Hypermarkets over the counter: Search for scale is forcing consolidation

The coming year, should see some hyper-activity in the organised retail business

With the recent Rs 700-crore Hypercity deal, Kishore Biyani has become king of the consolidation game in food and grocery retail and the last man standing in India’s organised retail, which has few success stories of which to boast.
 
Biyani tried many things in the past, failed in some and sold some, but he seems to have got his mojo back. Ever since he sold Pantaloons to the A V  Birla group in 2012, he has scooped up a series of companies —Big Apple, Bharti Retail, Nilgiris and so on over the past five years — to build his empire. His target is to reach Rs 1 lakh crore in revenue by 2021, from Rs 28,777 crore in 2016-17.
 
He is one of several players to understand the truth that scale is critical for profitability in grocery retail — either through organic growth or through buyouts.
 

For instance, Shoppers Stop announced three deals over the past three weeks. Amazon picked up 5 per cent in the company for Rs 179 crore on September 25. In the first week of October, it sold Hypercity to Future Retail for Rs 700 crore and announced its decision to exit its airport venture with the Nuance group.
 
No one knows better than Govind Shrikhande, managing director of Shoppers Stop, when he says unless there is scale, hypermarkets (an extended version of supermarkets) cannot be profitable. “Consolidation is the way out in hypermarkets,” he says.
 
That’s because size matters. Pankaj Jaju, founder at advisory firm Metta Capital Advisors, who advised both the Future Group and Shoppers Stop on the Hypercity deal, agrees. “Today, unless you have a turnover of Rs 5,000 crore, you are not profitable,” he says.
 
Shrikhande says a handful of food and grocery retailers are in the range of Rs 5,000 crore to Rs 15,000 turnover and others are still between Rs 500 and Rs 1,200 crore. “Chains will find it difficult to post profits if they do not have scale,” he adds.
 
As in any consumer business, if a retailer is large, the bargaining power with suppliers increases and they can pass on the benefits to customers and that in turn increases footfalls and sales, vital in a business that accounts for a minuscule percentage of the overall retail industry.
 
Shrikhande says Shoppers Stop had two options to raise funds for Hypercity, either from private equity, or from strategic investors. “Because of FDI (foreign direct investment) regulations, we were left with the option of strategic partner,” he explains. Though the National Democratic Alliance government has not prohibited FDI in multi-brand retail, the government is not disposed to encouraging such investments.
 
Analysts say barring a few firms like Azim Premji-promoted Premji Invest, domestic private equity players lack funds and understanding to buy into retail firms.
 
“If multi-brand retail rules are changed, it will change the scenario,” Abneesh Roy, senior vice-president of Edelweiss, says, referring to the proposal to lift the 51 per cent limit on FDI in multi-brand retails.
 
Driving the current round of consolidation is an unexpected improvement in performance. Jaju of Metta says retail valuations and the growth in same-store sales have improved significantly in the last one year, which have helped both sellers and buyers of the retail chains (same-store sales growth refers to growth from a retail chain’s stores that have been in the business for a year or more).
 
Same-store sales growth of the top retailers grew by roughly 16.2 per cent during the first quarter of this financial year, one of the best performances in the last several quarters. Shoppers Stop posted a 19.8 per cent same-store sales growth during the quarter while Future Retail’s Big Bazaar posted 15.9 per cent, one of the best for the chain.
 
“Valuations were cheap a year ago, less than one or half times of sales. But D-Mart’s entry in the public market re-rated the sector, Today, sellers have ability to get reasonable price,” he points out.
 
Stock market icon RK Damani owned D- Mart is the most consistently profitable retailer in the country. It listed at 102 per cent premium over its issue price of Rs 299 apiece on the exchanges in March this year. As a result, he reckons buyers are also expecting better prospects in the future.
 
This uptick in sales has been reflected in the stock prices of listed retail chains. The value of Future Retail’s stock has shot up four-fold in the last one year; Avenue Supermarts, the parent of D-Mart, has gone up 92 per cent and Shoppers Stop is up by 87 per cent.
 
But profitability remains an issue. “Only Future Retail, Reliance Retail and D-Mart are doing well (in food and grocery). Others are still figuring out the business model, “says Roy.
 
Roy predicts that Hypercity will be profitable under Future group principally because the latter has a high share of the fashion retail segment, about 35 per cent in its Big Bazaar stores. Hypercity only had 17 per cent share of fashion. Fashion is a relatively high margin business (35 to 40 per cent, with retailers’ own brands fetching up to 60 per cent). It is something of an exception in the retail business, which mostly operates on wafer thin margins and supply chain challenges, he points out.
 
Indeed, net margins in the retail business can be as low as two to three per cent and maintaining a country-wide supply chain is a nightmare in India, consultants say.
 
In contrast, Trent Hypermarket, a joint venture between Trent and UK’s Tesco; Aditya Birla’s More, Spencer’s and others, who set up ventures a decade ago,  are yet to post profits. Spencer’s posted a net loss of Rs 129 crore in FY 2017. Aditya Birla Retail posted a loss of Rs 650 crore in FY 2016 and Trent Hypermarket posted a net loss of Rs 44.77 crore in FY 2016.
 
While More and Spencer’s have made attempts to sell stake in the past, they now seem to be focusing on making the businesses profitable.
 
“Investors and promoters do not have indefinite gestation period,” says an investment banker requesting anonymity. “Ultimately, they want to see profits and returns on their investments,” he says. The coming year, then, should see some hyper-activity in the organised retail business.