Retail Sector - Dec 2007

®
Retail Sector Report

Company
December 13, 2007 FOR PRIVATE CIRCULATION
Rohit Ledwani
rohit.ledwani@kotak.com RETAIL - Time to get organized
+91 22 6634 1507
With only about 3% share in an estimated $320-bn Indian retail industry,
we see significant growth potential in the organized retail segment in
India. The expected growth in income levels, easy availability of credit,
increasing urbanization and favorable demographic conditions are
expected to put the Indian organized retail industry on a rapid growth
path. We expect a CAGR of 26% for this industry over the next four years
and have a positive view on the sector. We initiate coverage on Vishal
Retail with a BUY rating and a price target of Rs.861. We also initiate
coverage on Shoppers Stop with a REDUCE recommendation with a target
price of Rs.490, due to valuations.
Key investment rationale

q Low penetration provides growth potential. According to Crisil, the total
size of the retail industry in India is about US$320 bn, of which only 3-4% is
organized. This provides significant potential for growth, in our opinion. Over
the next few years, penetration levels of organized retail are expected to double
and reach approximately 9% of the total retail industry by 2011.
q Favorable Demographics. India has the youngest population in the world,
Companies covered with more than 50% of the population under the age of 25 according to E&Y.
n Vishal Retail This population is the consuming population and is the one with demanding
lifestyles. Thus, this is one of the key markets for retailers. We expect this to
n Shoppers Stop support growth of the organized retailing industry in India in the years to come.
x
Also, growth in urbanization is key for retailers to succeed as currently nearly
85% of the organized retail market is concentrated in India's eight largest cities.
The population of urban areas is expected to touch 550 mn in 2021 as compared
to 376 mn currently. (Source: Government of India)
q Rising income & consumption patterns to spur growth. With the economy
on an upswing, income levels and consumption patterns of the Indian consumer
are changing. The number of high income households has been growing at 20%
year on year since 1995-96 and by 2010, 35% of socio economic classes A&B
are expected to be double income homes, hence increasing their spending
capacity. Spending by Indian consumers is already 12% higher in the current
year as compared to the whole of the last year. They are expected to spend
42% more in the current year as compared to what they spent last year.
Also, with increase in income levels the spending on lifestyle products increases,
which is expected to fuel the growth of these formats in the retail industry.
We initiate coverage on Vishal Retail with a BUY rating and a price
target of Rs.861. We also initiate coverage on Shoppers Stop with a
REDUCE recommendation with a target price of Rs.490.
Risks & concerns

q Opposition from the unorganized sector and change in Government regulations.
q Slowdown in the economy and change in consumption patterns of the population
Peer Comparison based on FY09 earnings

Company Price EPS P/E EV/ ROE EBITDA NPM Target
(Rs) (Rs) (x) EBITDA (%) mgn (%) (%) (Rs)
Shoppers' Stop 492 7.7 63.9 19.0 8.5 6.0 1.6 490
Vishal 740 34.3 21.6 11.1 25.0 10.7 4.3 861
Source: Kotak Securities - Private Client Research
Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.
December 13, 2007 Kotak Securities - Private Client Research
Investment argument
Low penetration
The current penetration levels of organized retail are the lowest in the world. With
a massive population, the potential of the industry in India, going forward, is
tremendous. Companies have announced big plans to enter into various segments
in the industry. The penetration levels are as low as 3-4% overall and as low as 1%
in segments such as food and grocery retail. Clearly, the potential of the sector going
forward is enormous.
Favorable demographics provide enough potential for organized

retail
Out of India's population of about 1 bn, the overall target market for modern retail
is estimated at about 50 mn people. With more than 50% of the population being
under the age of 25, the market looks extremely attractive for organized retail players
as this population has demanding lifestyles. This segment forms a major portion of
any retailer's plan.
Growth in urbanization Growth in urbanization is a key driver for the organized retail industry. This is
is a key driver for the because, currently 85% of the organized retail market is concentrated in India's eight
organized retail largest cities. In India, the top six cities currently account for about 6% of the
industry population but contribute to 14% of GDP. The population of urban areas is expected
to touch 550 mn by 2021 as against 376(E) currently.
Rising incomes & consumption patterns to spur growth

Out of an estimated 209 mn households in India, nearly 6 mn are classified as 'rich'
as compared to 3 mn in 1999-2000 (Source: E&Y). Also, about 91 mn households
are classified as 'consuming' as compared to 55 mn in 1999-2000. While rich
households have income levels of greater than US$4700, the consuming class enjoys
average income of US$ 1000-4000. Also, the average income level of high-income
households has been growing at 20% YoY since 1995-96.
This growth in income brings along with it a higher disposable income, willingness
to spend and demand for better lifestyle. As income levels rise, one tends to spend
more on lifestyle related activities and products, which is a key driver for these
segments of the retail industry.
These can be clearly observed from the statistic that discretionary spending has been
seeing a 16% rise for upper and middle classes over the past three years. The private
final consumption expenditure (PFCE) which is basically what a consumer spends on
food and grocery, apparel, medical services, savings, entertainment etc, is estimated
to grow from Rs.18.9 trillion in 2005 to Rs.53.62 trillion in 2015 and is expected to
constitute 57.5% of India's GDP.
Easy availability of credit

The number of credit cards issued in India has been witnessing a strong growth over
the past few years. Currently, there are 22.6 mn cards in circulation as compared to
7.1 mn in 2003. This number is expected to grow by over 30% over the next few
years.
Easy availability of credit and also easy EMI schemes being offered by the bank as
well as companies do provide a boost to retail companies as this directly has an
impact in consumption patterns of people.
In India, less than 1% of personal consumption happens through credit cards as
compared to the global average of 5%. With a significant increase in the expected
usage of credit cards, the spending patterns of consumers are expected to change
further, in turn, benefiting organized retailers.
Retail Sector Report Please see the disclaimer on the last page For Private Circulation 2
Increased acceptance of "mall culture" to help growth

The organized retail boom was given a boost with the concept of shopping malls.
Currently, India has 179 operational malls and is expected to have 412 malls by 2010.
These malls attract footfalls in ten of thousands everyday and have become family
destinations to shop, eat and for entertainment.
While further details are not available, we believe the expected growth in shopping
malls and increased acceptance of the "Mall culture" should provide further boost to
the organized retail sector.
We initiate coverage on Shoppers' Stop with a REDUCE rating and Vishal
Retail with a BUY rating.
Brief synopsis of companies covered
SHOPPERS' STOP
Shoppers' Stop is a leading player in the lifestyle apparel segment. Shoppers' Stop
operates 1.17 mn sq ft of space across formats such as Shoppers' Stop, Home Stop,
Crossword, Café Brio, MAC and Mothercare.
The company is on an expansion mode. We estimate that an increase in capacity by
89% should result in revenues growing at a CAGR of 36% between FY07 and FY09.
Profits are expected to be stagnant at Rs.268 mn in FY09 viz-a-viz F07. EBIDTA
margins are seen moving downwards from 7.5% to 6.0% between FY07 and FY09.
Consequently, EPS is expected to be Rs.5.7 and Rs.7.7 in FY08 and FY09, respectively.
The main reason for the contracting margins and stagnant profit is that the company
is on an expansion mode and is setting up new stores and new formats. These new
stores take about three to five quarters to break even. Since some of the formats
are new, they will be biting into the margins until they gain some scale.
Financials (Standalone)
(Rs mn) FY07 FY08E FY09E
Sales 8,995 12,772 16,674
Operating Profit 674 715 1,004
Operating Margin (%) 7.5 5.6 6.0
PAT 261 197 268
EPS (Rs) 7.6 5.7 7.7
Source: Company
Our sum-of-the-parts We value the standalone business at Rs.440 using the DCF methodology. We have
valuation gives us a 12- valued the Hypercity stake at Rs.50 (0.72x Sales), giving it a discount to Pantaloons,
month target price of India's largest player in the value retail segment. Thus, our sum-of-the-parts
Rs.490 for Shoppers’ valuation gives us a 12-month target price of Rs.490.
Stop
VISHAL RETAIL
Vishal Retail is a leading player in the value retailing segment in Tier-II and Tier-III
cities. Vishal retail operates 1.26 mn square feet of space with majority of its stores
located in Tier-II and Tier-III cities. Vishal plans to expand its retail space to 2.1 mn
sq ft in FY08 and to 3.1 mn sq ft in FY09.
We are positive on the prospects of Vishal Retail as it has a strong foothold in the
cities that it is present in. Its margins are also high as most of the products sold are
in-house brands. We expect the revenues to grow at a CAGR of 72% between FY07
and FY09 and PAT to grow at a CAGR of 76% over the same period.
Financials
FY07 FY08 FY09
Sales 6,027 10,589 17,853
Operating Profit 670 1,240 1,916
Operating Margin (%) 11.1 11.7 10.7
PAT 250 465 768
EPS (Rs) 11.2 20.7 34.3
Source: Company
We recommend a BUY on We value the company on a P/E multiple basis. We accord a PE multiple of 25x to
Vishal Retail with a 12- our FY09E earnings. This is at a discount to Pantaloons which is India's largest
month price target of retailer and leader in the hypermarket segment. We recommend a BUY on Vishal
Rs.861 Retail with a 12-month price target of Rs.861.
This 10% discount to Pantaloon is because Pantaloon is the leader in the hyper
market segment and due to the relatively smaller size of Vishal Retail.
Organized retail in India

In India, retail is the largest industry, with a size of approximately US$320 bn and is
growing at a fast pace of 26% (Source: Cris Infac). With over 12 mn retail outlets,
India probably has the highest density of retail outlets in the world, with one for
approximately every 90 people. However, a majority of this is unorganized, consisting
mainly of small convenience stores, also known as kirana stores.
Among major developed as well as emerging economies, India is one of the most
under penetrated markets in terms of organized retailing. The current size of the
industry is at $320 bn, according to Crisil.
Cris Infac expects the KSA-Technopak, a retail consulting and research agency, predicts that by 2010,
Indian organized retail organised retailing in India will cross the $21.5-bn mark. Cris Infac expects the Indian
industry to grow at a organized retail industry to grow at a CAGR of 26% over the next four years. In
CAGR of 26% over the contrast, the unorganized retail industry, on the whole, is expected to grow at 6%.
next four years
With the economy on an upswing and with favorable demographics, the retail
industry is at an inflection point. Large investments are being announced by players
such as Reliance, Bharti-Wal-Mart, Aditya Birla Group and others.
PricewaterhouseCoopers estimates that $412 bn is expected to be invested in retail
over the next five years. This clearly indicates that there is a lot of growth to be
witnessed in this sector. With a population of 1 bn people there is an expectation of
phenomenal growth over the next few years.
Over the past few years, we have witnessed a rise in income of people, increase in
consumption and changing lifestyle patterns of the Indian society. Even smaller Tier
II and Tier III cities have witnessed tremendous growth over the past few years.
The retail market is no longer confined to bigger towns and cities. The real estate
boom introduced the concept of malls. This took the shopping experience and
entertainment levels to a new standard. Organized retail has, to a large extent, been
kick started by this concept of malls.
Journey of organized retail: The India story
End-to-End M&A,
Supply chain Shakeout,
Management, Consolidation,
Back-end High
opeation, Investments
Growth
Range, Technology,
Entry, Portfolio, Processes
Growth, Format
Expansion, Options e
pac
Top Line
tail S
Re
Focus ita
er cap
P
First Phase Second Phase Third Phase Fourth Phase

2000 2005 2008 2011
Source: E&Y The great Indian retail story
A study conducted by AT A study conducted by AT Kearney indicates that India is the top retail destination in
Kearney indicates that the world. The study ranks 30 emerging countries based on a set of 25 variables
India is the top retail including economic and political risk, retail market attractiveness and retail saturation
destination in the world levels. It has retained India's position at the top for the third successive year.
Global retail development index

