Retail sector: From sunrise to sunset? - Views on News from Equitymaster

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Retail sector: From sunrise to sunset?

Jan 15, 2009

Pegged to be the sunrise sector until a couple of months back, the global economic slump has hurt the booming retail sector's growth prospects like never before. The retailing business is linked to not just the consumption patterns and changing preferences of consumers but also to availability of disposable income in their hands. The same gets impacted as the economic growth decelerates. In this article, we take a look at factors that impacted growth of retail sector in CY08.Reduced footfalls, lower volumes: The economic slowdown led to frozen recruitments, loss of jobs and negligible salary hikes. Insecurity about the near future impacted the customers' ability to spend. This had an indirect but severe impact on the take offs for retailers who witnessed one of the worst topline performances even during the peak festival season.

Cost pressure refused to abate: To tap the available potential and increase penetration, retailers had lined up huge capex plans. With the increase in number of store roll out all cost heads such as personnel cost, rentals etc. tend to increase. With increased scale of operation economies of scale are expected to filter in. However, on account of inflationary pressures in the recent past, the cost of operation was on a higher side. Also, in case of retail business, rent is one of the major costs comprising around 10% of sales. The increase in demand for retail space and higher construction costs inflated the rental rates that exerted further pressure on margins.

To fund their ambitious expansion plans, retailers either opted to raise capital by diluting equity or leveraged their balance sheets. The move to expand scale of operation, expand customer base and extend reach across geographies further exerted pressure on the wafer thin margins in the form of increased finance and replacement cost (depreciation).

  • Also read - FMCG: Braveheart of 2008

    The way forward...

    Correction in realty prices may provide some relief: With the availability of retail space exceeding demand in recent months, rentals have come down by 25% to 30% in select areas. This may provide some relief to the retailers. Long term expansion plans can now be accelerated. But the question remains as to whether they have sufficient funds to bank upon the available opportunity?

    Changing strategies: The retailers are changing their strategies to attract more customers, improve efficiency and reduce costs. Apart from venturing into different formats and segments, they are also integrating services to improve customer service and contain costs with efficient logistics and sourcing facilities in place. These moves are directed towards mitigating competitive price pressures and improve stock turnaround time. It has also been observed that retailers are opting for private labels as a differentiating factor to provide cushion to declining profitability. To improve reach while containing costs, retailers are also trying out smaller size formats, franchisee route etc.

    Conversion ratio less likely to recuperate: While cost pressures such as rentals have eased, the numbers of footfalls and conversion ratio have also dropped. The same may not improve in near future on account of increased employment insecurity and poor spending power. The retail players are now busy liquidating their inventory. As increase in cash flow will provide finances to the companies to carry on their operations smoothly and also move ahead with their outlined plans. This may also help them shore up the return on invested capital.

    To conclude...
    Currently, the retail sector in India is in a nascent stage. Having said that, a prolonged economic slowdown can severely impact the growth of the sector going forward. The same has been visible as players in the sector have reported dismal numbers during the last quarter ended September 2008. Meanwhile, players who raced to capture the available potential and had lined up huge expansion plans to tap the potential market are also in trouble.

    The present retail environment is very challenging. Though near to medium term outlook is not so heartening, the long term growth prospects of the sector are intact. The same is on account of expectations of revival in economic growth. There is immense opportunity, as consumption levels are extremely low and aspiration levels are high. Consumers are now showing a growing preference for organised retail that will result in increased penetration. With the change in the economic cycle, the sector will find takers over the long run.

  • Also read - Is Satyam a cigar butt?

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