Aditya Birla Fashion and Retail Ltd. – Investment Thesis – Introspeck

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Aditya Birla Fashion and Retail Ltd. (ABFRL) is the largest listed apparel retailer in India and was formed on account of merger of 2 separate businesses – Madura Lifestyle and Pantaloons. The company sells its products across segments, right from value fashion all the way to premium formals. While Pantaloons has an exposure to all segments of Indian apparel industry – men’s, women’s and kids wear, Madura Fashions has traditionally been menswear focused with 4 flagship brands – Louis Phillippe, Van Heusen, Peter England and Allen Solly. The company further has a portfolio of global brands on a franchise basis like Ted Baker, Ralph Lauren, Forever 21 etc. and has also forayed into innerwear in 2017.

Both these companies are fairly mature (first Pantaloons store came up in 1997 and Louis Phillippe was launched in 1989) and have achieved significant penetration with a combined presence of 2,714 stores (Madura – 2,406 stores, Pantaloons – 308 stores) and 23,000+ distribution points (wholesale channel). Pantaloons rapid expansion under Future Group was fuelled by debt, and this company was sold to Aditya Birla Group in 2013.

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Since a large part of the business (in the form of Madura Lifestyle) merged into the listed company in 2016, only 4 years of history is relevant to us. The company follows the single digit margins of the apparel retail industry. However, ABFRL itself can be broken down into below businesses with EBITDA margins as follows –

Company Details 2016 2017 2018 2019
Madura Fashion   9% 8% 8% 8%
Lifestyle Brands Top 4 brands 11% 12% 12% 12%
Fast Fashion F21, value brands -9% -14% -13% -9%
Other Business Innerwear, global brands -26% -26% -26% -23%
Pantaloons Value Fashion -7% -6% 6% 7%
 Total   3% 3% 7% 8%
Source: Company Filings.

Although these are what Munger refers to as BS earnings, it can be seen that the legacy lifestyle business of Madura Fashions has the highest margins, which seem to be on account of better pricing in 4 legacy brands, in house manufacturing of garments and sale through wholesale channels, none of which are present in Pantaloons. The Birla group realised this too, when they recapitalised Pantaloons with 1,210 crores in 2016 and merged Madura Fashions in exchange of Pantaloons shares, diluting the existing shareholders to the extent of 88%. Overall revenue growth has been steady

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Particular 2013 2014 2015 2016 2017 2018 2019
Sales 1,285 1,661 1,851 6,034 6,603 7,172 8,118
increase   29% 11% 226% 9% 9% 13%
PBT -69 -188 -228 -110 54 49 149
Tax           -69 -172
PAT -69 -188 -228 -110 54 118 321
PAT Margin -5.4% -11.3% -12.3% -1.8% 0.8% 1.6% 4.0%
Source – Company Filings. Note: Company, on its volition has recognised higher deferred tax assets, anticipating higher profitability in future.

While it may appear that the profits have improved on account of increasing sales, the same has been on the back of changes in deferred tax assumptions and not a turnaround in operations, and as such remain low.

With low net worth due to earlier losses, the RoCEs (calculated after capitalizing the future rental obligations of the company) need to be considered, and not the RoE, which might be currently overstated. ABFRL has significant future rent obligations, not reflected in its Balance Sheet –

(in crores)
Within 1 year 441
1 – 5 years 1,118
More than 5 years 104
 Total 1,663
Net Worth 1,429
Operating lease as a % of Net worth 116%

After considering the above rent adjustment, company’s RoCE’s are

Particulars 2018 2019 2020E 2021E
Adj. RoCE 4.2% 5.8% 5.8% 6.8%
Estimates are made by me based on extrapolating 2019 numbers, only to highlight any turnaround is not expected to happen soon.

A look at the ABFRL’s cash conversion cycle reveals that it has a strong bargaining power towards its suppliers, as can be evidenced by the company’s payable days, since these almost cover all the inventory and debtors –

2013 2014 2015 2016 2017 2018 2019
Debtor Days 4 1 19 25 28 35
Inventory Days 145 129 147 172 157 164 163
Creditor Days 142 135 107 175 170 195 204
Cash Conversion Cycle (Days) 4 -2 41 16 12 -3 5
Note: Inventory and Payable Days have been considered on COGS basis.

With a favourable working capital cycle, the debt taken over by company has mostly been taken to fund organic and inorganic expansion, with significant capex nearing depreciation –

Particulars 2013 2014 2015 2016 2017 2018 2019
Capex -30 -117 -116 -1110 -303 -339 -287
Depreciation 54 109 183 338 242 281 282
Sales Growth   100% 11% 226% 9% 9% 13%

With favourable working capital cycle and low capex intensity, its critical to understand the margin profile of the company and take a deeper dive in the income statement of the company, which has the following cost structure –

Particulars 2013 2014 2015 2016 2017 2018 2019
Sales 100% 100% 100% 100% 100% 100% 100%
Raw Material Cost 58% 60% 58% 50% 46% 51% 51%
Change in Inventory 2% -2% -3% -4% 0% -3% -3%
Power and Fuel 3% 3% 3% 2% 2% 2% 2%
Other Mfr. Exp 0% 1% 0% 2% 3% 4% 3%
Employee Cost 7% 9% 10% 10% 11% 11% 11%
Advertisement 3% 4% 4% 7% 4% 5% 5%
Rent 13% 15% 15% 11% 16% 15% 14%
Admin Overhead 6% 7% 8% 15% 10% 9% 9%
Other Expense 1% 2% 2% 1% 2% 2% 1%
Depreciation 4% 7% 10% 6% 4% 4% 3%
OPM 1% -5% -6% 1% 3% 3% 3%
Source: Company filings