Rank Country Country Market Market Time GRDI
Risk attractiveness saturation Pressure Score
0 = high 0 = high 0 = high 0 = high 0 = high
100 = low 100 = low 100 = low 100 = low 100 = low
1 India 67 42 80 74 92
2 Russia 62 52 53 90 89
3 China 75 46 46 84 86
4 Vietnam 57 34 76 59 74
5 Ukraine 41 43 44 88 69
6 Chile 80 51 42 43 69
7 Latvia 77 32 21 86 68
8 Malaysia 70 44 46 54 68
9 Mexico 83 58 33 33 64
10 Saudi Arabia 65 40 35 35 64
Source: AT Kearney
The study also indicates that India is at the peaking stage in retail as the strategy
being currently employed by the retailers in India is a clear indication of this stage.
Stages in retail
OPENING PEAKING DECLINING CLOSING
Strategy Monitor market; Open sourcing office or Scale up openings Determine marker
consider sending step up retail stores; to capture market position; re evaluate
research team test the market share strategy as needed
Formats Not applicable Consider supermarkets Consider discount No pattern
and hypermarkets, models identified
cash and carry, and
convinence stores over
other formats as they
have higher success
rates
Labor Identify skilled Hire and train local Switch balance No pattern
labor pool for talent; create balance from expatriate identified
market with expatiate to local staff
employees
Source: AT Kearney
Key growth drivers

The current upswing in the economy, favorable demographics, availability of credit
and growth in infrastructure are all expected to propel the retail story forward. Apart
from this, the low penetration levels of organized retail have set the stage perfectly
for exponential growth in the sector over the next few years.
Favorable demographics
India, with a population of about 1 bn, is definitely a huge market waiting to be
tapped. Estimates suggest that the potential market for modern retail is at about 50
mn people, which is a sizeable number. This estimate is based on the fact that this
population of 50 mn is the consuming class.
India has the With 50% of the population being under 25 years old, the market looks extremely
youngest population attractive. These segments of the population have demanding lifestyles and
in the world contribute to the overall consumption. Hence, they form a major portion of any
retailer's plan. India has the youngest population in the world. In 2020, the average
Indian will be only 29 years old, compared with 37 in China and the US, 45 in West
Europe and 48 in Japan. (Business Line)
Urban markets are major markets for organized retailers. With increasing
urbanization, the retail market is witnessing a high growth rate. As of now, 85% of
India's retail market is concentrated in its eight largest cities. The top six cities of
Delhi, Mumbai, Bangalore, Chennai, Kolkata and Hyderabad form 6% of the
population but contribute to 14% of India's GDP.
Urbanization has been increasing at a rate of 2.7% in the last 10 years. It is expected
to increase at 2.4% between 2000 and 2015. The population in urban areas is
expected to touch 550 mn, from an estimated 379 mn in 2007, by 2021 (Source:
Ficci).
Population of India by age and sex - 1997 and 2020
Source: US Bureau of census
Also, a study by international consultant, Deloitte Touché Tohmatsu titled '2007 Global
Powers of Retailing' rates China, India and Russia as preferred retail destinations.
The study identifies 250 global retailers operating on an average in 5.9 countries
and increasing their international reach. While as many as 30 of these retailers are
present in China, only five - Metro, PPR, Marks & Spencer's, Shop Rite, Dairy Farm
- are in India. Further investments in India are expected to come in with relaxations
in Government rules and regulations.
Rising income & consumption patterns

In 2006, India had approximately 209 mn households, of which the 6 mn were 'rich'
households having annual incomes of over US$4700 and 75 mn were 'consuming'
class having annual incomes between US$1000-4700. (Source: E&Y).
The rising household incomes have led to a substantial change in the profile of the
Indian consumer. Demand for better lifestyles and willingness to spend is increasing
consumption. This is leading to the growth of modern retail formats.
The number of high Discretionary spending has seen a 16% rise for the urban upper and middle classes
income households has and the number of high income households has grown by 20% YoY since 1995-96
grown by 20% YoY since (Source: E&Y).
1995-96 (Source: E&Y)
In the table provided below, the profile of the 'Climbers', 'Consuming' and 'Very Rich'
consumers class is biased towards self-indulgent consumption patterns. It is projected
that by 2007, these segments will be over 170 mn households as compared to 124
mn in 2000. This will constitute about 86% of the population against about 69% in
2000.
Classification of households
Mn households 1994-1995 1999-2000 2006-2007
Very Rich 1 3 6
Consuming 29 55 91
Climbers 48 66 74
Aspirants 48 32 15
Destitute 35 24 13
Source: E&Y the great Indian retail story
In the above table, the "Very rich" class has annual income exceeding US$4700 and
is classified as Benefit Maximizers, owning cars and PCs. The "Consuming" class has
annual income of US$ 1000-4700 and is classified as Cost-benefit optimizers. They
consume bulk of branded consumer goods, 70% of two-wheelers, refrigerators and
washing machines. The "Climbers" have annual income of US$500-1000, are
classified as Cash-constrained benefit seekers and have at least one major durable
(mixer, sewing machine/television). "Aspirants" have annual income of US$350-500
and are classified as new entrants into consumption. They consume bicycles, radios
and fans. "Destitutes" have annual income of less than US$500 and have a Hand-
to-mouth existence.
According to E&Y, with the present population of 1.07 bn, the target consumer base
for most retailers currently stands at about 405 mn. Of this, about 30 mn have a
combined purchasing capacity of $230 bn. India's 6 mn strong 'rich' population shops
annually worth $28.36 bn. Going forward, the growth in income and urbanization is
expected to expand the market for retailers.
The total aggregate As income levels rise, it is expected to lead to higher spending and consumption
household disposable which will provide a boost to the retail sector. The total aggregate household
income is estimated to be disposable income is estimated to be growing at a CAGR of 5.9% (NCAER)
growing at a CAGR of
Studies have shown that as income levels rise the share spent on food and groceries
5.9% (NCAER)
in the total household income declines, despite an increase in absolute spends
towards these. Also, the proportion of income spent on lifestyle-related activities
increases. India is no exception. With increasing income levels and spending the retail
lifestyle segments and others are all set to witness tremendous growth.
Changing trends of Indian consumers

n For CY07, spending has gone up 12% in the last year
n Indian consumers have saved lesser by 45% in the last three years
n Indian consumers are expected to spend 42% more this year
n Consumers have increased purchases using credit cards by 30% in the last two
years
n Also, 35% of all social-economic classes (SEC) A & B households are expected to
be double income homes by 2010.
Source: Economic Times, NCAER 2006; Note: Data pertains to CY07
Private final consumption expenditure (PFCE) is basically what a consumer spends

on food and grocery, apparel, medical services, savings, entertainment, catering
services etc. PFCE is estimated to grow from Rs.18.91 trillion in 2005 to 53.62 trillion
in 2015. It is expected to constitute 57.5% of India's GDP.
Consumers want quality product

The new Indian consumer is now up to date with the latest developments in other
parts of the world and is now looking for quality products. Organized retail with its
corporate background will be able to provide the customer with quality as well as
accountability.
Hence, the consumer is slowly shifting to organized retail. Also, the cost savings that
organized retailers will be able to provide will be a factor in consumers shifting to
organized retail as India is known to be a highly price sensitive market.
Easy availability of credit

Cards in circulation (in mn)
Bankers expect the credit card business to grow by over 30% in 2007-08. Over the
years, credit cards have seen a growth from 7.1 mn in 2003 to 22.6 mn in 2007. As
25 compared to the number of cards in 2006, which stood at 17.5 mn, the number has
20 already grown by 30% this year.
15 However, the penetration levels of credit cards stands at only 2% in India compared
to a healthy 10-12% in developed economies. The current trend of growth in credit
10
cards is clearly a good sign for retail as this will directly impact consumption patterns
5 of consumers.
0 According to industry data, about 65% of the credit card customers are from Tier-I
cities, 20-22% from Tier-II cities and the balance from Tier-III cities.
2003
2004
2005
2006
2007
Another positive indicator is that less than 1% of the personal consumption

Source: Business Line expenditure is happening on cards. The global average stands at 5%. In some
developed nations, it is as high as 15%.
This growth in credit will have a direct impact on the consumption patterns, which
will result in growth of the retail industry.
Mall culture in vogue

There has been a sudden spurt in the number of malls coming up all over the country
and are attracting daily footfalls in millions. This is attracting retailers to open stores
in them. Malls provide not only a great shopping experience but are turning out to
be places for family outings, entertainment etc. This coupled with the rise in incomes
and willingness to spend is only boosting the growth of the industry.
As of today, India has 179 operational malls with 47.4 mn sq ft of retail space, and
is expected to have 412 malls offering 205 million sq ft of retail space in 2010, and
by 2015 there would be more than 715 operational malls offering 350 mn sq ft of
retail space and a very large chunk of these developments would be in India's Tier-
II and Tier-III cities. (Source: Images F&R Research)
Mall space growth in india
Source: Images F&R Research
Distribution of Mall space NUMBER OF OPERATIONAL MALLS IN INDIA 2004 - 2010*

across zones 2007 YEAR-END 2004 2006 2008* 2010*
Total supply: 47.4 mn sq.ft Delhi, NCR 9 28 64 79
Jaipur 3 7 12 14
East
Ludhiana 1 8 15
7%
Lucknow 1 1 4 5
South
14% Sonepat 3 7
West
Kolkata 3 4 19 25
44%
Bangalore 2 5 13 20
Hyderabad 1 5 12 16
North Chennai 1 2 6 11
35%
Kochi 1 3 5
Mysore 3 6
Greater Mumbai 5 30 56 68
Pune 2 7 10
Ahmedabad 2 5 6
Distribution of Mall space 2011 Nagpur 3 6 8
across zones 2007 Indore 2 5 7
Total supply: 236 mn sq.ft Other Tier-II & III Cities 4 12 63 111
East 29 105 289 412
West 9%
28%
South
In India's retail industry, food, beverages and tobacco form a substantial portion,
24%
comprising 76% of the total industry. However, it is in this sector where organized
retail penetration is the lowest, that is, 1%. According to a McKinsey report, the
share of an Indian household's spending on food is one of the highest in the world,
with 48% of income being spent on food and beverages.
North
The penetration of organized retail is highest in the footwear category at 31%
39%
followed by apparel, books, music/gifts, consumer durables, home décor and
Source: Images F&R Research furnishings.
Organized retail penetration
80 35
Share of total retail (LHS-%)
30
Share of organized retail (% - LHS)
60 25
Organized retail penetration (%-RHS)
20
40
15
20 10
5
0 0
Consumer
Food and
Music &
and textile
decor and
beverage
Beautycare
Books,
furnishing
Footwear
& watches
Clothing
Jewellery
durable
products
Home
gifts
Source: Crisil
Category-wise spend
The Indian consumer is spending most of his income on food, groceries and
beverages. Taking into account that penetration levels in this sector are the lowest
we can see this segment grow at a fast pace. Also, big players such as Reliance,
Bharti and RPG are all betting big on this sector. They are focused on back-end
logistics. These players are aiming to provide groceries at a low cost compared to
small neighborhood shops, street vendors etc, who, as of today, account for most of
the sales in groceries, vegetables etc.
Even segments such as jewelry, beauty care, books are seeing good growth, mainly
propelled by the growth in malls.
Organized retail: Category-wise share (2006)

Total retail Organised retail
(Rs bn) (Rs bn)
Food and beverage 9,510 93
Clothing and textile 1,190 195
Consumer durable 622 106
Home décor and furnishing 388 34
Jewelry and watches 549 34
Beauty care (products) 281 10
Footwear 134 44
Books, music and gifts 107 14
Total 12,781 530
Source: CrisInfac
Segment wise share in organized retail (2006)

Beauty care
(products)
2% Footwear
8% Books, music
Home décor and and gifts
furnishing 3%
6% Food and
Jewellery and beverage
watches 18%
6%
Consumer durable
20% Clothing and textile
37%
Source: CrisInfac
Major retail formats

