Corporates

Retailing

2013 Outlook: Indian Retail

Deteriorating Domestic Consumption to Squeeze Retailers
Outlook Report
Rating Outlook

Rating Outlook
Negative Outlook for 2013: India Ratings has maintained a negative outlook on the retail sector for 2013. This is because of the protracted weakness in consumers discretionary spending due to higher inflation, marginal real wage growth and low level of macroeconomic activity. Rapid credit squeeze, high operating costs and falling margins may also impact the credit profile of retailers. Ratings Partly Reflect Risk: The rating levels of India Ratings-rated retail companies have already factored in pressures on margin and revenue; this contributes to the high proportion of Stable Outlooks. Some companies with deteriorated credit metrics also have Stable Outlooks as India Ratings has already taken sufficient action to accommodate foreseeable stress. While in some cases, expectation of significant deleveraging is the driver for stable ratings despite pressure on operating metrics. Deteriorating Private Consumption Growth: Private Final Consumption Expenditure (PFCE) is at an eight-year low. The trend is even more worrisome since out of the last six quarters, four quarters had the lowest PFCE growth rate in the last 34 quarters. While PFCE tends to bounce back in response to government spending, a sustained recovery in consumption spending would depend on robust corporate earnings followed by a significant real wage hike and low consumer inflation. As such, these are less likely to happen in 2013. Muted Revenue Growth: The sector experienced overall single digit revenue growth in 2012 the first time in its history and is likely to grow at 3.0%-8.0% in 2013. An exception is Shoppers Stop Limited (SSL, IND A1) which is likely to exhibit double digit revenue growth at a slowing rate due to a fall in same-store-sales growth (SSSG). Most retailers witnessed a decline in yoy SSSG, becoming negative for major retailers from March 2012-September 2012. Retailers focussed on the luxury or premium segment may be worst hit with an expectation of flat-tonegative growth in overall revenues. Pressure on Margins: Median EBITDA margins of major players are likely to contract by 50bps-75bps in 2013. To combat slower SSSG, retailers are offering deep discounts which may generate volumes at the cost of margins. Retailers are also adopting cost-rationalisation measures such as closure of unprofitable stores, enhancing employee productivity and moderating new store addition. An increase in lease rentals (20bps-80bps as a percentage of revenue) and manpower costs (50bps-140bps) in FY12 over the FY11 levels further aggravated margin pressure. Deteriorating Credit Metrics: In 2013, working capital requirements may increase due to lower inventory turnover and need to support new stores. With cash flow from operations of retailers already negative and expected pressure on margins, the credit metrics of retailers would remain under pressure. The industrys working capital cycle shortened in FY12 as inventory levels reduced due to heavy discount driven sales adopted by most retailers. However, the need to support new stores led to an increase in overall debt levels in 2012. Push towards Deleveraging: Retailers inability to boost cash flows immediately and their high leverage levels may compel them to look for equity funding. Historically, most capital needs were met through debt. The proposed demerger of Pantaloon Retail India Limited (PRIL, 'IND A-'/Stable) and the proposed acquisition of a controlling stake of the newly formed entity by Aditya Birla Nuvo Limited (ABNL) is a case in point. At present foreign direct investment (FDI)

NEGATIVE

Related Research
Other Outlooks
www.indiaratings.co.in.com/outlooks

Analysts
Deep N Mukherjee +91 22 4000 1794 deep.mukherjee@indiaratings.co.in Priyanka Poddar

www.indiaratings.co.in

15 January 2013

Corporates
based equity infusion is a theoretical possibility given the complex government requirements, the existing retailers may have to significantly restructure their businesses before receiving such investments.

Figure 1

Decline in Overall Consumer Confidence Index

Largest Decline in past 3 years
(%) 135 130 125 120 115 Q110 Q210 Q310 Q111 Q211 Q311 Q411 Q112 Q212 Q312

What Could Change the Outlook

Improvement in Consumer Consumption Expenditure: A sustained reduction in consumer price inflation, coupled with a rise in real wages, is likely to restore the discretionary spending power of Indian consumers. Alternately, a sudden spurt in government spending may have a temporary beneficial impact on private consumption, ultimately benefitting the sector. Equity-Induced Deleveraging: Companies in the sector that may be successfully able to attract equity investors, so as to deleverage their balance sheet significantly are likely to improve their credit profile.

