Pantaloon share is no goldmine: note the FDI fineprint

Retail stocks have been sizzling ever since the government announced 51 percent FDI in multi-brand retail. While Indian retail companies stand to benefit in the long term in terms of back-end infrastructure and capital inflows, all is not well with their current business models as inflation and higher input prices have stifled demand.

Future Group firm Pantaloon Retail was the biggest gainer a day after the government announced the reform measures and jumped about 33 percent to Rs 209 during intra-day trade. Today the stock is down around 2 percent, but still trading at Rs 209.50. The stock has risen 42 percent in the last two weeks and most analysts have a bullish view on the stock.

"If I need to take a call on FDI I think the fastest...FDI infusion coming in one company will be Pantaloon, the largest in the retail space," said SP Tulsian in an interview to CNBC-TV18.

 Pantaloon share is no goldmine: note the FDI fineprint

Even if a state favoured foreign investment in retail, what would happen if the current regime was voted out in the next election? AFP

Similarly, Kunal Bothra, Manager (Retail Advisory) and Technical Analyst at LKP, says "the stock is set for a higher target of Rs 300 plus in the next few months. In terms of technicals, it is a perfect set-up for a big uptrend. It is one stock which I would definitely stay bullish on."

However, while foreign entities can invest up to 51 percent in multi-product retail, one significant constraint for existing retailers hoping to sew up FDI deals would be the location restrictions. Foreign retail is only allowed to open stores in the most populous cities. Secondly, states also have the last word in permitting entry.

Restructuring existing business a major challenge

So far only nine states have expressed their willingness to allow FDI in retail and 15 states have - at least verbally - rejected the proposal. So even if Pantaloon Retail may be theoretically the biggest beneficiary of the policy change, complicated structuring will have to be carried out by retailers to hive off stores in locations where FDI is not allowed (e.g. Gujarat, UP, Bengal, etc), into a separate entity.The remaining entity can then allow foreign direct investment. In other words, if Pantaloons wants to sell to foreign companies, it will have to demerge its stores in places/states where FDI is not allowed.

"Pantaloon is open to finding partners for its home formats but wants more states to come into the fold before attempting to find partners for its flagship value and lifestyle formats. Given the low margin nature of the home formats, we do not expect any meaningful triggers from FDI related deals over the next 1-2 years," said brokerage CLSA in a note today.

Foreign retailers at the mercy of state governments

Also, with foreign retailers at the mercy of state governments, they may go slow on long-term investment in India. Even if a state favoured foreign investment in retail, what would happen if the current regime was voted out in the next election? Would a company have to shut shop?" Given the state-level discretion involved here, the company may have to consider separate alliances or partnership structures," said JP Morgan in a note recently.

"FDI is a positive, but it's not the panacea for the sector," Macquarie Capital Securities India said in a note. The decision could not be viewed in isolation as several key reforms for the retail sector like implementation of the Model Agricultural Products Marketing Committee Act and GST were yet to materialise.

"Even well-funded business groups have not been able to grow their retail businesses rapidly. .. Given the opposition from several state governments, we believe FDI would be gradual and any benefit would be realised only in the long term," the report stated.

Investment in supply chain infrastructure might not be profitable without scale at the front end

Third, minimum investment has to be $100 million with at least 50 percent of the investment in the supply chain, and excluding investments in land. "Operating expenses of the supply chain would not be offset by the savings from reduced wastage without having a reasonable scale of operation at the front end. Therefore, restricting the number of cities and states where FDI will be allowed limits the attractiveness of the policy," said Deutsche Bank in a research report.

Further stake sales in non-core assets unlikely any time soon

Fourth, the Future Group had been in an aggressive expansion mode a few years ago, but eventually ran into a crisis with a consolidated debt of Rs 7,800 crore . To tide over the rough weather, it is slowly moving out of the businesses that are a drag on profitability as non-core assets do not add much value to the company.

Recently, the group pared Rs 6,000 crore of this debt when it sold two businesses, Pantaloons and Future Capital Holdings. In May, the Future Group sold a majority stake in Pantaloons departmental chain to AV Birla Group's Aditya Birla Nuvo for Rs 1,600 crore. Then in June, the Future Group announced the sale of its 53.67 percent stake in Future Capital Holdings to the US-based private equity firm Warburg Pincus for Rs 4,250 crore.

In order to make Pantaloon debt-free by 2013, Biyani has to sell a stake in its insurance business, the consumer electronics chain (eZone) and home furnishing network (Home Town. " In the absence of any stake sale in insurance, we expect further inflow from restructuring to be limited," said CLSA. Moreover, FDI not being allowed in cities like Bangalore (Karnataka) would still make the transaction even more complicated.

Put all these factors together, and the answer is that listed retailers are not the goldmine that some brokerages have made them out to be.

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Updated Date: Dec 20, 2014 20:06:44 IST