Caught in an up-Trent

PENNY WISE

The $180-billion Indian retail market is set to witness explosive growth in the organised segment, say experts who see the current piddly 2 per cent marketshare of organised players grow to 15-20 per cent by 2010.

Retail companies are taking this forecast seriously and are busy setting up outlets throughout the country. For instance, Shoppers Stop, a leading retailer, plans to utilise a significant part of the proceeds from its forthcoming IPO to set up 11 stores across the country.

Trent, one of Shoppers Stop's compatriots, seems to have benefited more from the buoyancy in the segment. Trent's scrip has been rallying splendidly, growing a whopping 94.6 per cent in the last five months. Analysts say a handful of factors contributed to the rise.

The first is Trent's proposed entry into mass-market retailing which has been seen as a positive (the company plans to start its hyper-mart chain - Star India Bazaar - in Ahmedabad in December).

The second factor is that the markets believe that the Shoppers Stop IPO is likely to be priced aggressively, which may have forced market players to buy stocks of peers like Trent. The recent spike at the counter has also been attributed to institutions which were known to have picked up significant chunks of the stock last week.

Trent was one of the early entrants into organised retailing. In 1998, it started operations under the brand name 'Westside' in Bangalore with a single retail store after taking over the city-based Littlewoods store.

It has since expanded its network to 14 stores across nine cities and ranks among the top five retailers in India. Specialising in apparels, Westside is positioned as a store for the family and is aimed at the middle and upper end of the retail market.

Unlike other stores, Trent follows the own brand /private label strategy. It sells its own brands in apparels instead of taking up franchises of established brands.

A typical Westside store portfolio consists of menswear, womenswear, lingerie, kidswear, household accessories, footwear, cosmetics and perfumes.

As much as 80 per cent of the company's sales come from apparels and 90 per cent from high-margin private labels. At around 47 per cent, the company's raw material cost-to-sales ratio is amongst the lowest in the industry.

However, the strategy of selling own brands has proved to be a drag. In FY01 it posted operational losses, though it reported net profits due to the income earned by selling the Lakme brand which it had owned.

However, it reported operating profits in FY02 when it started taking steps to cover fixed costs and improve its merchandise mix. Since then the topline growth has been good.

Behind the numbers
Opening of new stores has also aided the company. However, competitive pressure has forced it to offer discounts. This put pressure on margins. The cost of goods has gone up to 46 per cent during Q1FY05 compared to 42 per cent in Q1FY04.

This along with lower returns from its liquid investments hit the bottomline, which saw a 24 per cent dip during the quarter. Its returns from investments in the quarter slipped 58 per cent y-o-y.

In Q105, the company's other income accounted for 59 per cent of its profit before tax and extraordinary items compared with 53 per cent in FY04.

Operating margins declined over 550 basis points as a percentage of sales, mainly due to a 180-basis-point rise in other expenses. However, retail margins increased 57.18 per cent in the quarter to Rs 3.88 crore.

Future perfect?
Organised retailing is still in its infancy in India. At $3.60 billion, its share is merely 2 per cent of the estimated retail market size placed at $180 billion. Compare this with the ratios of USA (85 per cent), Malaysia (55 per cent), Thailand (40 per cent) and China (20 per cent) and the scope of growth look pretty bright. Trent's food-retailing initiative has been delayed due to problems in spotting locations.

However, it has signed up a property in a western suburb of Mumbai. The company has improved its merchandising function. It has also shifted its central warehouse to Pune from Bangalore. This would help it feed the stores better.

Not an early bird..
Trent has been accused of being overly conservative regarding its expansion strategy. It has added about 97,000 sq ft through five new stores in FY04. It plans to add similar space through another five stores by the end of FY05.

This will take its total retail space to 19 stores, spread over 3.5 lakh sq ft (the company plans to fund most of its capex through internal accruals). Compare this with Pantaloon Retail, which has gone all out with 30-40 outlets spread over 20 lakh sq ft.

"The conservative strategy of the company may prove to be a hindrance in reaching out to more customers," says Alok Agarwal, analyst at Motilal Oswal Securities.

Trent's own brand /private label strategy has benefited it as far as margins are concerned though the flipside includes the time taken by private labels to establish themselves and the higher advertising expenditure involved in the effort. This is among the reservations that analysts have about Trent.

Value call
Buoyed by the rally, the scrip is now hovering around Rs 360 levels, at a P/E of 19.5 times FY05 estimates. Analysts say the scrip is fairly valued at these levels.

"Trent's scrip had always been undervalued, which has been somewhat corrected by the steep rise in the last few trading sessions," says Agarwal.

In comparison, Pantaloon Retail trades at a P/E of around 23 times FY05 estimates. While the operating margins of the two companies are similar, Trent has Rs 110 crore worth of cash plus liquid investments as per its FY04 annual report.

"Given its reasonable profitability, and more importantly, the impressive cash position, the company deserves better valuations than its peers and is a long-term value play," says an analyst.

Though analysts expect the company to post good topline and bottomline growth in the coming quarters, they advocate a wait-and-watch approach before taking positions at the counter and peg an EPS target of Rs 18.5 for FY05.