Corporates

www.indiaratings.co.in 24 January 2014

Retailing

2014 Outlook: Retail Sector Operational Efficiency Drags Sector from Trough

Outlook Report

Negative to Stable Outlook: India Ratings & Research (Ind-Ra) has revised its FY15 retail

sector outlook to negative to stable from negative. Moderate single digit revenue growth and

operational efficiencies translating into stable margins comparable to levels seen thus far in

FY14 would result in marginal improvement in credit profile from FY13 levels for most retailers.

Ratings Partly Reflect Risk: The agency has a Stable Outlook on most rated retail

companies. Ind-Ra has factored in the benefits expected to accrue in revenue and operating

profitability on account of the change in strategy to combat the challenging economic

environment. Some companies with continued weak credit metrics also have Stable Outlooks

in expectation of significant deleveraging.

Consumption to Remain Subdued: Ind-Ra expects consumer sentiment to remain subdued

in FY15 amid reduced affordability. Private final consumption expenditure (PFCE) of 2.2%, for

the quarter ended September 2013, (quarter ended June 2013: 1.6%) was the second lowest

growth observed in the last 37 quarters. While capex and industrial activity is expected to

improve post 1HFY15 the subsequent real wage and urban consumption growth will likely be

seen beyond FY15.

Revenue Growth: Ind-Ra expects moderate space additions and stable growth from existing

stores to help the sector’s overall median revenue grow 8%-10% in FY15. The growth would be

tempered below the higher double digit growth witnessed in FY14 (1HFY14: 18.6%) on a lower

base of FY13. FY13 posted a median growth of 14% on the back of lower GDP growth,

persistently high inflation, spiralling interest rates and a decline in real incomes.

The agency believes that - retailers with a diversified product portfolio (i.e. with a presence in

the value and lifestyle segments) are more resilient to the ongoing economic pressures as

compared to retailers focussed singularly on the premium and high-end luxury segments.

Margin Pressures Contained: Ind-Ra expects moderate revenue growth and operational

efficiencies to help maintain median EBITDA margins near FY14 levels. The ongoing efforts for

driving operational efficiencies include measures such as changing the product mix, right-sizing

stores, rationalising/closing down unviable stores, centralising back-end functions such finance,

procurement and warehousing as well as closely monitoring cost structures.

Less Pressure on Cash Flows: Ind-Ra expects the working capital cycle for FY15 to remain

relatively better placed compared to the estimated FY14 levels largely due to lower inventory

requirements and lease deposits on account of moderation in expansion plans. Stable

operating profitability and lower working capital requirements are expected to reduce pressure

on operating cash flows of most retailers. The agency however, expects the free cash flows to

continue to remain negative in view of the impending moderate capex requirements.

Credit Profile: With retailers preferring to moderate their pace of expansion, their overall credit

profile in FY15 will likely improve from FY13 levels and be maintained around FY14 levels.

Efforts by some players to contain leverage by monetising non-core businesses or infusing

equity to deleverage balance sheet would be viewed as further positives.

Rating Outlook

STABLE

(2013 MID-YEA R :

NEGATIVE )

(2013: NEGAT IVE)

Sector Outlook

NEGATIVE TO

STABLE

(2013 MID-YEA R :

NEGATIVE)

(2013: NEGAT IVE) Negative Consumer Sentiment

Persists

Operational Efficiencies Benefit Margins

Space Optimization Drives Growth

Revenue Growth to Moderate

Uncertainty in Foreign Direct Investment

Related Research

2013 Mid-Year Outlook: Retail (July 2013)

2013 Outlook: Retail (January 2013)

Other Outlooks

Outlook 2014

Analysts

Janhavi Prabhu +91 22 4000 1754 janhavi.prabhu@indiaratings.co.in

Priyanka Poddar

+91 22 4000 1752 priyanka.poddar@indiaratings.co.in Shivani Mahajan +91 22 4000 1708 Shivani.mahajan@indiaratings.co.in

Corporates

2014 Outlook: Retail Sector

January 2014 2

Delayed FDI Roll-out Benefits: The agency continues to view foreign direct investment (FDI)

based equity infusion to be a theoretical possibility given the lack of political consensus on the

issue and complex government requirements which may require companies to restructure their

businesses before receiving such investments. (Please see: India Ratings: FDI in Retail -

Complexities to Undermine Benefits)

Outlook Sensitivities

Positive Outlook Unlikely: Given the low consumer confidence, deterioration in real wages

and low PFCE, Ind-Ra does not envisage a further outlook upgrade to positive even in the

event of a modest revival in sales and margins. However, 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: Companies which are able to attract equity investors under the

FDI route, would be able to deleverage their balance sheets significantly and hence improve

their credit profiles.

