Retail arms' merger: Multiple gains for Aditya Birla Nuvo

Apart from operational gains, having retail arms under a listed firm would boost ABN's valuation

The Aditya Birla Nuvo (ABN) stock is up nine per cent over the fortnight to Rs 1,758, on reports it will consolidate retail arms under its listed subsidiary, Pantaloon Fashion Retail. Analysts say merging its subsidiaries, Madura Garments, MGL Retail and privately-held Aditya Birla Retail (owner of More superstore chain) into Pantaloon Fashion should lead to strong gains, and is a smart one on both operational and valuation fronts. The focused approach will not only help the retail business (given the size) to compete better but improve capital allocation. Synergies, both on the selling and sourcing fronts, will help improve efficiencies and bargaining power. With operational gains, valuations of the retail entity as well as ABN will improve.

The issue for ABN investors has been the company’s poor valuation, given that good performance by one entity has been overshadowed by the poor show of others. This is among the key reasons why ABN is trading at a 75 per cent discount to its intrinsic value. Morgan Stanley analysts say the steep discount was on account of value businesses funding the growth business. The trend is unlikely to continue, as the growth businesses are self-sufficient, with manageable balance sheets. The discount is expected to reduce to 25 per cent.

The retail (fashion and lifestyle) business contributed 26 per cent or Rs 7,500 crore to ABN’s consolidated top line and 15 per cent (roughly Rs 500 crore) to earnings before interest and tax in FY14.

Of the retail pie, Madura Fashion, with brands such as Louis Philippe, Van Heusen, Allen Solly and Peter England, contributes more than half the revenues, and has been outperforming sector peers, generating pre-tax free cash-flow of Rs 320 crore in FY14. The company is expected to continue its focus on leveraging brand leadership, scaling up retail presence and enriching the product portfolio in branded apparel. Analysts at Morgan Stanley expect the retail segment’s revenues to grow 18 per cent annually between FY15 and FY17, driven by an improvement in the macro climate, extension of sub-categories, new launches and a 70-basis point rise in earnings before interest, taxes, depreciation, and amortisation margin by FY17.

A merger of the retail arms should boost gains further. Reports also suggest ABN might sell a minority stake to financial investors in the merged entity, leading to lower debt and interest costs. Most analysts have a ‘buy’ on ABN, with a consensus target price of Rs 2,250.  They say, further restructuring (including listing) especially for the finance vertical (includes life insurance business) would be a bigger trigger.