Aditya Birla Fashion & Retail Ltd Q3FY18 Result Update By Edelweiss

Profitability is back

We have been wrong on ABFRL over the past few quarters with the company underperforming our estimates and therefore the broader markets. This has been on account of multiple unforseen events (competition from e-commerce in FY16, demonetization in FY17, GST in FY18) which led to heavy volatlity in quarterly performances for companies across the sector. In addition, apparel business is inventory driven which has a limited shelf life due to constant changes in trends; and hence heavy discounting occurs during such unforseen events. As apparel and retail is a high operating leverage business, the profitability was accounted by such discounting. ABFRL in particular, has spent heavily in new businesses such as Forever 21, Pantaloons and innerwear which have futher compressed profitabilty. We feel that the worst is over for the sector and moreover for ABFRL with the foundation led for strong profitable growth. Its sheer brand strength alongwith a prudent long term strategy render it a multibagger. We re-iterate BUY as we roll over to FY20E with a revised TP of INR 256 (INR 205 earlier).

Madura and Pantaloons on track

ABFRL reported a 9% revenue growth which was slightly below expectations due to slower growth in Pantaloons and a slow October. However EBITDA margins improved from 5.1% in Q3FY17 to 7.4% in Q3FY18 which was above our estimates and led by Pantaloons. Madura has grown 8.2% in Q3FY18 with margins improving from 9.5% in Q3FY17 to 11.6% in Q3FY18. LTL was strong at 4% and the wholesale channel is also recovering. Pantaloons revenues grew 12% with flat SSG. However, Pantaloons has undergone cost rationalization in terms of resizing and rental terms which led to margins improving from 5.4% to a life-high 8.7%. While these margins are not sustainable, we feel that Pantaloons margins could surprise positively once SSG arrives. Pantaloons store expansion will continue at its current trend of 60-80 new stores with 20% on franchisee basis. Pantaloons has already turned cash positive and is now capable of funding itself for future growth.

Mixed results in new businesses

Innerwear continues to grow rapidly as it was opened in ~6000 outlets across 75 towns within 12 months of launch. Losses in the innerwear business are likely to persist due to high growth potential. Forever 21 revenues were lower due to closure/resizing of stores and slower store openings. Losses widened due to a one time inventory markdown of INR 16 Cr. Current store size and higher costs need to be rationalized to take on the increased competition in this segment. American Eagle and Ted Baker stores are likely to be launched next quarter.

Outlook and valuations:

‘BUY’ We believe ABFRL is best placed among branded apparel peers to reap significant benefits of the improving macroeconomic milieu due to the sheer quality & size of Madura’s 4 brands, presence in fastest growing segments such as value and fast fashion and an unparalleled distribution network. The company’s pole position, ability to generate free cash flow, and RoCE expansion will yield target multiple of 3x sales for Madura and 15x EV/EBITDA for Pantaloons, leading to a revised target price of INR 256 (INR 205 earlier). We re-iterate our Buy rating.