Future Retail

The present incarnation of Future Retail came about through a merger with Bharti Retail and demerger of non-retail and back-end businesses.  Now, all the company does is operate the retail business.  It has a clean balance sheet with most of the debt being for the working capital.  Here are a few reasons why I think it a very good business already and has high probability of being a great business.

Small Stores

Organized retailing of food and general merchandise in India started with relatively big stores.  These stores were mostly away from the population centers as they needed to control costs.  This model has worked well in many countries around the world.  However, in India the challenge came in terms of poor transport infrastructure.  Because of poor quality of roads and inadequate public transport, these stores did not get the expected footfalls.  As a result, the business suffered and the growth plans were shelved or greatly reduced.

The recent trend towards small stores has changed that.  These stores are typically 1000-2000 sq.ft. and are located in busy population centers.  They compete with small mom and pop shops and with larger independent players.  They are in locations where people already go to shop.  Many people prefer them to local stores because they are cleaner, are better stocked and allow you to browse the aisles and pick out what you want.  They also take electronic payments, which helped greatly during early days of demonetization drive.

Merger with Bharti Retail brought the Easy Day brand of small stores to the company.  These stores were set-up with the guidance of Wal-Mart and (I am guessing here) must be operationally very sound.  The company aims to aggressively expand this small stores business.  Number of stores are expected to increase to ~3000 from about 338 now in a few years.  They plan to expand by building central warehouses and opening many stores around that.  They have also been very active in inorganic growth.  Most recently they bought out the retail stores of Heritage Foods which gives them a strong network in Hyderabad and footholds in Chennai and Bangalore.  They are also re-branding their other small stores as Easy Day.

The small stores business is still EBDITA negative, but is expected to turn the corner in next 2-3 quarters.  I believe that a well-run small-store business could be a huge opportunity.  There is almost an endless need here (in move from unorganized sector to organized sector).  Company can keep plowing their cash back into the business for the foreseeable future.  This can lead to a very nice compounding effect.

In-house Brands

The company sources a lot of products from Future Consumer, a group firm.  Future Consumer is developing many brand in different FMCG areas.  Future Retail gets to keep higher margin on these products than on established brand products.  While this is only a nice to have in large-format Big Bazaar stores, I think in the small-format Easy Day stores it can be a big advantage by helping them offer lower prices and compete more aggressively with the local stores.

Scale

Retail demand scale.  Future Retail is one of the largest organized retail player and is growing rapidly through both organic and inorganic routes.

Management

First generation entrepreneur with proven success record.  Mr. Biyani has his detractors, but he seems to be committed to the business and to learn from his mistakes.  The company also seems to be encouraging leadership among the younger employees by giving them more responsibility and demanding results.  It will help if the company and the management commit themselves to even more openness with minority shareholders and higher corporate governance standards.

Growth Rate

The company reported about 13% same-store growth and about 10% growth in number of stores in last quarter.  So, the top-line is growing by about 25%.  Margins are also improving - they went up from 3.1% to 3.2% in last quarter.  The company expects small stores to break even in next 2-3 quarters, so there is reason to believe that margins can go up further.  Further, the D&A expenses don't go up proportionally with same-store revenue growth.  So, the bottom line can go up by 30% or more.

I have little doubt that the top-line will grow at a fairly robust pace for the next few year.  There might be short-term hits to the bottom-line due to acquisitions and rapid growth in small stores, but I believe chances of a significant hit are rather low.

Competition

There are 2 categories of competition.  There are companies with different business model than Future Retail such as D-Mart, Amazon and Big Basket.  And then there are other more or less similar players such as Reliance Retail, More and Spencer's.

I believe there is room for many players in many different formats in this space.  Retail is highly unorganized and will rapidly organize.  I think the major catalyst is changing customer preferences. Young people want to go to browse-able stores and organized players are much better suited to do that.

There is a place for Aldi's of the world (read D-Mart).  But there is a very big market for large stores (Big Bazaar, Spar etc.) and convenience stores. D-Mart runs an excellent operation, but it is a different business than Big Bazaar and Easy Day.

Online and mobile players, such as Amazon Grocery and Big Basket are growing at a brisk pace.  However, they are being run in customer-acquisition mode where they make a loss on most of their orders on per-order level, not to speak of the enterprise-level.  It remains to be seem how they will fare when their higher costs are passed on to customers.

Future Trends

I believe real (inflation-adjusted) rents for locations where a Easy Day store or Big Bazaar store can open will go down in future.  Since rent is a significant cost item, this should aid in increasing profits not only at Future Retail but also at other organized offline retail stores.

Modern retail, whether online or offline, will be won with analytics.  Future Retail seems to realize this.  They have identified “Top Consumption Micro-Markets” and are opening more stores in these.  The have a large loyalty program with 28 million members.  This data can be sieved to understand customer preferences.  I believe the company is already doing this.

Stock

Going by the past 2 quarterly earnings, the PE ratio at current market price (~Rs 125) is around 20.  I believe that undervalues the business significantly and ignores the growth prospects.  Not enough historic data exists for this new avatar of Future Retail and that might be part of the reason why the stock is so cheap.

The stock holding pattern is very favorable with 49% with promoters, 22% with institutions and about 9% each with Times Group and Bharti Group.  Free float is only about 4% with retail individuals and an estimated 1-2% with companies.

Disclaimer

This is not a stock recommendation.  I, my family and my friends might have positions in the stock.  I reserve the right to close or change them at any time without any notice.