The Hindu Business Line : Goodies in store for retail stocks

Pantaloon, a top pick across several brokerage houses, has had a dream run on the bourses over the past two years, rising nearly eight-fold since January 2004. The stock now trades at 100 times its trailing four-quarter per-share earnings. But no one appears eager to sell it just yet, as the company has been growing explosively with annual profits almost doubling over the past two years.

The spotlight has also been turned on other retail stocks, such as Shoppers' Stop and Trent, both of which significantly outperformed the market the past year. The reason for the skyrocketing valuations? For one, there are only three listed retailers. Given the nascent stage of the industry, everyone is betting on all three and investors will have to see which company makes it to the top.

Second, while the organised retail story has been unravelling over the past few years, it has really gained momentum in the last year, when the idea of permitting foreign direct investment (FDI) in the retail sector has been feverishly debated (see accompanying article for a detailed view on FDI offered by Mr B. S. Nagesh, CEO of Shoppers' Stop; he also shares his views on other issues in retailing in a wide-ranging interview featured on Page 11).

The prospect of retail FDI is still uncertain, but these stocks will still enjoy the fancy of investors with a long-term perspective. While the valuations seem steep, the mega expansion plans of these companies can transform the size and nature of their operations five years from now. With only a handful of players, the market is unlikely to get overcrowded soon, even if foreign retailers do set up shop. If earnings keep pace with the scaling up, it could lead to a collapse in valuation levels — a reason why investors do not mind the high price earnings multiples now — as the industry moves into adolescence.

Over the next year or two, however, the number of listed retailers is likely to grow, especially if the sector is thrown open to foreign investment.

Given the heterogeneity of the Indian market, foreign retailers might consider expanding in a phased manner, region by region. Besides, FDI, if permitted, is likely to be introduced in steps with restrictions, too; for instance, foreign retailers could be required to partner with Indian companies.

Aside from the fact that the size of the organised retailing pie is likely to increase once foreign retailers join the fray, the possibility that the Wal-Marts and Tescos could partner with Indian retailers has also enhanced the interest in Pantaloon, Trent and Shoppers' Stop, the bigger players. But the current retailers may not be the only candidates for partnerships or joint ventures.

According to industry sources, foreign retailers may prefer partnering large corporate houses that want to participate in the growth of the retail sector but would prefer not to take on the management of a retail chain.

This widens the scope for investment opportunities in companies that are outside the retail space. Corporate houses such as the Birlas and the Tatas have identified retail as one of their future thrust areas — Aditya Birla Nuvo (erstwhile Indian Rayon) already has a presence in retailing with a large number of readymade garment outlets while the Tatas have made a mark through their Westside and Titan showrooms.

The Mahindra group, with its sizeable real-estate across locations, may also be a prime candidate. The credibility of business practices offered by these groups will also provide a greater comfort level to foreign retailers looking for partnership deals.

Several companies have morphed into quasi-retail plays. Stocks of Titan and Bata enjoy rich valuations for their significant retail presence, followed by the likes of Raymond and Bombay Dyeing, which have developed a strong network through a mix of franchise and own outlets.

The lack of enough listed companies in the retail sectors has also led to companies such as Shringar Cinemas, PVR and Adlabs Films, with their presence in film-exhibition businesses through multiplexes, taking on the characteristics of retail stocks.

More pure-play retailers are, however, likely to join the listed space over the next year or two. Piramyd Retail and Provogue recently listed on the bourses. The RPG group, for instance, is likely to take its retail business public in the next two years. Most retailers have found it hard to scale up operations, partly because they lack the funds to back the substantial investment in the supply chain.

Given investors' appetite for retail stocks, however, such retailers may tap the primary market.

FIIs (foreign institutional investors) have so far not been allowed to invest in unlisted companies or in the primary market. While there is enough investor appetite for quality retail stocks, smaller chains may be inclined to raise funds privately, from foreign equity funds, and later list their companies to provide such stakeholders an exit option.

If the FIIs were allowed to invest in retail, it could trigger more primary market offers.

Investors would have to watch for these developments. Right now, the four listed players have developed their own distinct models. Pantaloon has successfully pulled off multiple formats in a short span of time. Its speed of execution of its ambitious expansion plans makes it the prime pick in the retail space and the stock is an FII favourite. FIIs hold about 30 per cent in Pantaloon Retail.

Shoppers' Stop has improved profitability despite the low contribution from high-margin private labels. Trent, too, has points in its favour, with a sound management and a strong balance-sheet.

Investors who already hold Pantaloon and Shoppers' Stop can retain their holdings, as we believe these are the best picks to ride the retail wave. Price declines due to market-linked weaknesses can be used to take exposure in these stocks. The returns may not, however, be significant from a near-term perspective. In quasi-retail stocks such as Bata and Titan, investors would also have to assess the fundamentals of their primary business first, before factoring in their gains from retail operations.

At present, a `hold' strategy may be the appropriate course in these quasi-retail plays too.