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Retail: Not so easy going - Views on News from Equitymaster
 
 
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  • Jun 24, 2009

    Retail: Not so easy going

    In our previous article we highlighted the factors that led to disappointing retail growth. Apart from those mistakes, there is an operational issue that also hurts the ability to reward shareholders for the capital invested.

    Source: Equitymaster Research
    Retailing is widely considered as working capital intensive industry. There is a time lag between payments made to the suppliers and payments received from customers. During their growth phase, they need to book inventory before stores roll out. Thus, huge amount of capital gets blocked in inventory. Further inefficient supply chain system and poor infrastructure necessities increase in fund requirements.

    Let's see how...
    The retailer is the final link in the supply chain. Goods are not only transported but need to be stocked. Moreover, retailers, to be competitive, need to ensure that the goods reach the consumers when desired and are in proper condition. All of this necessitates an efficient supply chain system. However, in India the players are largely dependent on a traditional supply chain network that has a host of intermediaries. On the other hand, in developed countries players rely on third party logistics providers. The same is lacking in India on account of the poor state of infrastructure such as road transport, electricity, a well connected cold chain and warehousing infrastructure, ports etc. The inadequate state of the infrastructure leads to pilferage during transportation. Cost of intermediation in India is high. In India, logistics cost is around 13%, comparatively higher than the developed countries (Source: Indo-Italian Chamber of Commerce). The same in developed countries like the US, comprises of 7% to 9% of the cost of the final product. All of this leads to a high cost of operations.

    To fund daily operations and expansion plans, retailers need to knock doors of financial institutions. High gearing exerts pressure on the wafer thin margins of the retailers. Retailers also raise capital by diluting equity to fund their ambitious expansion plans, which often can lead to a costlier mode of funding thereby restricting the returns to shareholders.

    While retailers were struggling to gain a foothold in the industry, the global financial crisis added to the woes of the companies. Availability of credit became a problem. Even if funding was available, the servicing of such high cost funds was another problem. The liquidity issues were further ballooned by slowing sales that resulted in lower inventory turnover and increasing working capital requirements for retailers.

    The increased cost of operations dents margins...
    Earlier, to shorten the working capital cycle and reduce inventory on books, retailers entered into strategic contracts with suppliers or tied up with logistics provider, as then footfalls were not an issue.

    However, now falling footfalls have impacted sales and hence inventory turnover. To free blocked capital, retailers offered huge discounts. They have also been trying to curtail expenses by re-aligning responsibilities and store staff.

    Source: Equitymaster Research Source: Equitymaster Research

    Deep discounts, stiff competition and high cost of operations have already impacted the profitability of the players. A check on costs did not fully compensate lower footfalls. Further, interest costs significantly dented the bottomline as the increased working capital requirement and expansion capital was being financed through sizeable debt. Few have also run into losses in FY09.

    Despite of it being a tough year for the retail sector, India tops the rankings of A.T. Kearney's Global Retail Development Index. India is still the most attractive destination for international retailers looking to expand into emerging markets on account of lower penetration levels, and it being a stable and stronger economy as compared to other emerging markets.

    The way ahead...
    There is immense opportunity, as consumption levels are extremely low and aspiration levels high. From a long term standpoint we do not doubt the growth of the retail sector, but the real boost to the sector's growth would be the result of a changed consumer attitude with changing lifestyle. Acceptance of modern retail formats is visible more in the new generation. Going forward, this new generation is likely to give a further fillip to the sector growth. Moreover, economic revival is likely to lend a helping hand to the retailers to sustain and improve sales. Retailers can also provide cushion to margins. Apart from cost control measures and efforts to improve inventory cycle, retailers can re-negotiate the rentals, re-evaluate store viability and expansion plans to expand margins. While long term growth prospects are positive, the short to medium term scenario remains a bit challenging.

     

     

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