Within organized retail, several formats have been introduced by players to cater to
varied segments. Different formats are characterized by variations in size, location,
product mix, target consumer, investment.
For example, a food and grocery store requires a location in a residential area
compared to a high street mall for a lifestyle apparel retailer. The store sizes are
generally 2000-4000 sq ft. Investment in terms of fixed costs is lower than that
required for a lifestyle store. There will also be faster turnover of inventory in such
stores and the average ticket sizes will be small but sales/sq ft are high and the
target consumer will be different from that of a lifestyle retailer.
In our opinion, the four major retail formats are:
Food & grocery

In 2003-04, private consumption expenditure in India amounted to Rs.16.9 trillion
(US$375 bn) of which, retail sales constitute about 61% (US$ 230 bn). In that fiscal,
food and grocery (US$154 bn) contributed to 41% of private consumption
expenditure and about 77% of total retail sales.
The food business in India is largely unorganized. Most food is sold in the local 'wet'
market, by vendors, roadside push cart sellers or tiny kirana stores. The all-India
food consumption is close to Rs.9 trillion, with the total urban consumption being
around Rs.3.3 trillion, whereas the aggregate revenues of large food companies and
retailers are estimated to be only 5% of the total Indian market, and around 15-
20% of total urban food consumption.
The penetration of The penetration of organized retail is only about 1% in this segment. The sector
organized retail is only has low gross margins, but there is a tremendous growth potential for the organized
about 1% in this sector in the form of hypermarkets, supermarkets and hard discount chains.
segment
Generally, stores are opened in residential areas and also part of hypermarkets.
Although few are located in malls, a vast majority of these stores are located in
residential areas. Generally, these stores are 2000-4000 sq ft in size and have high
sales/sq ft. Organized retailers are generally able to sell products at prices cheaper
than the ones offered by 'kirana' stores, due to their sourcing capabilities.
Established players in this segment are Pantaloons Food Bazaar, Subhiksha, and
Hypercity (Shoppers' Stop has a 19% stake). Players like Reliance with their 'Reliance
Fresh' stores, Spencer's Retail and Aditya Birla Group with the stores under the brand
name 'More' have recently entered into the market. There are also several regional
players such as 'Fabmall' in south India.
Stores such as Pantaloons' Food Bazaar are of sizes between 2000-20000 sq ft and
clock sales/sq ft of Rs.12000-14000. The average ticket size per customer is Rs.200.
The gross margins for Food Bazaar are in the range of 17-19% and net margins at
3-4%.
Apparels
The organized retail Apparels contribute close to 37% of total retail sales (according to Crisil). The
penetration in the organized retail penetration in this segment is close to 16%. We can further sub-
apparel segment is close divide the clothing retail business into lifestyle and value.
to 16%
In lifestyle retailing, the leading players in this segment are Shoppers' Stop, Trent,
Pantaloons, Central and Lifestyle (not listed). The margins in this business are higher
as compared to those in food and grocery retailing as these products have a smaller
market compared to that of food and grocery, purchases are made occasionally and
also because of lower presence of unorganized segments. For Pantaloons, the gross
margins are as high as 45%.
Players such as Shoppers' Stop stock goods from various manufacturers and only
20% of its sales are of private labels. However, Trent has 100% private labels. Hence,
its margins are even higher at over 10% EBITDA margins. Own brands (private
labels) generally have higher margins than products of other manufacturers.
In value retailing, Pantaloons operates stores under the name 'Brand Factory'. The
gross margins for this format stands at about 35%.
In lifestyle retailing, Pantaloon Fashion stores clock sales/sq ft of Rs.8500 and
operates 31 stores as of today. Shoppers' Stop had 22 stores as on March 2007 and
clocked sales/sq ft of close to Rs.8000. These sales are primarily of lifestyle apparels
In value retailing, Brand Factory clocks higher sales/sq ft of Rs.14000. Vishal Retail
is also a value retailer. It clocks a relatively lower sales/sq ft of Rs.7000. We note
that Vishal Retail also sells other products such as FMCG products, with apparels
constituting 60% of its revenue.
According to Cris Infac, margins between private labels and other labels are
dependent on several factors such as:
Margins
Private labels (%) National brands (%)
Gross margin 55 to 60 28 to 35
Brand building costs 8 to 10 Nil
Markdown liabilities 7 to 10 Nil
Others 3 to 5 Nil
Net margin 30 to 42 28 to 35
Stock turns 2.5 to 5.0 3.0 to 4.5
Source: CRIS INFAC
Consumer durables
According to Crisil, the According to Crisil, the organized retail penetration in this segment is 17%. However,
organized retail this segment is dominated by regional players such as 'Viveks' in south India. The
penetration in the pan-India players are E-zone and Electronics bazaar. The recently launched "Croma"
consumer durables chain is also aiming to have a pan-India presence. Reliance has entered into this
segment is 17% segment and recently launched its 'Reliance Digital' stores in New Delhi.
According to industry data, stores such as Electronics Bazaar and E-zone have been
clocking sales/sq ft in the range of Rs.13000-14000. We believe the gross margins
in this business are between 10-13%.
Hypermarkets
This format has seen unprecedented growth over the last few years. A hypermarket
generally sells products ranging from food and grocery to consumer durables. These
stores are fairly large in size.
Hypermarkets have The stores generally sell products at lower prices compared to the unorganized
clicked well with the retailers and have high sales/sq ft. We believe this is due to the sourcing capabilities
price sensitive and value of these companies. Hypermarkets have clicked well with the price sensitive and value
conscious consumer conscious consumer.
Players such as Big Bazaar, Vishal Retail, and Hypercity are leaders in this format.
New entrants such as Reliance are betting big on this format. Stores such as Big
Bazaar work with EBITDA margin of 6.5-7% and clock sales/sq feet of Rs.8000.
\Vishal Retail has sales/sq ft of Rs.7000. A majority of the stores of Vishal Retail are
located in Tier-II and Tier-III cities.
Hypercity has only one store as of today located in Mumbai. It is a very large store
of 125,000 sq ft and clocked a sales/sq ft of Rs.10400 in FY07.
The concept of hypermarket has been a success in India. Ever since Pantaloons
launched Big Bazaar in 2001 they now have 2.86 mn sq ft of Big Bazaar area.
Other formats
The other formats which have seen growth in the organized retail segment are home
décor, books and music retailing and jewelry.
The organized retail penetration in home décor and furnishings is 9%, 14% in books
and music and 6% in jewelry. The established player in the organized jewelry
retailing segment is Tanishq. In the books and music category the well established
players are Crossword (owned by Shoppers' Stop), Landmark (74% owned by Trent)
and Music world.
The home décor segment is also fragmented. Players such as Home Town, Furniture
bazaar and collection I (85% owned by Pantaloon) are now ramping up stores to
get a pan-India presence. Stores such as Home Town clock sales/sq ft of Rs.12000
and formats such as Furniture bazaar and Collection I clock sales/sq ft of Rs.6000,
in our estimate.
Benefits of retail
In our opinion, the growth in the retail sector can have a multiplier effect on the
economy. Some of the benefits which can accrue are:
n Farm income in India can increase if organized retail enhances farmer's
realizations on food items from the currently estimated low level of 30-35% of
retail price to the international norm of over 60% of retail price.
n This would come from cost savings that will result from improving the
underdeveloped supply chain for unprocessed food items. Higher farm incomes
will benefit the vast majority of the nation's population that is dependent on
agricultural income.
n The supply chain for unprocessed food items is fairly under-developed in India.
It has many layers leading to high wastages and a high cost of distribution.
Increased penetration of organized retail into the food and grocery (F&G)
segment can improve the supply chain and boost farm incomes.
The growth in the retail n The current farm realizations for unprocessed items are estimated at around
sector can have a Rs.1.2 trillion. If this segment shifts entirely to organized retailing and the
multiplier effect on the realizations of farmers are at levels comparable to developed countries (around
economy 60-65%)
n Higher farm income can boost the purchasing power of 60% of the population
adding to GDP growth through higher economic activity. For instance, if the
farmers spend 80% (given the lower propensity to save at low income levels) of
their incremental income, the economy will witness an incremental spending of
around Rs.1 trillion. This is equivalent to nearly 3% of India's GDP, even if the
economic multiplier effect is excluded.
n Companies are spending heavily on marketing, hence improving the growth of
the marketing sector as well. Intense competition will only further increase the
advertisement and marketing expenditure. Pantaloon has doubled its ad budget
from Rs.1 bn to Rs.2 bn this year. Even Shoppers' Stop has increased its spending
by 35% and will continue to keep its ad budget at 4% of its revenues.
n Also, logistics and supply chain companies are set to benefit from the retail boom.
Thus, growth in retail can have a multiplier effect on the economy.
Indian consumers: Largest beneficiaries

India's middle class as well as lower income consumers will be the ultimate gainers
with multiple benefits:
n Reduction of prices in typical monthly basic needs. Shopping bills may reduce by
at least 10% within the next 24-30 months, leading to generation of an equivalent
amount of surplus disposable income
n Improvement in quality of fresh/perishable products in the market
n Improved assortment and reliable availability of products
FDI in retail
Currently, foreign direct investment in retail chain stores is restricted in India.
Prior to 1997, there were no FDI restrictions in the domestic retail sector. Players
who entered were McDonalds, which opened in India in 1996 and Foodworld, which
was hived off as a 51:49 joint venture between Spencer & Company (RPG Group)
and Dairy Farm International. Companies that entered prior to 1997 have been
allowed to continue with their existing foreign equity components.
Currently, a foreign company can conduct business through the following channels:
Franchising
This entails the granting of rights by one party, the franchiser, to another, the
franchisee, in return for a sum of money. The franchisee is then allowed to exercise
those rights under the guidance of the franchiser. The franchiser owns the concept
and the brand name. The franchisee is allowed to conduct business using the
franchiser's know-how and brand name. (for example, Marks and Spencer's).
Cash and carry wholesale

FDI has been allowed to the extent of 100% in cash and carry wholesale business.
This business essentially means that a large distribution network is established to
aid local manufacturers in reducing the supply chain. This model has been designed
in such a manner that the wholesaler deals with small retailers and not directly with
consumers. (for example, Metro AG, Bharti-Wal-Mart)
Joint venture
Currently, FDI in retail is In this case, the international brand provides equity and support to an Indian entity.
restricted in India and However the share of the MNC is restricted to 49%. (for example, Reebok)
companies can operate
only through select Distribution
channels
The international company has to set up a distribution office in India and supply
products for sale to local retailers. (for example, Swarovski)
Manufacturing
Under this route, the international company has to set up an Indian company to
manufacture its products and then can it get the right to retail its products in India.
(for example, Bata, Benetton)
Single brand retail

FDI up to 51% has been allowed in retail trade of 'single brand' products with prior
government approval and under certain conditions:
n Products to be sold should be of a 'single brand' only.
n Products should be sold under the same brand internationally.
n 'Single brand' product retailing would cover only products that are branded during
manufacturing
Benefits of FDI in retail

n Inflow of investment and funds.
n Improvement in the quality of employment and generating more employment.
n Increased local sourcing, better value to end consumers, Investments and
improvement in the supply chains and warehousing.
n Growth of infrastructure.Increased efficiency which can lead to further cost
reduction.
n Stimulate infant industries and other supporting industries.
Drawbacks of FDI in retail

n Would give rise to cut-throat competition
n Promoting cartels and creating monopoly
n Increase in real estate prices
n Marginalize small domestic entrepreneurs.
n Displacement of unorganized players because of financial strength of foreign
companies
n Unfair trade practices like predatory pricing in case of absence of proper
regulatory guidelines
Steps being taken to protect margins

