Future Retail

Competitive Intensity dents margins, Accumulate

November 05, 2015

Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to important disclosures and disclaimers at the end of the report

Q2

FY1

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Amnish Aggarwal amnishaggarwal@plindia.com +91-22-66322233

Gaurav Jogani gauravjogani@plindia.com +91-22-66322238

Rating Accumulate

Price Rs122

Target Price Rs143

Implied Upside 17.2%

Sensex 26,304

Nifty 7,955

(Prices as on November 05, 2015)

Trading data

Market Cap. (Rs bn) 50.4

Shares o/s (m) 414.2

3M Avg. Daily value (Rs m) 121.5

Major shareholders

Promoters 51.81%

Foreign 19.43%

Domestic Inst. 4.22%

Public & Other 24.54%

Stock Performance

(%) 1M 6M 12M

Absolute (4.4) (6.1) 6.7

Relative (2.6) (2.0) 12.5

How we differ from Consensus

EPS (Rs) PL Cons. % Diff.

2016 2.2 3.1 -28.8

2017 5.2 5.7 -8.6

Price Performance (RIC: FURE.BO, BB: FRL IN)

Source: Bloomberg

020406080

100120140160

No

v-1

4

Jan

-15

Mar

-15

May

-15

Jul-

15

Sep

-15

No

v-1

5

(Rs)

FRL’s Q2FY16 same store sales (SSS) grew by an impressive 10.4% for value retail and 4.2% for Home retail despite shift in festive season and competition from online retail. However we note that deterioration in mix, heavy discounts on independence and holiday sales and aggressive advertising spends has dented margins at both gross and EBIDTA levels curtailing EBIDTA growth to 4.5%. We believe that competitive intensity will remain strong resulting in sustained pressures on margins in the medium term. FRL’s business realignment and merger with Bharti Retail (BRL) will be complete by March 2015 creating an asset light retail business with debt of only Rs12bn, ROCE of 25% and capex requirements for store leases only. (For details Read our report) Retain Accumulate.

Sales up 21.7%, sales mix and competition impacts margins; 2Q sales of Rs30.9bn grew 21.7% YoY led by strong response to Independence Day and holiday sales. Gross margins declined 50bps YoY (30bps QoQ) due to mix change in favour of lower margin food and grocery. EBITDA increased 4.5% YoY as margin declined 150bps to 8.9%. Higher advertising and marketing expenses (up 37%, 140bps) neutralized 50bps decline in rental cost and 10bps decline in staff cost. 21.2% decline in interest cost enabled Adj.PAT of Rs137m (Rs80m in Q2FY15). Operating matrix showed mixed trend as 16.4% growth in sales/ft and 12.8% increase in gross profit/ft was neutralized by 90bps increase in cost of retail, led by sharp increase in adspend.

Value Retailing SSS up by 10.4%; Home retailing up by 4.2%; SSS growth for Value retailing (Big Bazaar, FBB and Food Bazaar) increased by 10.4% (14.1% in Q2FY15) despite rising competition from online retail. Home Retailing (Home Town and E Zone) SSS grew 4.2% (7.8% in Q115).

Area increases by 0.2m sq ft on 13 closures; FRL added 17 stores (6BB, 7Home Town, 2 each of FBB and E Zone) and closed 13 stores (7 in 1Q) this adding 4 stores on a net basis. Store closures include 5 E Zones, 3 FBB, 3 Home town, 1 Big Bazaar and 1 Food Bazaar showing intent to close non performing stores on regular basis.

Key financials (Y/e March) 2014 2015 2016E 2017E

Revenues (Rs m) 115,774 103,417 118,717 139,469

Growth (%) 65.7 (10.7) 14.8 17.5

EBITDA (Rs m) 10,398 11,160 12,726 15,287

PAT (Rs m) (278) (265) 934 2,240

EPS (Rs) (1.2) (0.6) 2.2 5.2

Growth (%) 686.7 (46.9) (441.9) 139.9

Net DPS (Rs) 1.1 0.7 1.0 1.5

Profitability & Valuation 2014 2015 2016E 2017E

EBITDA margin (%) 9.0 10.8 10.7 11.0

RoE (%) (0.8) (0.6) 1.7 3.9

RoCE (%) 5.3 4.3 4.7 5.6

EV / sales (x) 0.8 0.9 0.9 0.8

EV / EBITDA (x) 8.6 8.7 8.1 7.0

PE (x) (101.2) (190.7) 55.8 23.2

P / BV (x) 0.9 1.0 0.9 0.9

Net dividend yield (%) 0.9 0.6 0.8 1.2

Source: Company Data; PL Research

November 05, 2015 2

Future Retail

Exhibit 1: Sales up 22.4%, EBITDA up 17.1% on 50bps margin decline

Y/e March Q2FY16 Q2FY15 YoY gr. (%) Q1FY16 H1FY16 H1FY15 YoY gr. (%)