Source: AC Neilson consumer confidence index

Key Issues Domestic Consumption to Remain Subdued

India Ratings expects muted revenue growth in most industries dependent on consumer spending including retail. A tentative relation exists among nominal wage growth, economic activity and more specifically the performance of businesses in the economy. The wage growth in turn impact consumption. Given the corporate profitability levels of FY12 and the expected profitability levels of FY13, salary hikes are likely to be much muted in FY13 and beyond than those observed in FY11 and FY12. An analysis of 500 top companies in Bombay Stock Exchange (BSE) suggests a lagged (one year) impact of salary and wages growth on previous years profitability. The PFCE growth rate of 3.68% at end-Q213 is the lowest in the last 34 quarters. The deterioration in PFCE is becoming a well-entrenched trend. The last six quarters witnessed four lowest growth rate observations in the last 34 quarters. This is in line with India Ratings expectations (refer to Mid-Year 2012 Outlook: Indian Retail, published in August 2012: http://indiaratings.co.in/Outlook2012). Government spending on salary and potentially direct transfers are also likely to be subdued. As such, PFCE is unlikely to show a significant improvement in 2013. While PFCE can temporarily spike up in response to government spending, a sustained improvement may require sustained growth in real wages in the economy and low consumer inflation. Government spending on salary and social spending are also likely to be subdued. . As such, PFCE is unlikely to show a significant improvement in 2013. Consumer confidence is also at a three-year low.

Figure 2

Figure 3

Muted Same Store Sales Growth

SSSG deteriorated for retailers in 2HFY12 and 1HFY13. A decline was reported in three out of the last four quarters. SSL (year-end March) registered deterioration in SSSG of 10%, 1% and 5% in Q4FY12, Q1FY13 and Q2FY13, respectively, while PRIL (year-end June) witnessed deterioration in its SSSG in some of the formats with negative 0.2% in value, negative 3.5% in home and positive 10.8% in lifestyle. Value retailing, generally considered more resilient to economic slowdowns than the lifestyle retail segment, has observed some pressure in the current period as customers are downshifting to more unorganised formats. PRILs SSSG decelerated for value and home retailing segments in Q3FY13 while its lifestyle segment benefitted by offering higher discounts and a reduction in excise duty on branded apparels to 3.6% from 4.5%. Related Criteria
Corporate Rating Methodology (September 2012)

Retailers such as PRIL, SSL and Trent Limited have increasingly moved towards private label sales to improve profitability. However, to combat slower SSSG, retailers are providing deep

2013 Outlook: Indian Retail January 2013

Corporates
discounts and promotional offers in lifestyle, which may generate volumes at the cost of margins. Gross margins deteriorated for SSL to 30.9% in September 2012 from 32.6% in June 2012. PRILs margins remained flat at 29.6% while Trents gross margin fell to 46.3% from 47.2% in the same period.
Figure 4

No Improvement in SSSG
(%) 70 60 50 40 30 20 10 0 -10 -20 Jun 10 PRIL - lifestyle PRIL - value PRIL - home Shopper's

Sep 10

Dec 10

Mar 11

Jun 11

Sep 11

Dec 11

Mar 12

Jun 12

Sep 12

Source: India Ratings, Company

Figure 5

Decline in Q-o-Q Sales Growth

(%) 70 60 50 40 30 20 10 0 -10 -20 Sep 10 PRIL Shopper's Trent Provogue Brandhouse retail

Dec 10

Mar 11

Jun 11

Sep 11

Dec 11

Mar 12

Jun 12

Sep 12

Source: India Ratings, company Figure 6

Increase in New Store Openings Y-o-Y

(Units) 350 300 250 200 150 100 50 0 PRIL FY09 FY11 FY10 FY12

Expansion Driven Revenue Growth

SSSG is unlikely to meaningfully improve in 2013. Overall revenue is likely to grow at 3.0%8.0% in 2013, with the exception being SSL. SSL is expected to exhibit double digit growth at a slower pace in 2013. Overall revenue growth for the sector fell to single digit in 2012 from double digit observed prior to 2012. Retailers with diversification across the value and luxury segments are likely to remain more resilient to a downturn. SSLs registered qoq top-line growth of 21.0%, 15.5% and 14.3% in Q4FY12, Q1FY13 and Q2FY13, respectively, while PRIL registered revenue growth of 7.6%, 3.6% and 5.1% in Q3FY11, Q4FY11, and Q1FY12. In terms of revenue growth, the worst affected would likely be retailers focussing on the premium and luxury segments. Such retailers may continue to show flat to negative revenue growth. As observed in more recently, new store additions are likely to continue to be the driver of revenue growth. SSL opened 13 new Shoppers stores in FY12. The company targets to have a total of 75 stores by end-FY15. PRIL added 41 PRIL stores, while Trent opened seven stores in FY12. India Ratings expects retailers to continue to open new stores in Tier 2 and Tier 3 cities as Tier 1 cities become saturated. However, the agency expects retailers to take a longer time to break even for new stores with a drop in footfall and slowing SSSG.

