change in stance bata in equity april 30, 2015...

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Key financials Year to March CY12 CY13 FY15 FY16E FY17E Net Revenues (` mn) 18,425 20,652 27,210 25,376 30,542 Operating Profits (` mn) 2,750 3,220 3,451 3,350 4,426 Net Profits (` mn) 1,721 1,909 2,065 2,101 2,891 Diluted EPS (`) 26.8 31.3 32.1 32.7 45.0 RoE (%) 27.1 26.1 22.7 20.0 24.0 P/E (x) 38.1 32.6 31.7 31.2 22.7 P/B (x) 9.4 7.8 6.7 5.9 5.1

Source: Company, Ambit Capital research, Note FY15 indicates financials for 15 months

Crouching Tiger, Hidden Dragon

Bata’s stock price has declined by more than 30% over the past three months, and its current valuation of 31x/23x FY16/FY17E EPS does not factor in its strong franchise (built around retail network size, product portfolio, and retail execution) and near-term operating leverage benefits. IT-related supply chain issues are over, and our channel checks suggest a sales growth revival to ~10% YoY from 1QFY16 despite weak macro demand. We expect 17%/29% revenue/EPS CAGR over FY15-18 alongside ~25% average RoCE; a gradual pickup in sales growth will act as a key near-term catalyst. Delayed initiatives around e-commerce and concept stores and higher advert spends will be executed over the next 12-18 months. Our DCF-based TP of `1,200 implies 37x/27x FY16/FY17E P/E, 18% upside. We upgrade to BUY. Competitive position: STRONG Changes to this position: NONE IT-related issues are resolved; store inventory levels back to normal Our channel checks indicate that the drag from poor IT implementation (click here for details) ended in Feb’15 after the firm re-instated the old IT software at its distribution centers without changing the new SAP software at stores. Thus, store inventory levels are back to normal, putting an end to loss in sales. Benefits from the new software will accrue in the future, e.g. access to store-specific MIS to the store manager to better prepare for future demand.

Sales growth of ~10% YoY from Mar’15; ~17% FY15-18E sales CAGR Our channel checks suggest that Bata’s revenue growth has revived to ~10% YoY from Mar’15 despite a weak macro. After a macro demand revival (likely from 2HFY16 onwards), sales growth will revive to 18-19%, benefitting from: (a) competitive advantages around retail network size, retail execution, and widened merchandise; and (b) implementation of initiatives around e-commerce, advert campaigns and concept store launch for women/kids. Initiatives around e-commerce/ad-campaign - Delayed, not cancelled India is the second-largest geography (after Italy) with the fastest growth profile for Bata globally and hence the parent firm does NOT want to miss out on the Indian growth opportunity. Moreover, in e-commerce, Bata India is in the process of: (a) creating a business unit internally for e-commerce with separate resource allocation and sales targets; (b) cross-pollinating the thought process adopted in countries like Indonesia, Thailand and Malaysia. As a result, albeit with a delay, we expect Bata to execute its planned initiatives around e-commerce, and improve customer connect over the next 1-2 years.

After >30% de-rating, current valuations offer an attractive entry point With network-size-related expenses of rentals and >50% of employee costs (equivalent to ~25% of revenues), we expect Bata’s 17% revenue CAGR to translate into EPS CAGR of ~28% in FY15-20. Bata trades at 31x/23x FY16/FY17E P/E, a ~10% discount to its three-year historical average P/E, and a 30-35% unjustified discount to other high-quality consumer discretionary stocks. Alongside Page Industries, we view Bata India as one of the most-attractive consumer stocks to BUY (TP `1,200, 18% upside).

CHANGE IN STANCE BATA IN EQUITY April 30, 2015

Bata IndiaBUY

Consumer Discretionary

Recommendation Mcap (bn): `65/US$1.0 6M ADV (mn): `270/US$4.3 CMP: `1,020 TP (12 mths): `1,200 Upside (%): 18

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: RED

Catalysts

Resumption of the advert campaign/ new concept store rollouts in 1HFY16

Revival of revenue growth to 10% YoY in 1QFY16 from flat YoY growth in 2HFY15

Performance (%)

Source: Bloomberg, Ambit Capital research

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Sensex BATA (RHS)

Analyst Details

Rakshit Ranjan, CFA

+91 22 3043 3201 [email protected]

Aditya Bagul +91 22 3043 3264

[email protected]

http://reports.ambitcapital.com/reports/Ambit_BataIndia_Supplychainissuesresolved_25Mar2015.pdf

Bata

April 30, 2015 Ambit Capital Pvt. Ltd.

Nov’14-Feb’15 weakness was transient; ~10% YoY growth likely in 1QFY16 Channel checks suggest IT issues are resolved Exhibit 1: Quarterly revenue growth (YoY)

Source: Ambit Capital research

Over the past five years, Bata has consistently reported revenue growth of 15-25% YoY in a strong macro demand environment. This momentum moderated to 9-13%, as the broader discretionary consumer demand weakened over the past 6-8 quarters.

