Pantaloon Retail: A slightly expensive deal

Realignment of the retail business is being done at higher valuations and will dilute EPS in the near term.

As part of plans to consolidate its retail operations, Pantaloon Retail (PRIL) on Wednesday approved the merger of consumer durables, home furnishings, home improvement and furnishings businesses of Home Solutions Retail (HSR), its 66.86 per cent subsidiary, with itself, and acquisition of the sports retail business of its wholly-owned subsidiary, Winner Sports.

However, the move didn’t go down well with the markets, which saw the deal as expensive and earnings dilutive in the near term.

This follows an alignment of the value retail format into a wholly-owned subsidiary. PRIL had also transferred three businesses, including Future brands, to promoters for Rs 190 crore.

Considering that HSR shareholders will be issued 5.9 million shares of PRIL and 6.3 million compulsorily convertible preference shares, the deal values HSR at about Rs 1,500 crore (market capitalisation to sales ratio of 1.4 times, based on 2008-09 numbers), which is higher than PRIL’s own valuation of about 1.15 times, according to analysts.

Second, HSR generated Rs 1,071 crore revenue in 2008-09, with a pre-tax loss of about Rs 57 crore. While same-store sales grew 1 per cent in the December 2009 quarter and HSR expected to achieve operational breakeven this year (ending June 2010), on about 20 per cent sales growth, breakeven at the profit after tax level is likely only in 2010-11. Hence, the deal is seen as EPS dilutive (about 6 per cent impact in 2010-11, according to analysts). However, the accumulated losses of HSR will offset the capital gains tax payable by PRIL due to the sale of businesses to promoters, according to IDFC-SSKI Research.

Overall, while the EPS impact may put some pressure on the stock in the near term, the long-term outlook is bright. The realignment will allow cash accruals to be deployed in the promising retail business. The balance sheet, therefore, will be healthier, even as proceeds from the qualified institutional placement and sales to promoters in the previous quarter should help lower debt and interest costs. Improving financials and balance sheet, along with the potential to unlock value (once the insurance business is demerged), will merit a re-rating for the stock, say analysts.

Meanwhile, Pantaloon Retail saw net sales grow 25 per cent in the December quarter. The lifestyle segment sales rose 25 per cent, as same-store sales clocked 11 per cent growth, outstripping numbers for value retail (with sales growth of 14 per cent and same-store sales growth of 7 per cent). PRIL’s operating profit jumped 29 per cent as margins improved by 33 basis points to 10.74 per cent with better inventory management and cost rationalisation.

Pantaloon’s stock slipped 1.75 per cent to close at Rs 382.50 on Thursday, as against Sensex’s 0.2 per cent decline. It currently trades at 21.85 times estimated 2010-11 earnings.

With inputs: Sunaina Vasudev & Sarath Chelluri