Shoppers

Trent

Source: India Ratings, company

2013 Outlook: Indian Retail January 2013

Corporates
Continued Pressure on Margins
India Ratings expects a drag on the sectors profitability in 2013 for most retailers as traction from new stores remains sub-par. However, the momentum in margin contraction observed in last several quarters is likely to lessen given the cost rationalisation measures. India Ratings expects EBITDA margins to fall by 50bps-75bps for the sector in 2013. On an average, margins fell by 3.4%-8.0% across retailers in quarter ended September 2012 from those in the quarter ended June 2012, with SSLs margins of 2.6%, PRIL 8.7% and Trent 1.9% from 1.5%, 9.3% and 4.7%, respectively. For major companies, employee costs as a percentage of revenue have crept up and are at a three-year high. Growth in lease rental has been marginal from the 2011 levels, but is still lower than the levels observed in 2009 and 2010. This component is unlikely to increase significantly given the weakness in commercial real estate. Also, retailers are actively and often successfully exploring options such as revenue share with the real estate provider to reduce the fixed nature of leasing cost.
Figure 7

Employee Cost as a % of Revenue

(%) 10 8 6 4 2 0 PRIL Source: India Ratings, company Shoppers Trent Provogue Brandhouse retail FY09 FY10 FY11 FY12

Retailers are adopting cost controls measures to counteract margin pressures. These measures include boosting labour productivity, better inventory management, increasing supply chain efficiencies and throughput from the new stores. Retailers may also close unprofitable stores and rationalise capex by opening new stores in Tier 2 and Tier 3 cities at a smaller scale. Muted commercial real estate prices in such locations may be a long-term positive.
Figure 8

Lease Rentals as a % of Revenue

(%) 12 10 8 6 4 2 0 PRIL Source: India Ratings, company Shoppers Trent Provogue Brandhouse retail FY09 FY10 FY11 FY12

Figure 9

2013 Outlook: Indian Retail January 2013

Corporates
EBITDA Margin Under Pressure
(%) 20 15 10 5 0 -5 -10 Jun 10 PRIL Shopper's Trent Provogue Brandhouse retail

Sep 10

Dec 10

Mar 11

Jun 11

Sep 11

Dec 11

Mar 12

Jun 12

Sep 12

Source: India Ratings, company

Working Capital Cycle

India Ratings expects working capital cycle to remain under pressure during 2013 as new stores will generate returns only after 12-15 months and sales will remain slow at the existing stores. Inventory levels to increase moderately in 2013 on account of slowing sales and new store openings that would require keeping higher inventory levels in 2013. Overall working capital cycle improved in FY12 as retailers tried to reduce inventory levels by offering higher discounts. However, this was partially offset by a lower credit period from suppliers. PRILs (core retail) inventory days are likely to have halved in FY12 from 162 in FY11. To free up cash and offload slow moving inventory, the company offloaded its inventory at the year end. However, SSLs inventory levels increased in FY12 due to slow moving sales resulting in a negative cash flow from operations.
Figure 10

Inventory Cycle Across Retailers

(Days) 260 220 180 140 100 60 20 PRIL Source: India Ratings, company Shoppers Trent Provogue Brandhouse retail FY09 FY10 FY11 FY12

Strain on Cash Flows

India Ratings expects retailers free cash flow (FCF) to remain negative in 2013 due to deteriorating margins, increased working capital requirements and aggressive expansions. Retailers have relied largely on debt to fund their expansion plans, which has reduced financial flexibility and could result in further liquidity strains during the year. Aggressive store expansions and higher capex led to a stretched liquidity position for most retailers in FY12. SSLs CFO and FCF turned negative in FY12. In India Ratings opinion, committed capex plans will further put strain on cash flows and increase debt. The likely margin contraction, expansion plans, along with increased need for inventory as retailers open up new stores will lead to increased cash flow needs which are likely to be debt funded, as it has been in the past. However, companies have been adopting various strategies to contain debt, including raising equity and sale of certain non-related assets as well as business segments, which may help in maintaining credit profiles and thereby trying to contain leverage levels

2013 Outlook: Indian Retail January 2013

Corporates
The proposed demerger of PRIL and the proposed acquisition of a controlling stake of the newly formed entity by ABNL is a case in point.