However, Bata reported a decline in revenues of 3% YoY in 4QCY14 and we expect it to report only 5% YoY in 1QCY15. This incremental weakness in revenue growth over the past six months is solely attributable to supply chain challenges faced by the firm due to the poor implementation of its new SAP software. Lack of adequate training provided to store managers around the use of this software and incorrect interpretation of stock ordering data by the distribution centers resulted in store-level inventory declining by 30-40% during Nov’14- Feb ’15 (please click here for our detailed note on this subject). These supply chain challenges continued until mid-Feb 2015 and have hence affected the revenue growth momentum in 1QCY15 as well.

These IT issues, we believe, have been resolved because:

In Feb’15, the firm reinstated the old IT platform at the distribution center level, without changing the new SAP software at the store level.

Store managers suggest that inventory levels, which declined 30-40% at the store level in Oct’14-Jan’15, are back to normal levels from Feb’15 onwards.

Some store managers have started reaping the intended benefits of the new software which includes improved efficiency of the distribution centers amidst a widened range of SKUs and use of store-level MIS by each store manager to better prepare for upcoming demand patterns.

We expect ~10% YoY revenue growth in 1HFY16 amidst a weak macro demand environment Our channel checks suggest that same-store sales growth has improved to 5-10% YoY in March for most stores. Although this sales momentum is affected by continued weakness in macro demand, it is similar to that experienced by these stores before the IT-related issues started in Nov’14. We do not expect consumer sentiment to improve before this year’s festival season i.e. 2HFY16 and hence expect Bata’s revenue growth to rise to only 10% YoY in 1HFY16 vs the ~3% decline in 4QCY14 and ~5% growth in 1QCY15E.

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Moderation in revenue growth due to macro slowdown

Moderation in revenue growth due to IT challenges

http://reports.ambitcapital.com/reports/Ambit_BataIndia_Supplychainissuesresolved_25Mar2015.pdf

Bata


E-commerce and other initiatives likely to be executed, albeit with a delay Bata’s recent sales growth moderation has drawn investor concern around whether the issues that Bata currently faces are related to just the macro slowdown and IT disruption, or whether Bata is losing market share due to e-commerce expansion in India.

E-commerce has NOT contributed to recent weakness in revenue growth… We DO NOT believe that Bata’s decline in revenues over the past six months was due to market share losses on e-commerce portals because:

Sales growth momentum is back to pre-Oct’14 levels across all stores: As highlighted previously, our channel checks with Bata’s store managers across India suggest that same-store sales growth has improved to 5-10% YoY in Mar’15 and Apr’15 for most stores, similar to the sales growth momentum that prevailed before the IT-related issues started in November 2014.

Currently e-commerce penetration is only ~3%; dominated by sportswear: In other emerging markets like China and the far-eastern countries, e-commerce penetration in the apparel & footwear category contributes to ~10-25% of category sales. Whilst this creates a substantial threat for Bata’s future growth prospects (discussed later in this note), it is barely ~3% currently in India (dominated by premium sportswear brands which are available at heavy discounts). As sportswear brands (North Star and Power) contribute to only ~12% of revenues for Bata, we DO NOT believe that the relevant e-commerce market penetration for Bata is meaningful enough to have created a substantial drag on its overall revenue growth momentum over the past six months.

Gravity of the IT issues: Back-of-the-envelope calculations indicate that a 30-40% reduction in inventory levels across stores will lead to a 10-15% decline in revenue growth rates for Bata, which is in line with the reported revenues for the firm in the quarter-ended Dec’14.

… However, e-commerce remains a threat that the firm is yet to tackle Stock availability on e-commerce remains a challenge: Online availability of Bata’s products (including availability of shoe sizes of displayed products) is poor both on its own website as well as on aggregators like ‘Flipkart’, ‘Amazon’ etc. Although e-commerce penetration in the footwear industry in India is still in the initial phase of evolution, the firm needs to execute these initiatives sooner rather than later before the segment’s e-commerce penetration becomes material enough in leather footwear (70% of overall revenues for Bata).

In our discussions with the management, we were informed that in order to combat the e-commerce expansion-related threat to its revenue growth rates in the future, the firm is putting in place:

Upgrades to the look and feel of its own website (www.bata.in) with improved logistics around product delivery and after sales service;

Separate business unit for e-commerce internally including a dedicated revenue target and resource allocation for this sales channel; and

Leverage, through knowledge-share, on Bata’s e-commerce related success in other countries like Indonesia, Thailand, and Singapore.

Bata


Other strategic initiatives – Some executed, others delayed Over the past two years, Bata India’s management has highlighted plans to roll-out several key strategic initiatives, some which have faced delays in implementation, resulting in the challenges highlighted below:

Poor customer communication: Having significantly upgraded its customer shopping experience as well as product portfolio over the past decade, Bata has been particularly weak in communication with its customers about this evolution. This results in an inter-generational drag on the brand ‘Bata’ in the minds of the consumers. In order to address this issue, Bata launched its (much awaited) advert campaign in March 2014. However this campaign was rolled back around Aug-Sept 2014, possibly due to the firm’s weak outlook for profitability amidst ongoing weakness in macro-demand. The firm needs to resume its efforts towards increase in customer communication in order to capitalise on its efforts towards becoming an aspirational brand in the future.

Rollout of new concept retail stores: Bata India has a wide product portfolio with 18 brands and over 4,000 SKUs being sold through an average retail store size of only ~2,500 sq ft. This creates a significant shelf space constraint on Bata’s ability to effectively showcase the product portfolio to its customers. In order to overcome this constraint, Bata has been working on plans to launch new retail formats like a concept store for women, and a chain of stores exclusively for Bubble Gummers (for kids). However, the launch of these stores has been delayed over the past 2-3 years.