Net Sales 30,984 25,460 21.7 28,995 59,979 49,143 22.0

Gross Profit 8,461 7,116 18.9 8,025 16,486 13,794 19.5

Margin (%) 27.3 28.0 27.7 27.5 28.1

Rent 1530 1377 11.1 1513 3044 2713 12.2

% of Net sales 4.9 5.4 5.2 5.1 5.5

Other Exp 4159 3086 34.7 3660 7819 5993 30.5

EBITDA 2,772 2,653 4.5 2,852 5,624 5,088 10.5

Margin (%) 8.9 10.4

9.8 9.4 10.4

Depreciation 1,358 1,281 6.1 1,342 2,701 2,522 7.1

Interest 1,353 1,716 (21.2) 1,511 2,864 3,334 (14.1)

Other Income 132 62 113.8 92 224 146 54.1

PBT 193 (282) NA 91 284 (622) NA

Tax 56 (202) NA 30 86 (202) NA

Tax rate (%) 29.1 71.5 33.1 30.4 32.4

Adj.PAT 137 (80) NA 61 198 (420) NA

Source: Company Data, PL Research

Exhibit 2: Improvement in sales and Gross profit/ft neutralised by higher adspend

Quarterly Operating Matrix Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15

Operating Area (mn Sq Ft) 10.4 10.4 10.9 10.9 11.4 11.3 11.5

Sales/ Ft (Rs) 2216 2234 2271 2393 2412 2526 2644

Growth % 1.7 3.5 3.7 8.6 8.8 13.0 16.4

Gross Profit (Rsmn) 6660 6677 7116 7633 7908 8025 8461

Gross profit/ft/month 214 215 217 233 232 237 245

Change (%) 17.5 10.2 8.6 16.2 8.3 10.6 12.8

Gross Margin % 28.4 28.2 28.0 28.8 28.5 27.7 27.3

Change (%) 3.8 1.6 1.2 2.0 0.1 -0.5 -0.6

EBIDTA Margin % 10.3 10.3 10.4 11.6 10.8 9.8 8.9

Cost of retail % 18.1 17.9 17.5 17.1 17.8 17.8 18.4

Source: PL Research

Sales mix change and higher adspend

impacts gross margins, EBIDTA margins

and cost of retail significantly

November 05, 2015 3

Future Retail

Exhibit 3: SSS growth up to 10.4% in a seasonal high quarter

2.7

7.5

(0.2)

5.1

8.1 10.4

8.0

3.3 2.2

9.2

14.1

10.1

7.6

10.310.4

-2.00.02.04.06.08.0

10.012.014.016.0

Mar

-12

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-14

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Big Bazaar SSS Growth (%)

Source: Company Data, PL Research

Exhibit 4: Home retailing growth slows down to 4.2%

(7.3

)

(4.5

)

(3.5

)

(3.4

)

(4.1

)

3.7

7.4

2.0

2.1

5.5 7

.8

7.5

16

3.8 4.2

(10.0)

(5.0)

-

5.0

10.0

15.0

20.0

Mar

-12

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-1

4

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Home Retailing SSS Growth (%)

Source: Company Data, PL Research

Exhibit 5: Q2FY16 witnesses 0.4m of gross area addition and 0.2m of net area addition on 14 store closures

Key Retail Metrics Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sept-15

Retail Space (m sq ft)

Big Bazaar 7.8 7.9 8.4 8.3 8.7 8.6 8.9

Home Town 1.3 1.2 1.2 1.3 1.3 1.3 1.4

FBB 0.4 0.4 0.4 0.4 0.5 0.5 0.5

E Zone 0.5 0.5 0.5 0.5 0.6 0.5 0.5

Food Bazaar 0.3 0.3 0.2 0.2 0.2 0.2 0.2

Others 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Total 10.4 10.4 10.9 10.9 11.4 11.3 11.5

Store Count (x)

