The Hindu Business Line : Trent: Buy

INVESTORS with an appetite for high risk can consider exposure to the stock of Trent. The stock has been re-rated considerably in the past month, following its foray into the rapidly-growing hypermarket format (a combination of a department store and a supermarket that offers a wide variety of products such as apparels, groceries and consumer durables at low prices).

Trent now trades at 40 times its trailing earnings per share. The stock has been accorded a lower multiple in the past compared to Pantaloon — the only other listed play in the retailing sector. This is because while Pantaloon grew at a scorching pace on the back of its expansion frenzy,

Trent followed a more conservative growth strategy, which tempered earnings growth. Also, Pantaloon's experiment with other retail formats has paid off, further boosting the stock.But Trent's foray into mass-market retailing (hypermarket format) is likely to fast-track its earnings growth. The company plans to open 25-30 such outlets over the next six years, with two/three likely to be set up over the next one year. This is besides furthering its apparel retailing chain, Westside. The aggressive plan is one of the factors for the recent re-rating of the stock. Trent also promises to bring a more distinct model to the retailing format, as private labels would account for 90 per cent of the products sold. The strategy of focussing on private labels has already paid off for its Westside departmental stores.

Venturing into this format would mean playing the volumes game, which would make safeguarding margins challenging.

While the use of private labels would help maintain margins, the lower operating margins may not provide much of a cushion if revenues were to take a hit. Profits would depend primarily on revenue growth.

As stores are added, the company would benefit from economies of scale, and efficient supply-chain management and a substantial portion of the revenues from additional stores would improve the bottomline. Trent is sitting on a cash pile and marginal debt, which puts it on a sound footing to expand in the near term.

Over the long term, however, it may have to resort to either higher debt or an expansion of the equity base, which may temper earnings growth.

Hypermarkets to drive growth

With 16 Westside stores, Trent is among the top apparel retailers. It plans to take this number to 19 next year. The growing popularity of retail formats that target the middle-class has, however, prompted Trent to pursue the hypermarket format more intently.

In October, it set up its first "Star India Bazaar" hypermarket in Ahmedabad, in October, and, by the end of this fiscal, plans to open two such stores in Mumbai and Bangalore, where Giant and Big Bazaar, are already present. Trent would be taking Giant and Big Bazaar stores — the two hypermarket formats of the RPG Group and Pantaloon respectively — head on. Unlike the competition, Star India Bazaar sells a majority of its products under private labels, which earn higher margins.

Trent hopes to leverage these margins in pricing its products more aggressively and also offers better discounts on some of the branded items it showcases. If this pays off, Trent would be better placed than its competitors to drive up volumes. And, at the same time, in a better position to maintain at least margins at the same level as its competitors.

Trent's ability to garner market share for its private labels, particularly in segments where branded players dominate, such as consumer durables, would also be crucial to the success of its venture.

Financials

Revenues grew 35 per cent in the June-September quarter. Operating margins remained stable at about 7.5 per cent, resulting in a 39 per cent growth in operating profits. Higher depreciation costs and a larger tax incidence, however, slowed profit growth.

Depreciation costs are likely to rise as the company expands. The contribution of `other income' is also likely to drop this year, as interest rates harden. Trent has more than Rs 100 crore in various investments which has led to the `other income' component contributing substantially to profits ( as much as 65 per cent of FY04 profits). These factors may depress earnings growth in the near term. However, Trent is likely to channel its accruals towards expansion, which may augur well for profitability.

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