Whilst the firm has reported delays in the initiatives discussed above, many other initiatives have been successfully implemented by Bata India in the meantime. These include:

Rollout of destination stores (>10,000 sft in size), one in Delhi, two in Mumbai, one in Bengaluru and one in Kolkata over the past 2 years. These stores help display the entire product portfolio of Bata’s 18 sub-brands, and also help change consumer perception of these brands.

Rollout of a loyalty programme for customers across the country last month, through which the firm can incentivize repeat footfalls and also possibly target customer communication around discounts/ schemes/ new product launches etc.

Bata has the intent and capability to execute the delayed initiatives Although Bata has been sluggish in the implementation of strategic initiatives as highlighted above, we believe that the firm has both the intent and capability to implement these initiatives in the future, due to the following factors:

Our discussions with the firm in the past suggest that India is the second largest (after Italy) and the fastest growth geography for BSO across the world and hence BSO does NOT want to miss out on the Indian growth opportunity.

Cross-pollination of the thought process behind the Asia-Pacific e-commerce launch is likely to happen with India, due to: (a) the presence of Bata’s Asia- Pacific head, Mr. Jorge Carbajal, on the board of Bata India; and (b) the additional responsibilities given to Bata India’s MD, Mr. Rajeev Gopalakrishnan, to oversee the operations of a new sub-region created within Asia Pacific (which includes Indonesia, Pakistan, Sri Lanka and Bangladesh). For instance, Bata’s Asia-Pacific regions (Singapore, Thailand, Malaysia, and Indonesia) launched their presence on e-commerce through the online portal, Zalora, the largest fashion e-commerce company in the Asia-Pacific region. This also includes advertisements launched through Google and Facebook.

Bata


We expect 18-19% YoY revenue growth in a strong macro demand environment We expect the organized Indian footwear industry to record a revenue CAGR of 17% driven by a combination of: (1) rising penetration of the overall footwear industry, (2) shift from unorganized to organized, (3) reduction in replacement cycles of footwear, (4) increase in the number of footwear consumed per individual, and (5) premiumisation of the consumption of footwear.

We expect Bata to grow at least in line with the market growth rates due to a combination of competitive advantages around: (a) wide range of product portfolio; (b) loyalty of its consumer base built around the superior product quality; (c) the widest retail networks across the country; and (d) high-quality talent retention at the store level through initiatives such introduction of K schemes (entrepreneurial store model) and career growth opportunities for the store-level staff.

Although Bata suffers from issues around intergenerational brand drag, shelf space constraint in its stores, and weak e-commerce presence, we believe these issues will be addressed over the next five years, through the planned strategic initiatives discussed above. Successful addressal of these initiatives is likely to result in market share gains for the firm in the overall organized footwear industry (current market share of ~30%) by 50-100bps each year. This is likely to enable Bata to record a revenue CAGR of 18-19% after the overall macro demand environment for discretionary consumption has revived back to normal levels.

Bata


Valuations - Attractive entry point After the more than 30% fall in its share price over the past three months, Bata currently trades at 31x/23x on FY16/FY17 P/E multiples, which is a ~10% discount to its corresponding three-year historical average P/E multiples, and a 30-35% discount to other high-quality consumer discretionary stocks. With the IT-related issues behind us, we expect Bata to deliver revenue CAGR of 17% and EPS CAGR of 29% over FY15-18 with ~25% average RoCE over this period. This will be delivered through strengths of Bata’s business model (retail network size, product portfolio, and retail execution) and operating leverage benefits. We expect revival in sales growth to ~10% YoY from 1QFY16 onwards despite a weak macro demand environment to act as a key near-term positive catalyst. Our DCF-based target price or `1,200 implies 37x/27x FY16/FY17 P/E, 18% upside from current levels. As a result, we change our stance from SELL to BUY.

Over 30% share price fall in three months; trading at 30-35% discount to quality consumer discretionary peers As shown in the exhibit below, after a share price fall of over 30% over the last three months, Bata currently trades at a ~10% discount to its three-year historical average P/E multiples.

Exhibit 2: One-year forward P/E chart - Over 30% de-rating over the last three months


Also, as highlighted in the table below, Bata currently trades at a 30-35% discount to other high-quality consumer discretionary companies, and ~2x that of international footwear retailers.

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Exhibit 3: Relative valuation table

Companies CMP (LC) Mcap (USD mn)

P/E Ratio EV/EBITDA RoE (%) Dividend

yield (FY15) %

Growth CAGR (FY15E-17E)