Big Bazaar 164 166 185 184 196 195 200

Home Town 30 29 29 32 35 38 42

FBB 30 30 38 38 52 51 50

E Zone 66 78 94 95 97 96 93

Food Bazaar 24 22 19 17 14 12 11

Others 7 8 8 8 7 6 6

Net Store Addition (x)

Big Bazaar 3 2 19 -1 12 -1 5

Home Town 3 -1 0 3 3 3 4

E Zone 3 0 8 0 14 -1 -1

Food Bazaar 19 12 16 1 2 -1 -3

Others -2 -2 -3 -2 -3 -2 -1

Net Addition QoQ (m sq ft)

Big Bazaar 0.1 0.1 0.5 -0.1 0.4 -0.1 0.2

Home Town -0.1 0.0 0.0 0.1 0.0 0.0 0.1

FBB 0.0 0.0 0.1 0.0 0.1 0.0 0.0

E Zone 0.1 0.0 0.1 0.0 0.0 0.0 0.0

Food Bazaar 0.0 0.0 -0.1 0.0 0.0 0.0 0.0

Others 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Source: Company Data, PL Research

November 05, 2015 4

Future Retail

FRL to realign business in tie-up with Bharti Retail

FRL has announced the split of its operations which also involves tie-up and

acquisition of retail business of the Bharti Group. The entire realignment will have

two phases as under:

Retail Business: Retail operations of FRL which has stores under Big Bazaar,

Food Bazaar, FBB, Home Town and E Zone brands, will be demerged into BRL.

The entity will be renamed as FRL. This entity will also operate front-end retail

business. Retail business will include leasing of store properties, product

sourcing, visual merchandising, marketing, sales and store operations.

Infrastructure and Investments: BRL will transfer its retail infrastructure arm

into FRL. FRL will have retail infrastructure and investments as its core business.

This company will be renamed as Future Enterprises. Infrastructure activity will

involve setting up in-store furniture, fixtures, fittings, electrical, IT infrastructure,

private label apparel manufacturing and various investments. It will have

investments in Future Generali Life, Future Generali General insurance, Future

Supply Chain Solutions, Future Consumer Enterprises, FLFL, Apollo and Golmohur

Mills.

November 05, 2015 5

Future Retail

BRL to hold 9% stake in FRL and FEL; OFCD gains to be shared

Shareholders of FRL will get 1 share of BRL for every 1 share held in FRL. BRL will

be renamed as Future Retail. The share capital of BRL is 43.4m shares of Rs2

each. The shareholders of FRL will have 428m shares in new entity. The Bharti

Group will have ~9.2% stake in new entity.

BRL does not have any debt, so the deal values the Bharti retail business at

~Rs5bn plus the optionally convertible debs of Rs2.5bn.

Shareholders of FRL will get 1 share of FEL (Future Enterprises) for every share

held in FRL. DVR holders will get one share each in both FRL and FEL after

restructuring.

OFCD holders of Rs2.5bn of Bharti Group will be issued shares in both the

entities in an arrived ratio. The allotment price will be as per SEBI formula.

Bharti Group will have a three-year lock in for selling the stake they would get in

FRL an FEL. They can sell stake after three years with the consent of FRL.

However, after a period of five years, they would be free to sell their stake in the

company.

Bharti Group (shares plus OFCD) will share the proceeds with FRL and FEL

between for sale of their stakes if the sales proceeds are above the minimum

threshold of Rs9.5bn. The sharing would be 50% of incremental if the sales

proceeds are more than Rs9.5bn, 60% of incremental if the proceeds are

between Rs14.5bn and Rs19.5bn and 75% if the proceeds are above Rs19.5bn.

FRL will have asset light retail business

FRL will have an asset light model as all the backend and store infrastructure will

be a part of Future Enterprises. FRL will take the store on lease, FEL will create

the infrastructure and fixtures for an annual lease charge and FRL will keep

inventory, staff and run the stores.

FRL will pay operating lease charges which are estimated to be Rs4.5bn for

existing stores. However, the future store capex will be done at an arm’s length

basis and would be at commercial rates. So for every new store addition, FRL’s

balance sheet will show lease deposits and P&L will show higher store rentals

and lease charge for furniture and fixtures.

FRL will have a debt of Rs12bn which will be mainly working capital debt.

