SECTOR UPDATE

RETAIL
Readytohithighstreet
India Equity Research | Retail

TheIndianretailstoryisfastgainingattentionontheglobalstagegoing beyonditsopshopimage.WebelievetheimplementationofFDIandGST would add to the bonanza, infusing a fresh momentum. Our recent interactions with the industry and discussions at the India Retail Forum indicatethatthesectorholdsimmensegrowthpotential.Indianretailers are expanding in tier II and III cities, offering specialized products and usingecommerce.We,however,areconcernedabouttheslackspending seeninQ2FY12andexpectthefestiveseasontoperkupthemood.

Indiafavouriteformostretailers,unhurtbyglobaldownturn
A recent survey by CB Richard Ellis has pegged India as the prime nation to attract most new retailers. The global downturn has made India more attractive from the retail view point as retailers see it as a good growth prospect, least likely to be affected by austerity measures. As more retail companies vie for space, availability of fresh, quality real estate will become dearer. We reckon that Pantaloon, with its existing 15.24mn sq ft operational space and a pipeline of 9mn sq ft incremental space, is well placed.

RetailersawaitFDI,GSTwithbatedbreath
The FDI is seen as a win-win for all from the farm gate to the retailer and eventually to the consumer. It would have also helped the modern retail raise sizeable funds to maintain growth. Though FDI is yet to be allowed, the government has relaxed norms, enabling back-end partners to sell 100% products (earlier 25% of their turnover) through the front-end partners. However, this does not address the scarcity of funds for the front-end expansion a case in point being Pantaloons. GST on the other hand would be a bigger game changer, providing the vital level playing field for all.

Bigretailershitvillageroads,devisestrategiestoconvertfootfalls
Big retailers are on an expansion spree entering markets of tier II and III cities while few retailers have been successful in converting footfalls into loyal customers via loyalty programmes (for Shoppers Stop, First Citizen members account for 72% of revenue). Having realized the growing importance of e-commerce (low inventory and no rentals), increasing number of retailers (E-Zone, electronic arm of future group) are resorting to this medium to serve the modern customer better.

Challengesremaingalore
In spite of the retail sector possessing a huge growth potential, it is equally exposed to challenges like political upheavals (Telangana), reduced discretionary spending, waferthin margins, unavailability of trained staff and funding issues.

AbneeshRoy
+91 22 6620 3141 abneesh.roy@edelcap.com

HarshMehta
+91 22 4063 5543 harsh.mehta@edelcap.com

Toppicks
Titan, Shoppers Stop

October 3, 2011
Edelweiss Research is also available on www.edelresearch.com, 1 Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

Edelweiss Securities Limited

Retail
"Pleasedon'taskmeforatimeline forRetailFDI,butweare proceedingveryfast.It'scertainly notonthebackburner." IndustrySecretaryR.P.Singh

HighlightsfromIndiaRetailForumandourttettewithindustry
Indianretailenjoysimmenseprospects As per a recent survey by CB Richard Ellis, India was the topmost country which attracted most of the new retailers while with eight new entrants in 2010, New Delhi became the fourth most popular city for new retailers. Global economic downturn has made India more lucrative from the retail view point for its good growth prospects and least possible impact from austerity measures. As more retail companies vie for space, availability of fresh quality real estate space will become scarcer. Pantaloon with existing 15.24mn sq ft operational space and pipeline of 9mn sq ft incremental space is well placed. FDI in multi-brand retail is likely to pace up the growth in retail but due to the sovereign debt crisis in the US and Europe, foreign investors seem to traveling through a rough patch - may not be too eager to enter big projects at the moment. RetailersawaitFDIwithbatedbreath Modern retail sector has an investment turnover ratio of 1.6x-2x and requires huge investment to fuel growth. Domestic investors having a shorter horizon have limited capacity to infuse funds which already comes at a high cost hence the impetus must come from foreign partners (who hold a long term horizon of 15-20 years) which would then help improve front-end as well as back-end facilities besides technology upgradation. This is likely to be a win-win game as all players from the farm gate to retailer to consumer will benefit from better remuneration to farmers, attractive margins for retailers and affordable prices for consumers.