FY16E FY17E FY16E FY17E FY16E FY17E EPS Revenue

BATA INDIA LTD 1,020 1,020 31.2 22.7 18.1 13.4 20.0 24.0 1.0 32% 18%

International Footwear Company

BELLE INTERNATIONAL HOLDINGS 10 11,340 14.8 13.7 8.7 8.1 16.8 17.0 - 6% 8%

DAPHNE INTERNATIONAL HOLDING 2 481 11.8 9.2 3.8 3.3 6.0 7.4 1.5 26% 6%

GENESCO INC 72 1,732 12.6 11.6 5.3 5.0 11.3 12.0 - 9% 4%

WOLVERINE WORLD WIDE INC 34 3,539 19.7 17.9 12.6 12.0 15.1 15.3 0.7 11% 5%

SKECHERS USA INC-CL A 90 4,727 17.4 15.6 10.3 10.3 17.8 18.7 - 18% 6%

BATA SHOE CO (BANGLADESH) 1,244 221 15.4 13.4 10.6 9.6 36.8 35.1 2.4 15% 10%

Median

15.1 13.5 9.5 8.9 16 16 0.7 13% 6%

Comparable Indian Companies

RELAXO FOOTWEARS LTD 690 652 35.0 26.1 18.6 14.8 24.8 25.6 0.1 33% 22%

JUBILANT FOODWORKS LTD 1,388 1,433 57.6 41.4 25.5 19.0 24.5 28.6 - 35% 28%

PAGE INDUSTRIES LTD 12,880 2,263 50.3 36.7 32.8 24.3 64.4 65.8 0.7 40% 32%

TTK PRESTIGE LTD 3,701 679 31.8 23.3 20.9 15.6 21.3 26.2 1.3 36% 19%

ASIAN PAINTS LTD 745 11,252 40.8 34.2 26.6 22.3 37.7 38.7 1.0 25% 16%

BERGER PAINTS INDIA LTD 207 2,255 38.7 31.6 22.9 19.3 26.4 27.2 0.6 30% 16%

Median

39.8 32.9 24.2 19.1 26 28 0.7 34% 20%

Source: Ambit capital research, Bloomberg.

We believe that on relative valuation multiples, Bata India deserves to see an upwards re-rating of at least 15-20% due to the following factors:

Bata India’s is the most relevant of all possible peers include players like Relaxo, Liberty and Mirza International, which operate only in the footwear retail market. However, consensus forecasts for earnings are not available for Liberty and Mirza. Bata is trading at a ~10-15% discount to Relaxo on P/E multiples, which is not justified due to: (a) limited potential for premiumisation of customer purchases over time within Relaxo’s portfolio of products since the firm focuses only on economy segment of footwear; and (b) expected EPS CAGR and RoCE of Relaxo being very similar to that of Bata.

Weakness in earnings growth momentum for Bata during Nov’14-Feb-15 was only temporary in nature due to the IT-related issue which prevailed in its supply chain at that time. Since this issue has now been resolved, our channel checks suggest that revenue growth momentum at a store level is back to normal i.e. ~10% expected revenue growth rate for Bata amidst weak macro demand environment and ~18-19% revenue CAGR likely during a strong macro demand environment. Hence, the ~10% discount on Bata’s P/E multiples as compared to its three-year historical average, we believe, is not justified.

Bata’s is trading at ~2x multiples of international footwear players, we believe, is justified by Bata’s superior revenue and EPS CAGR and RoCEs expected over the next two years (see the table below).

Bata’s EPS CAGR and RoCE over the next two years are not materially lower than other high-quality discretionary consumer companies. Whilst we expect most of the discretionary consumer peers like Asian Paints, Berger and Jubilant Foodworks, to de-rate by over 10-15%, we expect Bata to re-rate upwards by 15-20% from current levels, as investor confidence increases around Bata’s ability to revive earnings growth momentum to ~30% over the next three years, well supported by operating leverage benefits.

Bata


Comparison against other high-quality discretionary consumer companies In the exhibit below, we have used a framework to rate all the consumer stocks based on the following parameters:

(a) Longevity of category growth rates given potential to increase penetration, frequency of consumption and premiumisation;

(b) Positioning of the company on its competitive advantage framework, and hence ability to sustain trends of market share gains/retention/losses;

(c) Key man risk, thereby factoring in the probability of material changes to growth prospects of a company with changes to its senior management team;

(d) New category entry potential, and hence the ability of a firm to leverage on its existing strengths around brand and distribution to add new revenue growth drivers and hence increase the longevity of its medium-term growth period;

(e) Diversification of the product portfolio, and hence factoring in the exposure of a company’s growth trajectory to changes in the growth dynamics of a specific product category.

On these parameters, we view Bata as one of the best placed discretionary consumer companies, second only to Page Industries.

Exhibit 4: Competitive advantage framework for discretionary companies

Company Category growth

Competitive advantage vs.

peers

Diversification of portfolio Key man risk New category

possibility

Asian Paints

Berger Paints

BATA

Jubilant Foodworks

Page industries

TTK Prestige

Pidilite

Source Ambit Capital research

Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

As shown in the exhibit below, on valuation comparisons, Bata is attractively placed as compared to other discretionary consumer companies under our coverage with high earnings CAGR, healthy RoEs and low P/E multiples.

Exhibit 5: Earnings growth and valuation comparison

Source: Ambit Capital research; Bloomberg

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Bata


DCF-based valuation We use a DCF-based approach to value Bata, because: (a) it is a highly cash-generative business model, with a pre-tax CFO/EBITDA ratio of ~90% over CY07-FY15; and (b) the business is in a high growth phase, with CY07-13 EPS CAGR of 22% and FY15-18E EPS CAGR of 29%.

