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To shop or not?

When Reliance Industries Chairman Mukesh Ambani addressed his shareholders at the company’s annual general meeting (AGM) in June last year, the title of his speech was simple, yet telling—“Embarking on a Retail Revolution.”

By Krishna Gopalan        Print Edition: October 7, 2007

When Reliance Industries Chairman Mukesh Ambani addressed his shareholders at the company’s annual general meeting (AGM) in June last year, the title of his speech was simple, yet telling—“Embarking on a Retail Revolution.” Ambani outlined detailed plans for the retail sector, but what stood out was the size of his investment: a staggering Rs 25,000 crore and counting, with employment for over half a million Indians.

For long, there were talks of big names entering the sector, but now the ground level retail juggernaut is rolling.

Reliance Retail—this is the company that is spearheading the project—has rolled out over 300 stores in various formats among which are groceries, consumer electronics and the most recent being that of hypermarkets.

On a shopping spree?
 

The AV Birla Group launched its “More” brand of supermarkets in June this year while the Bharti-Walmart alliance is slowly unfurling its foray into retailing and is expected to make a splash soon.

Reserve Stock

But before taking the plunge into the sector, take a good, close look at the numbers. About 3 per cent of the total Indian retail comes from the organised sector and its value is barely Rs 30,000 crore. There’s potential for the sector, but it requires equally huge investments. And it will take time to pay off.

As of now, the number of listed companies is small in number. Pantaloon Retail, Trent and Shoppers’ Stop are the more prominent names which have enjoyed impressive valuations. For example, Shoppers’ Stop’s 12-month trailing P-E stands at a huge 86.2. Market observers often describe these numbers on account of a paucity of traded stocks. There’s not much for investors to choose from. The scenario is similar to that of wireless telecom sector that till about two years back had only Bharti Airtel as a listed stock. That has changed to now include Idea Cellular, Spice and Reliance Communications.

A recent report on the Indian retail sector by First Global, a research and brokerage outfit, says that the pace and size of the expansion plans of some of the players are a cause of concern. Bharti-Wal Mart, according to the report, will invest Rs 30,000 crore while the AV Birla Group will put in Rs 15,000 crore. “This level of competition would be a dampener for profits and return ratios,” adds the report.

Evidently, this is not an easy sector to be in. It’s a high volume business but the margins are waferthin. If volumes are low, the return on investment and the ability to recover fixed costs and breakeven levels get hard to attain. “We got into the business in 1999 and the first three-to-four years were spent in learning the business,” explains Nandan Piramal, Vice-Chairman and Executive Director, Piramyd Retail. According to him, the proportion of organised retail in large cities like Delhi and Mumbai could be between 15 and 20 per cent. “What has been encouraging is the changing culture of the consumers where levels of spending have increased sharply,” adds Piramal.

The Right Price

The game is all about valuations and it is anything but easy to take that judgment call on any stock. “Valuations in the sector will depend on the number of stores and real estate costs. This is a low margin business where high volumes are necessary,” points out Pinaki Ranjan Mishra, Partner, Ernst & Young. Investors need to assess the real estate costs, which is a major one. The logic: escalating costs of property take up a large proportion of the cost and so there’s a need to maintain a tight control on other costs. As selling prices are fixed, the smallest of increases in costs is a concern.

Piramal, while declining to outline investment projections, elaborates on how expensive it gets. “For our Piramyd stores, which are about 60,000 sq. ft in size, the investment required will be about Rs 1,300-1,400 per square foot. In the Trumart format, which is around 5,000 sq. ft, an investment of Rs 1,000 per square foot is required,” he states. The expansion plans are impressive with retail space doubling every year. From 500,000 sq. ft, it will increase to a million sq. ft over the next one year.

As the sector is still in the investment stage, it is mandatory for investors to take a long-term view. Companies are investing in new properties. This entails huge capital requirements, and so in the short run these expenses tend to weigh on the profit and loss account. On the other hand, footfalls take a while to increase and, therefore, sales stagger in the initial years. Research houses are concerned about this massive capex plan. “As per our estimates, there is a significant mismatch between the pace of such massive investments and the expected growth in demand till 2011. There are very bleak chances of the retail companies generating a reasonable return for the investors,” states First Global’s report.

As of now, among the handful of companies, only a few seem to have value written in them. One must take care to invest in the companies that have a sustainable business model and which can raise resources for expansion and investments easily. Another thing is that investors must have a long-term horizon as the fruits of the investment in the sector will reflect in time. But India’s changing demography with rising purchasing power leaves some room for comfort in the valuations.

As more companies get listed, investors will have a choice in the sector. In the event of high multiples not delivering value for the investors, things could only get tougher for those looking to raise money. Clearly, the story of Indian retail is not about the willingness of the consumer to spend, but depends on more serious issues like real estate costs and providing high-quality products. But if you are looking for bargains in the retail space, there’s hardly any right now.

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