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Retailing: Upsides from here? - Views on News from Equitymaster
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  • Jun 25, 2008

    Retailing: Upsides from here?

    Retail players are the link between manufacturers and end consumers. As retailers eliminate the middlemen, goods are sourced at cheaper rates. The benefits of shorter supply chain are enjoyed by all the three parties involved, manufacturer saves on commission cost, end consumer gets the product as cheaper rates and the retailer enjoys retailing margins. However, having to negotiate at both the ends, the retailers are struggling to sustain their margins.

    It is well understood that retailing is a volume game and one benefits with increased sales on account of economies of scale that kick in. However, a look at the three major retailers with different formats and scale of operation does not reveal the same.

    Scale of operation
    Sq feet m FY07 CAGR of past 3 years (%)
    Trent 0.7 27.8%
    Pantaloon 5.5 71.0%
    Shopper's Stop 1.2 21.0%

    For our analysis, we have considered Pantaloon, Shoppers Stop and Trent. Among the three, Trent is the smallest in term of retailing space. However, in terms of margins, earnings per share and returns to shareholders, it scores better. The reason behind the same is the nature of operation, apart from the strategies adopted and plans implemented.

    Difference in the nature of operation
    Trent and Shoppers Stop have focused more on the lifestyle retailing business, where volumes are not hefty but offer lucrative margins. They cater to middle and high-income groups. This is unlike Pantaloon that concentrates more on monthly consumption patterns across income classes. In the case of the latter, one of the reasons for the poor net margins is the lower gross margin, due to the nature of the business.

    Difference in profitability
    Availability of land at a right location and price to build or lease retail space is a prime requirement for a retailer. The recent boom in the real estate and construction activity is bridging the shortage of quality real estate. However, the delay in land acquisitions and clearances, and delivery of the agreed retail space by builders has deferred the expansion plans of the retailers impacting their sales growth. Further, the increase in demand for retail space and higher construction costs have inflated the rental rates. Though, most of these retailers have signed up considerable retail space at lower than the current market rates, delay in execution from the developersí side is impacting their growth. While a larger scale of operation has helped source goods at cheaper costs and saved on transportation and logistics, the rising fuel charges have also impacted the operating margins.

    Particularly in case of value retailer, as it is difficult to pass on the hike in cost of operation, the slim margins are further eroded. Moreover, rising competition is restricting players from increasing price points of the goods sold.

    Further, the retail players have lined up huge expansion plans. The players are not only expanding scale of operation but are also venturing into new formats and style of retailing to expand customer base and extend reach across geographies. These expansion plans have further exerted pressure on net margins on account of increased finance and replacement cost (depreciation). Further, the old formats have not matured enough to support their own growth. Retailers are raising capital either by diluting equity or leveraging their balance sheets (average debt to equity ratio in FY07 was 0.6 times) to fund expansion plans. Until the stores are able to fund their own growth and generate surplus cash for expansion, margins will remain under pressure.

    Not to forget, that the increasing competition is also taking a toll on margins. While, Pantaloon, Shoppers Stop and Trent operate different formats, they ultimately compete with each other in some specific product categories such as apparels. The move to gain larger share of customersí wallet is emptying the retailersí wallet. This in turn is impacting the returns for shareholders.

    What to expect?
    Considering the inflationary situation witnessed by the economy the discretionary spending is expected to take a hit in the medium term. In the value retail business, the growth may slowdown but will continue to fetch volumes, as the segment mainly comprises of food and grocery items and daily necessities. However, volumes in case of lifestyle retail might get impacted. Further, hike in interest rates will eat into the earnings of the leveraged players, in turn exerting pressure on already strained margins. Considering the sector prospects in near to medium term the retail sector does not seem to be very lucrative in terms of creating value for shareholders.

  • Also read - How to identify retailing stocks



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