Our DCF model generates a fair value of `1,200, 18% upside (implied multiple of 37x and 27x FY16/17 EPS). The stock is currently trading at 31x/23x FY16/17 EPS, a 30-35% discount to other good-quality discretionary consumer companies, which is NOT justified given the competitive advantages of Bata which rival that of other good-quality discretionary companies.

Our DCF model includes three stages:

Stage 1: Five-year growth phase – FY15-20 FY15-17 - Demand revival and operating leverage to result in 29% EPS

CAGR: Over the past four quarters, a weak macro demand environment and challenges around implementation of new SAP software has led to Bata reporting revenue growth rates of ~7% YoY vs 15-20% revenue growth rates being reported consistently in the past. Given high fixed costs around employee expenses and real estate rentals, this moderation in revenue growth rates has resulted in the firm reporting earnings decline by 13% YoY over the past four quarters. Expecting a broader discretionary consumer demand revival in FY16, we forecast 16% revenue CAGR for Bata over FY15-17 with operating leverage benefits likely to help it report EPS CAGR of 29% over the same period.

FY17-20 – 19% revenue CAGR and 27% EPS CAGR: With SSG growth expectations steady from FY18 onwards, we expect 19% revenue CAGR and 27% EPS CAGR for Bata over FY17-20. This includes an EBITDA margin expansion of ~200bps over this period supported by margin expansion initiatives around upgrades to manufacturing units and scale advantages.

Exhibit 6: We expect a steady increase in EBITDA margin over FY15-20

Source: Company, Ambit Capital research

Working capital efficiencies: Through incremental investments around inventory management at the store level, we expect a reduction in inventory days from 92 days in FY15 to 82 days in FY20 and hence a reduction in working capital cycle (excluding cash) from 37 days in FY15 to 30 days in FY20 respectively. This is likely to lead to an improvement in asset turnover (excluding cash) from 3.7x in FY15 to 5.2x in FY20. As a result of this, RoEs are likely to improve from 23% in FY15 to 32% in FY20.

Capex and surplus capital: With capacity utilisation of less than 75% currently and with a higher growth in outsourced manufacturing vs in-house manufacturing, we do not expect material capacity expansion requirements for Bata over the next 3-4 years. The largest avenue for capital expenditure for Bata is its retail store expansion. Assuming `4.3mn of capex per new store opening

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Bata


currently and an inflationary increase of ~8% CAGR to this store-level capex, we do not expect annual capex for the firm to increase beyond `800mn-900mn over the next six years. With operating cash flows of ~ `2bn in FY15E, recording a CAGR of 29% over FY15-20, and with no outstanding debt on the balance sheet, we see a potential for rapid growth in free cash flow to equity over the next six years.

Dividend payouts and capital reinvestment: Bata initiated dividend payouts in CY07, maintained a payout ratio of 25-35% since then and deleveraged its balance sheet over CY07-10, resulting in a cash accumulation of ~`3bn on the balance sheet till FY15. Going forward, we expect a rise in the payout ratio from ~30% currently to over 55% by FY20, a 45% DPS CAGR over the next five years.

Given the active involvement of the parent company (BSO) at a senior management level, Board level, and hence at a strategy planning level, we do not see a significant risk of capital misallocation by Bata over the longer term.

Currently, our DCF model conservatively forecasts surplus capital accumulation (despite a high dividend payout ratio) of `20bn by FY20, with a 7% annualised return on investment of this surplus capital into liquid money market instruments. However, deployment of some of this capital towards the rapid expansion of the retail store network is possible, if Bata aggressively rolls out new formats (plans in the pipeline for ‘Power’, ‘Marie Claire’ and ‘Bubblegummers’ EBOs) with a branding that is separate from ‘Bata’ (like it has already done for ‘Footin’) in the future.

Stage 2: Rising competition and penetration would lead to moderation towards perpetuity growth rate This stage of our DCF model forecasts a gradual moderation in revenue growth rates from 1% in FY19E to 5% in FY33 (an overall CAGR of 11% over this period), with PBIT margins remaining stable at 16-17% during this phase. This stage is based on our assumption that due to a rise in competitive intensity and penetration levels of organized footwear retail in India, Bata’s revenue growth would start moderating after CY20 gradually.

Exhibit 7: Our assumption on operating metrics in fade period of our DCF-based valuation


Stage 3: Growth to perpetuity Beyond FY33, we forecast a growth in revenues, earnings and cash flows of 5%, broadly in line with the long-term GDP growth forecasts for India.

WACC used for discounting of cash flows Our DCF model uses a WACC of 15.0% for the company, which is based on the computation shown in the table on the right.

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FY21E FY22E FY23E FY24E FY25E FY26E FY27E FY28E FY29E FY30E

FCFF (LHS) RoE (RHS) Revenue Growth (RHS) PBIT margin (RHS)

(` bn) (%)

WACC calculation Particulars %

Cost of Equity 15.0

Cost of Debt 12.0

Debt/Equity 0.0

Corporate Tax Rate 33.0

WACC 15.0


Bata


No changes to our estimates As highlighted in the table below, we have not made changes to our estimates. Our estimates factor in a low revenue growth of 14% YoY in FY16 reflecting the slowdown in the discretionary spends in 1HFY16 and the sluggishness in the implementation of strategic initiatives. We build in revenue growth of 20% YoY in FY17 due to the expectations of a revival in consumer sentiment, benefits from a weak base effect, and the benefits from the initiatives like store MIS and the loyalty program. We expect an earnings growth of 32% CAGR FY15-17 due to improved operating efficiencies and operating leverage gains.

