Ind-Ra Maintains Negative-to-Stable Outlook on Retail

India Ratings and Research (Ind-Ra) has maintained a negative-to-stable outlook for the retail sector for FY16, expecting a moderation in domestic consumption growth. A fall in consumer inflation may provide a breather to consumers, cushioning a fall in consumer demand particularly for consumer non-durables. However, households may divert some of their surplus to savings against spending to resuscitate their balance sheets, given the current positive real interest rate environment.

Ind-Ra's study of the 1,000 largest Indian corporates suggests that wage growth lags corporate profitability by 12-18 months with a correlation of around 0.70. The nominal wage is expected to grow meagrely in FY16 and FY17, based on muted earnings growth in FY15 for most Indian corporates and continuation of the same in FY16.

Rural spending is also likely to remain lukewarm given the doubts on agriculture production due to weather conditions and a decline in the growth rate of government (central and state) spending.

Ind-Ra expects sector median revenue growth to taper down to a mid-single digit for FY16 on lower volume growth and tepid same store sales growth. In addition, intense competition from e-commerce remains a worry for the sector. Ind-Ra believes that high logistics cost at e-tailers and significant discounts offered by them, which is eating into their gross margins, will throw a challenge at the long-term sustainability of the model. However till such time as online retailers secure capital, their onslaught may continue unabated.

However, EBITDA margin is likely to be maintained for FY16 near FY15 levels, particularly by major players, due to improved operating efficiency and ability to contain costs. For FY15, median sector opex grew around 10% (FY14: 20%). Ind-Ra believes that if the sector decides to chase aggressive revenue targets and acquire market share by resorting to longer discounting periods, which is worryingly becoming a norm in the sector, the upside to the margins could be limited over the medium term.

The credit profile of retailers could remain weak in FY16 because of increasing interest burden due to their highly leveraged balance sheets to acquire quality retail space at prime locations. Meaningful deleveraging is unlikely to occur in FY16 even if capex is lower, given significant bank loan repayments exposing retailers to refinancing risks. While some players may resort to asset sales and streamlining operations to reduce leverage levels, the commensurate reduction in cash flow from these assets will provide limited benefit to the credit profiles in FY16.

OUTLOOK SENSITIVITIES

Revival in Consumption: A sustained reduction in consumer price inflation, coupled with a rise in real wages could restore the discretionary spending power of the Indian consumer. Alternately, a sudden spurt in government spending could have a temporary beneficial impact on private consumption, ultimately benefitting the sector.

Equity-induced Deleveraging: A stable outlook for the sector could result if companies attract equity investors under the foreign direct investment route, or resort to asset sale, leading to a substantial reduction in their debt levels and improvement credit profiles.

Slowdown in Consumer Spending: A sustained deterioration in wages, fall in private final consumption expenditure and low consumer confidence leading to significant deterioration in the sales and profitability could lead to a negative outlook for the sector.

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