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Trent: Financial overview - Views on News from Equitymaster
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Trent: Financial overview
Nov 21, 2007

On account of change in lifestyle, entry of leading international brands, increased awareness and access to media, the Indian consumer has been showing a preference for different and new merchandise with convenience in shopping. In this article, we shall take a look at apparel major’s performance over the past 4 years. Look at revenues: Apparel retailing is the country’s second largest opportunity for the organised retailers after food and groceries. The company derives majority of the revenues from the apparel segment. Almost 90% of the apparels sold at the store are made or procured as per Westside specifications and sold exclusively at Westside stores under the owned labels (Westside or sub-brands of Westside like SRC, Westsport, 2Fast4U, Richmond etc.) The company’s brands are well recognized and private labels do act as a differentiating factor.

The apparel market in India grew at a CAGR of 11%, while organised apparel market grew at the rate of 30% to in the last 4 to 5 years. The company has been growing in line with the industry. In fact a tad higher, the operating revenues of the company have witnessed a CAGR of 42% YoY. In the past, competition was not stiff and there were few recognized players. However, with the boom in the sector, new players, including international players are foraying into this segment (evaluating options to be a part of the emerging market). Though we expect company to continue to grow in line with the industry, it will have to face stiff competition going forward.

The company’s revenue per sq ft has also witnessed CAGR of 10% in past 4 years, mainly on account of pricing edge that private labels have. However, reliance on privately owned label has its own downsides as it may affect customer entry and in turn, the conversion ratio, thus impacting revenue growth. Recently, the company has tied up with Bentton to cater to premium segment, in order to reduce dependence on own brands while targeting high-end premium segment.

Particulars FY03 FY04 FY05 FY06 FY07 CAGR 4 yrs
Total operating revenues 1,054 1,497 2,315 3,437 4,520 43.9%
Revenue per sq ft 4,408 4,473 4,819 5,728 6,466 10.1%

Private labels: Private labels are brands created by retailers. As they are bought at lower prices, retailers are able to pass on the cost savings to the consumers while still generating higher revenues and margins than on comparable branded products. Trent brands its products under the same name and focuses on building in-store brands, that is, its own labels.

The owned labels not only have better margins but also help wield control over merchandising and supply chain costs and the required changes and modifications to suit the changing customer profile on a timely basis. Further, it provides more flexibility to the retailer in terms of pricing of the merchandise and helps control the stock of inventory in a better way.

Particulars FY03 FY04 FY05 FY06 FY07 CAGR 4 yrs
Operating expenses 1,029 1,421 2,170 3,135 4,221 42.3%
Operating profit 25 76 145 302 299 85.5%
EBITDA margin (%) 2.4% 5.1% 6.3% 8.8% 6.6%  

The company has done exceedingly well in expanding its operating profits. However in FY07, the same witnessed a 2.2% contraction as compared to FY06 on account of scaling costs of operation. The costs of operation are rising on account of increasing competition and sky rocketing rentals and property prices, rising freight and fuel expenses, resulting into increased selling and distribution expenses. Employee costs have also been moving upwards, attributed not only to the expansion of outlets, but also due to pay hikes and high attrition rates. In order to curtail the high attrition rates, players have to review salaries/wages on a time-to-time basis. Further, increasing competition has led to increased ad spends in order to get the visibility for its products and position their brands in the minds of the customers.

The hike in costs is justified as the company is in expansion spree and it is an industry wide issue. Going forward, costs are expected to head northwards and rise in electricity charges and levy of the service tax on rentals has only aggravated the problem. Thus, players who will be able to produce designs as per the customer’s changing tastes and preferences and have developed an efficient supply chain system to cater to the needs of the consumers, while being cost effective, will have the competitive advantage.

A zero debt company: The management has completed its expansion programme by infusing further capital. During 1QFY08, it 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. The company is nearly debt free. Infact, it uses its significant cash balance to earn net interest income. The company was able to maintain significant cash balances (almost Rs 1.1 bn) until FY04, which only led to higher other income. As the company has raised equity to fund its expansion plans, we expect interest cost to be on a lower side going forward. However, depreciation provisioning will continue to move up, reflecting the increase in the number of stores.

Particulars FY03 FY04 FY05 FY06 FY07 CAGR 4 yrs
Other income 146 167 146 139 204 8.7%
Net profit 168 172 191 244 324 17.8%
Net margin (%) 14.0% 10.3% 7.7% 6.8% 6.9%  

As the company starts utilising its parked funds to expand, its other income and interest income will get impacted to some extent. Just to put things in perspective, whenever other income has shot up, Trent's net profit growth has almost certainly followed in tandem. This indicates the company’s dependence on its non-core operations to pep up its overall profitability.

Way forward
The company has hitherto focused on strategic expansions, and has grown at a slower pace than its peers. As mentioned earlier, with a few exceptions, almost all apparels are from private labels, due to which company’s gross margins compare favorably with its peers. However, the increasing competition and rising cost of operation is likely to continue to pressurise margins. Further, Trent lacks the execution pace of peers like Pantaloon Retail and Shopper’s Stop. In our view, though Trent will be among the foremost beneficiaries of the retail boom going forward, all positives are seemingly factored in the price. As such, the risk reward ratio is skewed towards risk and investors should thus practice caution.

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