Exhibit 8: Table indicating the changes in our estimates

Change In estimates New Estimates Old Estimates Divergence

Comments FY16E FY17E FY16E FY17E FY16E FY17E

Revenue 25,376 30,542 25,376 30,542 0% 0%

Factoring in delayed revival in SSG led by delayed revival in discretionary spends and slower than expected improvement in the branding / marketing strategy of the company

EBITDA 3,350 4,426 3,350 4,426 0% 0% EBITDA margin expansion FY16 onwards due to improved efficiencies and operating leverage benefits EBITDA Margins (%) 13.2 14.5 13.2 14.5 - -

PAT 2,101 2,891 2,101 2,891 0% 0% Due to factors highlighted above

Source: Ambit Capital Research, EBITDA margin divergence is indicated in basis points (bps)

Exhibit 9: Key Estimates and Assumptions

Particulars CY12 CY13 FY15E FY16E FY17E Comments

Profit and Loss

Retail revenue growth 19.0% 10.5% 4.6% 16.7% 20.4% 7% SSG CAGR and 110 -120 stores net additions each year over FY15-17

Non-Retail revenue growth incl. MEP 19.0% 18.0% 10.0% 16.0% 20.0% Assuming retail:non-retail split to be 81:19

Total revenue growth 19.0% 12.1% 5.4% 14.0% 20.4% Due the factors highlighted above

Gross margins 52.9% 54.1% 54.0% 54.5% 54.8% Due to improvement in productivity of manufacturing units

Employee cost including comm. on sales (% of sales) 13.7% 13.4% 14.7% 14.9% 14.3% Based on a wage inflation of 10% and a 1.5% CAGR

increase in the total employee count over FY14-17

Rental cost (% of sales) 11.7% 12.7% 13.8% 13.8% 13.3% Based on increase in average sq ft area per store by 3% and average rentals per sq ft by 4-5%

Advertising cost (% of sales) 0.9% 0.7% 1.2% 1.3% 1.6% Due to likely launch of a brand communication campaign in FY16-17

Other expenses (% of sales) 11.7% 11.7% 11.6% 11.3% 11.1% Due to scale efficiencies

EBITDA margins 14.9% 15.6% 12.7% 13.2% 14.5% Due to the factors highlighted above

Tax Rate 31.9% 31.4% 32.0% 32.0% 32.0% No tax shelters available to the firm

Net profit margins 9.3% 9.7% 7.6% 8.3% 9.5% Due to the factors highlighted above

Balance Sheet

Capex (` mn) 608 402 935 810 755 We expect Bata to incur `200mn and `600mn annually for modernising factories and opening new stores, respectively

Working Capital days (Excl. Cash) 40.6 39.6 36.9 41.8 34.9 Expect working capital cycle to decrease on the back of better inventory turns

Debtor Days 8.5 8.0 8.0 8.0 8.0 Expect debtor days to remain steady

Creditor Days 52.3 58.3 57.0 57.0 57.0 Expect creditor days to remain steady

Inventory Days 84.5 92.3 92.0 90.0 88.0 Due to Bata's continued investments behind store-level inventory management systems

Net debt/(cash) to equity (0.3) (0.3) (0.3) (0.4) (0.5)

Cash Flows

Operating cash flows 1,845 1,825 1,965 2,871 2,898 Free cash flow will increase significantly after the capex plan to modernise factories is over FCFF 1,103 1,158 1,309 2,367 2,557

Source: Company, Ambit Capital research

Bata


Risks to our BUY stance Significant delay in the implementation of strategic initiatives: To improve

its brand perception and to enhance the customers shopping experience Bata plans to implement initiatives around: (a) launch of an advert campaign, (b) roll out of new format stores, (c) roll out of ‘destination stores’ to display the full product range, and (d) e-commerce-related initiatives like improved product availability online. As highlighted in the previous sections, we expect these initiatives to start getting executed (albeit with a delay) over the next two years. Whilst the management has the intent and the capability to implement these initiatives, a significant delayed or improper execution would lead to lower revenue growth rates vs our forecasts. This remains the key risk to our assumptions.

Continued Macro slowdown: Bata India’s revenue growth for 9 months ending 30th September,2014 was 10% YoY lower than the revenue growth of over 17% CAGR (CY10-13) due to a broad-based slowdown in discretionary spend. A prolonged slowdown in consumer demand would lead to a lower growth trajectory vs our expectations.

Increase in royalty rates: Bata India currently pays a royalty of only ~1% to its parent (BSO) whilst the other subsidiaries of BSO pay 3-4% of their revenues as royalty. The provisions of the new Companies Act are more stringent on “Related Party Transactions”, and hence in favour of minority investors facing the risk of royalty hikes for an MNC’s subsidiary in India. However, these restrictions do not apply to contracts in-force prior to the enactment of the Act. Hence, Bata is exempt from such restrictions of royalty hike until 2020, when its current contract expires. Moreover, “Revised Clause 49” of the SEBI listing agreement poses restrictions on approvals for “Related Party transactions” above `500mn in size. Since Bata’s royalty payout is only ~`22mn currently, these SEBI restrictions do NOT apply to Bata.

