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Trent: Revenue train continues to chug

Feb 8, 2005

Performance Summary
Tata group's retailing arm, Trent Limited, declared its December quarter numbers recently. The company grew its revenues in strong double digits (up 67% YoY) during the quarter, continuing the trend it set in FY04 and 1HFY05. However, pressure on operating margins and lower other income saw the company reporting a marginal dip in bottomline. The company finished 9mFY05 with a 49% revenue growth and over 7% dip in bottomline.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 420 701 66.9% 1,148 1,711 49.1%
Expenditure 383 641 67.4% 1,039 1,582 52.2%
Operating profit (EBDITA) 37 61 61.7% 108 129 18.8%
EBDITA margin (%) 8.9% 8.6%   9.4% 7.5%  
Other income 33 16 -51.3% 75 69 -7.3%
Interest (net) 0 0 - 0 0 -
Depreciation 7 14 89.6% 22 31 43.6%
Profit before tax 63 62 -0.4% 161 167 3.4%
Tax 10 10 6.8% 31 45 47.3%
Extraordinary income/(expense)     - 1 0 -
Profit after tax 53 52 -1.7% 131 121 -7.4%
Net profit margin (%) 12.5% 7.4%   11.4% 7.1%  
No. of Shares (m) 13.1 13.1   13.1 13.1  
Diluted earnings per share* (x) 16.1 15.8   13.3 12.3  
P/E ratio (x)         43.9  
(* annualised)            

What is the company's business?
Starting out with one retail store under the brand name 'Westside' in Bangalore in April 1998, Trent has expanded its network to 16 stores across 11 cities. Specialising in apparels, Westside is positioned as a store for the family and is aimed at the middle and upper end of the mass market. Unlike other stores, Trent decided to have its own brands in apparels rather than take up franchises of established brands names like Arrow and Allen Solly. It has its own team of in-house designers who design exclusively for the store. Currently, a typical Westside store portfolio consists of menswear, womenswear, lingerie, kidswear, household accessories, footwear, cosmetics and perfumes. However, all merchandise at the stores, except cosmetics and perfumes, bears the Westside label. The company also launched its first hypermarket store (grocery, consumer goods, apparel, other durables) 'Star India Bazaar' in Ahmedabad, Gujarat in October 2004.

What has driven performance in 3QFY05?
Margin blues: The continuous opening of new stores is aiding the company's topline growth. While this is a positive, competitive pressure has forced the company to offer discounts, which has put pressure on margins. The company's cost of goods has gone up to 48.1% during 3QFY05 (44% in 3QFY04). This and lower returns from its liquid investments have impacted the bottomline. The margin pressure is likely to continue in the coming months as the company expands and opens new stores. It takes time to stabilise and grow in profitability.

Cost break-up
as a % of net sales 3QFY04 3QFY05 9mFY04 9mFY05
Total cost of goods 44.8% 48.1% 44.4% 48.0%
Staff cost 6.5% 5.5% 6.6% 6.2%
Advertisement & promotion 10.2% 12.6% 9.4% 10.5%
Store launch exp. amortised 1.0% 0.3% 1.1% 0.5%
Other expenditure 28.6% 24.8% 29.1% 27.3%
Total expenditure 91.1% 91.4% 90.6% 92.5%

New store momentum: Trent is looking at adding 3 more Westside stores in FY05, taking the total store tally to 19. The company launched its first hypermarket store (grocery, consumer goods, apparel, other durables) 'Star India Bazaar' in Ahmedabad, Gujarat in October end 2004. Though the company has not declared any numbers from this new store, we believe that this one store has clocked about Rs 190 m - Rs 200 m in revenues during the December quarter. One must remember that general store formats have always been able to attract larger footfalls and revenues than the sotre formats like Westside. Hence, revenues from these kinds of stores (if properly positioned) are likely to be higher. But on the flip side, the margins from this kind of business are absymal (in lower single digits). Trent has adopted a strategy to establish the Westside brand in all large towns with a population of over one lakh. This we believe, will continue to provide the necessary fillip to its topline and increase its economies of scale over the long term.

Segmental snapshot
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change FY04
Retailing 414 698 68.9% 1,117 1,701 52.3% 1,510
% contribution to revenues 97.6% 98.9% 96.5% 98.8% 1112.0%
PBIT 31 45 43.6% 73 110 51.3% 82
% contribution to PBIT 75.3% 85.7% 64.0% 83.7% 60.3%
PBIT margin (%) 7.5% 6.4% 6.5% 6.5% 5.4%
Income from current investments 10 8 -26.4% 41 21 -47.5%
% contribution to revenues 2.4% 1.1% 3.5% 1.2% 0.0%
PBIT 10 7 -26.8% 41 21 -47.6% 54
% contribution to PBIT 24.7% 14.3% 36.0% 16.3% 39.7%
PBIT margin (%) 100.0% 99.4% 100.0% 99.8% 99.7%
Total segment revenue 424 706 66.6% 1,158 1,723 48.7% 1,510
PBIT 41 52 26.2% 114 131 15.7% 136
PBIT margin (%) 9.7% 7.4% 9.8% 7.6% 9.0%

Cash rich: Most of this capex will be funded through internal accruals. The company had Rs 1.1 bn worth of cash plus liquid investments as per its FY04 annual report. This will mean a continuity of more or less zero interest costs going forward. However, depreciation provisioning will continue to move up, reflecting the increase in the number of stores.

Over the last five quarters
It is clear from the table below, that Trent has continued to grow revenues at a fast pace over the past one year consistently. However, it has not been able to keep its margin profile intact. Its operating margins have steadily declined indicating competitive pressure. Another thing to note is that whenever other income has shot up, Trent's net profit growth has almost certainly followed in tandem. It indicates that the company continues to depend heavily on its non-core operations to pep up its overall profitability. Just to put things in perspective, in FY04, Trent's other income made up for 53% of the company's profit before tax and extraordinary items (51% in 1HFY05).

3QFY04 4QFY04 1QFY05 2QFY05 3QFY05
Sales growth (YoY) 18.7% 31.9% 45.6% 33.4% 66.9%
OPM (%) 7.7% 5.3% 5.8% 7.6% 8.6%
Net profit growth (YoY) 83.8% 72.4% -23.8% 3.2% -1.7%
Other income growth (YoY) 149.7% 691.4% 20.2% 34.7% -51.3%

What to expect?
At Rs 541 the stock trades at 43.9 times annualised 9mFY05 earnings, market cap. to sales of 3.1x. The valuations are at the upper end of the spectrum. The optimism generated in the stock is largely owing to Trent's entry into the 'general store' model (much like Wal-Mart and Pantaloon's 'Big Bazaar'). It is estimated that revenues from this general store model will be far more than what it is deriving from its 'Westside' stores. The success of the general store is likely to see Trent add its muscle to this space. Consequently, its revenues are likely to take a significant leap in the coming years. However, profitability will be the key issue, till it achieves scale and settles down. In our view, though retail is the future, if one invests at this juncture, the risk reward ratio is unfavorable at least in the short term.

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