Profitability of offline retailers will get a boost after GST implementation, says Crisil
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Mumbai: Brick and mortar (B&M) retailers will post higher operating margins and faster revenue growth in the next two years even as they open more stores and increase capital expenditure (capex), a Crisil Ratings study said.
In the two years, operating margins of organized physical retailers may improve by a percentage point, while revenue will grow 14-16% against the 13% compounded annual growth rate recorded between fiscal years 2015 and 2017, the study dated 26 May said.
Big-box retailers are benefiting on three counts—fewer discounts by online retailers trying to reduce cash burn; implementation of the goods and services tax (GST) due to start on 1 July; and higher revenue per square feet thanks to rising sales.
“These will provide at least 100 basis point (bps) positive delta to operating margins from about 6% for B&M retailers,” said Anuj Sethi, senior director, Crisil Ratings. Profit margins will still remain 60 bps below the peak levels seen in fiscal 2012, added Sethi. One basis point is 0.01%.
India’s top three online retailers lost more than Rs30 crore per day—or Rs11,000 crore—in 2015-16 because of large-scale discounts and aggressive marketing, Crisil said. After the department of industrial policy and promotion (DIPP) issued regulations in March 2016, marketing and promotional spending by online retailers as a percentage of gross merchandise value (GMV), or value of goods sold on a site, has declined from 11-12% prior to the announcement to around 8% in the first half of fiscal 2017. Online retailers are aiming to reduce it to around 5-6% in the coming months, said the study.
B&M retailers are also bringing down the days of discounting and focusing on improving profit margins. “We are looking to improve our Ebitda margin by 200 bps every year,” said J. Suresh, chief executive officer of Arvind Retail Ltd’s retail and brands business. Ebitda is short for earnings before interest, tax, depreciation and amortisation—an indicator of operating profitability.
Arvind Retail, which sells brands such as Gap, Tommy Hilfiger, Arrow and Flying Machine, is working on improving efficiencies across its supply chain and reducing the contribution of discounts to overall revenue. Discounts currently contribute 16-17% of overall revenue and the company plans to reduce it to 14% in fiscal 2018, said Suresh.
Additionally, B&M retailers will also gain benefits with GST implementation as costs of doing business come down. For instance, rent is one of the largest cost components, ranging between 5-6% of sales for B&M retailers. Under GST, B&M retailers will be able to set off service tax on rent against taxes on goods. The B&M retail sector will also benefit from rationalization of logistics costs because of flexibility in procurement and seamless movement of goods facilitated by the implementation of GST, said the Crisil study.
Also, over the past two fiscal years, annual sales per square feet has increased 15% from Rs12,000 to Rs13,800 for a sample of 10 large B&M retailers. “This trend is likely to continue,” said Amit Bhave, director, Crisil Ratings.
As growth and profitability look up, Crisil expects capital expenditure (capex) of B&M retailers to increase by 15-20% over next two fiscals compared to capex incurred in past two fiscals. The top five Crisil-rated retailers are expected to have capex of Rs1,964 crore in fiscal 2017 an increase of nearly 30% over Rs1,379 crore in fiscal 2016.
To be sure, part of the capex increases will be debt-funded. However, improving operating metrics and better cash generation will continue to support the credit profiles of retailers, said Crisil.
Crisil-rated companies include Reliance Industries Ltd’s retail arm Reliance Retail Ltd, Metro Cash and Carry India Pvt Ltd, Shoppers Stop Ltd and Lifestyle International Pvt. Ltd. Crisil has ratings on 86 B&M retailers including 27 large (more than Rs500 crore revenue), 22 mid-sized (Rs100 crore to Rs500 crore revenue) and 37 small ones which were part of this study. Future Group’s listed companies are not rated by Crisil.