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Pantaloon: The high interest effect - Views on News from Equitymaster
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Pantaloon: The high interest effect
May 14, 2007

Performance summary
Pantaloon Retail declared robust results for the third quarter ended March 2007 (fiscal year ending June 2007). While the topline grew by 89% YoY, operating profits registered a 57% YoY growth. Rising raw material costs and staff costs have impacted the operating margins and this coupled with the high interest cost has resulted in the bottomline growing at a much lower pace than the topline.

Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 4,554 8,610 89.1% 12,926 22,171 71.5%
Expenditure 4,169 8,008 92.1% 11,879 20,583 73.3%
Operating profit (EBDITA) 385 603 56.6% 1048 1588 51.6%
EBDITA margin (%) 8.5% 7.0%   8.1% 7.2%  
Other income 5 9 102.2% 12 742 5910.7%
Interest 101 229 127.2% 237 561 136.3%
Depreciation 59 93 59.2% 142 243 70.7%
Profit before tax 230 290 25.9% 680 1,528 124.5%
Tax 68 103 51.4% 197 514 160.8%
Profit after tax/(loss) 162 187 15.3% 483 1,013 109.7%
Net profit margin (%) 3.6% 2.2%   3.7% 4.6%  
No. of shares (m) 141 134   141 134  
Diluted earnings per share (Rs)*         9.0  
Price to earnings ratio (x)         45.8  
(* trailing 12-months)

What is the company’s business?
Incorporated in 1987, Pantaloon Retail is among the pioneers in chain retailing. It is the largest retailer in the country having over 331 stores across segments in over 40 cities across the country, constituting 5 m square feet of retail space. Starting out with dedicated apparel stores (Pantaloon), the company has stores across the cross-section of the society. The company’s business is broadly divided into 2 segments, Lifestyle and Value retailing. On the apparels front it has Pantaloon (31 departmental stores), Central Malls (4 seamless malls as well as its other concepts). These stores can be classified under ‘Lifestyle Retailing’. On the general merchandise front it has Big Bazaar (51hypermarkets), Food Bazaar (77 supermarkets) and Fashion Station (5 fashion stores) and other delivery formats. These fall under ‘Value Retailing’.

The board has approved setting up of two subsidiaries with an investment of up to Rs 50 m each. One will sell branded consumer goods (associated with cricketer Sachin Tendulkar) and the other for mobile communication equipment.

What has driven performance in 3QFY07?
Impressive topline growth: The company has reported a stellar topline growth during 3QFY07 on account of growth across segments. As can be seen in the table below, the robust 89% YoY growth in the topline in 3QFY07 was achieved on account of almost 88% YoY growth in Value Retailing and 85% YoY growth in Lifestyle Retailing. The topline growth has also been driven by appreciable revenue growth reported by existing stores. The existing stores of Value Retailing segment reported 10% YoY growth, while the Lifestyle Retailing segment reported almost 21% YoY growth in sales.

Segmental information
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Value Retailing 2,979 5,585 87.5% 8,817 15,477 75.5%
PBIT 234 422 80.6% 663 1,181 78.2%
Lifestyle Retailing 1,528 2,833 85.4% 3,958 6,307 59.3%
PBIT 215 364 69.3% 569 868 52.6%
Others 119 303 154.2% 380 679 78.5%

Cost pressures evident: The company’s operating costs grew faster than the topline putting downward pressure on operating margins of the company. While raw material costs 9as percentage of sales) witnessed a rise, the staff costs (increased by 80 basis points) also played its part in denting the margins. The increase in staff costs was not only due to the expansion of outlets but also on account of inflationary pressure. Also, the industry is going through a high attrition phase and in order to retain talent, the company has to revise staff costs upwards on a time-to-time basis.

Cost break-up (as % of sales)
Particulars 3QFY06 3QFY07 9mFY06 9mFY07
Raw materials consumed 66.6% 67.5% 67.2% 67.1%
Staff cost 5.4% 6.2% 5.2% 6.7%
Other expenses 19.5% 19.3% 19.5% 19.0%

Net margin blues: Though the other income was higher by 102% YoY, the bottomline grew at a slower pace than the topline owing to higher interest costs and tax outgo. Though the net margins contracted by 150 basis points during 3QFY07, for 9mFY07 they have expanded by almost 90 basis points owing to the higher other income. If one were to exclude the other income effect, net margins have actually witnessed a sharp decline (240 basis points or 2.4%) during 9mFY07.

What to expect?
At the current price of Rs 412, the stock is trading at a price to earnings multiple of 45.8 times its trailing twelve months earnings. The management has aggressive growth plans to invest about Rs 40 bn in the next one year to expand its different retail chains as a part of its strategy to touch revenues of Rs 300 bn by FY11. However, the execution risk remains a concern. More importantly, the industry is highly capital-intensive and is susceptible to fluctuations in consumer spending. Therefore, we advise investors to exercise caution.

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