The big problem of Biyani's shrinking empire

In the past six months, Kishore Biyani, India's biggest retailer, has sold two businesses and plans to splice his remaining empire into three companies, each focused on a distinct segment: Fashion, groceries and home improvement, and food and fast-moving consumer goods.

Biyani's plan is to deleverage the balance sheet of Pantaloon Retail, his flagship, and simplify the group's organisational structure. Will it work?

Experts are keeping their finger crossed. "It's a good beginning, but divestments and restructuring alone may not be sufficient to solve Biyani's problem. Ultimately, he will have to ensure his companies start delivering operationally," says a senior analyst with Edelweiss Capital.

Her scepticism is not misplaced. The company's operations have repeatedly failed to generate enough cash flows, forcing the company to turn to lenders or investors to keep itself going.

The company had negative cash flows from operations in three of its last five financial years. In all, in these five years, the company's operations generated a negative cash flow of over Rs 1,220 crore (Rs 12.20 billion).

Not surprisingly, the company or its various subsidiaries and special purpose vehicles have raised debt and equity in each of the last five financial years.

On a consolidated basis, Pantaloon Retail has an all-India presence in value retail (Big Bazaar, Food Bazaar and others), lifestyle retail (Central, Brand Factory and others) and home retail (Home Town, Ezone and others) across various price points.

In the 12 months that ended in September, the company reported consolidated revenues of Rs 13,470 crore (Rs 134.70 billion), nearly six times those of the second-largest listed retailer, Shoppers Stop.

Its large size gives Pantalooon Retail high visibility and a strong bargaining power with vendors and real estate developers but, on the flip side, it has bogged down the group in a mountain of inventory and working capital.

According to estimates by CARE Ratings, at the end of the 12 months ended September 2012, Pantaloon Retail was sitting on inventory equivalent to 169 days of sales (five-and-a-half months) on a standalone basis.

The corresponding figure for 2010-11 was 106 days. Adjusted for payments outstanding to vendors, a little over three months of the company's standalone revenue, nearly Rs 1,200 crore (Rs 12 billion), was blocked in working capital.

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The situation on consolidated basis (which includes its value retail formats, Big Bazaar and Food Bazaar) isn't very different either.

In contrast, Shoppers Stop works on negative working capital and Titan works on thin working capital and is nearly debt-free.

Trent, which operates the Westside chain of stores, has reported a rise in working capital in recent years but the debt on its books is small.

Revival plans

In May this year, Biyani agreed to demerge Pantaloon chain of fashion stores into an independent listed company called Pantaloon Fashions in which Aditya Birla Nuvo will acquire a majority stake.

The deal, which is scheduled to close by the end of the current quarter, will reduce Pantalooon Retail's debt by Rs 1,600 crore (Rs 16 billion).

This was followed by the announcement that Pantaloon Retail will sell its 53.7 per cent stake in Future Capital Holdings to Warburg Pincus for Rs 560 crore (Rs 5.6 billion).

According to Edelweiss Capital, these two divestments could reduce Pantaloon Retail's debt to around Rs 4,500 crore (Rs 45 billion) by the end of 2012 from Rs 7,850 crore (Rs 78.50 billion) at the end of June 2011.

This will reduce Pantaloon Retail consolidated debt/equity to 1.5 from 2.5 a year ago. The estimate is based on the assumption that the company has not raised any fresh debt in the last 15 months since its last reported audited balance sheet for the year ended June 2011.

Analysts, however, warn that the gains may prove temporary unless the company's core retail business becomes cash positive.

"The cash infusion and debt reduction from the recent divestments give the group some valuable time to tighten its operations," says the retail analyst at Edelweiss Capital.

But, Pantalooon Retail's operating matrix makes experts doubt if there will be an immediate turnaround in its performance.

"Biyani tried to do too many things at the same time without reaching critical mass in any of his ventures. He succeeded for a while because capital was easily available and at low cost. The strategy was, however, never financially sustainable and stress began to show up once interest rate started climbing up and equity investors became more demanding," says Arvind Singhal, chairman of Technopak Advisors.

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According to Singhal, it won't be easy for Biyani to shrink his footprint without suffering some collateral damage.