Intensifying Competition, Extensive Discounts: Thus far in FY14, the retail sector has seen

extensive discounting. To the extent, the sector decides to chase aggressive revenue targets

and acquire market share by resorting to longer discounting periods, the margins and thereby

the credit profiles could get adversely affected.

Key Issues

Consumer Spending to Remain Subdued

Ind-Ra expects consumer sentiment to remain subdued in FY15 amid reduced affordability as

the consumer price inflation (CPI) outpaces nominal wage growth. However, a robust

agricultural output translating into meaningful rural demand is expected to provide a fillip to the

overall demand.

In FY13, CPI for industrial wage workers increased 16.4% yoy whereas nominal wage grew

only 13.8% thereby resulting in a decline in real incomes. RBI data suggests that the change in

financial assets for FY13 was 14.7% albeit higher than that of FY12, it was at par with the

change in financial liabilities for the same year. As a result in FY13, the net financial position of

Indian households did not change, after having weakened in the previous two years. For further

details regarding urban consumption trends refer report ‘Urban Consumption Driven Sectors in

Slow Lane’, dated 3 December 2013.

Private final consumption expenditure of 2.2% in 2QFY14 (1QFY14: 1.6%) was the second

lowest growth observed in the last 37 quarters.

While some improvement in capex and industrial activity is expected post 1HFY15, its impact

on meaningful real wage growth and improvement in urban consumption will likely be seen only

beyond FY15.

Corporates

2014 Outlook: Retail Sector

January 2014 3

Figure 1

Figure 2

Revenue Growth to Moderate

Ind-Ra expects overall median revenue growth for FY15 to be moderate and in the range of

8%-10% yoy over estimated FY14 level. This would largely be attributable to growth from new

store additions and marginal growth from existing stores as compared with estimated higher

growth in FY14 levels. The agency expects median space additions to be in the range of 10%-

11% for FY15.

Median revenue growth for 1HFY14 improved to 18.6% yoy after witnessing median growth of

14% yoy in revenues for FY13 (FY12: 22.1%). Low real GDP growth, persistently high inflation,

spiralling interest rates and a decline in real incomes have flattened consumer spending. This

in-turn slowed down same-store sales growth across most product segments over FY13. The

agency believes that the higher revenue growth in FYE14 could partially be attributed to the

lower base witnessed in FY13 as well as retailers extending deep discounts to boost sales.

Ind-Ra has analysed a scenario of improved consumer sentiment in 2HFY15 based on a stable

political and business environment following the general elections in FY15. In such a scenario,

the revenue growth would be in the range of 10%-15%.

0

4

8

12

16

20

FY08 FY09 FY10 FY11 FY12 FY13

Estimated growth in nominal wage CPI for industrial workers(%)

Nominal Wage Growth Barely Keeps Up with CPIDoes not support discretionary spending

Source: Prowess, BSE500 companies, RBI

0

2

4

6

8

10

12

0

4

8

12

16

20

24

Jun 06 Mar 07 Jan 08 Nov 08 Aug 09 Jun 10 Apr 11 Jan 12 Nov 12 Sep 13

PCFE at current price (LHS) PCFE at constant price (RHS)(%)

Private Final Consumption Expenditure Second low in 37 quaters

Source: RBI and Ind-Ra

(%)

Corporates

2014 Outlook: Retail Sector

January 2014 4

Figure 3

Retailers with a Diversified Product Mix, Fare Better

For FY15, the agency expects retailers focussed on value and lifestyle to be more resilient and

fare better as compared to players focussed on the premium and luxury segments. As such the

latter could continue to show flat to negative revenue growth.

In 1HFY14, Brandhouse Retail (with a presence in high-end luxury) saw revenues decline

23.7% yoy to INR 3.1bn while Shoppers Stop (consolidated) (with a presence across lifestyle

and value) clocked a 23.7% growth of INR 19.3bn. During this period, the Lifestyle segment

performed better as compared to its value counterpart. The agency sees this as a result of

massive discounts luring in consumers and a shift in consumer spending towards low-ticket

personal items (such as apparels, general merchandise etc.) over high-ticket items such as

consumer durables. Electronics underperformed due to high import costs on account of rupee

depreciation. Hypercity (a Shoppers Stop format store) exited large appliances such as TVs,

laptops and cameras.

