While RIL gains, deal may not be as sweet for Future Group shareholders

Valuation concerns could weigh on the stock price of Future Enterprises

The mega deal between the retail arm of Reliance Industries (RIL) and the Future Group is positive for the shareholders of the former, but the jury is out on the benefit of the same for the latter. The Rs 24,713 crore deal will enable Reliance Retail to expand its geographic reach, product basket and strengthen its back-end infrastructure. For the Future Group, the deal is expected to pare down debt and consolidate the remaining businesses under Future Enterprises. 

The big gainer from the transaction is clearly Reliance Retail. The company, which operates 11,784 stores across the country, will get access to about 1,500-2,000 stores of the Future Group, adding an incremental 13-17 per cent to its network. Areawise, the addition would be around 70 per cent given Future group’s 20 million square foot of retail presence as compared to Reliance Retail’s 28.7 million square feet at the end of June quarter. 

“The key benefits of the acquisition of Future Group assets for Reliance is addition of incremental area, significant reduction in time-to-market and ability to negotiate better deals with suppliers given the expanded presence,” said Rajiv Sharma, head of institutional equity research at SBICAP Securities.

Analysts estimate that it would have taken India’s largest retailer about three years to replicate the Future Group’s assets across the country including in-house brands. Considering this scenario, they said the Rs 24,713 crore valuation and the Rs 2,800 crore investment in Future Enterprises -- taking the total outflow to over Rs 27,000 -- crore was not over the top. 

Given that benefits outweigh the costs, analysts such as Akhil Parekh of Elara Capital say that the deal will be earnings accretive for Reliance Retail. This will be led by the top line support from acquired operations. However, RIL investors would have to be patient as the integration process is complex and could be time consuming, Sharma added.

The reason why some analysts believe caution is warranted is due to past experience. While experts underline the gains in the fashion segment to Reliance Retail from the deal, they also indicate the execution challenges as was the case with Aditya Birla Fashion and Retail (ABFRL) turnaround of Pantaloons acquired from the Future Group. “A few large stores were contributing to the majority of revenues and it took ABFRL over two years to get their return on investment,” they said. While valuations of Reliance Retail (currently at 30 times enterprise value or EV to operating profit) will increase, the key trigger the Street will await for are new investors, which will create a benchmark for valuation of the entity. Of the Rs 2,100 per share consensus target price of RIL, half is attributed to Jio Platforms (Jio) and about 28 per cent or Rs 600 per share is due to Reliance Retail. The contribution of Reliance Retail could increase to Rs 700-Rs 750 per share going ahead. 

For Future group shareholders, the first reading of the slump sale and merger of key listed group entities with Future Enterprises, seems to be a win-win. However, that might not be the case. Given the swap ratio and Future Enterprise (FEL) market price of Rs 20.20 a share, the premium for the five non-FEL listed entities to the closing prices on Friday ranges from 33-75 per cent. Analysts however highlight that the arbitrage opportunity might not be available if Future Enterprise stock falls on valuation concerns. 

On an expanded equity post the merger of the group entities into FEL, the EV of FEL stands at Rs 27,000 crore. Excluding the joint ventures, the EV to operating profit for the company is at 58 times. The valuation post the deal for a third party manufacturer of FMCG and fashion is on the higher side given the most expensive stock in the retail segment (Avenue Supermarts) trades at 35 times.

While Future Group has highlighted the 20-25 per cent revenue growth and margin expansion potential from supply opportunities to Reliance Retail and the general trade, the premium to existing entities is quite high, say analysts. Further, the price of the preferential issue is around Rs 16-17 a share which indicates a 15-20 per cent discount to FEL’s current price. 

The impact on other listed retailers will not be uniform. While a large player could lead to a pricing war, analysts say Avenue could benefit as Reliance Retail rationalises its store network in tier 1 locations to avoid duplication and focuses on expansion in tier 2 and tier 3 cities. Any rebranding of Future Lifestyle Fashions (Brand Factory) and its brands could benefit Trent given its predominant private label collection. Finally for ABFRL, which was a major supplier to Future Group of brands such as Van Heusen, how the brand mix evolves at the new merged operations of Reliance Retail could impact its revenues.