With fixed cost base (Rent + Advt. + Employee + other Overheads + Depreciation) forming around 45% of the cost base and raw material costs higher than 50%, company’s margins will continue remaining in single digits over a long term, while sudden change in RM costs or lower turnover, could quickly turn negative as expenses like rent and employee costs cannot be scaled down rapidly. For retail companies in a growth phase, an important metric is the same store sales growth, or Like to Like Sales Growth (LTL), which has been quite inconsistent for Pantaloons –

Particulars 2017 2018 2019
Pantaloons 5% 14% 1.4%
Madura     5.3%

Another important parameter to analyse efficiency of a retail operation is sales per square footage. This parameter would not be suitable for Madura since it sells through both, the retail and the wholesale channel, while Pantaloons, which sells only through its own stores, has the following metrics –

Particulars 2013 2014 2015 2016 2017 2018 2019
Area (mn sq. ft.) 1.7 2.0 2.3 2.9 3.2 3.7 4.0
Pantaloons Rev. (Crs.) 1,285 1,661 1,851 2,157 2,552 2,862 3,194
revenue per sq. ft. (INR) 7,560 8,306 8,047 7,438 7,975 7,735 7,985
increase   10% -3% -8% 7% -3% 3%

As can be seen from above, Pantaloons’ sales per square foot has largely remained stagnant despite more advertising spend and moving from a 2 season model to a 4 season model. This is far lower than the growth in domestic apparel consumption by almost 14% per year in the last 9 years.


Revenues in INR Crores. Source: Screener

Comparing ABFRL with Trent, VMart and Shoppers Stop, following insights emerge –

  1. All the above retailers earn post tax margins in the range of 2-4%.
  2. What separates the better quality companies (in this case Vmart) is higher asset turnover (above 2x), which has led to the company earning very high returns on capital employed.
  3. However, ABFRL may not be able to do as well as Vmart, since Vmart is focused on Tier 2 and 3 towns, where real estate and manpower is cheap, while ABFRL is focused mostly in urban densely packed areas due to which its cost base is higher and competition more intense.
  4. Further, despite incurring significant expense on ad spends, the sales per square feet in Pantaloons have not increased.

Business Assessment

Here is my dilemma – what makes one apparel retailer better than the other – Is it cost control or better purchasing / design? If it is cost control, the likes of fashion trends, thoughtful sourcing and brand perception do not seem to be quite relevant. However, this defies the success of company’s own legacy brands like Louis Phillippe which have been maintaining a premium offering over last so many years. Yet, ABFRL continues pouring money on expanding value segment and opening newer retail outlets, while reducing sales mix through wholesale route, which is down to 58% from 65% in 2018. The wholesale route in my understanding was asset light and monetized brands, instead competing only on real estate. Further, I have not analysed their innerwear foray or expanding through franchisees since these are newer initiatives and follow a similar playbook.

Not only ABFRL, but the best company in the lot, V-Mart Ltd., also has been incredibly cost savvy, with rentals at 4% of sales compared to ABFRL’s 14%, all the while striving to sell through its own outlets eschewing wholesale completely in order to focus on the buyer experience. Does any apparel retailer then, ever have a competitive advantage? I think I have found myself in a place where an analyst often is – 10 feet away from the truth, one that probably only a business owner grasps, albeit instinctively. I, for now conclude, that a good retailer has to have 2 essential ingredients – deft sourcing (non measurable) and cost control (measurable) to earn above average returns to over a long term, with the metrics to track being SSSG (same store sales growth) and Operating Margins across cycles and peers. It is for this reason that there is no analysis for online retailers in this post since both the above metrics are absent.

This analysis is also a useful reminder of an important lesson that working capital requirements and uses are very specific to certain industries, and whether a company has good working capital management or not can be gauged only by comparing its peers from the same industry and not across sectors. In a similar vein, high cash conversion cycle does not tell us anything about the financial health of a business, since some businesses simply end up having negative working capital, despite being lousy (case in point is PVR, the food vendor).

This is one of those companies that I would not even want to have a valuation on since –

  1. The company’s cost structure does not allow to have positive surprise in margins.  
  2. Asset turnover of pantaloons has been stagnant despite the industry growing in double digits. With fashion e-tailers consolidating and having gone through the teething troubles, competition is expected to intensify going forward.
  3. Despite its brand legacy and 15 million loyal customers, online store of ABFRL was launched only in 2019, significantly later than expected.

Open Questions

  1. To what extent can company’s operating margins improve if operating leverage kicks in?
  2. Do fashion e-tailers have a cost advantage over offline retailers in rent and employee cost?
  3. To what extent do fashion trends dictate customer choice? Where do these trends emerge from?
  4. What are the negatives of ABFRL’s move from 4 season model to a 12 season model (company to restock its stores with new collection every month)?

ABFRL is one of those companies that I am letting go without reaching a satisfying end since I find it to be non investible at any price. Feel free to write back in case you have any observations on the retail sector in general or a company in particular.

Happy Investing!

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Umang Shah
Through his writing, Umang shares his perspectives on how he thinks of investing, decision making, books and life in general.
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