multiple benefits for the combined Birla group entity. First, size. After acquiring Pantaloons and with organic expansion, the company’s footprint has increased from a million sq ft in FY10 to 4.8 mn in FY15. This includes the 134 stores and outlets of Pantaloons and 1,735 exclusive business outlets of Madura Garments.

Currently, the combined entity, to be named Aditya Birla Fashion & Retail (ABFRL), is expected to end FY15 with a turnover of Rs 5,400 crore, with operating earnings of Rs 511 crore and an operating profit margin of about 9.5 per cent. The company is expected to gain from scale benefits in sourcing, avoid duplication in real estate assets, improve the supply chain and have a common information technology backbone.

The advantage of scale and housing of top-notch brands of Madura (Louis Philippe, Van Heusen, Allan Solly, Peter England) in Pantaloons is expected to improve the margins of the combined entity from the sub-10 per cent levels to those of Madura Garments, pegged at 12.8 per cent for FY15. The biggest scope for improvement could be in Pantaloons. It had earnings before interest, taxes, depreciation and amortisation (Ebitda) of Rs 58 crore on revenue of Rs 1,390 crore, translating to an Ebitda margin of 4.17 per cent. Given the cost benefits and the fact that it has operationally outperformed sector peers, investors are also likely to give better valuations for the Madura Garments portfolio as against the earlier one of 18 times the ratio of enterprise value to Ebitda, which is at a discount to sector peers such as Shoppers Stop at 22 times.  

After the restructuring, the company has said it would invest Rs 450-500 crore annually for the next three years, to add 250-300 Madura Garments stores and 25-30 of Pantaloons. While Pantaloons makes a loss, part of the funding could come from Madura, which had generated Rs 325 crore of pre-tax free cash flow in FY14. The long-term growth drivers for the branded business remain — rising disposable incomes, urbanisation, a rising share of organised retail and more working women. How the combined entity is able to capture the synergies and whether it translates into improvement in profitability is the key to sustaining the share prices.  

There is value for investors in Aditya Birla Nuvo, too. The Street will now give better valuations to businesses which were earlier getting a substantial discount, given the complicated structure, leading to lack of clarity in capital allocation and risk exposure. Shareholders now have the option of directly investing in the retail businesses, rather than in a conglomerate (telecom stake, financial services and manufacturing that includes insulators, fertilisers, etc). The holding company discount, earlier pegged at 75 per cent, is likely to come down to 25 per cent, according to analysts at Morgan Stanley. The key value-unlocking proposal the Street will look at could be the listing of various verticals under its financials business.