"Therewouldbemanifoldincrease ininvestment(byus)ifFDIinmulti brandretailisopenedup," WalMartIndiaPresident,RajJain

WebelieveFDIisgoingtobea gamechangerforIndiaandwe welcomeFDI.FDIboughtinthe rightformat,withtherightchecks and balanceswillhelpthecountrys economytogrowfasterandfaster -GovindShrikhande,MD, ShoppersStop

Chart1:Indicativepricebuiltup 9.0
7.2

8.30 0.3 0.46 0.46 0.61

(Unit price)

5.4 3.6 1.8 0.0

4.40

0.48

0.08

Overall transit cost

Price to consumer

Market yard cess

Processor margin

cost of collection centre

Processor value addition

Farm gate price

Channel costs

Source:E&Y,Edelweissresearch

FDI should have a positive impact on food inflation on account of the reduction in supply chain. Overall GDP of the country will benefit from inflows of foreign capital as was seen in China where post FDI, exports grew aiding the GDP growth. FDI implementation is also likely to improve productivity and create job opportunities (employment in China doubled and quadrupled in Thailand post FDI). However, on the back of low political interest, FDI in multibrand retail has taken a backseat but the benefit of permitting 100% FDI in cash and carry model is likely to surface in the near term. Modern retail contributes ~8% to FMCG sector and is expected to grow rapidly if FDI in multi-brand retail is permitted.
2 Edelweiss Securities Limited

Retail
The Department of Industrial Policy and Promotion (DIPP) recently relaxed the definition of group companies for cash and carry model which would enable the back-end foreign partner to sell 100% products through the front-end retail partner (earlier the foreign partner could sell only 25% of their turnover). This relaxation is likely to benefit the existing joint ventures namely, Bharti-Wal Mart and Tata-Tesco. However, this does not address the scarcity of funds for front end expansion likely to be critical for Pantaloons. GST:Abiggergamechanger The introduction of GST will eliminate various taxes charged by states and Central governments, bringing all players on a level-playing field as small retailers will lose the differential tax advantage over organized retailers. Consequently, retailers (including FMCG players like HUL and GCPL) are more enthused with the implementation of GST than FDI entry (which is on the backburner, riddled with riders). However, some state governments are not in favor of GST as they view it as a step towards reduced financial autonomy. Retailersbankonincreasingpenetrationlevels,targetsmallercities Big retail players are on an expansion spree to exploit the potential growth. This is evident from the fact that Future Group, Shoppers Stop and Reliance Retail have together picked up ~10mn sq feet of retail space recently. Prime space availability is indispensable so as to increase penetration levels.

Table1:Retailersonanexpansionspree
Company Shopper's Stop Lifestyle Pantaloons Bharti Group Tanishq Marks and Spencer McDonalds Hamleys Mango Outletsinpipeline 24 25 55 20 15 10 30 20 6
Source:Company,Edelweissresearch

WorldsFirstGoldJewelleryCar helpscreatebuzzaroundGoldplus massmarketfranchiseofTitan

In order to sustain the growth momentum, it is inevitable to tap the untapped market. Instead of relying solely on existing customers, retailers are now looking to expand the customer base by entering tier II and III cities. The consumer here is becoming increasingly like his tier I counterpart less keen on price tag and willing to try out new products. Retailers like Titan, Shoppers Stop, Aditya Birla Retail, GAS Jeans and Provogue have realized the potential in these cities and are looking to expand in these areas. Almost 70% of new mall space is likely to come up in non-metros though it should be kept in mind that the psychology and taste of this customer will be different and he will require more help on the shop floor and more education of products. Infrastructure will also be a hitch making accessibility a challenge for retailers. According to the World Gold Council, rural and semi-urban markets make up 60% of Indias gold jewellery market, but branded jewellery accounts for only ~ 7% of this market. Given the humungous opportunity in small towns and rural India, Titan is focusing on its mass market franchise Goldplus. It has launched a lower priced product using diamantine (a low cost diamond substitute) especially for the rural market. Also to energize customer interest in

