 "Nothing much changes for Future Retail despite fresh equity")
Future Retail’s current situation has been necessitated due to its rampant expansion in the past, which resulted in piling up of debt. By March 2012, the company had nearly Rs 8,000 crore (consolidated) of debt resulting in an interest outgo of over Rs 1,600 crore which ate away most of the operating profit that it earned.
The sale of the lifestyle businesses has brought down debt to Rs 5,700 crore, but it’s still too high. Interest cost accounts for 98 per cent of the company’s earnings before interest and tax (EBIT). In order to pare debt levels further, Future Retail has decided to raise money through equity. Out of the Rs 2,000 crore that the company is raising, nearly 75 per cent or Rs 1,500 crore will go into repayment of debt, bringing it down to Rs 4,200 crore levels.
Investors don’t seem pleased with the company’s recent efforts to reduce debt. Future Retail’s stock fell by another 3 per cent on Wednesday after falling by 7 per cent on Tuesday, the day the news hit the market. The market has not appreciated the fact that Future Retail is using equity – a costlier source of funding over the long run -- to repay debt. And more importantly, it has not escaped the attention of investors that the company would still be left with a sizeable amount of debt despite the equity dilution.
The core business is not in a great position and that’s probably the source of worry for investors. In the recently announced results, Future Retail’s same store sales growth (SSG) increased by only 2.2 per cent. The entire sector is going through a tectonic shift. Thankfully for domestic retailers the Narendra Modi government is not in favour of foreign direct investment in the retail sector. But despite that the sector has bigger problems ahead. They have a more aggressive e-retail segment to compete with.
CLSA believes that the e-retailing sector in the country has touched $3 billion mark and is growing rapidly, much faster than the older, brick-and-mortar variant. What is worrisome is the scant respect these retailers have for profitability. With little or no rentals and fewer employees to pay for (most of the e-retailers have started outsourcing logistics), e-retailers have a competitive advantage over the conventional ones.
For a retailer, the cost of goods accounts for nearly three-fourth of its operating expenditure. Employees, rentals and other expenses account for 15 per cent, which leaves around 10 per cent of operating profit in the hands of the retailer. For e-retailers, goods take up most of the cost with rentals and employees forming a small amount. Despite these cost advantages, e–retailers are incurring losses as most of them are willing to forgo profit in order to gain market share. As a result, goods at e-retailers are sold at lower prices than malls like those of Future Retail. Retail companies are sacrificing sales growth to remain profitable and are not joining the price war initiated by the e-retailers.
This scenario is unlikely to change for the better any time soon. With foreign players like Amazon establishing base in the country, retailers will have to sweat it out. Increasing footfalls and same store sales growth are going to be the major challenges that retailers are facing. By selling equity, Future Retail has bought some breathing space to fight these e-retailers.