Pain not over yet for Pantaloon Retail

While core retail sales grew in single digit, debt will remain at elevated levels despite the recent deal with Aditya Birla Nuvo

Pantaloon Retail posted disappointing performance for the quarter ended March 2012, reflecting continued stress in its core business. Not surprisingly, its stock fell 4.65 per cent on Wednesday, to close at Rs 140.65. While core retail sales grew in single digits, net profit declined significantly in the March quarter compared to the year-ago period. The marginal improvement in operating profit margins provided some solace. Nevertheless, analysts expect the trend of weak performance to continue even after the company’s recent deal with Aditya Birla Nuvo.

The stock is down 41 per cent over the last one year and is the cheapest retail stock available at 18 times FY13 estimated earnings (year ended June). Though most negatives seem to be factored in, the pressure on the stock will continue until the time the company manages to meaningfully reduce debt and unlocks value in non-core assets.

Demand concerns
Pantaloon faced an uphill task in pushing its sales growth into double digits, despite the discount season, promotions, space expansion (0.51 million square feet in the quarter-ending March taking it to a total of 16.33 million) and partial reversal in price rises (taken earlier in apparels) following decline in cotton prices. Same-store sales growth (SSSG) for value retail business, which has come off from 12 per cent levels in the December 2010 quarter, slipped marginally to 2.7 per cent. However, it slipped by a higher margin in case of other formats like lifestyle, whereas home retail disappointed significantly. Says Kishore Biyani, managing director and promoter of Pantaloon, “SSSG was impacted by weak demand largely in home and electronic categories”.

In the core retail business, operating profit margin improved 34 basis points to a little over nine per cent, thanks to lower raw material and employee costs; sequentially too, margins were up 20 basis points, which is positive. However, these gains were offset by a 57 per cent jump in interest costs to Rs 173 crore. At 5.7 per cent of sales, the interest cost to sales ratio was the highest ever for Pantaloon. Thus, net profit margin slipped below 0.5 per cent for the first time.

Notably, analysts do not expect an improvement in the company’s performance in the coming quarters. Says Amnish Aggarwal, analyst, Motilal Oswal Securities, “Pantaloon remains susceptible due to slowdown in consumer spending, high inventory (120 days sales) and debt levels (Rs 5,500 crore).”

FY12: INTEREST COST WOES
Core retail biz in Rs  crore	March qtr 12	FY12E	FY13E
Net sales	3,026	12,498	14,660
Y-o-Y change (%)	7.6	13.4	17.3
Operating profit	277	1,122	1,321
Y-o-Y change (%)	11.7	16.9	17.7
Net profit	12	113	182
Y-o-Y change (%)	-76.2	-40.7	61.4
E: Estimates The company’s financial year ends in June    Source: Company,   Analyst reports

Recent strategic initiatives
While the overall slowdown is beyond the company’s control, in a bid to deleverage the balance sheet and strengthen its core retail business, Pantaloon recently announced plans to demerge the flagship ‘Pantaloon’ apparel retail business into a separate listed entity and partner with Aditya Birla Nuvo (ABN). The deal, which will see ABN subscribe to the convertible debentures of the demerged entity worth Rs 800 crore, also involves transfer of debt worth Rs 800 crore into the new entity.

Post-completion of the demerger process (which will take 8-10 months), the debentures will get converted into equity and on listing ABN will further announce an open offer to raise its stake to 50.01 per cent thus making it a subsidiary. Existing shareholders will own proportionate shares in the demerged entity, which along with support of ABN would enjoy a better standing in the industry. Says Biyani, “The alignment with ABN’s extensive fashion brand portfolio and network through Madura Garments will help the demerged company to strengthen its competitive edge over similar fashion-led retailers.” The demerged entity will have a full range of casual wear, ethnic wear, formal wear, party wear and sportswear addressing all consumer categories.

However, even as the deal will help reduce Pantaloon’s debt by Rs 1,600 crore, it will still remain high at Rs 3,600 crore. The net gains for Pantaloon, too, are also not expected to be significant, say analysts, who are not excited about the deal. Says Gautam Duggad, analyst, Prabhudas Lilladher, “This transaction helps in reducing interest costs by roughly Rs 180-200 crore, but Pantaloon format would have generated an operating profit of Rs 197-204 crore . Therefore, technically, the deal appears Ebitda-neutral. Moreover, divesting attractive profitable retail formats will pull down valuations of the residual businesses.”

Jamshed Dadabhoy, analyst, Citigroup Global Markets, echoes a similar view. He says, “The transaction is earnings, neutral for Pantaloon. If management divests the high margin formats and Pantaloon Retail retains the lower margin high working capital-intensive formats, it could result in a de-rating in the valuation of Pantaloon, post-restructuring.”

However, Bharat Chhoda, analyst, ICICI Direct, who agrees with Duggad and Dadabhoy, sees a silver lining. He says, “While this deal seems to be P&L-neutral, we believe the inventory days will come down with a lower share of apparel in the overall sales mix and the company will require lower working capital finance, as the food business (albeit a lower margin business) has a higher inventory turn as compared to apparel.”

Pantaloon also plans to sell the entire 54 per cent stake in Future Capital Holdings to its wholly owned subsidiary, Future Venture Retail, monetise some investments in the financial services business by FY12-end and form a wholly owned subsidiary for HomeTown. Further, it is making a Rs 200-crore preferential equity offer to an investor. Though these initiatives are encouraging, FDI in retail, sizeable reduction of debt and divestment in non-core assets are panacea for Pantaloon’s stock to click.

Says Duggad in a post-results note, “We would prefer to see divestment of non-core assets before we turn positive. FDI in multi-brand retail looks difficult in the current political environment, potentially closing any incremental possibility of fund raising for the company. Revival of multi-brand retail and divestment of non-core assets are the key triggers.”