Retail is a low margin, high volume business. With the retail boom being witnessed
in the country, all companies are on an expansion mode and adding stores at a fast
pace. This expansion is leading to cost pressures and biting into the margins of the
retailers. In order to protect its margins and also with the aim to counter competition
in the industry, companies are taking several measures to stay competitive and also
expand margins, as well as offer best prices to the customer.
Companies such as Reliance Retail have announced a plan to set up a massive supply
chain which will involve sourcing products directly from farmers/manufacturers, hence
avoiding all middle men and resulting in significant low costs of sourcing.
In case of apparel retailing, companies are now concentrating towards developing
their own private labels in order to expand margins. Players such as Shoppers' Stop
and Reliance Retail are altering their product mix in order to include more private
labels as the margins in these are higher than other brands.
Lifestyle retailers are Lifestyle retailers are also looking at options such as becoming anchor tenants in
also looking at options malls so as to reduce lease costs, which are a very significant proportion of their
such as becoming anchor costs. Players such as Shoppers' Stop and Trent have already tied up with mall
tenants in malls so as to developers and have agreed to be their anchor tenants for several of their projects.
reduce lease costs This provides a win-win situation to both developers and retailers, as developers are
aware that such stores can attract footfalls to the malls. Companies also get into
revenue sharing agreements with mall developers and thereby reduce their lease
costs.
Companies are concentrating on their back-end by setting up warehouses at different
locations so as to ensure sourcing costs are low as well as stocks reach stores on
time. Players such as Vishal Retail and Pantaloons have several distribution centers
located all over India to take care of their supply chain. Pantaloon has set up a
company called Future Logistics, which provides all the back end support to all its
businesses.
Risks & concerns

Delays in mall construction may delay launch plans of retailers
A survey by ICICI Property and Technopak suggested that malls would account for
half of the total organized sector retail space demand in the next five years. However,
the rising cost of retail space in India is affecting the growth plans of retailers. Real
estate costs are hampering their margins, which are already not very high.
Retailers, in order to get prime real estate, have even started to look at residential
properties located at prime locations to convert them into retail outlets/malls. They
are also entering into long-term lease arrangements with mall developers as anchor
tenants in order to reduce lease costs and also entering into revenue sharing
agreements.
High employee costs

Companies are now Another major concern is staff costs. Owing to increasing competition and new
looking at innovative entrants in the retail business, attrition levels for the industry have gone up
retention schemes in drastically resulting in high expenses to retain and hire new people. Staff costs have
order to reduce attrition gone up by 35% since 2006. Companies are now focusing on retaining their
and reduce employee employees and are forced to offer them higher salaries and bonuses, which in turn
costs have an impact on the profitability of the companies. Companies are now looking at
innovative retention schemes in order to reduce attrition and reduce employee costs.
Opposition to organized retail

Opposition from the unorganized sector and any consequent political opposition can
hamper growth plans of retailers. Also, delays in opening up the retail sector to FDI
may impact growth rates of the sector, going forward.
Pressure on margins
Another important fact is the pressure on margins, which the retailers will face once
competition enters. Retailing as such is a low margin business. EBITDA margins for
food and groceries are wafer thin at 3-3.5%. Margins in the apparel business are in
the range of 8-16%.
Retailers are Given the big expansion plans of retailers, net profits may have to take a hit in order
concentrating more to increase volumes. Retailers are concentrating more and more on private labels
and more on private where margins are higher. However, we still feel that, going forward, this is a key
labels where margins risk in this business. The company that is able to properly understand the consumer
are higher and his needs would be the one that will survive in the long run.
Conclusion
We are positive on the sector and believe current players such as Pantaloon,
Shoppers' Stop, Vishal Retail and Trent are well positioned to take full advantage of
the growth in the sector. With the growth in consumerism, urbanization and a young
population the retail sector is clearly on an upswing.
To protect margins, retailers have now started to concentrate on their supply chain
and logistics so as to ensure low cost of procurement. As such retail is a high volume,
low margin business and one which requires sizeable investments in working capital.
Average margins across major formats are as under:
Table
Format Gross margins (%) EBITDA margins (%)
Apparel: Lifestyle 35-45 8-16
Value 32-37 10-12
Hypermarkets 25-30 6-7
Food and Grocery 15-20 3-4
Source: Kotak Securities Private Client Research
We feel that looking at With organized retail penetration levels of 3-3.5% of the total industry, and as low
the size of the market as 1% in segments such as food and grocery the scope for growth is tremendous.
and the potential, there Players such as Reliance Retail, Aditya Birla group are all expected to do well, going
is a market large enough forward. Although there may be questions about the cutthroat competition we feel
for several large players that looking at the size of the market and the potential, there is a market large
to co-exist enough for several large players to co-exist.
Even in case of other segments such as apparel and value retailing, the penetration
levels are low and with growth in number of malls and hypermarkets, established
players such as Shoppers' Stop, Trent, Pantaloon are expected to benefit as they
have a strong foothold and pan-India presence already.
Our preferred pick in the sector is Vishal Retail.
Rohit Ledwani
rohit.ledwani@kotak.com SHOPPERS' STOP
+91 22 6634 1507
Price : Rs.492 Recommendation : REDUCE
Target Price : Rs.490 FY09E PE : 63.9x
Shoppers' Stop is one of the leading players in lifestyle apparel
retailing and has a strong foothold in metro cities. In FY07, the
company had 1.17 mn sq ft of space and reported sales of Rs.8.99 bn.
The company is on an expansion mode and wants to rapidly increase
its presence across the country. With this rapid expansion, we estimate
Stock details
margins will come under pressure going forward for the next two
BSE code : 532638
years. We are initiating coverage with a REDUCE recommendation.
NSE code : SHOPERSTOP
Market cap (Rsm) : 17146 We estimate that the company will operate 1.62 mn sq ft in FY08 and
Free float (%) : 33.84 2.21 mn sq ft in FY09. The company has also introduced new specialty
52-wk Hi/Lo (Rs) : 777/441
formats such as Arcelia, MAC and Mothercare in order to diversify its
Avg. daily volume (m) : 3487
portfolio. However, since these are new formats and will take three to
Shares o/s (m) : 34.85
four quarters to break even, they will significantly impact the overall
results of the company. For standalone Shopper's Stop stores high
Summary table - Standalone
operating costs particularly that of lease rentals and energy costs are
Rs mn FY07 FY08E FY09E
impacting margins.
Sales 8,995 12,772 16,674
Growth % 32.8 42.0 30.6 The company also has the option of increasing its stake in Hypercity
EBITDA 674 715 1,004 from the current 19% to 51% by December 31 2008. The 51% stake
EBITDA margin % 7.49 5.60 6.02 in hypercity gives us a value of Rs.50 per share of Shoppers Stop and
Net profit 261 197 268 we feel that the current market price clearly discounts the potential of
Net cash (debt) (137) (488) (1,698) this format as well. We estimate the company's revenue will grow at a
EPS (Rs) 7.6 5.7 7.7 CAGR of 36% between FY07 and FY09. However, we estimate EPS will
Growth % (3.5) (24.5) 35.9 stagnant and Rs.7.7 in FY09 as compared to Rs.7.6 in FY07. Based on
CEPS 15.0 16.9 23.2 our DCF valuation, we value the standalone business at Rs.440 per
DPS (Rs) 1.5 1.1 1.5 share and Rs.50 per share for the Hypercity stake. Given the pressure
ROE % 9.2 6.6 8.5 on earnings, going forward, we recommend a REDUCE.
ROCE % 11.9 9.8 11.8
EV/Sales (x) 2.0 1.4 1.1 Key disinvestment rationale
EV/EBITDA (x) 26.9 25.6 19.0
P/E (x) 64.9 86.9 63.9 Expansion plans to impact earnings
P/Cash Earnings 32.8 29.2 21.2
Shoppers' Stop is currently present in 12 cities. The expansion plans of the
P/BV (x) 5.8 5.6 5.3
company have been slow over the past two years primarily due to delay by mall
Source: Company, Kotak Securities - Private developers in handling over stores. Over the next three years, we expect that
Client Research
the company will open 18 new stores. We also believe the company will be
Shareholding pattern (Q1FY08) expanding its specialty stores such as Mothercare and Café Brio and new formats
such as Arcelia. As the stores that had got delayed are now ready to open, this
Corportae
sudden bunch up of stores could impact margins significantly, going forward.
Bodies
Banks, 4.7% Public Consequently, the total area is expected to go up to 1.62 mn sq ft in FY08 and
Fis, Ins cos 4.4% to 2.21 mn sq feet in FY09 from 1.17 mn sq feet in FY07. Although this
0.4% expansion is expected to contribute to the sales, EBITDA and net level we
MFs
estimate the company's earnings will be impacted negatively in the medium
UTI
term. This is primarily because these stores operate on a negative EBITDA
9.0% Promoters initially and will take three to five quarters to break even. With lot of stores
66.2% expected to open over the next two years we estimate earnings will take a hit.
FIIs
These costs pressures bite into the margins earned by the older matured stores
15.3%
and hence impact the results of the company.
One-year performance (Rel to nifty)
Hypercity stake
Shoppers' Stop has the option of taking a 51% stake in Hypercity, which
Sensex
currently operates one hypermarket in Mumbai and is 125,000 sq ft in size.
Currently, Shoppers' Stop has about 19% stake in Hypercity. Hypercity has been
very successful. In FY07, the first year of operation, it clocked a turnover of
Rs.1.3 bn. However, the expansion plans of Hypercity have been delayed. With
SSL
the slow expansion of the format we feel the valuation of Rs.50 per share of
Shoppers' Stop fully reflects the potential. The additional stake will be acquired
by Shoppers' Stop at cost plus 10%. We assume Shoppers' Stop will operate
Source: Capitaline
seven Hypercity stores at end of FY09.
High lease rentals & operating costs

Shoppers' Stop being a lifestyle retailer operates most of its stores in malls or high
streets. With a boom in the real estate space the lease costs have risen significantly
and these have a direct impact on margins. Recently, Shoppers' Stop opened two
new stores in Delhi with lease costs of Rs.100/sq ft, which we feel are very high.
These can have significant impact particularly in the initial stages of a store and
impact overall earnings.
Other operating costs such as energy costs have also risen significantly in areas such
as Mumbai and are straining the earnings of the company.
New formats to take time to break even and mature

Shoppers' Stop launched the Mothercare and MAC formats over the last two years
and the latest format Arcelia in Q2FY08. These are intended to drive growth, going
forward. As competition sets into the apparel retailing, companies that can
differentiate themselves are expected to do well. With precisely this motive,
Shoppers' Stop is now building on these formats. However, in the near future we
see these stores reporting operating losses until the format matures and expansion
plans are complete. We do not see this happening for the next two years and
estimate margins of the total business will come under pressure.
Competition
With increased competition in the lifestyle retail space we do not see Shoppers' Stop
like to like growth growing at the pace of 21% that it achieved in FY07. This could
slow down sales going forward.
Valuation & recommendations

