Sector Review: Retail

Macquarie Research: The Indian retail sector is currently going through a rough patch. While falling real estate costs provide some relief, slowing same store sales growth and a capital crunch have impacted growth prospects and profitability.

Q4CY08 Same Store Sales (SSS) growth for the Indian retailers turned negative for the first time. Slowing growth and a high base effect (from 2007) impacted sales. The problem was sharper in the high-end products (lifestyle retail) versus items of daily consumption (value retail). Shopper’s Stop saw its SSS growth fall from 16% in 1QCY08 to -4% in 4QCY08.

Economic slowdown
Macquarie expects India’s GDP growth to slow from 9.3% in FY3/08E to 5.5% in FY3/10E. We believe slower GDP growth is likely to drive SSS growth down to 8% for value retail and under 8% for lifestyle retail.

Slower SSS growth is reflected in our revised estimates and is the basis of our preference for Pantaloon (~60% sales from value retail) over Shopper’s Stop (pure play on department stores).
The credit crunch has also hit the sector hard with debt funding becoming difficult (and expensive) and no appetite for equity raisings. This has resulted in the companies having to curtail their (over) ambitious store roll out plans. Pantaloon’s operations can support growth of around 1m–2m sqf per year with limited external funding in our view. Shopper’s Stop, on the other hand, cannot do without external funds.

FDI plans
Foreign direct investment is curtailed in the Indian retail sector. Once central government elections are complete in May 2009, we believe there is a 10% probability that FDI may be allowed in ‘multi-brand’ retail.

This will allow foreign players to enter, who are likely to then pick up stakes in the incumbents (such as Pantaloon), providing funds for growth and expertise in managing large-format outlets and inventory.

The last three years saw a sharp rise in retail rents due to supply-demand dynamics. With more supply coming through and a slowdown in store opening plans by most retailers, rents have started falling.
We expect this to continue and average rents to fall at least another 25% over the next 12 months (we also cover the property sector). Employee costs are also under downward pressure.
We expect near-term profitability in the sector to remain under pressure. However, we expect Pantaloon to be able to tide over this tough period given its exposure to value retail and eventual capital raising.
Shopper’s Stop, on the other hand, is likely to remain under pressure for at least the next three–four quarters.

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