Muted Same Store Sales Growth

For 1QFY14 and 2QFY14, Shoppers (year-end March) witnessed SSSG of 12% and 15.5%

respectively. For 2QFY13, Shoppers witnessed like-to-like volume growth of only 9%. While

Future Retail Limited’s (FRL) (year-end December) value segment witnessed SSSG of 8.1%,

10.4% and 8% in 1QCY13, 2QCY13 and 3QCY13 respectively. The industry passed on the

benefit of excise duty cuts on branded apparel to customers by way of discounts to prop up

volumes. This is also indicated in almost flat gross margins. Median gross margins for 1HFY14

increased yoy marginally by 30bp. Shopper’s gross margins increased by 10bp to 37.6%, while

Trent Ltd. on the other hand reported a 32bp improvement in gross margins to 50% by

increasing the share of its private labels.

However, muted consumer spending due to prevalent economic uncertainties will likely drag

into FY15 and SSSG will taper down for the year. Any further efforts by retailers to resort to

aggressive discounting could adversely impact margins.

-40

-20

0

20

40

60

80

100

FY09 FY10 FY11 FY12 FY13 1HFY14ª

Shoppers Trent Provogue Brandhouse Retail V-mart(%)

Uptick in H1FY14 Revenue Growth – Low base of FY13

a 1HFY14: StandaloneSource: Ind-Ra, Company, Ace Equity

Corporates

2014 Outlook: Retail Sector

January 2014 5

Figure 4

Retailers to Continue Space Optimization

The agency expects average space addition in FY15 to be in the range of 10%-11%. This is

relatively low as compared to the 13% space-addition estimated for FY14. This moderated

pace of expansion would ensure that a large proportion of stores are now mature stores with

steady revenue streams untouched by new stores such as hypermarkets/departmental stores,

which on an average require around 18-24 months to break-even. This measured pace of

expansion is also expected to support revenue growth as well as insulate margins which

would’ve otherwise come under pressure given the length of time needed by new stores to

break-even.

During FY13, Shoppers and Trent rationalised the underperforming retail space. Shoppers’

space addition for FY13 grew 18.4% yoy (FY12: 48.5%, FY11: 41.1%), while Trent’s

(consolidated) grew 2.5% in FY13 from 7.5% in FY12. Space moderation has partially helped

report stronger revenue growth in 1HFY14 as compared to FY13. Shoppers’ (consolidated)

average sales per sq. ft. for 1HFY14 witnessed a 14.4% yoy growth to INR 3,721/sq ft (FY13:

negative 3.7% yoy to INR6,733/sqft). The agency expects around 10.7% yoy growth in average

sales per sq ft for Trent (standalone) in 1HFY14 (FY13: 9.1%).

During FY13, Trent closed down four unviable Westside stores whereas Shoppers closed down

one store in FY13 and one in 1HFY14.

Shoppers Stop plans to open a total of 11 standalone stores in FY14 raising its total number of

pan-India stores to 66 (FY13: 55 stores) and an additional eight in FY15 to increase its grand

total to 74 stores. On the Hypercity front, it plans to open two stores in FY14 and another two-

three stores in FY15. V-Mart Retail is expected to add 25 stores over FY14-FY15 (FY13: 69

stores).

Figure 5

-10

-5

0

5

10

15

20

Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13

PRIL – Lifestyle PRIL – Value PRIL – Home Shopper's(%)

Same-Store -Sales Growth Improves – Q2FY14 Discounting PropelsVolume Growth

a PRIL Lifestyle has been demerged from June 2013Source: India Ratings, Company

0

20

40

60

80

100

120

Shoppers Trent V-Mart

FY09 FY10 FY11 FY12 FY13

Moderation in Space Additions

(Units)

Source: Ind-Ra, Company Presentations

Corporates

2014 Outlook: Retail Sector

January 2014 6

Figure 6

Margin Pressure to be Contained

With no major improvement expected in the overall economic situation, the agency expects

median operating margins for FY15 to remain near expected FY14 levels. For 1HFY14, the

median operating margins improved by 87bp. Ind-Ra opines that the lower cost base in FY13,

the benefits of process improvements and the moderate pace of expansion will result in stable

margins despite poor consumer sentiment. In FY13, median operating margins contracted by

110bp hurt by poor SSSG. However, the decline would’ve been sharper had the retailers not

undertaken process improvements to control the cost base.

For FY13, median operating costs (opex) grew 8.5% yoy which was significantly lower than the

18.5% growth witnessed in FY12 (FY11: 24.5%). In 1HFY14, median opex expenses increased

by 17.9% yoy. However, excluding Vmart which is on an aggressive expansion spree, the

growth was only 10.6% yoy indicating that growth in expenses was in line or potentially lower

than the pace of new space additions during the period.