Edelweiss Securities Limited

Retail
Goldplus, Titan plans to showcase Worlds First Gold Jewellery Car in 29 Goldplus outlets over the next five months. Onlineretailgainingincreasingacceptancethoughqualityneedstoimprove While e-commerce constitutes ~4% of the total retail industry in India, it plays a more significant role in prompting purchases. While the ads may induce interest in an individual, he only becomes a customer after he gets details of the product online, compares with competitive offerings, takes opinion from current users and then decides to buy. For the urban consumer, four-walls is no longer the shop, the site itself is the shop which comes with advantages of convenience and time-saving. Online retail is seen as a basic minimum requirement for a modern, cross border retailer. To do well in e-retailing, it becomes more important for the retailer to infuse confidence in consumer. Indian consumer is said to be defined by ABCD Astrology, Bollywood, Cricket and Discounts. The retailer is increasingly understanding this psyche of the consumer as is evident from the propositions of sites like Snapdeal.com , Yebhi.com, timtara.com, and DealsandYou.com (banking on discounts) and increasing presence of celebrities in ads and promotions of new products. Operating online enables the retailers to provide extra discounts as it eliminates the cost of maintenance of high levels of inventory and rentals. Often retailers use the online platform to test the market before committing to physical stores. It helps retailers to gauge the taste and preference of the new customer. However, retailers with a physical store presence in the country are more likely to have a transactional capability. Timetoconvertwindowshopperstocustomerswithvalueproposition Amid this enormous potential comes the challenge gratifying an affluent, attentive and adamant Indian consumer. The Indian demographic is rapidly skewing towards a more productive age group with 52% of the population being below the age of 30 years. This target audience with a high disposable income is less conservative in spending, more receptive to global thinking and open to spend more to enjoy convenience. Consumers no longer accept basic products as they are quite vocal about their likes and want what is globally available value added product coupled with good after sales service. We therefore believe that Indian retailers need to energize their enthusiasm to convert these footfalls to purchases which can with some effort be made brand loyal customers. For instance Shoppers Stops loyalty program (first citizen members contributing 72% to Shoppers Stop revenue) has been a major success. The retailers can also target the mass segment with low-priced offerings, helping them to increase volume sales. Since these consumers are more price sensitive, they are also open to some compromise on quality. Having realized the potential of this segment, several apparel brands (Marks & Spencer, ITC Wills Lifestyle) have introduced blended (cotton blended with man-made fibers like polyester) low cost options. These customers, at a later point in time, can be converted to brand loyal customers.

InIndia,wecannotcatertothe growingconsumerclassunlesswe godigital,giventhecostand logisticalchallengesofphysical presenceandthesizeofour country MrKashyapDeorah,President, FutureBazaar.com

Edelweiss Securities Limited

Retail
Challengesgalore Reduced discretionary spends: Inflationary pressure has weighed heavily on consumer spending with discretionary spend seeing a downtrend in the recent past. Private consumption growth slipped from 8% in Q4FY11 to 6.3% in Q1FY12; consumer durables industry grew at a meager 4.2% between April and July this year as compared to 18.5% growth in the same period last year. Despite the inherent attraction to gold by Indian consumers, gold jewellery sales in the month of August were muted (on account of sky high prices). The stock market, the leading indicator of consumer sentiments, continues to follow the bearish track. The upcoming festive season is likely to see enthused spending but whether the growth story is sustainable will only be confirmed post October when the festive season ends.

