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Trent: Other income saves the day! - Views on News from Equitymaster
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Trent: Other income saves the day!
Nov 14, 2007

Performance summary
  • Topline declines marginally during 2QFY08, while in 1HFY08 the same grows by 7% YoY.
  • Rising costs and subdued topline performance leads to 24% YoY fall in operating profits in 2QFY08.

  • PAT grows by 14% YoY aided by 42% YoY growth in other income.

  • If other income is excluded, net profit declines by 20% YoY owing to strained EBITDA margins.

Financial performance snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 1,203 1,195 -0.7% 2,254 2,411 7.0%
Expenditure 1,105 1,120 1.4% 2,076 2,236 7.7%
Operating profit (EBDITA) 98 75 -23.8% 178 175 -1.2%
EBDITA margin (%) 8.1% 6.2%   7.9% 7.3%  
Other income 44 62 42.2% 75 82 9.4%
Interest 3 3 1.2% 7 7 -7.2%
Depreciation & amortisation 26 21 -18.9% 40 35 -11.2%
Profit before tax 112 112 -0.1% 206 216 4.8%
Tax 32 21 -34.7% 60 47 -22.4%
Profit after tax 80 91 13.8% 146 169 16.0%
Net profit margin (%) 6.7% 7.6%   6.5% 7.0%  
No. of shares (m)       14 19  
Diluted earnings per share (Rs)*         20.9  
P/E (x)         24.5  
* trailing 12-months

What is the company’s business?
Trent Limited commenced operations in 1998 with a single store under the brand name ‘Westside’, which specialised in apparels. Over the years, the company has increased its product offerings and has moved into products like footwear, cosmetics, perfumes, household accessories and gifts, all in the non-food segment. In the food segment, the company, in October 2004, launched its first store – ‘Star India Bazaar’ – in Ahmedabad. The store provides staple foods, beverages, health and beauty products, vegetables, fruits, dairy products, consumer electronics and household items. In 2005, it acquired Landmark, India's largest book and music retailer. In a recently signed deal, Trent has agreed to anchor 12 malls set up by DLF Universal Ltd across the country, at its Westside, Landmark and Star India Bazaar outlets. This amounts to about 27 locations, totalling to about a million square feet of space. The company has recently signed a 50:50 venture with Benetton group for setting up 100 fashion show rooms in India that are known world over as Sisley stores.

What has driven performance in 2QFY08?
Surprises on topline: During the quarter while the players in the retail sector have witnessed growth in topline Trent has surprised with a marginal decline in the topline. This was not expected as the retail sector is at a nascent stage in India and is growing at CAGR of 40%. In the early stages, generally it is observed that companies are able to report good topline growth either on account of volume growth or increase in retail space. A fall in topline will come only when the company shuts down few of its stores. However, Trent is on an expansion spree. As the company does not provide details, the exact reason for the subdued performance is not known.

In 1HFY08, the company’s topline has grown by 7% YoY, despite lackluster performance during the quarter under review. Had not the company witnessed marginal decline in topline during 2QFY08 the performance in the first half would have been far better.

Costs pressurise margins: The operating margins of the company contracted by 190 basis points (1.9%) in 2QFY08 on account of increased competition, scale-up in the cost of operations and compressed topline growth. Employee costs have been taking a toll on retailers’ margins across the industry and Trent is no exception to the same. The 50 basis points (0.5%) surge in the company’s staff cost during 2QFY08 is on account of attrition. Given that it is a key problem faced by the industry, companies are forced to revise wages and salaries upwards to retain talent and The other reason for higher staff costs is the huge expansion plans being undertaken by the company. Ad spends also increased as Trent aimed to improve visibility of its products and create brand recall in the mind of the customers with the increase in competition.

Though in 1HFY08, the company witnessed a respectable topline growth, costs continued to grow at a faster pace as compared to growth in net sales resulting in a 60 basis points (0.6%) contraction in EBITDA margins. Though in the first half, the company was able to curtail most of the operating costs, employee costs increased significantly putting downward pressure on operating margins.

Cost break-up
As a % of net sales 2QFY07 2QFY08 1HFY07 1HFY08
(Increase)/Decrease stock in trade -13.8% -1.8% -10.1% 0.0%
Consumption of raw materials 0.5% 0.4% 0.6% 0.4%
Staff cost 6.2% 6.7% 6.3% 7.1%
Advertising and sales promotion expenses 8.5% 8.7% 9.5% 8.3%
Other expenditure 64.9% 51.5% 60.4% 49.6%
Purchase of finished products 25.5% 28.4% 25.5% 27.3%

Other income boost: Despite the unimpressive performance at the topline and operating level, bottomline grew by 14% YoY during 2QFY08 on account of 42% YoY growth in other income. Lower tax expenses were also instrumental in contributing to the bottomline growth. If one excludes other income, the net profit has actually declined by almost 20% YoY.

What to expect?
At the current price of Rs 512, the stock is trading at a price to earnings multiple of 25 times its trailing twelve months earnings. The company recently came up with a rights issue of 1:5 to fund its expansion plans (plans to set up 30 new stores), upgradation and expansion of some of the existing stores over the next three years. While the management has chalked out massive expansion plans, which are expected to augur well from a long-term perspective, the execution risk with respect to the same remains a concern. Considering the rising competition and fluctuations in consumer spending, increasing and maintaining current level of operations will be the key issue till it achieves scale. Considering these factors and stretched valuations, we advise investors to exercise caution.

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