FY13 median opex as a percentage of sales were closer to FY12 levels. Retailers have

undertaken efforts to reduce/resize/rationalise unviable stores and centralise certain back-end

functions such as finance, procurement and warehousing. This has helped reduce process

inefficiencies and cut down the overall cost base. In addition, some of the players such as Trent

have slashed advertising spends. Median employee cost as a percentage of sales (excluding

Vmart – an aggressive player) for FY13 has been almost the same as that of last year

indicating that companies decelerated hiring and implemented measures to increase employee

productivity per sq ft. Also alternative channels such as the rapidly growing e-commerce

segment have helped players control costs to some extent.

Figure 7

Rentals: Ind-Ra expects rentals as a percentage of revenues to remain flat on weaker demand

for commercial retail space. The growing prominence of the revenue-share model between

0

10

20

30

40

50

60

FY09 FY10 FY11 FY12 FY13 1HFY14

Shoppers Trent Provogue Brandhouse Retail V-mart(%)

Operating Cost as Percentage of Revenues Maintained at FY12 Levels

a 1HFY14: Standalone

Source: Ind-Ra, Company, Ace Equity

-4

0

4

8

12

16

FY09 FY10 FY11 FY12 FY13 1HFY14

Shoppers Trent Provogue Brandhouse Retail V-mart(%)

EBITDA Margin Improve in H1FY14

a 1HFY14: Standalone

Source: Ind-Ra, Company, Ace Equity

Corporates

2014 Outlook: Retail Sector

January 2014 7

retailers and real estate providers could also help retailers manage costs.

According to industry reports, the Pan India mall stock for the top seven Indian cities -

Bangalore, Chennai, Delhi, Kolkata, Hyderabad, Mumbai and Pune - is expected to increase to

95.7 million square feet in 2015 from 76 million square feet in 2013. In 2013, an estimated

supply of around 5.2 million square feet was registered, a 22% increase over the previous

year’s supply of shopping malls. In FY13, rentals as a percentage of overall revenues declined

by 50bp yoy.

Figure 8

Tighter Inventory Management

Ind-Ra expects the working capital cycle for FY15 to remain relatively better placed as

compared to the estimated FY14 levels largely due to lower inventory lease deposit

requirements mainly due to moderated pace of expansion

The overall working capital cycle improved in FY13 as retailers tried to reduce inventory levels

by offering higher discounts/liquidating older inventory. Shopper’s inventory levels (65 days)

were the same as last year’s, whereas Trent’s inventory levels declined to 86 days from 104

days a year ago. As at September 2013 (on a 12 month trailing basis) inventory levels

increased marginally on account of additional stores.

Figure 9

Credit Profile Unlikely to Deteriorate

Ind-Ra expects cash flow from operation to improve as compared to FY13 levels on the back of

stable profitability and lower working capital requirements (especially inventory). However, free

cash flow would continue to remain negative in spite of cautious expansion given that retailers

would continue to add new stores funded by debt. However, the agency expects the overall

credit profile to be better as compared to FY13 levels on account of higher operating

profitability.

0

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8

10

12

FY09 FY10 FY11 FY12 FY13

Shoppers Trent Provogue Brandhouse Retailª Vmart(%)

Lease Rentals as % of Sales Remained Flat or Declined for FY13

a 1HFY14: Standalone

Source: Ind-Ra, Company, Ace Equity

20

60

100

140

180

220

260

Shoppers Trent Provogue Brandhouse Retail V-Mart

FY09 FY10 FY11 FY12 FY13

Decline in Inventory days for FY13

(Days)

Source: India Ratings, Company, Ace Equity

Corporates

2014 Outlook: Retail Sector

January 2014 8

Ind-Ra expects retailers to continue to deleverage their balance sheets by monetising their

assets or raising equity to pay off debt and fund part of the capex. The way FRL exited the

Pantaloons format business in June 2013 to Peter England Fashions and Retail Limited

(PFRL), a 100% indirect subsidiary of Aditya Birla Nuvo Limited (ABNL). FRL is also in talks to

hive off its non-core insurance business.

FDI in Multi-Brand Retail – Challenges Ahead

Retailers’ low cash flows and high leverage levels may compel them to look for equity funding

via the FDI route. However, the current political and regulatory risks, lack of clarity in FDI and

instances of alleged questionable practises, under the existing Foreign Corrupt Practises Act

(FCPA), could further increase the challenge of attracting FDI in sectors such as retail. The

agency continues to view FDI based equity infusion to be a theoretical possibility given the lack

of political consensus on the issue and complex government requirements which may require

companies to restructure their businesses before receiving such investments.