We recommend We estimate the company’s revenues to grow at a CAGR of 36% between FY07 and
investors REDUCE with FY09 and EPS to be Rs.5.7 in FY08 and Rs.7.7 in FY09.
a 12 month target
Based on DCF methodology we value the standalone business at Rs.440 per share
price of Rs.490
and the Hypercity stake at Rs.50 per share.
Hence we recommend investors REDUCE with a 12 month target price of Rs.490.
Risks and Concerns

n Better performance on the margin front could impact our estimates and could
result in better earnings for the company which is an upside risk to our
recommendation.
n A fall in lease rentals could also improve operating margin and hence be an upside
risk to our estimates.
n Faster opening of new stores would also result in better sales and could impact
our estimates of slow expansion.
n On the down side: Further delay in opening of stores could further impact
earnings negatively.
BUSINESS OVERVIEW
Shoppers' Stop, promoted by the Raheja group, is India's oldest organized retailer.
It commenced operations in 1991 with a store in Andheri, a suburb in Mumbai. The
store sold apparel, perfumes and lifestyle products. Over the past 15 years, Shoppers'
Stop has become a well known brand in apparel retailing and operates 23 stores
with over 1 mn sq ft as on March 31 2007.
Shoppers' Stop went public in 2003 and raised over Rs.1 bn to fund its future
expansion plans. The company aims to operate close to 45 stores over the next few
years.
Shoppers' Stop also owns the Crossword chain of book stores. It recently formed a
JV with Nuance and won bids to operate duty free stores at the international airports
of Bangalore and Hyderabad. Shoppers' Stop also operates a store at the Mumbai
airport under the name 'Stop & Go'. Currently, it is India's largest airport retailer.
Shoppers' Stop also has two stores called Home Stop in Mumbai and Bangalore,
which are one-stop shops for all home needs ranging furniture to bedroom
furnishings, kitchen appliances, health equipment etc.
They are also promoters of a hypermarket called Hypercity. Hypercity, currently, has
one store in Malad in Mumbai. Shoppers' Stop has an option to pick up a 51% stake
in Hypercity before December 31 2008 at a premium of 10% compared to cost.
During FY07, Shoppers' Stop acquired a 19% stake in Hypercity.
Shoppers' Stop also formed a JV with Argos of UK, which is primarily into catalog
retailing. Shoppers' Stop plans to set up and expand this format of retailing within
the next year.
As on March 31 2007 Shoppers' Stop has also tied up with cosmetics giant Estee Lauder to open MAC
Shoppers' Stop along stores in India. The first store was started in Mumbai in 2005. They have also forayed
with its specialty stores into the food and beverages segment. They own cafes under the brand name 'Café
has 1.17 mn sq ft in Brio', which currently operates 16 outlets and another fast food joint called 'Desi
operation Café' in Mumbai.
Apart from this, Shoppers' Stop also acquired a 45% stake in Time Zone
entertainment. The latter is in the business of operating family entertainment centers
in five outlets in four cities.
As on March 31 2007 Shoppers' Stop along with its specialty stores has 1.17 mn sq
ft in operation, with employee strength of 3071.
KEY DISINVESTMENT ARGUMENT

Delayed expansion plans
Shoppers' Stop's expansion plans have not been a high growth track as compared
to its peers in the retail business. Its plans have been delayed primarily due to delay
in handing over of stores by mall developers. In FY07, the company managed to
open only one Shoppers' Stop store and one Home Stop store. These delays
considerably impact the growth of earnings.
However, many stores that were delayed are now getting ready to open over the
next two years. However these new stores have very high operating costs and put
a significant pressure on the overall margins of the Company. The stores generally
take about four quarters to break even. In this period, they are loss making and
impact the profitability of the company significantly.
Shoppers' Stop is currently present in 12 cities. Over the next three years, we believe
the company will open 18 new stores. We also expect it to extend the reach of its
specialty stores such as Mothercare and Café Brio and other specialty formats such
as MAC and Arcelia. We estimate that the company will increase total area to 1.62
mn sq feet in FY08 and to 2.21 mn sq feet in FY09. This would result in an increase
in area by over 89% as compared to FY07.
Area as on 30th June 2007 (Sq feet)

Also, since the company would be on an expansion mode over the next few years,
we estimate margins will be under pressure for the next three to four years. With
Shoppers' Stop 22.00 operating expenses such as lease and energy costs also rising significantly, the new
Home Stop 2.00 stores will be draining resources until they mature. Even the new formats will take
Mothercare 13.00* time to mature and we see the margins under pressure over the next two years.
Mac 2.00
F&B Outlets 22.00 This capex will be financed by IPO proceeds that were raised and partly by debt.
Crossword 23.00*
Also, the company said they could be raising further funds via a rights issue.
However, we have not considered the dilution arising out of the rights issue and have
Source: Company, * - including 7 considered that the company would finance the capex through debt and internal
shop in shops, ** - including 9
shop in shops accruals.
Hypercity stake
Area (mn sq. feet) Shoppers' Stop has the option of taking a 51% stake in Hypercity, which currently
operates one standalone hypermarket in Mumbai and is 125,000 sq ft in size. In the
3.0 first year of operation, Hypercity clocked a turnover of Rs.1.3 bn. Hypercity is also
2.5 expected to expand its reach over the next few years.
2.0
However, the expansion plans of Hypercity have also not taken off as expected.
1.5
Although the store has done well in the past year, we feel the current price fully
1.0 discounts the potential of the business, going forward. The operating margins of the
0.5 business are close to 6%.
0.0
Shoppers' Stop currently holds 19% stake in Hypercity and has an option to buy
FY08E
FY09E
FY10E
FY11E
51% stake at cost plus 10% by December 2008. We value Hypercity at 0.72x Market
Cap/Sales (FY09E) giving it a 20% discount to Pantaloon, which is the leading player
in the hypermarket segment. This gives us a value of Rs.50 per share of Shoppers'
Source: Kotak Securities - Private
Client Research Stop for the 51% stake. The total cost of acquiring this additional stake is expected
to be Rs.3.5 mn.
Going forward, we have assumed the Hypercity area will expand to 0.7 mn sq ft
Hypercity Sales Growth (Rs mn)
from the current 0.12 mn sq ft between FY08-FY10.
5000
High operating costs
4000
Being a lifestyle retailer, Shoppers' Stop opens most of its stores in malls or high
3000
streets. With a boom in real estate market, lease costs have shot up significantly.
2000 Lease costs form a major part of the operating expense of a retailer. With this cost
1000
rising, margins are expected to come under significant pressure.
0 Also costs such as energy costs have been on the rise. In locations such as Mumbai
the electricity costs have almost tripled for retailers and have put earnings under
FY08E
FY09E
FY07
pressure.
The service tax on rentals may further increase operating costs. The company has
Source: Company, Kotak Securities made a provision of 9 mn for service tax on rentals this year.
- Private Client Research
With the company on an expansion mode, the new stores and new formats will have
high operating costs and are expected to keep margins under pressure over the next
few years.
Conservative accounting policies

In FY07, Shoppers' Stop changed its accounting method of depreciation, by reducing
the life of assets. This resulted in a loss in the last quarter of the year. This added
depreciation will impact the net earnings of the company. Hence the company
reported a flat growth in profits over FY06-FY07.
In the long run this is a good move as Shoppers' Stop renovates its stores every
five years and this change in depreciation better reflects the asset life, which
otherwise was overstated. However, this added depreciation could impact the net
profits of the company over the next two years and hence keep the net margins
low.
Competition
With the retail sector on a strong growth track the apparel retailing segment is
expected to get crowded with players such as Reliance Retail, AV Birla group all
expected to make their entry into the segment. Players such as Trent are also
expected to significantly increase their space over the next few years. The increase
in competition could slow down earnings of the company going forward.
New formats to take time to break even and mature

Shoppers' Stop runs a variety of specialty formats such as MAC, Mothercare, and
F&B outlets Café Brio and Arcelia. These are new stores and are reporting losses.
The management expects stores to break even within three to five quarters after
opening of a new store. With the company in an expansion mode on these formats
also, we expect margins to be under pressure until they formats gain some scale
and so that new store openings do not result in losses.
Financials
For the year, ended March 31 2007 Shoppers' Stop clocked a turnover of Rs.8.99
Growth in net Sales of the
bn, a jump of 33% from the previous year. EBITDA margins were at 7.5% as
company
compared to 7.2% in FY06. The company reported a PAT of Rs.261 mn, as compared
to 271 mn in FY06. The main reason for this de growth was that due to the change
8000
in the method of depreciation by the company in Q4FY07, the company posted a
6000 loss at the PAT level of Rs.22.7 mn.
However, for the year ended FY07, the company had shown an increase in sales/sq
4000
ft from Rs.7576 in FY06 to 7973 in FY07.
2000
Financial Summary Q2FY08
0 (Rs mn) Shoppers' Stop New initiatives Total
FY04
FY05
FY06
FY07
Revenue 2660.20 347.00 3007.20

Operating income 45.30 8.80 54.10
Operating expenses 725.40 147.40 872.80
Source: Company Annual Report
EBITDA 157.40 -23.80 133.60
Finance charges 8.40 3.60 12.00
Depreciation 87.80 11.70 99.50
PBT 61.20 -39.10 22.10
Source: Company
Financial summary Q2FY08

(Rs mn) Q2FY08 Q2FY07
Retail turnover 3042.80 2201.90
Retail Sales (Before VAT) 3007.20 2174.20
Sales Net of VAT 2870.60 2086.90
Margin on Sales 952.20 667.60
Margin on sales % 31.70 30.70
Other retail operating income 35.70 27.70
Other income 18.50 3.20
Operating expenses 872.80 544.30
Operating expenses % 29.00 25.00
EBITDA 133.60 154.20
EBITDA % 4.40 7.10
Finance income 16.60 23.90
Finance charges 28.60 9.90
Depreciation 99.50 48.30
PBT 22.10 119.80
Tax 17.90 45.80
PAT 4.20 74.00
Source: Company
n For Q2FY08, Shoppers' Stop revenues grew at 38% as compared to the

corresponding quarter last year.
n EBITDA margins are down from 7% to 4.1% this year. Higher employee costs,
energy costs were the main reason for the margins moving downwards. Also, the
new stores have been reporting negative EBITDA thus eating into the profitability.
New initiatives reported losses of Rs.23.8 mn at the EBITDA level.
n PAT was down 94% to Rs.4.2 mn for the quarter.
We expect EPS to n The H1FY08 of the company showed a revenue growth of 35% and same store
stagnate at Rs.7.7 in sales growth of 20%. Sales/sq ft for the quarter stood at Rs.3961 as compared
FY09 vis-a-vis Rs.7.6 in to Rs.3919 last year.
FY07
n However, EBITDA margins were down at 5.1% as compared to 7.2% last year.
n PBT also declined 69% from Rs.230 mn last year to Rs.70.9 mn this year.
n PAT declined 76% from Rs.144 mn to Rs.34.4 mn this year. PAT margins were at
0.6%.
n The operating costs rose from 26% of sales to 29.3% primarily due to higher
employee, lease and other operating expenses.
n Going forward, we see the same trend continuing in terms of revenues and
EBITDA. The new stores will still take another three to four quarters before
reporting profits and until then we see the margins subdued on the operating as
well as PAT levels.
Shoppers Stop financials (Standalone)

(Rs mn) 2007 2008E 2009E
Income 8,995 12,772 16,674
Cost of Goods Sold 8,321 12,057 15,670
Operating Profit (EBDIT) 674 715 1,004
Depreciation & Amortisation 256 390 540
Gross profit(EBIT) 418 325 464
Interest (47) 113 153
Other Income 22 83 90
PBT 487 295 400
Tax 225 97 132
PAT 261 197 268
Source: Kotak Securities Private Client Research
Going forward, we see the company's revenue growing at a CAGR of 36% over FY07-
FY09 and space increasing from 1.17 mn sq ft to 2.21 mn sq ft in FY09. This would
mean an additional 11 stores.
However, we see margins contracting significantly in this period as the company is
on an expansion mode. We estimate there would be costs pressures going forward.
We have assumed that in FY09 the EBITDA margins to be at 6%.
Valuation and Recommendation

Going forward, we expect the company's revenues to grow at a CAGR of 36%
between FY07 and FY09 and EPS to de grow to Rs.5.7 in FY08 and Rs.7.7 in FY09
as compared to Rs.7.6 in FY07. We value the standalone business at Rs.440 per
share, based on DCF methodology and the Hypercity stake at Rs.50 per share.
This gives us a valuation of Rs.490 per share. We therefore recommend investors
REDUCE the stock with a price target of Rs.490.
Concerns
n Better performance on the margin front could impact our estimates and result in
better earnings for the company which is an upside risk to our recommendation.
n A fall in lease rentals could also improve operating margin and hence be an upside
risk to our estimates.
n Faster opening of new stores would also result in better sales and could impact
our estimates of slow expansion.
n On the down side: Further delay in opening of stores could further impact
earnings negatively.
Financials: Shoppers Stop Ltd. (Standalone)
Profit and loss statement (Rs mn) Balance sheet (Rs mn)
Year end March FY07 FY08E FY09E Year end March FY07 FY08E FY09E
Revenues 8,995 12,772 16,674 Cash and cash equivalents 995 643 233
% change yoy 32.8 42.0 30.6 Accounts receivable 73 178 232
EBITDA 674 715 1,004 Others 1,245 1,450 2,112
% change yoy 37.6 6.1 40.4 Current Assets 2,312 2,271 2,577
Depreciation 256 390 540 Inventories 1,152 1,600 2,250
EBIT 418 325 464 LT investments 489 - -
% change yoy 19.2 (22.2) 42.8 Net fixed assets 1,522 2,008 2,704
Net Interest (47) 113 153 Total Assets 5,475 5,880 7,531
Earnings Before Tax 487 295 400 Payables 1,223 1,550 2,145
% change yoy 20.9 (39.5) 35.9 Others 128 140 190
Tax 225 97 132 Current liabilities 1,351 1,690 2,335
as % of EBT 46.3 33.0 33.0
Net Income adj 261 197 268 LT debt 1,131 1,131 1,931
% change yoy (3.5) (24.5) 35.9 Other liabilities(deferred tax) 41 - -
Shares outstanding (m) 34.5 34.9 34.9
EPS (Rs) 7.6 5.7 7.7 Equity & reserves 2,952 3,058 3,265
DPS (Rs) 1.5 1.1 1.5 Total Liabilities 5,475 5,880 7,531
CEPS 15.0 16.9 23.2 BVPS (Rs) 85.6 87.8 93.7
Cash flow statement (Rs mn) Ratio analysis

