Future Retail – Market leader in fast growing modern retail industry
Future retail, a part of Future Group is India’s largest modern retailer with retail space covering 13.3mn sq.ft. as on 31st Dec 2016. Company sells products ranging from food, apparels, and appliances to general merchandise through large and small store formats including Big Bazaar (BB), Easyday (ED), Foodhall, Fashion at Big Bazaar (FBB), and ezone. By the end of Q3FY17, company had 231 Big Bazaar Stores, and 379 Easy Day stores with Big Bazaar forming majority (75%) of the company’s retail space.
Future group led the India’s modern retail industry in the early phase of its growth rate during late 90’s and earlier years of 21st century. To capture the consumer market of fast growing urban Indians, company has expanded aggressively across the country and created brand for itself through stores like Big Bazaar. But the whole industry got affected when the economy was in its down cycle after the 2011. This coupled with sharp rise in e-commerce industry over the last few years pushed these players further down side. Future group which has grown at the cost of profitability also suffered heavily with its highly levered balance sheet.
Group went thorough complete restructuring process in the last two to three years and Future Retail emerged as pure play retail business with asset light model. Future Group has acquired Bharti Retail (Easy Day stores) and consolidated it with Big Bazaar and renamed company as Future Retail Ltd. Company with its continuously improving economics is at the right place to capture the modern India’s consumption story.
Aggressive store expansion to drive revenue growth over the next three years:
As per industry reports during the next five years (CY16-21), organized retail is expected to grow at 30% per annum. Further within the organized retail industry, neighborhood stores hold the largest potential and are expected to grow by 43% per annum.
Post-merger with Bharti’s retail operations, FRL’s convenience store network at 379 stores is now the largest and the widest convenience store network in India. From 379 stores in December 2016, the company targets to increase the store count to 750 (including 140 stores from Heritage acquisition) by September 2018. Heritage foods, is in the process of adding 20-25 stores during FY18, before its proposed acquisition by Future retail. FRL targets to increase its number of convenience stores to 3000 by FY20. This means that the company will add 750-1000 stores per annum. FRL plans to add about 10-15 stores per annum in Big bazaar and fbb, which means about 3-5% store addition to the existing store network. We expect FRL’s revenue to grow at 16% CAGR during FY17e-20e led by SSSG growth of 12-14% per annum in Big Bazaar & fbb and 10% per annum in Easy day. During the next three years, we expect Big Bazaar and fbb to grow at 15% CAGR and Easy day to grow at 31% CAGR.
Keen on improving efficiencies across its operations:
The key focus area for FRL during the next 3 years will be increasing footfalls and achieving a higher SSSG (same store sales growth). The contribution of private label brands which are of high margin is expected to increase from current 10% levels to 20% of revenue during next three years. The integration of small stores network with that of hypermarket chain has helped in improving efficiencies in terms of trade, relationships, and sourcing networks of the hypermarket chain. Easy day convenience stores have been reporting an EBIDTA loss in the past with EBIDTA margins at about -5.0-5.5% in FY15. Post its integration with Future Retail, the company has been working aggressively on turnaround of these convenience stores and has been able to improve the EBIDTA margins to an estimated -1% during 3QFY17. We expect this process to continue further and we believe that Easy Day will become break even during current financial year.
The Key Focus for Big Bazaar will be driving revenue through increase in revenue per store/per square feet. Further the company will also focus on increasing the component of private label in the food and beverages segment. The company plans to achieve this by improving assortment across its stores depending on the local tastes, increase in loyalty programs and increase in bill value per customer. With the above mentioned steps we expect EBIDTA margin to expand 130bps during FY17e-20e led by improvement in profitability of the convenience stores coupled with higher revenue per store and higher private label share in food and HPC in Big Bazaar and fbb. Additionally, operating leverage is expected to kick in with increase in scale of operation leading to gain in profit margins.
Rationalization of inventory will lead to higher turnover:
FRL substantially reduced its inventory levels during the last two years to 106 days in 1HFY17 from about 163 days in FY15. This reduction in inventory was due to reduction in inventory levels in Big Bazaar from about 130 days to about 110 days and due to re-structuring of the company. Going ahead, the company plans to reduce its inventory levels from 106 days to about 70 days during the next 3 years. We factor in a reduction in inventory levels to 93 days by FY20e. This as per our understanding will be primarily led by rationalization of its inventory in home improvement and electronics business, Increase in contribution of private label, sourcing of raw materials and product from few large vendors, increase in centralized buying and direct procurement.
Higher inventory turnover coupled with improvement in operating margins will lead to Higher RoCE there by leading to higher free cash flow generation. We expect FRL to post significant improvement in free cash flows during the next three years, led by accelerated growth in earnings and inventory management. Additionally, capex will be limited at INR250m, which will primarily comprise of investments in information technology and data analytic tools. We expect FRL to generate sustained free cash flow from FY18e at about INR4.0bn.
Valuations & Conclusion:
We expect FRL’s revenues and earnings to grow at 16% and 35% CAGR over the next three years led by aggressive store expansion and improvement in operating margins. The stock is trading at a PE of 23x FY18E and 14x FY19E and we expect valuations to improve further with the increase in FCF generation and improvement in return metrics (RoE & RoCE – 20%+) in the coming few years.