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Indian retailer Trent reported a strong set of numbers in the June quarter. The company’s new Zudio outlets, which cater to budget-conscious consumers, have been a resounding success.
A sharp rise in footfalls aided growth, and Tata Group company’s consolidated net profit for the June quarter almost doubled year-on-year. The retailer’s shares jumped 10% to a record high after the results. Trent has also been on a hiring spree – its employee count more than doubled over FY22.
The Indian retail sector is on the cusp of a major transformation. According to a report by JLL, retail space could grow from 89 million sq ft in 2024 to 134 million sq ft by the end of 2028.
Eighty-eight new retail developments with a total area of around 45 million sq ft are expected to be added in seven cities – Mumbai, Delhi-NCR, Bengaluru, Hyderabad, Pune, Kolkata, and Chennai – over the next five years. Of these, 12 are large projects encompassing at least one million sq ft each. They account for 37% of the total new space expected by 2028.
Retail boom incoming?
Retailers are expanding aggressively as the sector is seeing strong growth, driven by increased urbanisation and demand for organised and high-quality retail spaces. Thanks to social media, this demand extends to tier-2 and tier-3 towns.
All of this underscores India’s emergence as a key player in the global retail market. According to BCG, retail space for electronics, fashion, grocery, jewellery and quick service restaurants (QSR) is expected to grow rapidly in the coming decade.
More importantly, BCG believes the operating margins of Indian retailers across these categories are slightly better than those of their US counterparts. With a hybrid model (online and offline), most large retailers in India have made inroads in the hinterland without losing market share in the metros.
Volatile industry
However, the retail industry is by nature prone to sharp peaks and troughs. Retailers make money by producing merchandise, adding a markup and selling it to individual customers, either as private labels or third-party brands.
Some retailers own their outlets to keep costs and branding under control. Others operate out of rented stores or through a franchise model.
A lean workforce is one of the earliest signs of stress on a retailer’s margins. While a few retailers have increased their employee count over the past two years, others have chosen to operate with a smaller workforce.
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According toThe Economic Times12 listed lifestyle retailers, grocery retailers and QSRs cut their workforces by around 26,000 in the past two financial years as they slowed down store expansion.
Apart from the ownership or rental costs of the store and manpower costs, there are two key variables that determine a retailer’s prospects of profitability – the share of discounted sales, and inventory turnover. Retailers that don’t keep these fixed and variable operating costs in check have seen their fundamentals deteriorate.
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As Warren Buffet wrote in his 1995 letter to shareholders:
“Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses.
“In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail.”
Nevertheless, the valuations of most retail stocks in India continue to defy gravity. The valuations of Trent,Jubilant Foodworks, andAvenue Supermartsin particular factor in an unrealistic pace of growth.
It’s therefore important for investors to separate the wheat from the chaff and invest in only the stocks that offer a margin of safety.
Disclaimer:This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com