Aditya Birla Fashion and Retail – Good Brands don’t equal Good Business?

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion.

  • NSE: ABFRL is one of India’s largest fashion retail companies with Madura (premium) and Pantaloon (value) house of brands.
  • ABFRL’s brands include household names that capture the entire gamut of discount and premium customers, including in-house and foreign brands such as Van Heusen, Peter England, Global Desi and Forever 21.
  • ABFRL has the ownership / perpetual license of its brands unlike competitors like Future Fashion and Retail and Shoppers Stop. Intangible Assets.
  • These intangible assets however are not translating into improved ROCE (Return on Capital Employed) and this is not a source of competitive sustainable advantage
  • We can blame the industry structure and the value conscious Indian buyer who prefers substitutes to brands when it comes to discretionary spending such as apparel. The discount disruption by online players like Myntra and Amazon has spoiled the buyer and changed industry structure.
  • We can also blame the huge debt on its books and asset-heavy (rent is 600 crore) model of its brick and mortar retail format, which leaves little in terms of EPS for stock price appreciation.
  • To give you a sense of the enormity of debt, the company reported post-merger, a Goodwill of 1795 crore (which includes Pantaloons, Madura and Forever 21) but the debt with accrued interest stood at 1881 crore.
  • Premium brands do not necessarily lend to margins – Compare ABFRL with Kewal Kiran that manufactures discount brands such as Killer Jeans. Kewal Kiran has an OPM of 15% while ABFRL with its premium brand portfolio clocks under 10%. What matters more is getting the right product-market mix and returns on operating assets.
  • Even in the same omnichannel format, COGS is 93% of sales while Future Lifestyle Retail (Central, Brand Factory etc.) manages costs more efficiently (COGS 90% of sales).

Thoughts on the post-Merger Future

  • Investing decision depends on 2 factors –
    • How you feel the Industry Structure will evolve, i.e. will it move towards omnichannel or stay focussed on heavy discount online sellers?
    • How will the post-2015 merger between Madura and Pantaloons play out in terms of producing operational synergies?
  • If Industry moves towards omnichannel presence it will benefit ABFRL due to its presence across segments and geographies. However Amazon has recently tied up with Shoppers Stop and this will provide stiff future Omnichannel competition.
  • The Madura (menswear) component of ABFRL business is EPS accretive but the Pantaloons (womens/kidswear) business is loss-making. The future depends on how effective the turnaround of Pantaloons will be.
  • The future depends on the effectiveness of operational synergies arising out of the merger between Madura and Pantaloons (See below)
2018-01-21_14-14-05.jpg
In 2015, Madura merged with Pantaloons under ABFRL (after de-merging from AB Nuvo), this raised margins and asset turnover temporarily but it is again going down, i.e. Merger is still not creating synergies

Thoughts on Relative Valuation

  • Enterprise Value / Net Operating Revenue and EV / EBIDTA ratios are both twice that of Future Lifestyle, which is reasonable given the Debt to Equity of ABFRL is also twice that of Future Lifestyle. This seems to indicate Market is not giving a premium to ABFRL over Future Lifestyle inspite of its “premium brands”. The brands also in turn are not giving any incremental ROE benefit to ABFRL.
  • The market is not discounting future operational synergies from the Madura / Pantaloon merger. Perhaps it doubts the execution capabilities of AB group (Other group companies like Grasim, Hindalco haven’t created investor wealth) or is just put off by the debt on books.
  • Both Future Lifestyle and ABFRL will be beneficiaries of a secular uptick in consumer growth due to operational leverage but Future Lifestyle may benefit much more (See below).
2018-01-21_14-41-17.jpg
As opposed to ABFRL, Future Lifestyle has lightened its assets and increased turnover. It is also debt-lite. Operating leverage will impact EPS much more directly here.

Earnings Quality

  • On Jan 9th, 2018, the CFO S. Visvanathan has resigned to pursue a career outside the Aditya Birla Group, or so the group said in a press release.
  • In 2016-2017, the Cash Flow from Operations went up from 310 to 418 crore.
  • The DSO and Inventory Days also went up in the period and so did the Days Payables Outstanding which very conveniently shows a decrease in cash conversion cycle.2018-01-21_17-54-37
  • These ratios may suggest favorable trade terms, vertical integration or may warrant a deeper dive to check for financial controls for ABFRL.

DISCLAIMER:

This post is not BUY/SELL/HOLD advice but a statement of my personal analysis and opinion. I do not have any position in stocks mentioned in this post.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

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