A TIGHT FIT

It's not that the footfalls are not coming in. But products are not flying off the shop shelves as they used to some years back. Moreover, Pantaloon Retail's been selling more of the less profitable products in the value segment rather than the expensive lifestyle items.

And with the share of value products going up, the business is under some stress. The growth in the top line (for a comparable number of stores) has slipped to 18 per cent in the year to June 2007 from 35 per cent a couple of years back.

Explains Rakesh Biyani, CEO Retail at Pantaloon, "The share of products in the value segment, that typically fetch lower margins, has gone up to 71 per cent in FY07from 68 per cent last year.

That, together with higher costs towards building infrasructure, has impacted profitability." Sure enough, the combination of the two is crimping margins: gross margins are down from 33 per cent in FY06 to 31.7 per cent in FY07. Moreover, operating margins have dropped from 8 per cent in FY05 to 6.7 per cent in FY07.

The product mix is unlikely to change in a hurry. But Pantaloon is going all out to focus on its lifestyle products, innovating and improving quality. Analysts agree that's the way to go. Says Hemant Patel, who tracks the retail space at Enam Securities, "The key challenge for Pantaloon will be to improve the revenue per square foot. That would require the retailer to latch on to changing trends in fashion."

Biyani has the strategy all chalked out. "We plan to invest and build a host of private label brands such as Dreamline, Homestyle, Hot & Spice, Knighthood and Buffalo. "It's very important to have brands especially for items such as jeans," says the CEO, adding that Pantaloon will also be working with the Levis and Lee brands. Moreover, Biyani's trying to up the share of private labels, which are more profitable. "For items such as bed linen, it's possible to sell as much as 80 per cent of the category through private labels," he observes. By 2010, Pantaloon hopes to be earning more than half the sales from its Big Bazaar hypermarket stores from store brands; currently they contribute 38 per cent. For the lifestyle segment, where the proportion of private labels is relatively high at over 70 per cent, the share would go up to 80 per cent.

Even then with the competition getting keener especially in the food and grocery segment, it's not going to be easy. "It's not easy to sell anything at very high prices in this country," Biyani concedes. Adds Enam's Patel, "It is difficult for retailers to expand margins given the competition and the lack of pricing power."

Indeed the June 2007 quarter has been a difficult one for the retailer with the gross margin crashing by 550 basis points to sub 30 per cent levels, the lowest since June 2003. "There was some pressure on marked downs," admits Biyani.

He concedes inventories have been high but explains that stocks were built up in anticipation of new store rollouts that were delayed. That may be true but market watchers are concerned about the way in which Pantaloon accounts for inventories at market price less 15 per cent. Other retailers value them more conservatively at the lower of cost or a "realisable" value.

Why then does the stock trade at fancy multiples of about 75 times for the current year and about 50 times for FY09? To begin with analysts are valuing other businesses that are part of the consolidated entity and are betting that their value will be unlocked.

Moreover, as Raman Manglorkar , AT Kearney, explains, "While margins could fall as the grocery-based formats proliferate, the advantage with a format like that of Big Bazaar, is that it can do higher inventory turns and lower asset utilisation. Therefore, over the long term the return on capital employed will actually increase. Valuations are being given for future cash flows." If the cash is to flow in, Pantaloon will need to pull up its socks.