Pantaloon Retail: A two-pronged strategy

Tough market conditions weigh on the company’s debt reduction plan.

Pantaloon Retail recently announced it would raise up to Rs 1,500 crore through a convertible issue or debt instruments with warrants. It is also looking to exit non-core (non-retail) businesses, including Future Capital Holdings, within a year. This could fetch the company around Rs 3,500 crore.

Both events are important catalysts for the stock and will be key items to monitor as the company is saddled with high inventory (110 days), which has led to higher working capital and increased its debt-equity ratio to 2.5 times. As a result, its interest costs have substantially risen to 5 per cent of sales or, 59 per cent of operating profit, in the year ended June 2011, thus impacting profitability.

However, both raising capital and exiting non-core businesses are going to be challenges. The company doesn’t plan to dilute more than 15 per cent of its equity to raise funds. Also, it doesn’t want the debt-equity ratio to go higher than 1.33. But, at the current market prices, the equity portion is likely to result in higher dilution, fear analysts. They also feel that divesting businesses in a hurry may end up compromising for lower valuation, given the subdued business environment and weak capital markets. Says Sunita Sachdev, analyst at UBS Investment Research, “We fear the divestment of non-core businesses could be pushed now, given the urgency of capital issuance in a risk-off market.”

If the company waits for better times, the delay will further dent profitability. If foreign direct investment (FDI) in multi-brand retail is cleared, it stands to benefit. Says Bharat Chhoda, analyst, ICICI Direct, “Since the company is highly leveraged, any fund for expansion will have to be raised through routes other than debt and, thus, FDI in retail would benefit the company.” But, the problem is that the government doesn’t seem to be in a hurry to change the policy, yet.

The stock has corrected 29 per cent in the last month and, at 12 times its estimated FY13 earnings, is trading at the lower end of its five-year band, factoring in the concerns. Though analysts are optimistic about the company’s future, given its efforts at restructuring, the uncertainty will continue till its interest burden comes down. The positive is that it will grow same-store sales at 15 per cent and maintain its operating margin at eight-nine per cent.