Covid-19 to shave off over a third of apparel retailers' revenues

While operating profitability is likely to be impacted by around 200 bps, absolute fall in operating profits will be much sharper, necessitating additional funding

The Rs 1.7-trillion organised apparel retail sector is likely to witness a 30-35 per cent decline in revenues this financial year because of temporary store closures, restricted mobility, and low-income visibility for consumers owing to the Covid-19 pandemic, says a Crisil Ratings study.

While operating profitability is expected to be impacted by around 200 basis points (bps), the absolute fall in operating profit can be much sharper, necessitating additional fundraising, mainly debt, by firms to make up for the cash flow shortfall. This will affect credit metrics for apparel retailers, the study says.

The analysis, based on a sample of 60 Crisil-rated apparel retailers (representing a third of the sector’s revenue), considers the staggered easing of the lockdown, and the majority of stores reopening in June. Demand is expected to recover to pre-lockdown levels only during the October-December festive season, it says. Pent up demand, as well as the behaviour of consumers after the lifting of the lockdown, will have a bearing on the pace of recovery.

In the apparel segment, sales of the departmental store format (accounting for a third of revenues of the sample set) will be hit harder, with around 40 per cent decline in revenues, as half of these departmental stores are mainly located in malls and tier-1 cities.

 

 

For value fashion retailers (accounting for two-thirds of revenues of sample set), the impact will be lower at around 30 per cent, as these have a higher presence in tier-2 and 3 cities. A higher proportion of standalone stores and the expected benefit from downtrading, with income levels on the decline, will also benefit this segment, says the Crisil study. Apparel retailers are also likely to see a higher contribution from online channels this financial year, driven by a changing buying pattern amid the pandemic.

“To increase footfall, retailers may have to offer discounts, while also incurring higher costs to ensure adherence to social distancing. On the other hand, we also expect retailers to convert a portion of fixed lease rentals to variable, in addition to pruning employee cost, and other discretionary spends. Considering these aspects, operating profitability will moderate by up to 200 bps this financial year, from around 7-8 per cent in FY20,” said Gautam Shahi, director, Crisil Ratings,
 

Converting lease rentals from fixed to variable is critical, as the margin impact will be severe otherwise. 

Lease rentals and employee costs typically constitute 20 per cent of the overall revenues of the apparel retailers and a large proportion of these costs is fixed in nature. With cash flows being crunched, retailers are seen availing additional debt to make up for the near-term shortfall in cash accruals vis-à-vis fixed obligations. “In the past two years, the debt protection metrics of apparel retailers remained healthy, supported by strong operating performance and prudent capital expenditure,” said Ankit Hakhu, director, Crisil Ratings,
 

However, weakened business levels and lower profitability will lead to a moderation in debt metrics — for instance, the interest coverage ratio, which stood at over 5 times in the past two financial years, is expected to weaken to just over 3 times FY21, he said.

Apparel retailers with omnichannel presence, balanced mix of brands and private labels, sufficient liquidity, and access to support from strong parents or groups will be placed better to counter the challenging business environment. The extent of pandemic and ability to manage rental costs will be monitorable.