Growing in style

PENNY WISE

Koutons Retail's brand positioning strategy, a fast expanding network and foray into related segments make it a good investment proposition.

A unique franchise model has helped Koutons Retail India, an integrated apparel manufacturing and retail company to grow at a scorching rate; up from 74 stores in FY05 to 1,175 stores in FY08 (average store size being 750 square feet).

The company intends to capitalise on the buoyancy in the organised retail sector, which is expected to grow at a CAGR of 40 per cent for the next two years, partly helped by doubling the number of stores by end of FY10.

Foray into the women's and kids wear segment, acquisition of regional brands and entry into international markets should provide the next leg of growth to the company and enable it to sustain high margins.

Premium brand for the masses
Koutons provides a complete range of men's apparel under the brands Koutons and Charlie Outlaw. Its brands are positioned as ''value for money, but high on fashion'' and target the lifestyle aspirations of middle-class consumers falling in the 22-45 age group.

The company's manufacturing-led retail model eliminates mark-ups (which can range about 25-40 per cent of the final price) at multiple stages by intermediaries, distributors, wholesalers and retailers across the supply chain.

Also, given the volumes it generates (sales of 19.1 million garments in FY08 against 9.2 million in FY07), Koutons holds significant pricing power with its vendors.

Both these factors help the company earn enviable margins (OPM of over 19 per cent in FY08), even after passing on a substantial part of the savings to its customers in the form of lower prices.

Scalable unique business model
Koutons' franchisee model is different from its peers as it offers its franchisee minimum guaranteed payments covering lease rentals, employee costs, and other establishment costs apart from incentivised sales.

Products are consigned to the franchisees, who do not bear the inventory risk except for pilferage--the risk of unsold stock remains with Koutons.

The company collects a security deposit (bearing nominal interest rate) from the franchisee towards the apparels that the latter stocks at the outlet. This model is highly attractive for franchisees who seek security and low investment, which is reflected in the rapid ramp up as well as the fact that franchisee churn rate has cumulatively been less than 1.5 per cent since inception.

Effecting required change
Koutons has manufacturing capacity of 12.36 million pieces per annum and finishing capacity of 22.92 million pieces per annum with 18 in-house manufacturing / finishing units and 14 warehouses spread across Gurgaon.

The company plans to shift 7-8 of its smaller manufacturing units to an integrated unit at Gurgoan panning 4.5 lakh square feet by April 2009. This move would improve production efficiencies and reduce the lease rental costs (Rs 4-5 crore per year), which increase to the tune of 10-15 per cent every three years.

Also, with the advent of VAT and rationalisation of sales taxes, the company would be setting up warehouses in the eastern and southern part of India as well, which would further improve its logistical capabilities.

Growth drivers
With 58 per cent of the Rs 20,000 crore apparel market consisting of ladies and kids wear, where margins are typically higher than those in the men's segment, it was only logical for Koutons to cash in on this opportunity.

In FY08, the company introduced a line of women's and kids wear under the Les femme and Koutons Junior brands, respectively through its existing outlets. The company plans to open 100 EBOs (Exclusive Brand Outlets) each under both these brands in FY09 and double that number to 200 each in FY10. Its acquisition of the Upper Class brand, which has a strong foothold in the ladies apparel segment, will give the company a head start in its women's wear business.

Koutons would be enlarging its product portfolio in FY09 by adding categories like accessories and handbags for women along with belts and shoes for men with a view to increase the footfalls in the outlets and thereby assist cross-selling.

Koutons' recent announcement to enter West Asia by the end of 2008, whereby it plans to open 30 EBOs each of Koutons and Charlie brand, should provide the company with global visibility.

Concerns
Due to the nature of its business, Koutons finds large sum of money blocked up in the form of working capital--in FY08, working capital amounted to almost 68 per cent of annual sales. While this ratio is typically high for retail players, for Koutons, it may remain so due to the rapid expansion of its network.

The company though has been working on enhancing its IT capabilities for better management. This has helped it to bring down the average inventory days from 213 in FY07 to 202 in FY08.

On the other hand, to lessen the risk of stock obsolescence, the company has been deploying the strategy of shifting the unsold stock from metros to tier III towns, thanks to the time lag in fashion trends between metros and tier III towns.

Thirdly, Koutons and Charlie Outlaw have historically been strong regional brands in north and north-western India and replicating this success story in the South is yet to be seen. But with Koutons' sound business strategy, clear road-map of its targets and excellent execution skills, these fears tend to undermine. 
 

VOLUME PLAY
(Rs crore)	FY08	FY 09E	FY 10E
Net sales	793.50	1,350.00	1,830.00
OPM (%)	19.20	18.10	18.30
Net profit	69.09	112.00	163.00
EPS (Rs)	22.51	36.66	53.36
PE (x)	33.20	20.40	14.00
FY09 & FY10 are analysts estimates

Investment rationale
Koutons is amongst the largest branded apparel manufacturer and retailer with a reach in 450 cities across India.

Although competition in the retail apparel segment is heating up, the inherent advantage of Koutons' model - backward integration, positioning (value proposition) and first mover advantage - is not easy to replicate within a short period of time.

On the back of the company's aggressive rollout plan and diversification to high-margin segments, the company enjoys better valuations than its peers like Kewal Kiran and Zodiac Clothing, although not strictly comparable. 
 

MARCHING AHEAD
Particulars	Koutons	Kewal  Kiran	Provogue**	Zodiac Clothing**
Net sales*	102.00%	82.40%	43.60%	27.30%
Net profit*	229.60%	78.70%	53.30%	55.50%
P/E ^	20.2	12.1	40.3***	10.2
* CAGR (FY05-FY08) ** CAGR based on FY08 estimates *** Excluding value of Prozone SPV from CMP ^ On one-year forward EPS estimates

The discount to Koutons' valuation vis-à-vis Provogue (considering only the retail business) should hopefully narrow down going forward. Even if it doesn't, Koutons' growth prospects (revenue and earnings are expected to grow at CAGRs of 52 per cent and 53.6 per cent between FY08-10E, respectively) provides comfort. The stock has the potential to deliver returns of 25-30 per cent annually over the next two years.