"All of Pantaloon retail formats and related back-end ventures were directly or indirectly connected to each other. Selects divestments such as Pantaloon Fashion may destabilise the entire group and set it back for years," he says.

There is some merit in this argument. Unlike many of his counterparts, Biyani's retail empire is vertically as well as horizontally integrated with investments in manufacturing, supply chain & logistics, IT systems and real estate, among others.

In such a scenario, any divestment in the front-end, like that of Pantaloon Fashion, shrinks the potential market for the group's manufacturing ventures such as Indus League Clothing, Biba Apparels and Holii Accessories.

Given this, financial gains from the sell-off could be offset by potential losses in other businesses.

This may be the reason why India Ratings (formerly Fitch India Ratings) kept its rating of Pantaloon Retail unchanged after the company announced the demerger of Pantaloon Fashion in May this year.

According to the agency, gains from the demerger in the form of lower inventory requirements will be counterbalanced by a decline in its operating profitability, resulting in no immediate credit impact.

Weighed by interest

Another worry for analysts is the company's rising interest outgo, which is now growing faster than its operating profit.

In the quarter ended September 2012, Pantaloon Retail's interest outgo was Rs 420 crore (Rs 4.2 billion) on a consolidated basis, up 100 per cent year-on-year and 30 per cent sequentially.

In contrast, its core operating profit (excluding other income) grew 46 per cent year-on-year and just 13 per cent sequentially. At this rate, interest burden may surpass company's operating profit making its finances unsustainable.

According to the company, the high interest outgo in the last quarter was just an accounting entry and not an actual figure.

"The consolidated numbers for the September 2012 quarter includes the entire interest outgo of Future Capital Holdings for the April-September period. We have since sold off Future Capital Holdings and you will see a dramatic decline in our interest burden in the next quarter," claims the company's spokesperson.

According to regulatory filings by Future Capital Holdings, since renamed Capital First, the company has paid an interest of Rs 237.5 crore (Rs 2.37 billion) in the first half of the current financial year.

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Pantaloon Retail claims to have included this entire amount in its consolidated results for the quarter, though it owned only 53.7 per cent of Future Capital Holdings.

According to accounting norms, Pantaloon Retail's share should have been limited to its economic interest in the subsidiary: 53.7 per cent.

Analysts and ratings agencies, however, refuse to buy the company's version. "The company's explanation doesn't sound logical and we have asked for more details," says Smita Rajpurkar, who handles the Pantaloon Retail account at CARE Ratings.

The agency has assigned A- rating to Pantaloon Retail and has kept the rating unchanged despite the recent announcements by the company.

"We are waiting for the completion of the demerger and the company to release its audited financials for the 2012 financial year." Pantaloon Retail had last reported its audited financial results for the year ending June 2011.

Analysts say interest outgo is a good pointer to a firm's debt burden and can be used to estimate a company's outstanding debt if the full balance sheet is not available.

If we use this test on Pantaloon Retail, its consolidated total debt would work out to be anywhere between Rs 4,600 crore (Rs 46 billion) and Rs 8,800 crore (Rs 88 billion), assuming three interest rate scenarios: 15 per cent, 12 per cent and 10 per cent.

Considering the company's effective interest burden was 10.2 in 2011-12, the true figure could be somewhere in the middle.

"This means that the company could end the current year with only a small reduction in its overall debt despite two divestments. This is not a healthy sign," says a senior analyst with a leading brokerage firm in Mumbai on the condition of anonymity.

The company, however, claims that Pantaloon Retail's consolidated debt will reduce to as low as Rs 3,500 crore (Rs 35 billion) once the demerger of Pantaloon Fashion is complete and further to almost Rs 2,000 crore (Rs 20 billion) after the divestments of its stake in the two insurance ventures with Generali of Italy.

"We are on course to reduce the leverage ratio to less than 1 in the next few quarters," says the company spokesperson.

Given the avid deal maker that Biyani is - he has created over three dozen companies and two dozen retail formats in the past 15 years - he may succeed in bringing down the debt in the near term. But, nothing stops it from shooting up again, unless he learns to run a tight ship.