Brick and mortar retailers to step up capex by 15-20%: Crisil

With growth and profitability starting to look up, organised brick and mortar (B&M) retailers are expected to increase their capital expenditure (capex) by 15-20% over the next two fiscals, said a Crisil report. Despite increase in capex, which will be part debt funded, the research and ratings firm said, improving operating metrics and better cash generation will continue to support the credit profiles of retailers.

Amit Bhave, director, Crisil Ratings, said, the credit profiles of organised Crisil rated B&M retailers have benefited from improved scale of business, better cash generation, continued promoter support, and prudent capex in the recent past. "For instance, the debt/ebitda (earnings before interest, tax, depreciation and amortisation) ratio improved to about three times in fiscal 2017, compared with four times in fiscal 2015, supported by a 50-60 basis points (bps) increase in ebitda margins and prudent management of debt levels," said Bhave.

The improvement in credit profiles, Crisil said, is reflected in the credit ratio (upgrades to downgrades) for its rated B&M retailer portfolio, remaining above 1 time in past four fiscals. "This trend is likely to be sustained over the medium term," it said.

Additionally, operating margins of the organised B&M retailers are expected to improve by 100 bps from about 6% over next two fiscals. This is primarily due to factors like online retailers going slow on discounts to reduce cash burn, benefits from the implementation of goods and services tax (GST) and increasing store productivity.

Further, pace of store expansion is also expected to increase over the medium term to cater to the increasing demand. Despite this, Crisil expects the credit profiles of its rated B&M retailers to remain steady, driven by better operating metrics and adequate debt metrics.

Crisil has outstanding ratings on 86 B&M retailers including 27 large (more than Rs 500 crore revenue), 22 mid-sized (Rs 100 crore to Rs 500 crore revenue) and 37 small ones.

Interestingly, India's top three online retailers lost more than Rs 30 crore per day – or Rs 11,000 crore1 in fiscal 2016 – because of large-scale discounts and aggressive marketing. Besides, the Department of Industrial Policy & Promotion (DIPP) regulation in March 2016, which restricts discounting and vendor concentration, has been favourable for B&M retailers. Consequently, online retailers have been gradually focusing on lowering share of discounts as well as losses, which has led to moderation in their growth.

Also, under GST, B&M retailers will be able to set off service tax on rent against taxes on goods. Rent is one of their largest cost components, ranging between 5-6% of sales. The B&M retail sector will also benefit from rationalisation of logistics costs because of flexibility in procurement and seamless movement of goods facilitated by the implementation of GST.

Revenue growth of the organised B&M retail sector is expected to improve to 14-16% annually in the next two fiscals compared with 13% compounded annual growth rate seen between fiscals 2015 and 2017. Also, over the past two fiscals, annual sales per square feet has increased 15% from Rs 12,000 to Rs 13,800 for a sample of 10 large B&M retailers.

Crisil believes that continuation of this trend would result in better store productivity and improved operating leverage. Anuj Sethi, senior director, Crisil Ratings, expects profitability of B&M retailers improving as competitive intensity (from online rivals) moderates and service tax on rent gets set off in the GST regime.

"And as growth rises, so will revenue per square feet, which, in turn, will improve their fixed-cost absorption ability. That will provide at least 100 bps positive delta to operating margins for B&M retailers," said Sethi.

POWER OF MALLS

• Revenue growth is expected to improve to 14-16% annually over the next two years as e-commerce goes slow on discounting
   
• Crisil expects the credit profiles of its rated brick and mortar retailers to remain steady