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Trent: On a new growth trajectory

Nov 17, 2004

Performance summary
Tata group's retailing arm, Trent Limited's market cap has gone up by over 22% since yesterday. What was the key reason for this? Let's take a look at the company's recent performance to get an idea. The company grew its revenues in strong double digits during the first half of FY05, continuing the trend it set in FY04. The company's topline was up over 38% during the period. However, pressure on operating margins resulted in the retailing major reporting an 11% dip in bottomline.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 406 541 33.4% 728 1,010 38.8%
Expenditure 372 500 34.5% 657 942 43.4%
Operating profit (EBDITA) 34 41 21.3% 71 68 -3.8%
EBDITA margin (%) 8.3% 7.6%   9.8% 6.8%  
Other income 19 26 34.7% 42 53 26.9%
Interest (net) 0 0 - 0 0 -
Depreciation 8 9 15.5% 14 17 19.8%
Profit before tax 45 58 28.0% 99 104 5.8%
Tax 10 21 108.7% 21 35 66.1%
Extraordinary income/(expense) 1 0 - 1 0 -
Profit after tax 36 37 3.2% 78 70 -11.3%
Net profit margin (%) 8.8% 6.8%   10.8% 6.9%  
No. of Shares (m) 13.1 13.1   13.1 13.1  
Diluted earnings per share* (x) 10.9 11.2   11.9 10.6  
P/E ratio (x)         46.7  
(* annualised)            

What is the company’s business?
Starting out with one retail store under the brand name ‘Westside’ in Bangalore in April 1998, Trent has expanded its network to 16 stores across 11 cities. Specialising in apparels, Westside is positioned as a store for the family and is aimed at the middle and upper end of the mass market. Unlike other stores, Trent decided to have its own brands in apparels rather than take up franchises of established brands names like Arrow and Allen Solly. It has its own team of in-house designers who design exclusively for the store. Currently, a typical Westside store portfolio consists of menswear, womenswear, lingerie, kidswear, household accessories, footwear, cosmetics and perfumes. However, all merchandise at the stores, except cosmetics and perfumes, bears the Westside label.

What has driven performance in 1HFY05?
Margin blues:  The continuous opening of new stores is aiding the company's topline growth. While this is a positive, competitive pressure has forced the company to offer discounts, which has put pressure on margins. The company's cost of goods has gone up to 48.0% during 1HFY05 (44.1% in 1HFY04). This and lower returns from its liquid investments have impacted the bottomline, which saw an 11% dip during the period under review.

Cost break-up
as a % of net sales 2QFY04 2QFY05 1HFY04 1HFY05
Total cost of goods 45.6% 50.1% 44.1% 48.0%
Staff cost 6.4% 6.3% 6.6% 6.6%
Advertisement & promotion 8.0% 8.4% 8.9% 9.0%
Store launch exp. amortised 2.2% 0.4% 1.2% 0.5%
Other expenditure 29.4% 27.2% 29.3% 29.0%
Total expenditure 91.7% 92.4% 90.2% 93.2%

New store momentum:  Trent is looking at adding 3 more Westside stores in FY05, taking the total store tally to 19. The company has launched its first hypermarket store (grocery, consumer goods, apparel, other durables) 'Star India Bazaar' in Ahmedabad, Gujarat in October end this year. Trent has adopted a strategy to establish the Westside brand in all large towns with a population of over one lakh. This we believe, will continue to provide the necessary fillip to its topline and increase its economies of scale over the long term.

Cash rich:  Most of this capex will be funded through internal accruals. The company had Rs 1.1 bn worth of cash plus liquid investments as per its FY04 annual report. This will mean a continuity of more or less zero interest costs going forward. However, depreciation provisioning will continue to move up, reflecting the increase in the number of stores.

Over the last few quarters
It is clear from the table below, that Trent has continued to grow revenues at a fast pace over the past one year consistently. However, it has not been able to keep its margin profile intact. Its operating margins have steadily declined indicating competitive pressure. Another thing to note is that whenever other income has shot up, Trent's net profit growth has almost certainly followed in tandem. It indicates that the company continues to depend heavily on its non-core operations to pep up its overall profitability. Just to put things in perspective, in FY04, Trent's other income made up for 53% of the company's profit before tax and extraordinary items (51% in 1HFY05).

  1QFY04 2QFY04 3QFY04 4QFY04 1QFY05 2QFY05
Sales growth (YoY) 61.2% 50.4% 18.7% 31.9% 45.6% 33.4%
OPM (%) 10.6% 7.3% 7.7% 5.3% 5.8% 7.6%
Net profit growth (YoY) 82.8% 41.6% 83.8% 72.4% -23.8% 3.2%
Other income growth (YoY) -47.3% 107.4% 149.7% 691.4% 20.2% 34.7%

What to expect?
At Rs 495, the stock trades at 46.7 times annualised 1HFY05 earnings, market cap. to sales of 3.2x. The valuations are at the upper end of the spectrum. So what is the reason for this buying interest?

The optimism generated in the stock is largely owing to Trent's entry into the 'general store' model (much like Wal-Mart and Pantaloon's 'Big Bazaar'). It is estimated that revenues from this general store model will be far more than what it is deriving from its 'Westside' stores. The success of the general store is likely to see Trent add its muscle to this space. Consequently, its revenues are likely to take a significant leap in the coming years. However, profitability will be the key issue, till it achieves scale and settles down.

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