Retail business will have more than 200 Hypermarts (Including 15 Easy Day

Markets) and will have 185 Easyday convenience stores. The move will

considerably bolster the presence of FRL in north India.

FRL will retain Easyday brand for convenience stores, while Easyday markets will

be rebranded as Big Bazaar. BRL has 4 easy day markets at same locations as Big

Bazaar; these will be converted into other formats of Future Group.

November 05, 2015 6

Future Retail

The resultant entity is likely to have a balance sheet size of Rs40bn and ROCE

exceeding 25%. We expect FRL to increase the pace of store openings after the

realignment, given improved balance sheet and lease based model.

BRL has annual loss of Rs3bn, turnaround challenging

BRL has sales of Rs17bn, EBITDA loss of Rs2.8bn and PAT loss of Rs3.2bn in FY15.

Easy Day convenience stores account for 2/3rd of sales and are EBITDA positive. Easy

Day markets account for 1/3 rd of sales and account for most of the loss. BRL has

food and grocery centric business model due to which it has gross margin of only

10% as against 28% for FRL. FRL has 40% of sales from apparel and another 25%

from general merchandise which provides a flip to gross margins of the company.

FRL expects to achieve breakeven in BRL business by the end of FY16 and expects

synergies in operations from product sourcing, distribution centre costs, IT

Infrastructure, marketing and sales mix and manpower costs. In addition, BRL has

some of the best practices and systems from Walmart, which will improve things for

FRL. However, we remain concerned on certain grey areas:

FRL operates in Hypermarts, while BRL has major part of sales from convenience

stores. It won’t be easy for FRL to replace the infrastructure and cut costs in

Easy Day stores. FRL and BRL will close down one store each which will overlap.

Business mix of BRL is skewed towards food and grocery unlike FRL, which has

higher share from apparel and general merchandise.

Future Enterprises; Deleveraging key to survival

FRL’s resultant business of in-store infrastructure, apparel manufacturing and group

investments will be housed in “Future Enterprises”. Future Group plans to start the

lease based in-store infrastructure model for other retail players also. However, we

remain cautious on this given that:

FEL will have high debt of Rs35bn and would require significant reduction in

debt by sale of investments in order to curtail its losses. We believe it could have

interest burden of Rs4bn and depreciation of Rs5bn with annual lease income of

Rs4.5bn. Moreover it would require investing periodically to create in-store

infrastructure for new store openings of FRL.

We expect deleveraging to start with Future Supply chain solutions in the

coming few months; this is expected to realize Rs6-7bn for FEL. In FY15, FSC

reported revenues of Rs4.1bn (up 23.1% YoY), EBITDA of Rs660m (up 113.8%

YoY) and PAT of Rs250m (Up 485.1% YoY).

We expect gradual divestment in other ventures including insurance ventures

and real estate in apparel parks.

November 05, 2015 7

Future Retail

Income Statement (Rs m)

Y/e March 2014 2015 2016E 2017E

Net Revenue 115,774 103,417 118,717 139,469

Raw Material Expenses 84,977 74,082 84,954 99,709

Gross Profit 30,798 29,335 33,763 39,760

Employee Cost 4,239 3,819 4,571 5,439

Other Expenses 16,161 14,356 16,466 19,034

EBITDA 10,398 11,160 12,726 15,287

Depr. & Amortization 4,043 5,129 5,699 6,251

Net Interest 6,648 6,423 5,633 5,692

Other Income 277 267 294 323

Profit before Tax (294) (391) 1,394 3,344

Total Tax (15) (127) 460 1,103

Profit after Tax (279) (264) 934 2,240

Ex-Od items / Min. Int. 613 2,010 — —

Adj. PAT (278) (265) 934 2,240

Avg. Shares O/S (m) 231.6 414.2 427.7 427.7

EPS (Rs.) (1.2) (0.6) 2.2 5.2

Cash Flow Abstract (Rs m)

Y/e March 2014 2015 2016E 2017E

C/F from Operations (1,614) 11,494 6,414 14,963

C/F from Investing (13,384) (6,418) (8,736) —

C/F from Financing 15,474 (1,754) 3,609 —

Inc. / Dec. in Cash 476 3,322 1,287 14,963

Opening Cash 555 1,025 1,045 —

Closing Cash 1,025 1,045 2,182 —

FCFF (29,917) (1,408) (4,768) (3,121)