Positive catalysts We expect the following events to act as a positive catalyst for Bata over the next 12 months:

Resumption of normalcy in revenue growth rates from 1QFY16: With the IT issue drag no more affecting store-level sales (source: our recent channel checks), resumption of revenue growth rates to ~10% YoY in 1QFY16 despite sluggish macro demand environment is likely to be a positive catalyst especially since investor concerns have recently increased around whether or not the weakness in recent quarters is more driven by Bata’s weak e-commerce offering.

Aggressive resumption of the advert campaign in 1HFY16: As highlighted previously, one of the biggest issues that Bata currently faces includes poor brand communication with its customers. Whilst the firm had launched a high-quality advert campaign in March 2014, this initiative has not been pursued further, with poor advert spends over the past 3-4 months, possibly due to weak profitability over this period. An aggressive resumption of such brand communication can result in improved prospects of market share gains by Bata.

Successful roll-out of new retail formats in FY16: Bata faces constraints around selling over 4000 SKUs through an average store size of only 2,500 sq ft; replication of the Hush Puppies EBO model to include a new retail format rollout around women’s collection EBOs or sportswear EBO is likely to bring some of Bata’s merchandise-related strengths to the forefront and hence enable market share gains for the firm.

Bata


Sharper-than-expected revival in discretionary demand environment: We currently expect a revival in SSG for Bata from -4.3% in FY15 to 8% in FY16 and 11% from FY18 onwards. This increase in growth rates is solely driven by our expectations of a discretionary demand revival from FY16 onwards. Hence, a sharper-than-expected growth in consumer demand over the next 6-12 months can result in upgrades to our revenue growth and hence EPS growth estimates for Bata.

Ambit vs consensus Our FY16 and FY17 forecasts are lower than consensus estimates by ~3% on revenue and by 10-15% on EBITDA. We believe that the magnitude of the improvement in EBITDA margins as expected by consensus is unlikely given the weak revenue outlook in 1HFY16 which brings in negative operating leverage. Given the recent correction in the share price, we believe that an upcoming downgrade to consensus forecasts has already been factored in and hence this is NOT likely to result in a negative catalyst for Bata.

Exhibit 10: Ambit vs consensus

Ambit vs Consensus (̀ mn)

Ambit Consensus Divergence Comment

FY16E FY17E FY16E FY17E FY16E FY17E

Sales 25,376 30,542 26,251 31,252 -3% -2% We factor in lower SSG as explained earlier on account of delayed revival in the discretionary spends

EBITDA 3,350 4,426 3,889 4,912 -14% -10% We factor in healthy EBITDA margin expansion of 110 bps in FY17 due to improved efficiencies and operating leverage benefits EBITDA margin 13.2 14.5 14.8 15.7 (161) (123)

PAT 2,101 2,891 2,415 3,125 -13% -8% Due to above-mentioned factors

Source: Bloomberg, Ambit Capital research. Please note the financials for FY15 indicate the performance for 15 months

Forensic accounting scores Exhibit 11: Explanation for our forensic accounting scores on the first page

Segment Score Comment

Accounting GREEN Bata India's cash conversion has increased significantly from CY06 onwards and this has resulted in CFO (Pre-tax) / EBITDA of above 90% in CY06-13. Working capital management has also improved significantly from 76 days in CY06 to 40 days in CY13.

Predictability AMBER No consensus estimates are available historically and hence we are unable to comment on the predictability of revenues and earnings.

Earnings momentum RED The consensus has downgraded their estimates for FY15 meaningfully whilst retaining their estimates for FY16, possibly factoring in higher growth momentum 1HFY16 onwards.


Bata


Balance Sheet (` mn)

Year to December CY12 CY13 FY15 FY16E FY17E FY18E

Shareholders' equity 643 643 643 643 643 643

Reserves & surplus 6,348 7,756 9,186 10,536 12,249 14,284

Total net worth 6,990 8,399 9,829 11,179 12,891 14,927

Loan funds 1 0 0 0 0 0

Deferred tax liability (444) (681) (681) (681) (681)

(681)