Chart2:SSSgrowthinShoppersStopsdepartmentstoresslows 25.0 Rising inflationary pressure; slowdown in overall global 19.0 economy
13.0 Lehman crisis; economic slowdown in India

Chart3:SSSgrowthinHomeretail(PRIL)declinessharply 66.0 Rising inflationary pressure; Lehman crisis; 44.0 slowdown in economic overall global slowdown in India economy 22.0
(%)

(%)

7.0 1.0 (5.0)

0.0 (22.0) (44.0)

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q1FY11 Q2FY11 Q3FY11 Q4 FY10

Q1FY09

Q2FY09

Q3FY09

Q4FY09

Q1FY10

Q2FY10

Q3FY10

Q4FY10

Q1FY11

Q2FY11

Q3FY11

Q4FY11

Q1FY12

Source:Company,Edelweissresearch

Wafer-thin margins: Despite the huge size of the retail market, players are finding it difficult to earn profits. Except segments like apparel, players drive a low-cost strategy, working at significantly lower margins compared to their foreign peers. With differentiation being very low, discount is more often used as a tool to entice the customer. Trained staff: The shopper now makes choices not just based on the product but on the entire shopping experience. This makes it essential for retailers to have a well trained staff. Front-end staff at most retail stores fails to meet consumer expectations and having realized this, industry veterans like B.S.Nagesh has initiated training programmes for front-end retail staff. Struggle for prime retail space: The retail expansion race - intensified in the recent past has high demand and low supply of quality space. This is also creating a hitch for international players to enter the Indian market. To add to the woes of retailers, as per a recent order by the Delhi High Court (similar orders were earlier passed by high courts of Punjab and Haryana, Karnataka, Orissa and Bombay as well), service tax (~10.3%) will be levied on rentals (with a retrospective effect from 2007). The huge impact of this is evident from the fact that Shoppers Stop would be liable to pay ~INR 170mn. Political instability: Delayed decision making on the part of government has played the role of a speed breaker for growth in retail sector. For instance, the current unrest in

Edelweiss Securities Limited

Q4FY11

Retail
Hyderabad (over Telangana issue) is impacting sales of retailers as activities in city have come to a halt. Itisourtasktogoaboutitina manner,inwhichthenationenjoys thebenefitsofmoreFDIinretail trade,withouthurtingourdomestic interests.Icanassurethatwewill donothingwhichwillhurtthe essentialinterestsofthesmall Indiantradecommunity PrimeMinisterManmohanSingh Unemployment-A key concern: One of the main grounds on which FDI in multi-brand retail is being opposed is the fear that it will lead to unemployment for small retailers, traders and kirana stores. However, historic data shows that with FDI implementation, employment increased two folds in China and four folds in Thailand. Franchise model may repel FDI: Policies of the state make it imperative for foreign players to operate through a franchise model (except in cash and carry). In a global retailer survey by CB Richard Ellis, it was found that 35% of luxury and business fashion retailers and 28% of homeware and department stores showed preference to operate their own store over the franchise model. However, most retailers agreed that operating through a franchise helps to test new markets, spread risk associated with aggressive expansion and achieve substantial market penetration.

Recognizingeffortsofretailers The retail players have done well even in the high inflationary environment which has led to a significant decrease in discretionary spends. The industry has rewarded the efforts of players at various retail forums, namely- the number of listed players being awarded at the 8th annual Images Retail Awards (IRA) on 23rd September, 2011 at Mumbai; and Shoppers Stop being awarded the ''BEST SUPPLY CHAIN EXCELLENCE AWARD'' in the Retail vertical during the 5th Express, Logistics and Supply Chain Conclave, conducted by ELSC (Express Logistics and Supply Chain) at Mumbai.

Table2:AnnualImagesRetailAwardsatIndiaRetailForumMumbai
AwardCategory Most Admired Retailer of the Year: Department Store Most Admired Retail Launch of the Year Most Admired Retailer of the Year: Home Products Most Admired Retail Professional of the Year Most Admired Retailer of the Year: Luxury

Winner LIFESTYLE HAMLEYS HOME TOWN BHASKAR BHAT, MD, TITAN INDUSTRIES TANISHQ

Source:Company,Edelweissresearch

Outlook
The quarter, Q2FY12 is likely to be a soft one for the retail sector looking at the high inflationary environment and sky high commodity prices. However, we believe discretionary spending would pick up in the coming festive season. Yet, the true picture of growth in the sector will be apparent post-October when festive season ends. The relaxation of norms in the cash and carry model is a positive move. Similar promptness in FDI in multi-brand retail and GST implementation will go a long way. Titan and Shoppers Stop are our top picks in the retail space.

