Buy Bata India - Management Meet Update - Nirmal Bang

We had a meeting with the management of Bata India (BIL) recently regarding its key strategies. After the meeting, we are more confident on BIL's margin levers. We have retained our Buy rating on BIL with a target price of Rs1,310 based on 16.0x/26.5x CY15E EV/EBITDA and P/E, respectively. Followings are the key highlights:

Lease rentals versus gross margin: As per the management, looking at lease rentals and gross margin in isolation will not give a true picture of BIL. It attributed the rising lease rentals because of: 1) Rise in rentals at the time of agreement renewal, 2) Higher addition of new stores, and 3) Increased share of stores set up in malls compared to standalone stores, where lease rentals are higher. An analysis of the past 13 years indicates a correlation between rising lease rentals and improving gross margin. During CY06-CY09, lease rentals as a percentage of sales increased 475bps from 4.5% to 9.3% and at the same time, gross margin improved 295bps from 50.0% to 53.0%. BIL set up ~592 stores over CY08-CY13, with more than 50% of these outlets being established towards the end of CY08. A major proportion of these outlets, particularly in the past three years, were opened at malls where the lease rentals are high and consequently, lease rental costs increased 351bps from 9.2% to 12.7% over CY10-CY13, but as BIL was conservative in product price hikes and the share of outsourcing also rose, the gross margin remained flat in the 52.7%-52.9% range. BIL went for a price hike of ~5% in 4QCY13. The increased share of outlets set up at malls will improve average realisation and thereby, gross margin. As result, gross margin rose 117ps in CY13 and 279bps in 4QCY13. We expect a 350bps rise in lease rentals over CY10-CY13, which can improve gross margin by more than 200bps because of a better product mix and strong revenue following the scale-up from ~415 outlets established in the past three years.

Operating margin may touch the 20% mark: Operating margin improved 224bps/638bps in the past three/five years, respectively. With the scope for further efficiency in all cost heads, there is enough headroom for improvement in operating margin. We believe BIL's business model has the potential to achieve operating margin of 20% in the long run due to: 1) Improving gross margin, 2) Lower employee costs because of the voluntary retirement scheme (VRS), 3) Moderation in lease rentals, and 4) Lower power/fuel as well as manufacturing costs following the modernisation of three out of five plants. Excluding one-off items like VRS and one-time service tax amnesty payment of Rs101mn/~Rs55mn, respectively, BIL posted operating margin of 19% for 4QCY13 at a time when revenue growth was muted at 8.9%. In the near term, because of higher advertisement expenses and also opex to improve the supply chain/logistics, a part of operating margin improvement may be dented. We expect the operating margin to rise 167bps at 17.3% over CY13-CY15E.

Introduction of new retail format stores: BIL continues to introduce new retail format stores. Five years ago, it introduced a larger format store of 3,000sqft-4,000sqft. Recently, it introduced a very large format store spread over 20,000sqft at Viviana Mall in Thane, Maharashtra. It also opened a store in city-store format at Saket in Gurgaon, Haryana. In CY11, BIL introduced an altogether new format for youth under the Footin brand. BIL is exploring various new formats including separate women's outlet, exclusive brand outlets for leading brands in line with Hush Puppies, improvement in e-tailing etc. These new retail format stores are likely to widen the target customers for BIL and provide additional growth.

Source : Equity Bulls

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