EBIT 418 325 464 EBITDA margin (%) 7.5 5.6 6.0
Depreciation 256 390 540 EBIT margin (%) 4.6 2.5 2.8
Change in working capital 504 419 721 Net profit margin (%) 2.9 1.5 1.6
Operating cash flow 170 296 283 Adjusted EPS growth (%) -3.5 -24.5 35.9
Interest (47) 113 153
Tax 225 97 132 Receivables (days) 3.0 5.1 5.1
Cash flow from operations (9) 86 (2) Inventory (days) 46.8 45.7 49.3
Capex 540 877 1,236 Sales / Net Fixed Assets (%) 6.9 6.5 6.2
(Inc)/dec in investments 138 (489) - Interest coverage (x) 0.0 1.0 2.0
Cash flow from investing (679) (388) (1,236)
Adjustment for depreciation (12) - -
Debt/ equity ratio 0.4 0.4 0.6
adjustment for reserves 44 (46) -
Total adjustments 32 (46) -
ROE (%) 9.2 6.6 8.5
Dividend paid (61) (45) (61)
ROCE (%) 11.9 9.8 11.8
Other income 22 83 90
Proceeds from equity issue 4 - -
EV/ Sales (x) 2.0 1.4 1.1
Increase/(decrease) in debt 546 (0) 800
Deferred tax credit 41 (41) - EV/EBITDA (x) 26.9 25.6 19.0
Cash flow from financing 553 (4) 828 Price to earnings (x) 64.9 86.9 63.9
Change in cash (103) (352) (410) Price to book value (x) 5.8 5.6 5.3
Opening cash 1,098 995 643 Price to cash earnings (x) 32.8 29.2 21.2
Closing cash 995 643 233
Source: Company, Kotak Securities - Private Client Research
Rohit Ledwani
rohit.ledwani@kotak.com VISHAL RETAIL
+91 22 6634 1507
Price : Rs.740 Recommendation : BUY
Target Price : Rs.861 FY09E PE : 21.6x
Vishal Retail is one of the leading players in the value retail segment.
It operates 50 stores in 18 states spread over 1.26 mn sq ft. The
company recently went public and raised Rs.1.1 bn to fund its future
expansion plans. It operates mainly in the hypermarket segment and
Stock details most of it sales are of apparel.
BSE code : 532867
The company's revenue has grown at a CAGR of 86% between FY03-
NSE code : VISHALRET
Market cap (Rsm) : 16569
FY07 and net profit at a CAGR of 160% over the same period. Going
Free float (%) : 36.07 forward, we estimate the high growth to continue. We are positive on
52-wk Hi/Lo (Rs) : 815/423 the prospects of the company given its strong foothold in Tier-II and
Avg. daily volume (m) : 29802 Tier-III cities. The company's operating margins are higher at 11.1%
Shares o/s (m) : 22.39 mainly due to lower costs of rentals and share of private and quasi
private labels. The company plans to aggressively expand in Tier-II and
Summary table III cities. We estimate the company will operate 2.1 mn sq ft of space
Rs mn FY07 FY08E FY09E by FY08. We feel this expansion will further strengthen the presence
Sales 6,027 10,589 17,853 of the company in smaller cities and will significantly add to its
Growth % 108.9 75.7 68.6 revenues and profits. It has a strong supply chain. With further
EBITDA 670 1,240 1,916
EBITDA margin % 11.1 11.7 10.7
expansion and economies of scale we do not see the margins coming
PBT 393 693 1,147 under too much pressure, going forward. We estimate the revenues to
Growth (%) 110.0 76.5 65.4 grow at a CAGR of 72% between FY07 and FY09 and PAT to grow at a
Net profit 250 465 768
CAGR of 76% in the same period. At the current price of Rs.740, the
Growth (%) 100.3 85.9 65.4
EPS (Rs) 11.2 20.7 34.3 stock discounts FY08 and FY09 earnings by 36x and 22x, respectively.
Net cash (debt) (2,281) (2,954) (4,347) We are positive on the company, and recommend investors BUY the
ROE % 25.0 23.1 25.0 stock with a price target of Rs.861.
ROCE % 21.6 19.8 21.8
Operating Cash Flow (1,008) 140 736
Net W Capital (Days) 150.5 123.6 97.4 Key investment rationale
P/E (x) 66.3 35.7 21.6
P/BV (x) 13.1 6.0 4.9
DPS (Rs) 0.0 3.1 5.1
First mover advantage in Tier-II and Tier-III cities
EV/Sales (x) 3.2 1.9 1.2 Vishal Retail's stores are located primarily in small towns and its concept is to
EV/EBITDA (x) 28.4 16.2 11.1
provide quality at low costs. It has been able to develop a strong connect with
Source: Company, Kotak Securities - Private
Client Research
the middle and lower income groups and has a strong foothold in small towns.
As none of the big retailers have ventured into small cities as yet Vishal Retail
has a first mover advantage and has built a strong reputation.
Shareholding pattern (Q1FY08)
Corporate Public Low real estate costs
Bodies 8.2%
17.8% Since Vishal Retail's stores are located in Tier-II and Tier-III cities, it has lower
real estate costs compared to other retailers who are primarily present in metro
Banks, Fis, and Tier-I cities. The average rental per sq ft is only Rs.32 for Vishal Retail as
Ins cos compared to Rs.70 for Shoppers' Stop and Rs.50 for Pantaloons. This allows the
0.2%
Promoters company to achieve a higher level of profitability.
MFs UTI 63.9%
3.0%
FIIs
In-house brands / private labels expected to prevent margin
6.8% erosion
Source: Capitaline
The overall company's sales currently consist of only 10% of in-house brands
and 20% of its apparel sales are of private labels. Going forward, the company
wants to further increase its sales of private labels as these have higher margins.
One-year performance (Rel to nifty)
Its EBITDA margins in FY07 were 11.1% and net margins at 4.2%. With
economies of scale kicking in further, we do not see these margins reducing
Sensex
significantly even though the company is on an expansion mode and this
increase in sales of private labels will help protect its margins.
Vishal
Source: Capitaline
Procurement from low-cost production centers and efficient

logistics
In order to keep margins stable Vishal Retail has a strong distribution network with
warehouses spread across the country and has a fleet of its own trucks. The company
also sources products from low cost centers such as China and has also set up an
office there for sourcing.
Increasing sales of FMCG and other private labels

Sales of private labels accounted for only 10% of the total revenues in FY07, and
more than 60% of revenues of the company come from apparels. However, with a
view to reduce seasonality, Vishal is now focused on increasing the proportion of
FMCG products sales. This is also expected to help in attracting more footfalls.
As competition sets in, such measures to increase footfalls will be helpful in
increasing its same store growth. In order to nullify the dip in margins due to sales
of FMCG products, Vishal has its own private labels for products such as toothbrushes
etc.
Valuation and recommendation

We recommend The current price discounts FY08 earnings by 36x and FY09 earnings by 22x. We
investors BUY with a estimate sales to grow at a CAGR of 72% between FY07 and FY09 and PAT to grow
price target of Rs.861 at a CAGR 76% in the same period. We value the stock on a P/E multiple of 25(x)
based on FY09 earnings giving it a discount to Pantaloon, owing to the fact that it
is the leader in the hyper market segment and Vishal being relatively smaller. We
recommend investors BUY with a price target of Rs.861.
Risks and Concerns

n High inventory level: Last year the inventory days of Vishal Retail shot up to
151 days. Such high levels of inventory block up working capital and also will
have to be sold at low prices or written off on a later date. We have assumed
the inventory days to decline going forward as in FY07 the inventory was higher
due to SAP implementation and piling of inventory for new stores.
n Competition: As other companies expand their presence in Tier-II and Tier-III
cities Vishal may have to face competition, going forward.
n Staff costs: With growth in the sector, the company will now have to spend
more on retaining its employees and high staff costs can impact margins, going
forward.
COMPANY BACKGROUND AND MANAGEMENT

Promoted by Ram Chandra Agarwal.
Vishal Retail is one of the leading players in the value retail segment. It operates 50
stores in 18 states spread over 1.26 mn sq ft. The company started off as a retailer
of readymade apparel in Kolkata in 2001. Vishal has a diversified portfolio of offerings
ranging from readymade garments to FMCG products, household products, groceries,
toys, footwear etc.
The company either manufactures products in-house or procures them directly from
manufacturers to reduce costs and achieve economies of scale. Vishal Retail has got
a manufacturing plant in Gurgaon and seven distribution centers across the country.
The company has a fleet of owned trucks in order to maintain an efficient logistics
system. Out of its 50 stores, 43 are located in Tier-II and Tier-III cities. The company
operates its stores under the brand name 'Vishal Mega Mart'.
Vishal Retail plans to Vishal Retail plans to further expand its base of 50 stores covering 1.26 mn sq ft to
further expand its base 2.1 mn sq ft in FY08. A total of 22 new stores will be funded from the money raised
of 50 stores covering in the IPO and the balance from internal accruals. Out of these 22 new stores, 18
1.26 mn sq ft to 2.1 mn will be opened in Tier-III cities, one in a Tier-II city and the remaining three in Tier-
sq ft in FY08 I cities. The company wants to strengthen sales from its private labels by expanding
its manufacturing and importing products from low-cost locations like China, thereby
achieving superior profitability, going forward.
INVESTMENT ARGUMENT
Tremendous growth opportunities in organized retail in small
cities
With most retail companies focusing on metro and Tier-I cities, Vishal has decided
to concentrate on smaller towns and cities. It is a strategy that has benefited the
company immensely. With hardly any presence of organized retailers in these cities,
we believe Vishal will stand to benefit immensely as the population of these cities
are becoming more aspirational and are willing to spend in such stores. Vishal will
have a first movers advantage in these cities and will help it get a strong foothold in
these cities before any competition sets in and will become a dominant retailer in
these cities
This strategy has also helped the company to have strong margins as the capex costs
as well as lease costs are significantly lower as compared to metro and Tier I cities.
With its first mover advantage Vishal has built a successful model and in just five
years created a strong brand for itself.
Strong player in value retail segment

