Shobhana Subramanian: Big bazaars, small customers

With sales growth in older stores and margins both falling, Pantaloon needs to keep costs in check.

With its high decibel 'sabse saste 3 din' campaign last month, India's top retailer Pantaloon Retail clearly has no problem attracting customers to stores, but getting them to buy is a different matter altogether. Sales from the Rs 3,237 crore retailer's existing stores ('same store', in jargon) grew a mere 3.6 per cent in January (on a year-on-year basis) as compared to 29 per cent in January 2007, and the last six month's average of 10 per cent. October, the festival season, saw a similarly dismal performance when sales fell 25 per cent "" things picked up with Diwali in November but sales for the value segment (Big Bazaar and Food Bazaar) for the two-month period rose just 2.8 per cent as compared to a much higher 15 per cent in 2006. For the Lifestyle segment (Pantaloon and Fashion Station), things were marginally better with sales in these two months rising 9 per cent in 2007 as against over 20 per cent in 2006.

For the entire company, of course, sales have grown faster in 2007-08. Overall sales for the year are expected to grow 78 per cent as compared to 71.3 per cent in 2006-07 "" but this includes sales from new stores as well. It's true that in mature western markets where the penetration of organised retail is high, growth in same-store sales do peter off after three years or so, and settle at around 1-2 per cent. In India, however, where the penetration of organised retail is very low, the slowdown is alarming. 
 

SAME STORE SALES ARE SLOWING                                                 % change, y-o-y
	Value Segment*		Lifestyle Segment**
	2007	2006	2007	2006
Jan	29	41	17	27
Feb	10	26	34	14
March	10	27	21	6
April	2.3	17	20	20
May	1.5	19	1.5	17
June	10	11	23	19
July	2.2	25	19	31
Aug	21	37	11	33
Sep	12	15	11	35
Oct	-25	7	-7	3
Nov	40	12	30	10
Dec	8	31	16	31
Note: Value sales grew 3.6% in January 2008 and Lifestyle sales 5.4% Value retailing contributes 72% of Pantaloon Retail's turnover *Big Bazaar and Food Bazaar ** Pantaloon and Central

Since consumer spending is clearly on the rise, the only reason for sluggish sales is the greater competition and the possibility that organised retail is still not offering the kind of value propositions which will make it unbeatable. While the penetration of organised retail is 3-4 per cent at the all-India level, it is true that in major cities, there are pockets where organised retailers are located close to each other and offer more or less the same merchandise.

Pantaloon Retail has tried to beat this slowdown through rapid expansion. The overall sales growth shows the strategy is working, but this is happening at a huge cost "" the company's profit margins are getting eroded and revenues per square foot of space are declining. Total sales for the last four quarters show that the revenue per square foot has been slowing. While a sequential comparison may not be strictly in order for the lifestyle segment which is, to some extent, a seasonal business, the value segment (Big Bazaar and Food Bazaar) is much less so. 
 

OVERALL MARGINS ARE FALLING*
in %	Q1FY07	Q2FY07	Q3FY07	Q4FY07	Q1FY08	Q2FY08
Sales growth	65.4	59.5	89.1	77.3	80.1	63
Gross Profit Margin	34.1	32.2	32.5	29.3	31.5	30.4
Operating Profit Margin	6.9	7.6	7	5.6	8.8	8.9
Net Profit Margin	6.4	5.8	2.1	1.8	2.7	2.6
* Figures pertain to existing and new stores
BOTH TOPLINE AND BOTTOMLINE ARE IN TROUBLE
	Q1FY07	Q2FY07	Q3FY07	Q4FY07	Q1FY08	Q2FY08
Space (Mn sqft)	2.9	3.7	4.4	5	5.8	6.6
Revenue (Rs mn)	6,033	7,527	8,610	10,196	10,864	12,268
Rev/sq ft (Rs)	2,080	2,034	1,957	2,039	1,873	1,859
EBITDA (Rs mn)	415	570	603	568	956	1,096
EBITDA/sq ft (Rs)	143	154	137	114	165	166

The result is that sales are not growing fast enough to leave the retailer with a decent gross margin. The gross margin, which does not reflect real estate costs or start-up costs for new stores, has been falling. From 33 per cent in FY06, it slipped to 31.7 per cent in FY07, and in the June 2007 quarter this fell 550 basis points y-o-y. Even in the first two quarters of the current year, gross margins fell by 266 basis points y-o-y and 180 basis points y-o-y, respectively.

One reason for this is the gradual shift in the product mix towards the value segment "" Big Bazaar and Food Bazaar "" where products are far less profitable. Value retailing today contributes approximately 72 per cent to turnover, up from 68 per cent in FY06 "" lifestyle retailing accounts for the rest. Another reason is the higher promotional offers required to sustain same store sales in the value-retail formats. Besides, the increasing contribution from the relatively low margin consumer electronics business is also partly to blame.

With real estate and salary expenses on the rise, operating margins too have not been really robust averaging 7 per cent over the last eight quarters. However, of late, some scale benefits and better supply chain efficiencies appear to be creeping in, boosting margins in the first half of FY08. One of the main reasons for the bounce back in operating profit margins in the first quarter of FY08, when they expanded after four quarters of margin contraction, is lower staff costs and other overheads. In the second quarter of FY08 too, the ratio of employee costs to sales improved significantly "" it dropped from 6.5 to 5.7 per cent. Besides, there was a less-than-proportionate increase in marketing and general overheads.

While margins could remain flat as grocery-based formats proliferate, the advantage with a format like Big Bazaar is that it can do higher inventory turns. However, that too doesn't seem to be happening in any significant manner. In fact, one of the key concerns of analysts is the high level of finished goods inventory. The company's inventory rose by Rs 160 crore in Q2FY08 and the inventory-to-sales ratio stood at 12. 8 per cent, compared with 13 per cent in Q2FY07. In Q1FY08 too, there was a sharp rise in inventory, by Rs 140 crore, and the inventory-to-sales ratio rose to 12.9 per cent compared with 6.5 per cent in Q1FY07.

Stocks as per cent of sales have been rising since the third quarter of FY07. While some of it can be attributed to stocking up for new rollouts, it is nonetheless disconcerting. What makes things worse is that Pantaloon persists with an inventory accounting policy that is less prudent than those of its competitors. The valuation method overstates inventory and therefore, profits "" Pantaloon values its inventory at the retail price less a markdown (about 15 per cent) compared with the standard retail practice that values inventory at the cost of bringing it to the point of sale or the selling price, whichever is lower.

Pantaloon can protect its margins by increasing the share of private and store brands "" which it is doing. The share of store brands for the value segment is currently 38 per cent and should go up to 50 per cent by FY2010. For the lifestyle segment, however, there isn't much scope for further increases since such brands are already at around 70 per cent.

The competition in the food and grocery segment, which accounts for 40 per cent of consumer spending at the all-India level, is keen with chains such as TruMart, Reliance Fresh and Subhiksha growing. The Pantaloon group itself is launching KB Fair Price shops. All of this will hit margins since each chain tries to woo customers through huge discounts. The result is that, while Pantaloon's gross margins are over 30 per cent, net margins are under 3 per cent. So, even if the company is in a growth phase, there can be little doubt costs are completely out of whack. Unless the benefits of scale are seen quickly, the company's growth may be painful. And if, as expected, the economy starts to slow down, it will hurt the retailer even more.