FDI in Multi-Brand Retail A Long-Term Positive

On 14 September 2012, the government of India approved FDI in multi brand retail up to 51% and further simplified FDI in single brand product retail. India Ratings expects international retailers, especially in the hypermarket format, to establish their footprint in the Indian market over the next one to two years, subject to the resolution of the associated political issues (refer to India Ratings: FDI in Retail - Complexities to Undermine Benefits, published in September 2012).

2012 Review
As per India Ratings expectations, most of the issuers credit profiles weakened in 2012. This was the result of the continued decline in consumers discretionary spending, a fall in real GDP and a persistent rise in inflation and interest rates that eroded the disposable income in the hands of consumers. Overall demand shrank as retailers experienced revenue declines across the life style as well as value-based formats. Margins contracted as prices declined yoy. This coupled with higher-than-expected new store openings adversely affected retailers cash flows. SSLs CFOs and FCF turned negative in FY12. India Ratings believes that new stores will generate returns only after 12-15 months, while inventory is blocked upfront. As a result, retailers will continue to face cash flow pressures and negative FCF over the medium term, until expansion rates moderate. In 2012, India Ratings took negative rating action on SSL due to its greater-than-expected liquidity issues and a higher-than-expected decline in its credit profiles. India Ratings expects the retail outlook for India to remain negative in the short term. However, with the liberalisation of FDI in multi-brand retailing this could translate into a positive impact on the capital structure and liquidity profile of companies in the next two to three years.

2013 Outlook: Indian Retail January 2013

Corporates
Annex 1
Figure 11

Select India Ratings-Rated Retail Companies

Issuer Pantaloon Retail (India) Ltd Shoppers Stop Ltd Future Value Retail Limited Tristar Retail Blues Clothing Company Limited
Source: India Ratings

Long-term rating IND AIND A IND BBIND BB+

Outlook Stable Stable Stable Stable

Short-term rating IND A1 IND A1 IND A1 IND A4+ IND A4+

2013 Outlook: Indian Retail January 2013

Corporates
Annex 2
Figure 12

Retail Companies Profile for FY12

Presence cities Formats PRIL (consolidated) 92.0 --Big Bazaar --Food Bazaar --Pantaloons --Central --KB Fair Price --Home Town No of stores Area Sales EBITDAR EBITDA EBITDA margin (%) Interest Total assets Total debt Total adjusted debt Net worth CFO FCF Adjusted net debt/EBIDTAR EBITDAR/net interest+rent Debtor days Inventory days Creditor days Net cash conversion cycle 316 PRIL Stores, 448 FVRL Stores 16.7 115,093 16,134 7,703 6.7 6,291 84,897 36,361 95,376 33,660 n.a. n.a. 5.7 1.1 6 82 25 63 SSL (consolidated) Trent (consolidated) 20.0 33.0 --Departmental stores --Hypercity --Mothercare --Crossroads --MAC & Estee Lauder --Other spec formats 67 westside 15 star bazaar, 19 landmark and 5 fashion yatra 4.4 2.5 27,742 3,285 909 3.3 422 14,501 4,356 20,994 5,161 -475 -1,184 19.9 1.2 9 65 46 28 18,449 514 -571 -3.1 104 20,144 3,013 10,608 11,639 -748 -3,095 6.4 0.4 4 104 55 53 51 --Westside --Star Bazaar --Landmark --Other sp formats (Sisley)

n.a. Not available PRIL results includes unaudited core retail results for FY12 Source: India Ratings, company reports

2013 Outlook: Indian Retail January 2013

Corporates
Annex 3
Figure 13

Credit Profile of Retail Companies

FY09 PRIL Debt/EBITDA (x) Adjusted net debt/EBITDAR (x) Operating EBITDAR/fixed charge (x) CFO % of sales SSL Debt/EBITDA (x) Adjusted net debt/EBITDAR (X) Operating EBITDAR/fixed charge (x) CFO % of sales Trent Debt/EBITDA (X) Adjusted net debt/EBITDAR (x) Operating EBITDAR/fixed charge (x) CFO % of sales
PRIL results includes unaudited core retail results for FY12 Source: Company reports, India Ratings