Vishal's retail business works on the 'value retailing' concept - providing quality
products at low prices. Vishal has been able to develop a strong customer connect
with its target segment of middle and lower middle class consumers.
In our opinion, the company has been able to provide these because of its relatively
lower costs in the form of lower rents and also it's sourcing capabilities. The company
has a strong back end supported by distribution centers and transport facilities spread
across the country. It has close to 0.8 mn of warehousing space. The company's
focus on private and quasi private labels has ensured higher margins for the company
and low prices for the consumer.
Focus on all aspects such as manufacturing, private/quasi private labels, supply chain,
low cost of rentals has ensured that Vishal Retail always provided consumers with
quality at low costs and has built a strong reputation in this segment.
Procurement from low-cost production centers and efficient

logistics
In order to obtain cost efficiencies, Vishal Retail already procures and intends to
increasingly procure products from low-cost production centers across the globe. In
India, for example, it sources shirts from locations such as Tirupur and uses its strong
distribution network to obtain cost savings.
Rather than focusing on national private labels, Vishal stocks quasi private labels.
This gives Vishal Retail more bargaining power as such brands are localized, are
directly procured from the manufacturers, in turn have higher margins. In FY07, these
labels contributed to 72% of sales.
It also sources a few products from low cost locations like China. It has set up a
sourcing office in China, which is helping in overall sourcing for the company. Efficient
sourcing, along with a strong distribution network is one of the key strengths of
Vishal Retail.
Approximately 5% of the products of the company are imported. This figure however
will increase as Vishal increases scale. Sales of products that are imported from
destinations like China have higher margins. This will also prevent margins from
coming under pressure as the company expands its presence.
The company also set up SAP for better inventory management. This will ensure
working capital is not locked up in inventory as well as stocks are replenished just
in time to ensure shelves are always stocked and costs are kept to the minimum.
Presence in Tier-II and Tier-III cities, low real estate costs

Vishal Retail operates and aims to expand, primarily in Tier II and Tier III cities
where the penetration of organized retail is very low. This strategy reduces the cost
of running a store as rentals in these towns are relatively low compared to a Tier I
city.
On an average, Vishal Also, big retailers like Pantaloon and Shoppers' Stop do not have any significant
Retail has been paying a presence in these Tier-II and Tier-III cities. Hence, this reduces the risk arising from
rental of Rs.32 per sq ft competition. On an average, Vishal Retail has been paying a rental of Rs.32 per sq
ft for all its stores. This compares favorably with competition, which pays average
rentals of Rs.50-75 per sq feet.
Out of the 1.84 mn sq ft it plans to add by FY09, Vishal Retail has already tied up
for 1 mn sq ft and the remaining is in the pipeline.
Aggressive store openings - strong execution skills

Over the past four years, Vishal has expanded its stores from seven (in 2003) to 49
(in 2007). With this, Vishal has shown strong execution skills which are very essential
in the retail business.
As the stores need not be located in malls, Vishal Retail is not dependent on mall
developers, who generally cause delay in handing over properties. Since its stores
can be stand-alone stores and real estate costs are lower in cities that it aims to
operate, we feel that Vishal will be able to get real estate without any delay.
It further plans to expand its space to 2.1 mn sq ft in FY08 and to 3.1 mn sq feet
in FY09. The total number of stores is expected to go up to 124 by FY09, with
average store sizes being 25,000 sq ft. With strong execution skills and low real
estate costs, we expect the company to perform well over the next two years. It
has shown over 100% CAGR in sales over past few years and this strong growth is
expected to continue going forward.
Area at the end of the year (mn sq ft) New stores opened between FY03-FY07
Year end 31st-March 2007 2006 2005 2004 2003
3.5
3.0 No. of stores at the beginning of the year 26 16 14 9 7
2.5 Stores opened during the year 27 11 4 5 7
2.0 Total stores at the end of the year 49 26 16 14 7
1.5
1.0 Source: Company
0.5
0.0
We have assumed the space will expand to 2.1 mn sq ft in FY08 and to 3.1 mn sq
ft in FY09.
FY03
FY04
FY05
FY06
FY08
FY09
High margins
Source: Company
Because of low cost of sourcing and manufacturing, Vishal Retail's operating and
net profit margins are higher than any of its peers. We do not see margins coming
under too much pressure going forward.
Focusing on increasing sales of private labels & FMCG products

In order to increase footfalls and reduce the risk of seasonality of its products such
as apparel, Vishal Retail is increasing the mix of FMCG products in its stores. This
will ensure footfalls throughout the year. This, in turn, may lead to higher sales of
its apparel.
However, other than private labels the company has been able to report high margins
also due to the fact that most of its apparel other than the private labels are quasi
brands, which have higher margins as compared to national brands. It aims to keep
national brands in very low quantities going forward. The company wants to continue
its focus on quasi brands to protect margins.
Vishal Retail also aims to manufacture at least 25% of its apparel requirements in-
house. As of FY07, the contribution of private labels was 9.7% overall. The rise in
sales of private labels could help in improving margins as well as reducing
dependencies on few suppliers. This is expected to keep overall margins intact as
the company is on an expansion mode
Financials
In FY07, Vishal Retail reported sales of Rs.6.03 bn, EBITDA of Rs.670 mn and PAT
HY1FY08 Result Summary
of Rs.249 mn. The company's revenues have grown at a CAGR of 90% between FY04
(Rs mn) HY1FY08 and FY07 and PAT has grown at a CAGR of 302% in the same period.
Income 3851.6
Cost of Goods Sold 3409.5
EBITDA margins have improved significantly from 3.3% in FY04 to 11.1% in FY07.
Operating Profit (EBDIT) 442.2 For the half year ended September 30 2007 Vishal Retail posted sales of Rs.3.85 bn
Depreciation & Amortisation 108.2 and net profit of Rs.147.2 mn. EBITDA margins were at 11.5%, which are higher
Gross profit(EBIT) 334.0 than the margins recorded for FY07 which stood at 11.1%. The sales/sq ft stood at
Interest 134.1 Rs.2872 for the half year.
Other Income 32.7
During the period under review Vishal Retail added 2509 employees, seven new
PBT 232.6
warehouses spread over 0.4 mn sq ft, taking the warehouse space to 0.89 mn sq ft.
Tax 85.3
PAT 147.3 During the period under review, they also commenced operations of their garment
manufacturing plant located in Dehradun, which has a capacity of 5000 units/day.
Source: Company
Imports as a percentage of sales also increased to 7% as compared to 5% for the
full FY07.
The improvement in operating margins, we feel, is primarily due to savings accrued
from low cost sourcing and improved margins on products. It is also because only
one store was opened, hence there was no significant cost pressure. The share of
non apparel sales increased to over 40% during this period.
Only one new store was opened during the first half of the year. However, Vishal
Retail has signed MoUs for 45 new stores spanning an area of 0.99 mn sq ft.
Sales break up HY1FY08 Going forward we estimate the company's revenues will grow at a CAGR of 72%
between FY07 and FY09 and net profit at CAGR of 76% during the same period.
Others However, on the Operating margin front we estimate the margins to be 11.7% in
1% FY08 and 10.7% in FY09, primarily because of increased competition in the retail
FMCG
space that it operates in, and cost pressures that could be faced during expansion
20%
going forward with increased competition.
Based on our estimates, we expect the company to report an EPS of Rs.34.3 in FY09
Non and we give Vishal Retail a 10% discount to Pantaloon, which is the leader in the
Apparel
Apparel hypermarket segment and also India' largest retailer. Based on this we value Vishal
20%
59% Retail at a P/E of 25(x) on FY09 earnings and recommend investors BUY with a target
price of Rs.861.
Source: Company Valuation & recommendation

Going forward, we estimate the company's revenue will grow at a CAGR of 72% over
FY07-FY09. Net profit will grow at 76% over the same period. We value Vishal Retail
on P/E of 25x, based on FY09 earnings, giving it a discount to Pantaloon. Pantaloon
is the leader in the Indian retail industry and also in the hypermarket segment with
its store Big Bazaar and other value retailing formats such as Brand Factory and Food
Bazaar.
We recommend investors Vishal has grown at a scorching pace over the last few years. We feel this growth
BUY Vishal Retail with a will continue, going forward. We recommend investors BUY Vishal Retail with a price
price target of Rs.861. target of Rs.861.
Concerns
n High level of inventory. Vishal Retails inventory days shot up from 99 to 151
days in FY07. This pile up of inventory locks up working capital and may result in
the inventory having to be sold at low prices. The reason for the pile of inventory
was due to implementation of SAP and for new stores.
n Staff costs. Owing to the competition in the retail sector the company will have
to spend more to retain its employees and factors like attrition etc will have to
be countered owing to the demand for professionals in the sector.
n Competition. Vishal had the first mover advantage in the Tier-II and III cities
where it primarily operates. However, with these cities now coming under the
radar of other players Vishal will have to face stiff competition
Financials: Vishal Retail
Profit and loss statement (Rs mn) Balance sheet (Rs mn)
Revenues 6,027 10,589 17,853 Cash and cash equivalents 152 546 253
% change yoy 108.9 75.7 68.6 Accounts receivable 1 2 3
EBITDA 670 1,240 1,916 Others 3,154 4,668 6,403
% change yoy 154.5 85.0 54.5 Current Assets 3,307 5,217 6,659
Depreciation 153 302 450
EBIT 518 938 1,466 LT investments - - -
% change yoy 146.7 81.2 56.3 Net fixed assets 1,082 2,128 2,978
Net Interest 148 297 405 Total Assets 4,389 7,345 9,637
Earnings Before Tax 393 693 1,147 Payables - - -
% change yoy 110.0 76.5 65.4 Others 671 1,086 1,641
Tax 143 229 379 Current liabilities 671 1,086 1,641
as % of EBT 36.4 33.0 33.0
Net Income adj 250 465 768 LT debt 2,432 3,500 4,600
% change yoy 100.3 85.9 65.4 Other liabilities(deferred tax) 18 - -
Shares outstanding (m) 22.4 22.4 22.4
EPS (Rs) 11.2 20.7 34.3 Equity & reserves 1,268 2,759 3,397
DPS (Rs) 0.0 3.1 5.1 Total Liabilities 4,389 7,345 9,637
CEPS 18.0 34.2 54.4 BVPS (Rs) 56.6 123.2 151.6
Cash flow statement (Rs mn) Ratio analysis

EBIT 518 938 1,466 EBITDA margin (%) 11.1 11.7 10.7
Depreciation 153 302 450 EBIT margin (%) 8.6 8.9 8.2
Change in working capital 1,679 1,100 1,180 Net profit margin (%) 4.1 4.4 4.3
Operating cash flow (1,008) 140 736 Adjusted EPS growth (%) 100.3 85.9 65.4
Interest 148 297 405
Tax 143 229 379 Receivables (days) 0.1 0.1 0.1
Cash flow from operations (1,299) (385) (48) Inventory (days) 150.9 120.6 95.1
Capex 831 1,349 1,300 Sales / Net Fixed Assets (%) 5.6 5.0 6.0
Cash flow from investing (831) (1,349) (1,300) Interest coverage (x) 0.0 0.0 0.0
Adjustment for depreciation (2) - -
Adjustment for reserves 328 1,066 -
Debt/ equity ratio 1.9 1.3 1.4
Total adjustments 326 1,066 -
Dividend paid - (79) (131)
ROE (%) 25.0 23.1 25.0
Other income 23 52 86
ROCE (%) 21.6 19.8 21.8
Proceeds from equity issue (38) 41 -
Increase/(decrease) in debt 1,882 1,068 1,100
EV/ Sales (x) 3.2 1.9 1.2
Deferred tax credit 6 (18) -
Cash flow from financing 1,873 1,063 1,055 EV/EBITDA (x) 28.4 16.2 11.1
Change in cash 69 395 (293) Price to earnings (x) 66.3 35.7 21.6
Opening cash 83 152 546 Price to book value (x) 13.1 6.0 4.9
Closing cash 152 546 253 Price to cash earnings (x) 41.2 21.6 13.6
Source: Company, Kotak Securities - Private Client Research
ANNEXURE
Big ticket investments being made
Around $22 bn are expected to be invested in retail over the next few years. Big
players such as Reliance, Bharti (with its JV with Wal-Mart), and Dabur are all set to
foray into the fast growing retail space. These companies have already announced
their plans to grow aggressively in this space.
Reliance Retail
Reliance is planning to Reliance is planning to invest $6 bn over the next five years. Out of this,
invest $6 bn over the approximately 20-25% will be invested in developing a supply chain to support its
next five years retail activities, so as to derive sufficient cost savings. The company is planning
complete backward integration right from contract farming to having its own air
strips, warehouses and cold storage. Reliance has already opened stores in Delhi,
Hyderabad and Bangalore and several other cities. The company has stated its goal
to achieve a turnover of Rs.100 bn from its retail business in the future.
The main strategy for Reliance is to open Reliance Fresh outlets within a radius of
3-4 km each in order to serve larger sections of the population. That means an
average of at least 35 stores in all major metros.
It is also launching mini-hypermarkets under the name 'Reliance Mini Mart' and is
expected to open 65 outlets by March 2008.
The company has also forayed in the consumer durables business under the brand
name 'Reliance Digital'. According to the company, they plan to open 100 stores in
the first year of its operation and earn revenues of Rs.15-20 bn. It has tied up with
Videocon for the supply of color televisions and color picture tubes. Reliance will sell
these under the Reliance brand. It is also looking at entering the after sales service
segment.
Demand for consumer durables rising rapidly

