India Ratings & Research (Ind-Ra) has revised its outlook on the retail sector for FY15 to negative to stable from negative. Ind-Ra expects median EBITDA margins for FY15 to remain at levels observed thus far in FY14. Operational efficiencies translating into stable margins as seen in 1HFY14 would marginally improve credit profiles of most retailers from FY13 levels. For 1HFY14, the median operating margins improved by 87bp yoy. As such, FY13 was possibly the weakest period since FY10 for the retail sector with margins falling by 110bp from FY12. However, efforts by retailers to deleverage by monetising non-core businesses could be positive for the sector.
Ind-Ra expects urban consumer sentiment to remain subdued in FY15 amid reduced affordability. Private final consumption expenditure (PFCE) for the quarter ended September 2013 was at 2.2 percent (quarter ended June 2013: 1.6 percent), the second lowest growth observed in the last 37 quarters. While some improvement in capex and industrial activity is anticipated post 1HFY15, the subsequent real wage and urban consumption growth will likely be seen only after FY15. The agency believes that companies with a diversified product portfolio (i.e. with a presence in the value and lifestyle segments) would be more resilient to the ongoing economic pressures as compared to players focussed singularly on the premium and high-end luxury segments.
Ind-Ra expects overall median revenue growth for the sector to be in the range of 8 percent-10 percent in FY15. Muted consumer spending due to prevalent economic uncertainties will likely drag into FY15 and same-store-sales-growth will taper down for the year. The agency notes that post the economic slowdown in FY13, 1HFY14 the median revenue grew 18.6 percent y-o-y partially on account of the lower base effect as well as improved volumes especially in 2QFY14 due to extended discounting. To the extent, the sector decides to chase aggressive revenue targets and acquire market share by resorting to longer discounting periods, the margins and thereby the credit profile could get adversely affected.
The agency expects average space addition in FY15 to be in the range of 10 percent-11percent, much lower than that of previous years, but still a critical driver of revenue growth. As new hypermarkets/departmental stores on average require around 18-24 months to break-even, the expected moderation in store additions could help keep inventories lean.
Increased operational efficiency could well be the reason for the slight margin improvement for major retailers. Retailers have implemented various measures such as changing the product mix, right-sizing stores, rationalising/closing down unviable stores, centralising back-end functions such finance, procurement and warehousing as well as closely monitoring their cost structures. In FY13, median operating costs grew 8.5 percent y-o-y, significantly below the 18.5 percent y-o-y growth witnessed in FY12 (FY11: 24.5 percent yoy). As a percentage of sales, operating costs were closer to FY12 levels.
The agency continues to view FDI based equity infusion to be a theoretical possibility. FDI investment in Indian retail has always been plagued with operational risks and implementation uncertainty given the regulatory stranglehold along with the lack of political consensus. The risk has only increased of late to the extent that foreign investors may additionally face a regulatory or reputation risk in their home jurisdictions. Recent instances of alleged questionable practises, under the existing Foreign Corrupt Practises Act, may further increase the challenge of attracting FDI in sectors such as retail.
The agency has a Stable Outlook on most rated retail companies. Ind-Ra has factored in the benefits expected to accrue in revenue and operating profitability on account of the change in strategy to combat the challenging economic environment. Some companies with continued weak credit metrics also have Stable Outlooks in expectation of significant deleveraging.
What Can Change the Outlook
Positive Outlook Unlikely: Given the low consumer confidence, deterioration in real wages and low PFCE, Ind-Ra does not envisage a change in the outlook to positive even in the event of a modest revival in sales and margins. However, 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: Retail companies which can successfully attract equity investors under the FDI route, and also deleverage their balance sheets significantly are likely to improve their credit profiles.