Aditya Birla Fashion and Retail Ltd: Results Update

Aditya Birla fashion and retail Ltd: As shared many times earlier, this one is my favourite and best pick in Indian fashion retail. For dec-17 quarter, it has posted great results; top line at 1862 cr from a715 cr but the real factor is that it has posted net profit of 35 cr from loss of 12 cr last year Q3. The main factor behind this is the performance of Pantaloons which has operating profits of 29 cr against loss of 6 cr last year. I am waiting for this transformation for long and it has happened now although i feel it has been delayed only due to demoney and GST melodrama. Its underlying main business of men's fashion brands was always doing well...it was only the restructuring and losses of pantaloons which were eating all the profits. But i have seen Indian markets having problems in evaluating a company having two separate businesses one which is legacy and doing well and the other which is under transformation and having losses but still significant business. But i have seen Indian market does the valuation on "net" basis...net profits of both businesses although both should be valued separately because loss incurring business is also having valuation, it has assets.

Pantaloons is a big business...in fact it has net capital employed of around 1600 cr compared with 1300 cr of Madurai fashion but still its turnover is around half of Madurai. Turnover of 2500 cr on assets base of 1600 cr is still small...so there will be high growth in the future. Birlas are very shrewd businessmen. I have always find Birlas and Bajajs having much better business sense than the likes of Tatas and others even Reliance. Tatas were caught off guard as 15 years back there was no competition to them but now they are doing their best to erase all that lethargy so i am buying all the legacy businesses of Tatas like Tata Chem, Tata power, Tata Global, Indian Hotels. Tata global i am done with long time back so as Tata Chem but Tata power has great value still.

Out of total debt of ABFRL at around 2000 cr, some 1300-1400 cr is for Pantaloons. But Pantaloons with its value fashion and women apparel business as Madurai is mainly a men’s branded apparel business. Most significantly, as compared to value business of other retailers like Arvind which are still under infancy, Pantaloons is a much matured business and very soon will be a major profit contributor. Aditya birla is trying to restructure its business model since acquisition and has introduced major steps like more focus on private labels and much better inventory control. Due to these Pantaloons is on the cusp of strong growth in future.

In earlier posts and emails, I have already explained the undervaluation of ABFRL compared to players like Arvind despite having much superior branded apparel business. Arvind sold 10% stake in its retail arm at 740 cr valuing the same at 7400 cr. Its EBITDA was around 180 cr so it has been valued at 40 times of EBITDA. ABFRL has EBITDA of its Branded fashion (Madurai Fashion) business at around 400-450 cr (although the same has been impacted due to demoney and GST issues). But ABFRL’s brands Van Heusen, Allen Solley, Peter England and Louis Philippe earn revenues of 1000 cr each which were the first to achieve the same in India; as compared to this Arvind’s brands like Arrow/US Polo has revenues around 500 cr each. Also, the brand positioning of ABFRL’s brand is way higher than Arvind and has much better retail footprint,  margin and maturity profile. Arvind is just a beginner so I feel ABFRL should get much higher value than Arvind…around 50-60 times taking valuation of ABFRL at 20000-25000 cr. Pantaloons with EBITDA of 200 cr should fetch valuation of 20 times taking its valuation at 4000 cr (but it is minimum). So ABFRL  should get the valuation of some 30000 cr even with moderate valuation multiples; its current market value is 12000 cr!

Moreover I still feel that ABFRL could not perform up to its potential in last two years mainly due to online discount war by e-tailers like Amazon and Flipkart as ABFRL chose to avoid the discounting path in order to retain its premium standing in the market. I have seen the likes of Raymond, Arrow etc. offering big discounts at these portals but never the brands of ABFRL. That’s the reason I have always seen people choosing ABFRL’s brands for special occasions like marriages, parties etc. due to premium positioning of its brands. The quality of its products is top notch, in fact much better than the other as far as my experience is concerned. ABFRL has introduced innerwear products under Van Heusen brand and the same is witnessing high growth and this will be one of the highest growth area.

Now the discounting war among the E-tailers is getting over as it was a war meant to destroy both badly with no clear winner in the long term as people would choose the physical stores for shopping when there are no discounts. So I think the business it lost due to this will return in the future and the top line and margins we are seeing today do not reflect the real picture of their strength and standing in the market.

Retail business is very difficult in India and there is severe competition as everybody wants to garner maximum share in this vast high growth market. But when I hear people talking about retail, I hear the names like Reliance, Big bazaar, D-mart. But very few know that the real winner of Indian retail is not from these ones- it is the humble CSD of Indian defence. In 2014-15 they were the highest net profit earners with NP at 236 cr on revenue of 13000 cr. Last year their turnover was 17000 cr but I don’t have the figure of NP. Although it has some advantages due to low prices and people always talk about the misuse of these canteens. But my aim is to highlight something very significant. CSD canteens operate on wafer thin margins of 1%-2% against 10%-20% of private sector retailers which I think even out any advantage of low prices. But CSD canteens earn better because they save two biggest costs of private retailers- Real estate and advertising.

Real estate and advertising-I think private retailers like ABFRL will show much better margins once they tackle these two. Real estate costs in retail are highest in India when retail is just in its infancy…so I think this is big anomaly and requires urgent attention. In fact, ABFRL has already started working in this direction and closed around 200 loss making stores last year. Indian retail market is overcrowded which resulted in the heating up of the rentals due to high demands but now consolidation is under way as stores are being shut down due to lack of profits as real estate alone accounts for some 20-30% of the costs. Moreover GST will enable these players to get the input of GST paid on lease rentals as earlier they were not getting any input for service tax paid on lease rentals as they were paying sales tax (VAT) on their products so input of centre level service tax was not allowed against state level sales tax. So this will save the cost for them. Like, in this qtr their lease rent costs have come down to 267 cr from 278 cr...i think this may have some impact of GST input. Waiting for the comments from the management. I also expect cooling down of Indian real estate market and this will have positive impact on the margins. Advertising cost will also come down as at present the focus is on brand positioning and making people aware of these brands. But over time due to consolidation and lower competition this will come down. In fact, in 2016-17 the advertising and sales promotion costs of ABFRL have come down to 287cr from 395 cr in 2015-16. So I’ll be tracking these two factors as both account for major part of their costs (1100 cr lease rent in 2016-17) and can be a target area for reduction.

Re-rating candidate at 156…must buy.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the stock discussed in this Post).