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Retail: Sailing through hard times - Views on News from Equitymaster
 
 
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  • Jun 17, 2009

    Retail: Sailing through hard times

    The retail sector was growing at the rate of 30% to 40% and was expected to continue growing at the same rate going forward. Transition from the traditional retail to organised retailing was expected to take place on the back of changing consumer mindset, lower penetration levels, changing demographic mix, media proliferation, etc. The organised retail was expected to receive investments to the tune of US$ 25 bn over the next 4 to 5 years. But the financial crisis that impacted economic growth put breaks on the retail sector growth.

    The investment plans were foiled by the problems on the real estate front and policy issues. Further, there is likely to be a delay in expansion plans owing to slowing demand and high cost of funds. The retailing business is linked to not just the consumption patterns and changing preferences of consumers but also to amount of disposable income in their hands. The same gets impacted as the economic growth decelerates. The industry had lined up huge expansion plans, which had to be deferred owing to slowing sales and credit availability issues. Of the planned investments in terms of store openings and retail space, the industry has reached a target of 60% to 70%. The organised retail penetration was expected to touch 16% by 2012 from the current 5%. But slowing growth has impacted expansion plans and consumption. The same is likely to limit organised retail penetration to 10% to 11%.

    The disappointing retail growth is not just attributed to high rentals, policy issues and poor infrastructure but retailers have themselves dug their own grave. Here is how it happened:

    They crowded out locations: Before entering any business, it is crucial for an entrepreneur to conduct market research and feasibility studies. Retailers, mall developers to some extent failed to do so. It is not just important to select the right location at the right price but also to build suitable infrastructure. For instance, the booming IT and real estate sector were driving factors for upcoming malls, especially the Gurgaon region. The locality has seen massive development in the past few years. However, too many malls had come up, which were not in keeping with the population in that region. Moreover, the infrastructure was not planned considering the locality, region, cost structure, etc. Replicating western models in India only leads to cost escalation. Instead, malls need to be designed considering local conditions.

    Having said that, while malls have not been a true success story, standalone stores of retailers have also been facing problems, the chief one being clustering. For instance, one may find 4 to 5 retailers operating within 3 kms to 5 kms of an area and few regions devoid of retail outlets. Consider this example. Thane is a place in the northeast of Mumbai. In the extended part of Thane, one gets to see big size stores such as Spinach, Big Bazaar, D- Mart and the like, which cater to residents within 3 to 5 kms of the area. On the other hand, Ghatkopar, a central suburban area, is devoid of malls or modern retailers. Thus, some regions or locations are facing problems of plenty, while some are untouched locations.

    They are not as efficient as mom and pop stores: Traditional retail outlets called as mom and pop stores or kirana stores are competitive as compared to the modern retail format. Modern retail formats failed to provide services that match those of kirana stores. While consumers are showing growing acceptance for new age retailing, a complete shift has not yet taken place. Considering the lifestyle and social set up in India, the business capacity of traditional retailers is better. They understand customers' needs and preferences well owing to personal (one to one) interaction. Their model is also cost efficient and well established over the generations. They offer convenience (transportation, product range, etc), personalized services in terms of home service on placement of order and credit. The new age retail outlets are still struggling to get their model right in providing an alternative to neighbourhood retailers.

    Source: Equitymaster

    They outlined expansion plans beyond capacity: The retail players have lined up huge expansion plans. The players were not only expanding scale of operation but were also venturing into new formats and style of retailing to expand customer base and extend reach across geographies. The huge capex plans have exerted pressure on net margins on account of increased interest costs and depreciation charges. Further, the old formats have not matured enough to support their own growth. Retailers raised capital either by diluting equity or leveraging their balance sheets. The interest coverage ratio has fallen indicating that the comfort level in terms of payment of interest on outstanding debt is descending.

    To conclude...
    Amidst these issues, slowing economy has impacted growth prospects of the sector, which is more dependent on disposable income in the hands of the consumers. The present retail environment is very challenging. Existing and new entrants have a lesson to learn from the mistakes done by discount retailer Subhiksha (now a distressed retailer). This would involve outlining plans depending upon what the balance sheet can take. There is a hard lesson to be learnt from the struggling retailer Vishal Retail too, which is also facing issues of financial crunch. Both these retailers had outlined plans way beyond their balance strength. In order to thrive in these hard times, having sufficient cash flows is the order of the day.

    So those retailers who are able to rationalise their costs and increase footfalls to cushion margins will see enhancement in cash flows. With that they would be better placed to reduce debt burden or service the same. Though the 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 and low penetration levels.

     

     

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