• APRIL 6, 2001

Trent: Can it be a Gap Inc.?

Remember Warren Buffett, the billionaire investor whose insurance cum investment company Berkshire Hathway gave a return of over 25% to investors in the year 2000. This was the same year when the tech laden NASDAQ lost 40% of its market cap in its worst loss ever.

Guess what is Mr. Buffett buying into these days. A filing with the Securities and Exchange Commission, US shows that Berkshire Hathaway Inc. has spent US$ 204 m for 8 m shares of the San Francisco-based clothing retailer Gap Inc. Berkshire invested about US$ 3.5 bn last year in San Francisco-based bank giant Wells Fargo and US$ 181 m in electricity company GPU Inc.

For now let’s dwell only upon Mr. Buffett’s choice to buy into a retailing company. Since one of the world’s leading investment ‘guru’ is buying into retailing, let’s see what India has to offer. There are not many ‘listed’ retailing stores in the country. Pantaloon, Bombay Swadeshi Stores and Trent are three of the very few listed companies worth any mention. Let’s look in detail at Trent Limited (the Tata Group promoted retailing venture) versus Gap Inc.

Gap, Inc. is a global specialty retailer that operates stores selling casual apparel, personal care and other accessories for men, women and children. GPS's brands include Gap, Banana Republic and Old Navy. For the year FY01, GPS net sales rose by 18% to US$ 13.7 bn. Net profit fell 22% to US$ 878 m. Revenues reflect increased retail selling space and expansion of existing stores. Earnings were offset by decreased merchandise margins.

FY01 (US$ m) Gap Inc.Trent*
Net Profit8783
Operating profit margin 10.1%13.9%
Net profit margin6.4%7.6%#
Book value per share (US$)3.43.2
Return on equity34.5%6.4%
Return on assets13.9%5.9%
Current market price (US$)23.71.5
EPS (US$)1.00.2
P/e ratio (X)23.76.7
Price/sales (X)1.50.1
Price/book value (X)6.90.5
1 US$ = Rs 46.5
* estimated
# excluding other income

On the other hand Trent was born after the Tata’s sold out the ‘Lakme’ cosmetics business to Hindustan Lever Limited for a consideration of Rs 6 bn. The Group decided to venture into retailing and since 1998 has opened five ‘Westside’ stores in India. 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. Trent decided to have its own brands in apparels rather than go in for taking up franchises of established brand names like Arrow and Allen Solly, to keep its product prices affordable.

The company’s turnover in FY00 has grown at a CAGR of 193% over the last two years to Rs 336 m. Its profits have stood at a staid Rs 125 m, but this is largely because of huge Rs 248 m other income. In other words, Trent earned an operational loss in FY00. The other income comes from the huge cash it has kept in investments. But this is slowly changing. The cash it has earned by selling off Lakme is being deployed to set up more Westside stores across the country. The company plans to increase the number of such stores from 5 currently to over 15 in the next one-year.

The effects of this transition are already beginning to take shape. Trent has shown an encouraging performance in the first nine months of FY01. The company's turnover has improved 26% over the corresponding period in FY00. As a result its operating margins have nearly doubled to 14%.

What is good to see in Trent is its consistently improving topline. In the December quarter too, the company has shown a 36% jump in its topline. This is in an environment when overall consumer spending was slowing down. Its bottomline has also shown signs of improvement, in sync with the topline growth. The only area where Trent is showing a decline is its net margins, but this is because the other income is on a decline. This is a good sign. As the company's operations are picking up and the share of other income is going down. Hence, quality of earnings is improving.

There is a wide disparity in the valuations of Gap Inc. and Trent. Gap Inc. earns better returns on its business and this could be the reason for differences in valuation. Another reason for the disparity in valuation divergence could be because Trent is in a growing phase and hence faces a lot more uncertainties as compared to Gap, which has already established itself. But one must also note that Trent earns better margins than Gap and this may need to be reflected in the valuations.

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