The Pantaloon stock has been under pressure, given
weak sales due to the slowdown in the past few months. It has lagged the Sensex
in the past 10 months posting a return of close to 44% compared to 70% return
recorded by the benchmark index during the same time period.

Even
though the company has cut down its aggressive expansion plan, it still remains
the largest organised retailer with about 13 million sq feet of space featuring
116 Big Bazaars, 45 Pantaloons, 9 Centrals and 93 other stores. This is in
contrast to Shoppers Stop’s 1.8 million sq feet of total retail space.

With 72% of Pantaloon’s sales coming from the value retail
format, the company’s focus is on providing a mass shopping experience
— which would mean settling for lower margins.

With a net
profit margin of 2.4%, the company plans to increase the share of private label
in its product offering which should boost its margins. As private label is a
high-margin segment, Pantaloon is also launching a private label
‘Ektaa’ in the food category to increase its share of the
customer’s wallet. Another area of focus is on increasing the margins
through its fashion garmenting business.

At 1.2, Pantaloon’s
debt-to-equity ratio looks stretched although the company is aiming to bring
down its leverage to sub 1x level — something which investors ought to
welcome. The stock is currently trading at 44 times and it’s trailing 12
months earnings and eight and half times of its annual revenues.

The
stock is also trading at 2.7x its book value (net worth) during the year ended
June 2009 and looks richly valued, given its expected earning growth in the next
few quarters. At the September 2009 quarter’s annualised EPS of Rs 9.16,
its one-year forward P/E will be 35x. Pantaloon will need to ensure that there
is a significant growth momentum to justify any further appreciation in its
stock price.

With a spate of contracts up for renewal in
January, about 10 fast moving consumer goods (FMCG) companies have ruled out
higher margins, accusing big retailers of pushing their own labels at the
expense of their established brands and not meeting the sales and expansion
targets as per the contracts.

“Modern retail today is not
offering us the kind of throughput to demand such margins. Also it doesn’t
help us when retailers promote their own labels and competing brands at our
expense,” said Hoshedar K Press of Godrej Consumer Products
(GCPL).

FMCG sales from modern formats, which recorded a growth of
over 30% in the past two to three years, had dropped early this year mainly due
to closure of several retail outlets as part of a strategy correction by
retailers, with consumer demand in urban areas dropping dramatically as the
world slipped into its worst economic crisis since the
1930s.

“The scale-up (expansion of stores) in terms of outlets
has not happened, as was told to us in the initial contracts. Also, the
contribution of modern trade in terms of sales targets remains far below
projections,” said an official at a leading Delhi-based FMCG firm,
requesting not to be named.

Things have improved since and retailers
such as Future Group, Reliance Retail and More have started expanding their
operations on the back of improved consumer sentiment in urban centres that is
helping high-end, high-margin products to stage a comeback.

And they
have renewed their demand for higher margins from FMCG companies. When
contacted, Kishore Biyani, CEO of Future Group, said, “Margins will always
be an issue. Both sides have to mutually look at ways of growing
profitability.”

Traditionally, modern retailers roughly operate
on margins varying from 10-15% while the traditional trade operates at around
10-12%, depending on the product category. The face-off is expected to make the
two industries to continue working against one other’s interest.

While retailers are giving higher visibility to private labels and
smaller brands that offer higher margins, manufacturers are helping traditional
grocers (kiranas) to use the best practices of modern trade such as category
layout and standardised units.

Retailers’ own brands are 10-20%
cheaper than established brands and offer higher profit margins of over 40% than
other brands. Aditya Birla Retail’s private labels include Feasters brand
of biscuits, fruit juices, noodles and pasta; Enriche shampoo, Kitchen’s
Promise spices and Fresh-o-dent toothbrushes and toothpaste. Spencer’s
sells private labels under the Spencer’s Smart Choice while Future
Group’s private FMCG brands include Fresh n Pure, Cleanmate, Tasty Treat,
Caremate, Sach.

Also, smaller companies such as Garden Foods, Capital
Foods, Cremica, Fena, Ghadi among others in the FMCG space are making rapid
strides and giving the bigger players a run for their money. Manufacturers, in
turn, are taking kiranas under their wing and helping them offer better service,
pricing and variety to take on competition from modern
formats.

Grocers are giving discounts on branded products like
detergents, shampoos, soaps, oil, atta and other grocery products from 5-20% by
collectively sourcing or aligning themselves with corporates like Hindustan
Unilever, P&G and others to be their ‘preferred suppliers’, who
are adopting these stores and working with them to manage inventory
better.