FCFE (3,808) (15,860) (73) 405

Key Financial Metrics

Y/e March 2014 2015 2016E 2017E

Growth

Revenue (%) 65.7 (10.7) 14.8 17.5

EBITDA (%) 33.9 7.3 14.0 20.1

PAT (%) 686.7 (5.0) (453.0) 139.9

EPS (%) 686.7 (46.9) (441.9) 139.9

Profitability

EBITDA Margin (%) 9.0 10.8 10.7 11.0

PAT Margin (%) (0.2) (0.3) 0.8 1.6

RoCE (%) 5.3 4.3 4.7 5.6

RoE (%) (0.8) (0.6) 1.7 3.9

Balance Sheet

Net Debt : Equity 1.9 0.9 0.9 0.9

Net Wrkng Cap. (days) — — — —

Valuation

PER (x) (101.2) (190.7) 55.8 23.2

P / B (x) 0.9 1.0 0.9 0.9

EV / EBITDA (x) 8.6 8.7 8.1 7.0

EV / Sales (x) 0.8 0.9 0.9 0.8

Earnings Quality

Eff. Tax Rate 5.2 32.4 33.0 33.0

Other Inc / PBT (94.4) (68.3) 21.1 9.7

Eff. Depr. Rate (%) 8.1 9.0 9.1 9.1

FCFE / PAT 1,367.5 5,996.3 (7.8) 18.1

Source: Company Data, PL Research.

Balance Sheet Abstract (Rs m)

Y/e March 2014 2015 2016E 2017E

Shareholder's Funds 32,517 51,979 57,016 58,739

Total Debt 62,680 48,228 52,922 56,448

Other Liabilities 1,802 1,675 1,721 1,831

Total Liabilities 96,998 101,882 111,659 117,018

Net Fixed Assets 47,041 51,066 53,632 53,215

Goodwill — — — —

Investments 13,495 12,952 12,952 12,952

Net Current Assets 32,655 32,074 38,815 44,041

Cash & Equivalents 1,025 1,045 2,182 1,611

Other Current Assets 48,128 55,313 63,855 74,506

Current Liabilities 16,498 24,284 27,222 32,077

Other Assets 3,807 5,790 6,260 6,811

Total Assets 96,998 101,881 111,659 117,018

Quarterly Financials (Rs m)

Y/e March Q2FY15 Q4FY15 Q1FY16 Q2FY16

Net Revenue 23,170 27,726 28,995 30,984

EBITDA 2,050 2,985 2,852 2,772

% of revenue 8.8 10.8 9.8 8.9

Depr. & Amortization 800 1,324 1,342 1,358

Net Interest 1,380 1,510 1,419 1,221

Other Income 60 72 92 132

Profit before Tax (130) 152 91 193

Total Tax (50) 49 30 56

Profit after Tax (80) 103 61 137

Adj. PAT (80) 103 61 137

Key Operating Metrics

Y/e March 2014 2015 2016E 2017E

Inventory Days 118 124 129 128

Interest/EBITDA (%) 66.6 59.9 46.6 39.3

SSS growth Value — — — —

Big Bazaar — — — —

Food Bazaar — — — —

Store Addition — — — —

Big Bazaar — 32.0 34.0 32.0

Food Bazaar (19.0) (10.0) — —

FBB 4.0 22.0 20.0 20.0

Home Town (9.0) 5.0 5.0 —

E Zone 28.0 31.0 34.0 32.0

Source: Company Data, PL Research.

November 05, 2015 8

Future Retail

Prabhudas Lilladher Pvt. Ltd.

3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai-400 018, India

Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209

Rating Distribution of Research Coverage PL’s Recommendation Nomenclature

44.1% 44.1%

11.8%

0.0%0%

10%

20%

30%

40%

50%

BUY Accumulate Reduce Sell

% o

f To

tal C

ove

rage

BUY : Over 15% Outperformance to Sensex over 12-months

Accumulate : Outperformance to Sensex over 12-months

Reduce : Underperformance to Sensex over 12-months

Sell : Over 15% underperformance to Sensex over 12-months

Trading Buy : Over 10% absolute upside in 1-month

Trading Sell : Over 10% absolute decline in 1-month

Not Rated (NR) : No specific call on the stock

Under Review (UR) : Rating likely to change shortly

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The research analysts, with respect to each issuer and its securities covered by them in this research report, certify that: All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and No part of his or her or their compensation was, is or will be directly related to the specific recommendation or views expressed in this research report

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