Should Investors be Worried About Stocks Like Trent and DMart?

Indian retailer Trent reported a strong set of numbers in the latest quarter.

The company's newly launched Zudio outlets have been a resounding success. The stores cater to budget-conscious consumers.

The sharp rise in footfalls aided the growth. The retailer's shares jumped 10% to a record high after the June quarter results.

The Tata Group company's consolidated net profit for the June quarter almost doubled on a year-on-year basis.

It's interesting that the retailer has also been on a hiring spree. The company's employee count has more than doubled over FY22.

The Indian retail sector is on the cusp of a major transformation, with a projected 50% increase in retail space by the end of 2028.

According to a report by JLL, India's retail sector could witness the overall retailing space grow to 134 m sq. ft. by the end of 2028 from 89 m sq. ft. in 2024.

Close to 88 new retail developments with a cumulative area of around 45 m sq. ft. are expected to come on stream in the seven cities - Mumbai, Delhi-NCR, Bengaluru, Hyderabad, Pune, Kolkata, and Chennai - over the next 5 years.

Out of the 88 upcoming retail developments in the next five years, there will be 12 large-sized projects encompassing area of at least 1 million sq. ft. each. These projects will contribute a substantial portion, amounting to 37% of the total supply expected until 2028.

The aggressive expansion plans of the retail sector are not without reason. The sector is witnessing strong growth driven by increased urbanisation and demand for organised and high-quality retail spaces.

With the sharp shift in the consumer lifestyle, tier 2 & 3 cities are in demand for vibrant retailing spaces. This is fuelled by the rising demand for big brands thanks to their reach on social media.

This highlights India's emergence as a key player in the global retail market.

According to BCG, the retailing space of electronics, fashion, grocery, jewellery and Quick Service Restaurants (QSR) are expected to witness the biggest growth in the coming decade.

More importantly, BCG believes that the operating margins of Indian retailers across these categories are slightly better than that of their American counterparts. With a hybrid model (online + offline), most of the large retailers in India have made inroads into the hinterland, without losing their share in the metros.

However, the business model of the retail sector is such that the industry can witness sharp peaks and troughs.

A retailer typically makes money by earning a margin on the merchandise its procures and sells to the end customer. Such merchandise can be either sold under its own private labels or as third-party brands.

Further, the retailer can either own the retail outlets to keep costs as well as branding under control. Or it can operate out of rented stores or in a franchise model.

One of the earliest signs of stress on margins is the tendency of retailers to operate with a lean workforce.

So, while few retailers have doubled down on their employee count over past two years, few others have chosen to run with a smaller workforce.

Employee Count (nos)

	FY22	FY24	Change
Avenue Supermart (Dmart)	52,089	73,932	41.9%
Jubilant Foodworks	30,376	34,120	12.3%
Page Ind	27,730	22,564	-18.6%
Titan	22,466	17,535	-21.9%
Trent	13,938	29,275	110.0%
Vmart	8,660	10,935	26.3%
Bata	8,630	10,422	20.8%

Source: Ace Equity, Annual Reports

According to Economic Times, as many as 12 listed lifestyle, grocery retailers, and quick-service restaurants (QSRs) cut their workforce by around 26,000 in last two financial years as they slowed down store expansion.

Now apart from the ownership or rental costs of the store and the manpower costs, there are two key variables that determine the retailer's prospects of profitability. These variables are the share of the discounted sales and the inventory turnover.

Retailers that are not conscious of keeping the fixed and variable store operating costs in check have seen fundamental deteriorate.

Valuations of Retailing Majors

As of Aug 20, 2024	RoE (%)	D/E (x)	P/E (x)	P/BV (x)	PEG (x)
Avenue Supermart (Dmart)	14.5	0.0	125.0	17.7	5.4
Jubilant Foodworks	12.4	1.9	152.0	19.0	NM
Page Ind	38.4	0.1	79.2	28.6	9.8
Titan	32.9	1.6	89.3	32.8	4.4
Trent	27.2	0.4	193.0	59.4	3.4
V-Mart Retail	NM	1.9	NM	9.5	NM
Bata India	19.8	0.9	51.5	12.0	NM

Source: Ace Equity, Annual Reports
NM - Not meaningful (negative ratios)

Like Warren Buffet wrote in his 1995 letter to shareholders -

• Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses.
  
  In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail.

Nevertheless, the valuations of most retail stocks in India continue to display a gravity defying act. In the cases of Trent, Jubilant Foodworks, and Avenue Supermarts in particular, the valuations seem to factor in an unrealistic pace of growth.

It's therefore important for investors to separate the wheat from the chaff and invest in only the stocks that offer some margin of safety.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)