Future Retail outlook stable

Last Updated: Fri, Apr 05, 2013 12:36 hrs

Kolkata, Apr 5 (IBNS) India Ratings & Research (Ind-Ra) has affirmed Future Retail Limited's (FRL, erstwhile Pantaloons' Retail (India) Limited) Long-Term Issuer Rating at 'IND A-'. The Outlook is Stable. A list of additional rating actions is provided at the end of this commentary.

The affirmation reflects the likelihood of an improvement in FRL's credit profile in FY13 (year ended 31 December 2013) which however will remain in line with the current ratings.

This will result from the company's deleveraging of balance sheet through divestment of its non-core business while improving operating profitability by focussing on operational parameters (same-store-sales growth (SSSG), inventory turnover and operating margins) and controlling its operating cost structure.

For FY12, excluding the Pantaloons fashion format business, FRL's annualised adjusted net leverage (adjusted net debt/EBITDAR) increased to 7.5x (FY11: 6.6x) on account of higher debt levels.

The agency expects the company's initiatives to reduce debt levels to help it improve its overall net leverage (adjusted net debt/EBITDAR) below 7x.

FRL has extended its financial year end from June to December and had closed FY12 as 18 months ended 31 December 2012. For the purpose of analysis, Ind-Ra has taken a consolidated view of FRL (all retail operations) excluding Future Capital Holdings (FCH; non-retail business).

To reduce its debt, FRL divested a 41.7% stake in its non-core business FCH for INR4.5bn in 2012. The company is also exiting the Pantaloons fashion format business, which accounted for around 12.8% of revenue and 24.5% of EBITDA in 2012, and awaiting final approval.

This may reduce debt by INR16bn. Ind-Ra expects improvements in FRL's operating profitability from a higher proportion of private labels in its lifestyle business coupled with a change in its merchandise mix towards higher margin products.

In Q6FY12, on account of improved consumer sentiment, the company reported SSSG of 5.1%, 12.7% and negative 3.4% yoy in the value, lifestyle and home segments compared with 3.2%, 5.3% and negative 3.2% in the quarter ended 31 December 2011.

For the six months ended 31 December 2012, average sales per sq. ft. (in core retail) increased 6.7% yoy to INR3,800/sq.ft. and margins by 44bps yoy to 9.3%. FRL is consolidating its operations by rationalising unprofitable formats and resizing some of the existing store which are likely to translate into further cost savings.

The ratings factor in expected cash inflows on account of FRL's sale of equity stake in both the life and non-life insurance business for around INR7bn to INR8bn based on the valuation to be agreed between the parties.

FRL has also streamlined its supply chain operations by consolidating its back-end operations (distribution centre at Mihan, Nagpur).

This is likely to result in improved inventory management and reduction in obsolescence. Ind-Ra expects working capital efficiencies coupled with an improvement in operating profitability to translate into lower pressure on cash flows from operations for the company.

The ratings continue to reflect FRL´s leadership position in India´s organised retail sector with an area of 16.4 million sq. ft., over 15 years of management experience, a large focus on value retail (58% of FY12 consolidated revenue) and a large size that puts it in a favourable bargaining position with various suppliers.

The company also faces reduced execution risk as new space addition would account for below 20% of the overall space.

The ratings continue to be constrained by FRL's high net leverage and working capital intensity (mainly inventory) of the business. For FY12, FRL reported blended inventory days of 195 (excluding the Pantaloons format business, FY11: 162) on account of higher inventories in the lifestyle business.

The company may be required to financially support its loss-making subsidiaries through investments, inter-corporate deposits and corporate guarantees.

FRL and Future Ventures India Ltd (FVIL) have decided to consolidate their fashion businesses into a new entity Future Lifestyle Fashion Limited (FLFL). This would result in a further debt reduction of around INR12.2bn for FRL. However, it has not been factored into the ratings as more clarity is needed regarding this realignment.

Rating Sensitivities

Negative: Weakening in SSSG, resulting in lower EBITDA margins or higher-than-expected debt-led capex/investment in its core business/subsidiaries, leading to adjusted net leverage exceeding 7.0x on a sustained basis may result in negative rating action.

Positive: Positive rating guidelines would include an improvement in PRIL´s operating parameters (such as inventory turns and operating margins) leading to lower adjusted net leverage levels of around 5x and higher net fixed charge (operating EBITDAR/net interest expense + rents) of above 1.5x on a sustained basis.

FRL is the flagship company of Future Group and operates in 95 cities. It operates both in the value retailing and the lifestyle segment business.

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