Rs. In mn 2009-2010 2005-06 2001-02 1995-96
white goods 19923 13062 9030 5827
CTVs regular 9957 6295 4580 1785
motorcycles 8369 4663 2599 760
Cars 3466 1560 788 276
Source: NCAER
Five year projected growth

Product 1 year growth 5 years growth*
Cars & Utility vehicles 11% 16%
Colour Television 12% 12%
Paints 11% 14%
Two Wheelers 11% 11.5%
Washing Machines 5% 7%
* five years growth is projected CAGR (2010-2011 over 2005-2006)

One year growth is y-o-y growth (2006-07 over 2005-06)
Source: Crisil Research
Reliance is also planning to enter the luxury goods market. The company is tying up
with brands like Louis Vuitton.
Reliance is also launching specialty formats such as health and wellness, jewelry,
footwear, books and music, home solutions and cosmetic stores. These stores are
expected to have a heavy mix of private labels.
Roll out plan across formats:

Category Size in square feet No. of stores (over 3 years)
Health and Wellness 5500-15000 4000
Jewellery 6500-14000 150
Apple stores 2000-5500 37
Home Solutions 1-2.5 lakh 13
Books and Music 5000-15000 23
Reliance mini mart 11000-50000 200
Apparel 30000-50000 100
Source: Economic Times
In FY07, Reliance acquired Adani Retail, a retail chain in Gujarat, for a price of about
Rs.1.1 bn. The buyout will give Reliance access to 54 retail locations (neighborhood
stores, supermarkets and hypermarkets) across nine cities in Gujarat in one shot.
Besides this, Reliance will get its infrastructure and sourcing facilities.
With commercial real estate prices shooting up across India, the acquisition will help
the company control costs substantially as 60% of Adani retail outlets are company-
owned.
Reliance is also entering the e-commerce business. The company has appointed a
separate team to kick start this venture. It is planning to have depots at various
locations that will serve as pick up points for products. With an increase in broadband
penetration and rising real estate costs, Reliance believes this will contribute about
5-6% of its total revenues in the next two to three years. The company will use this
format to link its front-end and back-end logistics.
According to industry sources, in order to overcome the competition from local kirana'
stores, Reliance Retail has come up with a strategy to bring these local kirana stores
into its own network by taking their property on lease. The company is signing a
non-competition agreement with them that bars them from conducting a similar
business. Reliance is paying four to five times more than the prevailing market rent
to these shops.
This is much more than the sales of these stores. This is proving to be a win-win for
both Reliance as well as these small shops. The latter would otherwise have been
impacted by the presence of Reliance stores in their vicinity.
Reliance will use these acquired outlets to sell fruits, vegetables and groceries under
the 'Reliance Fresh' banner.
Recently Reliance opened its apparel retailing store under the brand 'Reliance Trends'.
These stores have a mix of both private labels and brands of other manufacturers.
Bharti-WalMart
Bharti plans to invest Bharti has tied up with Wal-Mart and will be investing in supply chain, logistics and
$2.5 bn by 2011 and wholesale cash and carry stores. Bharti is also planning to start neighborhood stores,
aims to earn revenues which will be 100% owned by Bharti, since FDI is not allowed in multi-brand retail.
of $4.5 bn out of it by Bharti's tie-up with Wal-Mart will be only for the back end. The company aims to
2015 have 10 mn sq ft of retail space and employ 60,000 employees. Bharti plans to invest
$2.5 bn by 2011 and aims to earn revenues of $4.5 bn out of it by 2015.
Dabur
Dabur is planning to invest Rs.1.4 bn by 2010 in the retail health and beauty business
by opening 350 stores. They plan to open 1000 stores by the tenth year of their
operation.
Aditya Birla group

The group plans to invest about Rs.150 bn in its retail foray. It plans to open
supermarkets and hypermarkets and also use its company Madura Garments as a
key in its retail plans. The group recently acquired a retain chain in south India called
'Trinethra'. 'Trinethra' has most of its stores in Karnataka and Andhra Pradesh under
the brand name 'Fabmall' (in Karnataka) and 'Trinethra' (in Andhra Pradesh.)
It has 172 stores and one hypermarket in Mysore called 'Fabcity'. Trinethra, which
has adopted convenience and supermarket formats, is focused on selling food and
groceries in residential areas. However, some of the stores also offer pharmaceutical
products. Trinethra also offers value-added services like forex remittances and bill
payments. A typical Trinethra store measures around 2500 sq ft. The chains of stores
are serviced by an infrastructure of central warehouses in Andhra Pradesh, Karnataka,
Tamil Nadu and Kerala, with a space of about 50,000 sq ft each.
Spencer’s Retail
Currently, the group has Spencer's Retail is part of the RPG Group. The company plans to open 2,000 retail
320 outlets, including stores covering 1 mn sq ft by 2009 with an investment of Rs.10 bn. Currently, the
Spencer's Hypermarkets, group has 320 outlets, including Spencer's Hypermarkets, Spencer's Fresh Stores,
Spencer's Fresh Stores, Spencer's Express Stores and Spencer's Daily Stores. It plans to close the current
Spencer's Express Stores fiscal will 600 Spencer's Daily stores.
and Spencer's Daily
The company also has plans to roll out a chain of consumer electronic stores. To
Stores
start with the company plans to open five in South India and the stores are expected
to be of a minimum area of 4000 sq ft.
Subhiksha
Chennai-based Subhiksha is a retail chain, which has the format of local 'kirana'
stores. However, Subhiksha sells products at a discounted price. The chain's target
customers are those who spend about Rs.2000-3000 a month for their household
expenses on food and toiletries. In India, this is a massive market owing to the sheer
size of the country's population. The company sells products about 10% cheaper
and also provides free home delivery. Hence, the chain provides the convenience of
a 'kirana' store.
In March 2006, Subhiksha had 120 outlets, mostly in Chennai. These have now grown
to more than 650 outlets with 74 in Mumbai and over 100 in Delhi. The chain plans
to have 1000 outlets by the end of the year and is eyeing 2000 in the next two
years. The retailer is aiming for a turnover of Rs.10 bn from the present Rs.3.5 bn.
The chain has seen an increase in profit margins as well, from 2% in 2003 to close
to 3.5% in 2007.
Trent
Trent is a wholly-owned Tata company. The company has entered into an agreement
with the Xander Group Inc, a global private equity firm. The Xander Group, through
one or more of its fund vehicles, will invest in the development of an institutional
retail real estate portfolio in India in partnership with high quality Indian developers.
The company would have anchor tenancy rights and obligations and would participate
with Xander in the management of such a portfolio and its growth.
Trent also has strong growth plans in its current formats such as Westside, Landmark
and Star India Bazaar. As per the management, Westside a fashion retailer and is
expected to operate 37 stores by FY08 as against the current 24. Star India Bazaar
is the company's hypermarket in Ahmedabad. The company is expanding to four
stores this year. Five more Landmark stores will also be added this year. Trent has
also raised money through a rights issue a few months ago to fund its expansion
plans.
Another Tata company Infinity Retail is expected to invest around Rs.4.5 bn to expand
its chain of multi-brand outlets of consumer durables and electronics called 'Croma'.
In fiscal 2007-08, 40 of these mega stores will be opened. The company has set a
target of over 100 'Croma' stores by 2010. The Croma stores will feature over 180
brands of consumer durables and electronics. Spread across 15,000 to 20,000 sq ft,
these stores will offer products across eight categories including home entertainment,
home appliances, white goods, computers and peripherals, communication, music and
gaming software.
Research Team
Name Sector Tel No E-mail id
Dipen Shah IT, Media, Telecom +91 22 6634 1376 dipen.shah@kotak.com
Sanjeev Zarbade Capital Goods, Engineering +91 22 6634 1258 sanjeev.zarbade@kotak.com
Teena Virmani Construction, Cement, Mid Cap +91 22 6634 1237 teena.virmani@kotak.com
Awadhesh Garg Pharmaceuticals +91 22 6634 1406 awadhesh.garg@kotak.com
Apurva Doshi Logistics, Textiles, Mid Cap +91 22 6634 1366 doshi.apurva@kotak.com
Saurabh Gurnurkar IT, Media, Telecom +91 22 6634 1273 saurabh.gurnurkar@kotak.com
Saurabh Agrawal Metals, Mining +91 22 6634 1291 agrawal.saurabh@kotak.com
Saday Sinha Banking, Economy +91 22 6634 1440 saday.sinha@kotak.com
Rohit Ledwani Retail +91 22 6634 1507 rohit.ledwani@kotak.com
Sarika Lohra NBFCs +91 22 6634 1480 sarika.lohra@kotak.com
Chetan Shet FMCG, Power +91 22 6634 1382 chetan.shet@kotak.com
Shrikant Chouhan Technical analyst +91 22 6634 1439 shrikant.chouhan@kotak.com
Kaustav Ray Editor +91 22 6634 1223 kaustav.ray@kotak.com
K. Kathirvelu Production +91 22 6634 1557 k.kathirvelu@kotak.com
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Retail Sector Report

December 13, 2007 FOR PRIVATE CIRCULATION

Key investment rationale

Risks & concerns

Peer Comparison based on FY09 earnings

Source: Kotak Securities - Private Client Research

Favorable demographics provide enough potential for organized

Rising incomes & consumption patterns to spur growth

Easy availability of credit

Increased acceptance of "mall culture" to help growth

Brief synopsis of companies covered

Organized retail in India

Journey of organized retail: The India story

First Phase Second Phase Third Phase Fourth Phase

Source: E&Y The great Indian retail story

Global retail development index

Key growth drivers

Population of India by age and sex - 1997 and 2020

Source: US Bureau of census

Rising income & consumption patterns

Source: E&Y the great Indian retail story

Changing trends of Indian consumers

Private final consumption expenditure (PFCE) is basically what a consumer spends

Consumers want quality product

Easy availability of credit

Another positive indicator is that less than 1% of the personal consumption

Mall culture in vogue

Mall space growth in india

Source: Images F&R Research

Distribution of Mall space NUMBER OF OPERATIONAL MALLS IN INDIA 2004 - 2010*

Organized retail penetration

Organized retail: Category-wise share (2006)

Segment wise share in organized retail (2006)

Major retail formats

Food & grocery

Source: CRIS INFAC

Indian consumers: Largest beneficiaries

Cash and carry wholesale

Single brand retail

Benefits of FDI in retail

Drawbacks of FDI in retail

Steps being taken to protect margins

Risks & concerns

High employee costs

Opposition to organized retail

Source: Kotak Securities Private Client Research

High lease rentals & operating costs

New formats to take time to break even and mature

Valuation & recommendations

Risks and Concerns

KEY DISINVESTMENT ARGUMENT

Area as on 30th June 2007 (Sq feet)

Conservative accounting policies

New formats to take time to break even and mature

Revenue 2660.20 347.00 3007.20

Financial summary Q2FY08

n For Q2FY08, Shoppers' Stop revenues grew at 38% as compared to the

Shoppers Stop financials (Standalone)

Source: Kotak Securities Private Client Research

Valuation and Recommendation

Financials: Shoppers Stop Ltd. (Standalone)

Cash flow statement (Rs mn) Ratio analysis