Table3:Valuationsummary
Company Retail Pantaloon Retail Shoppers' Stop Titan Industries RetailMean Market Price(INR) 198 350 209 528 / 196 505 / 261 238 / 140 52WH/L Mcap (USDMn) 889 589 3788 DilutedEPS(INR) FY11 FY12E 9.4 5.4 4.9 11.4 9.5 6.4 FY13E 15.8 13.5 8.3 FY11 20.9 64.6 42.8 42.8x P/E(x) FY12E 17.3 37.0 32.7 29.0x FY13E 12.5 25.9 25.3 21.2x EV/EBITDA(x) FY11 FY12E 8.2 22.4 29.6 20.1x 7.4 18.8 22.1 16.1x FY13E 6.4 12.9 16.9 12.1x ROE(%) FY11 FY12E FY13E 6.4 11.9 49.0 22.4 7.3 15.7 46.0 23.0 9.4 18.9 43.4 23.9 Div CAGR(%) yield(%) FY13E FY1113E 1.0 NA 1.2 1.1 29.4 58.1 30.2 39.2

Source:company,Edelweissresearch

Edelweiss Securities Limited

Retail
EdelweissSecuritiesLimited,Edelweiss House, off C.S.T. Road, Kalina, Mumbai 400 098. Board: (91-22) 4009 4400,Email:research@edelcap.com
VikasKhemani Nischal Maheshwari Head Institutional Equities Head Research vikas.khemani@edelcap.com nischal.maheshwari@edelcap.com +91 22 2286 4206 +91 22 6623 3411

Coveragegroup(s)ofstocksbyprimaryanalyst(s):Retail
Pantaloon Retail, Shoppers Stop, S Kumars Nationwide, Titan Industries RecentResearch Date Company Titan Industries Titan Industries Title Price (INR) 222 206 Recos Buy Buy

1,150 950 750 550 350 150 Buy

20-Sep-11 29-Aug-11

Rural mural: Toeing the FMCG line; EdelFlash Gold is gold, reassures our Survey; CompanyUpdate Long-term bet; ResultUpdate

(INR)

29-Aug-11

Buy Pantaloon Buy Retail

281

Buy

DistributionofRatings/MarketCap
Buy

Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09

EdelweissResearchCoverageUniverse

RatingInterpretation Rating Buy Hold Reduce appreciate more than 15% over a 12-month period appreciate up to 15% over a 12-month period depreciate more than 5% over a 12-month period
Expected to

Hold

Reduce

Total

Rating Distribution* * 2 stocks under review Market Cap (INR)

> 50bn

119

47

15

184

Between 10bn and 50 bn

< 10bn

111

57

16

Access the entire repository of Edelweiss Research on www.edelresearch.com

This document has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss, its holding company and associate companies are a full service, integrated investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. Edelweiss or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. We and our affiliates, group companies, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Edelweiss and affiliates/ group companies to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither Edelweiss nor any of its affiliates, group companies, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a guide to future performance. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. For recipients in the United States: This report was prepared by Edelweiss Securities, which is not a FINRA member nor a broker-dealer registered with the SEC. US persons receiving this research and wishing to effect any transactions in any security discussed in the report should contact an SEC-registered broker-dealer. In order to conduct business with Institutional Investors based in the U.S., Edelweiss Securities has entered into a chaperoning agreement with a U.S. registered broker-dealer, Marco Polo Securities Inc. ("Marco Polo"). Copyright 2009 Edelweiss Research (Edelweiss Securities Ltd). All rights reserved

Edelweiss Securities Limited