FY10 4.6 5.5 1.3 8.8 2.5 5.3 1.5 5.5 19.4 9.0 1.1 -4.3

FY11 6.3 6.5 1.3 -6.7 2.2 5.1 1.4 5.0 19.3 8.4 1.0 -3.2

FY12 4.7 5.9 1.1 n.a. 4.8 6.4 1.2 -1.7 -5.3 19.9 0.4 -4.1

6.3 6.2 1.2 -4.7 14.3 8.1 1.0 4.3 -24.9 15.0 0.6 -4.7

2013 Outlook: Indian Retail January 2013

Corporates

ALL CREDIT RATINGS ASSIGNED BY INDIA RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://WWW.INDIARATINGS.CO.IN/UNDERSTANDINGCREDITRATINGS.JSP IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.INDIARATINGS.CO.IN. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. INDIA RATINGS CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.
Copyright 2012 by Fitch, Inc., Fitch Ratings Ltd. and its subsidiaries. One State Street Plaza, NY, NY 10004.Telephone: 1-800-753-4824, (212) 908-0500. Fax: (212) 480-4435. Reproduction or retransmission in whole or in part is prohibited except by permission. All rights reserved. In issuing and maintaining its ratings, India Ratings & Research (India Ratings) relies on factual information it receives from issuers and underwriters and from other sources India Ratings believes to be credible. India Ratings conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for a given security or in a given jurisdiction. The manner of India Ratings factual investigation and the scope of the third-party verification it obtains will vary depending on the nature of the rated security and its issuer, the requirements and practices in the jurisdiction in which the rated security is offered and sold and/or the issuer is located, the availability and nature of relevant public information, access to the management of the issuer and its advisers, the availability of pre-existing third-party verifications such as audit reports, agreed-upon procedures letters, appraisals, actuarial reports, engineering reports, legal opinions and other reports provided by third parties, the availability of independent and competent third-party verification sources with respect to the particular security or in the particular jurisdiction of the issuer, and a variety of other factors. Users of India Ratings ratings should understand that neither an enhanced factual investigation nor any third-party verification can ensure that all of the information India Ratings relies on in connection with a rating will be accurate and complete. Ultimately, the issuer and its advisers are responsible for the accuracy of the information they provide to India Ratings and to the market in offering documents and other reports. In issuing its ratings India Ratings must rely on the work of experts, including independent auditors with respect to financial statements and attorneys with respect to legal and tax matters. Further, ratings are inherently forward-looking and embody assumptions and predictions about future events that by their nature cannot be verified as facts. As a result, despite any verification of current facts, ratings can be affected by future events or conditions that were not anticipated at the time a rating was issued or affirmed. The information in this report is provided "as is" without any representation or warranty of any kind. A rating provided by India Ratings is an opinion as to the creditworthiness of a security. This opinion is based on established criteria and methodologies that India Ratings is continuously evaluating and updating. Therefore, ratings are the collective work product of India Ratings and no individual, or group of individuals, is solely responsible for a rating. The rating does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. India Ratings is not engaged in the offer or sale of any security. All India Ratings reports have shared authorship. Individuals identified in a India Ratings report were involved in, but are not solely responsible for, the opinions stated therein. The individuals are named for contact purposes only. A report providing a rating by India Ratings is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. Ratings may be changed or withdrawn at any time for any reason in the sole discretion of India Ratings. India Ratings does not provide investment advice of any sort. Ratings are not a recommendation to buy, sell, or hold any security. Ratings do not comment on the adequacy of market price, the suitability of any security for a particular investor, or the tax-exempt nature or taxability of payments made in respect to any security. India Ratings receives fees from issuers, insurers, guarantors, other obligors, and underwriters for rating securities. The assignment, publication, or dissemination of a rating by India Ratings shall not constitute a consent by India Ratings to use its name as an expert in connection with any registration statement filed under the United States securities laws, the Financial Services and Markets Act of 2000 of the United Kingdom, or the securities laws of any particular jurisdiction including India. Due to the relative efficiency of electronic publishing and distribution, India Ratings research may be available to electronic subscribers up to three days earlier than to print subscribers.

2013 Outlook: Indian Retail January 2013

10