2013 Review

Slow revenue growth and deteriorating operating profitability have negatively impacted the

credit profiles of most retailers. This was a result of weakness in consumer’s discretionary

spending due to higher inflation, marginal real wage growth and low level of macroeconomic

activity. Rapid credit squeeze, high operating costs and falling margins have all impacted the

credit profiles of retailers.

Overall demand shrank and retailers experienced revenue declines across the life style as well

as value-based formats. Given the sector-wide slowdown retailers cut back on capex and

rationalised overall cost structures in FY13 leading to improved cash flows. In 1HFY14, the

industry bottomed out and witnessed an improvement in the overall financial metrics given the

low base of FY13 and retailers focussed on revenue growth through rampant discounts to

boost volumes. Operational efficiency led to overall improvement in operating profitability in

1HFY14 which was up from FY13 levels but still below the FY11 levels.

Ind-Ra affirmed FRL’s Long-Term Issuer Rating in April 2013. The affirmation reflected the

likelihood of FRL’s credit profile improving yoy for the financial year ending December 2013

(CY13) and beyond. The affirmation also reflected the expected de-leveraging that would be

driven by the divestment of certain businesses such as the pantaloons format business to

ABNL and the monetisation of its insurance business. In December 2012, Ind-Ra took a

negative rating action on Shoppers’ due to its high liquidity pressures, negative cash flows and

a significant decline in its credit profile.

Corporates

2014 Outlook: Retail Sector

January 2014 9

Annex 1

Figure 10

Figure 11

Figure 12

0

10

20

30

40

50

60

FY09 FY10 FY11 FY12 FY13 1HFY14

Shoppers Trent Provogue Brandhouse Retail V-mart(%)

Median Gross Margins Remained Flat for H1FY14

a 1HFY14: Standalone

Source: Ind-Ra, Company, Ace Equity

0

2

4

6

8

10

FY09 FY10 FY11 FY12 FY13

Shoppers Trent Provogue Brandhouse Retail V-Mart(%)

Employee Cost as a % of Revenue

Source: India Ratings, Company

0

4

8

12

16

FY09 FY10 FY11 FY12 FY13

Shoppers Trent Provogue Brandhouse Retail V-mart(Times)

Deterioration in Credit Profile for FY13

Source: Ind-Ra, Company, Ace Equity

Corporates

2014 Outlook: Retail Sector

January 2014 10

Annex 2

Figure 13 Select India Ratings-Rated Retail Companies Issuer Long-term rating Outlook Short-term rating

Future Retail Ltd IND A- Stable IND A1 Shoppers Stop Ltd -- -- IND A1 Future Value Retail Limited IND A- Stable -- Takshila Retail Private Limited IND D -- --

Source: India Ratings

Corporates

2014 Outlook: Retail Sector

January 2014 11

Annex 3

Figure 14 Retail Companies Profile for FY13

FRL

(consolidated)ª SSL (consolidated) Trent

(consolidated) V-Mart

Presence cities 92.0 20.0 42.0 n.a. Formats Big Bazaar Departmental stores Westside Fashion Food Bazaar Hypercity Star Bazaar Kirana Central Mothercare Landmark KB Fair Price Crossroads Other sp

formats (Sisley)

Home Town MAC & Estee Lauder Other spec formats No of stores 317 PRIL Stores,

236 FVRL Stores 55 Shoppers Stop, 12

Hypercity 70 westside 15 star bazaar, 19

landmark

69

Average area 16.38 4.70 2.50 5.58 Sales 190,289 31,635 21,320 3,835 EBITDAR 28,616 3,577 1,053 560 EBITDA 14,885 823 -120 391 EBITDA margin (%) 7.8 2.6 -0.6 10.2% Interest 10,165 547 104 57 Total assets 15,372 15,370 22,092 2,489 Total debt 81,525 6,066 3457.6 354.2 Total adjusted debt 177,644 25,340 11,669 1,537 Net worth 32,885 5,009 23,826 1,477 CFO -2,227 60.2 369.8 97.8 FCF -22,864 - 1,165.5 -998.9 -123.7 Adjusted net debt/EBIDTAR

7.5 7.0 9.1 2.74

EBITDAR/net interest+rent

1.2 0.6 0.82 5.63

Debtor days 16 10 4 10 Inventory days 188 65 86 65 Creditor days 74 45 66 45 Net cash conversion cycle

130 30 31 30

n.a. – Not available ª FRL FY13 in CY13 ended Dec 2012 (18 months results). The leverage ratios for CY12 are excluding the Pantaloons format business on an annualised basis. The financial summary comprises the Pantaloons format business Source: India Ratings, company reports, Ace Equity

Corporates

2014 Outlook: Retail Sector

January 2014 12

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