Total liabilities 6,547 7,718 9,148 10,498 12,210 14,246

Gross block 5,636 6,039 6,974 7,783 8,538 9,241

Net block 2,434 2,483 2,601 2,689 2,665 2,542

CWIP 181 237 237 237 237 237

Investments 0 0 0 0 0 0

Inventories 4,621 5,827 6,858 6,257 7,364 8,556

Debtors 449 509 596 556 669 796

Cash and cash equivalents 1,877 2,573 3,231 4,833 6,199 7,987

Loans & Advances 1,209 1,413 1,789 1,669 2,008 2,388

Other current assets 80 97 97 97 97 97

Total current assets 8,236 10,419 12,572 13,412 16,338 19,824

Creditors 2,941 3,654 4,249 3,963 4,770 5,671

Other current liabilities 565 877 820 765 920 1,094

Provisions 798 891 1,193 1,112 1,339 1,592

Total current liabilities 4,304 5,421 6,262 5,840 7,029 8,357

Net current assets 3,932 4,998 6,310 7,572 9,309 11,467

Total assets 6,547 7,718 9,148 10,498 12,210 14,246

Source: Ambit capital research

Income Statement (` mn) Year to December CY12 CY13 FY15 FY16E FY17E FY18E

Net Sales 18,425 20,652 27,210 25,376 30,542 36,314

% growth 19.0% 12.1% 31.8% -6.7% 20.4% 18.9%

Raw materials Cost 8,680 9,488 12,526 11,556 13,820 16,428

Employees cost and comm. on sales 2,524 2,775 4,012 3,792 4,358 5,022

Rent expenses 2,153 2,619 3,751 3,493 4,075 4,715

Advertisement expenses 157 139 313 317 473 635

Other Admin, S&D expenses 2,161 2,410 3,156 2,867 3,390 3,969

Total operating expenses 15,675 17,432 23,759 22,026 26,117 30,771

EBITDA 2,750 3,220 3,451 3,350 4,426 5,543

% growth 19.6% 17.1% 7.2% -2.9% 32.1% 25.3%

Depreciation 514 592 817 722 779 826

EBIT 2,236 2,627 2,635 2,628 3,647 4,717

Non-operating Income 301 315 419 475 617 814

Interest expenditure 10 13 16 13 13 13

PBT 2,526 2,929 3,037 3,090 4,251 5,519

Tax expenses 805 920 972 989 1,360 1,766

Adjusted PAT 1,721 2,010 2,065 2,101 2,891 3,753

% growth -33.5% 16.8% 2.8% 1.8% 37.6% 29.8%

Extraordinary items - (101) - - - -

Reported PAT / Net profit 1,721 1,909 2,065 2,101 2,891 3,753


Bata


Cash-flow statement (` mn)

Year to December CY12 CY13 FY15 FY16E FY17E FY18E

PBT 2,526 2,829 3,037 3,090 4,251 5,519

Depreciation 514 592 817 722 779 826

Others 33 120 (263) (293) (400)

(535)

Tax (788) (1,106) (972) (989) (1,360)

(1,766)

(Increase)/Decrease in working capital (441) (609) (654) 340 (371)

(370)

Cash flow from operating activities 1,845 1,825 1,965 2,871 2,898 3,673

Capex (833) (787) (935) (810) (755)

(703)

(Increase)/Decrease in investments - - - - - -

Interest income 91 120 279 306 413 548

Others - - - - - - Cash flow from investing activities (excl FD) (742) (667) (656) (504)

(341)

(155) Net borrowings - - - - - -

Interest paid (10) (13) (16) (13) (13)

(13)

Dividend paid (446) (449) (635) (751) (1,178)

(1,717)

Others - - - - - -

Cash flow from financing activities (456) (462) (651) (764) (1,191)

(1,730)

Net change in cash 647 696 658 1,602 1,366 1,788

Closing cash balance 1,877 2,573 3,231 4,833 6,199 7,987

Free cash flow 1,103 1,158 1,309 2,367 2,557 3,518


Ratio Analysis Year to December CY12 CY13 FY15 FY16E FY17E FY18E

Gross margin (%) 52.9 54.1 54.0 54.5 54.8 54.8

EBITDA margin (%) 14.9 15.6 12.7 13.2 14.5 15.3

EBIT margin (%) 12.1 12.7 9.7 10.4 11.9 13.0

Net profit margin (%) 9.3 9.7 7.6 8.3 9.5 10.3

Dividend payout ratio (%) 26 26 31 36 41 46

Net debt/equity (x) (0.3) (0.3) (0.3) (0.4) (0.5) (0.5)

Asset turnover excluding cash (x) 3.3 3.3 3.7 3.3 3.9 4.3

Working capital turnover (x) 6.4 6.4 6.9 6.0 7.1 7.3

Gross block turnover (x) 3.5 3.5 4.2 3.4 3.7 4.1

RoCE (%) 26.8 26.2 22.8 20.1 24.1 27.0

ROE (%) 27.1 26.1 22.7 20.0 24.0 27.0

Source Ambit capital research

Valuation Year to December CY12 CY13 FY15 FY16E FY17E

EPS (`) 26.8 31.3 32.1 32.7 45.0

Book value per share (`) 109 131 153 174 201

Dividend per share (`) 6.0 6.5 8.4 10.0 15.7

P/E (x) 38.1 32.6 31.7 31.2 22.7

P/BV (x) 9.4 7.8 6.7 5.9 5.1

EV/EBITDA (x) 23.2 19.6 18.1 18.1 13.4

Price/Sales (x) 3.6 3.2 2.4 2.6 2.1

Dividend yield (%) 0.6 0.6 0.8 1.0 1.5

Source Ambit capital research

Bata


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Aditya Bagul Consumer (022) 30433264 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Real Estate (022) 30433205 [email protected]

Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]

Prashant Mittal, CFA Derivatives (022) 30433218 [email protected]

Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Midcaps – Chemical / Retail (022) 30433242 [email protected]

Ritesh Vaidya Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Sandeep Gupta Media / Midcaps (022) 30433211 [email protected]

Tanuj Mukhija, CFA E&C / Infra / Industrials (022) 30433203 [email protected]

Utsav Mehta, CFA Technology (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

Bata


Bata india ltd (BATA IN, BUY) - Stock price performance


0200400600800

1,0001,2001,4001,600

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BATA INDIA LTD

Bata


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock

Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities is available on request.

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change in stance bata in equity april 30, 2015...

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