Tesco Trent JV - A Step Closer - PhillipCapital

Tesco Plc has entered into an agreement with Trent Limited to form a 50:50 Joint Venture in Trent Hypermarket Limited (THL) which operates the Star Bazaar retail business in India. Tesco's investment will be around £85 million (Rs 8.5 bn; higher than the earlier reported Rs6.6 bn). Trent has approved definitive agreements in this regard. The agreements envisage that Tesco Overseas Investments Ltd, a wholly owned subsidiary of Tesco, would purchase part of the equity shares currently held by the company in THL to the tune of Rs 1.5 bn and would separately subscribe to additional equity shares for an amount of Rs 7bn. We had mentioned in our note dated 20th December 2013, this structure of acquisition of shares is the most likely.

On completion of the transaction THL will operate 12 stores (in Maharashtra and Karnataka) retailing a range of merchandise including food and grocery, personal and home care products, home and kitchen, fashion and accessories etc. The stores are operated under the 'Star Bazaar' and 'Star Daily' banners, and spread across the Southern and Western regions of India.

While the substance of the JV remains unchanged, the valuation of THL is higher than estimated earlier. The transaction values the JV at an equity value (pre-money) of Rs17 bn implying Price/Sales of 2x on FY14E sales. As a corollary, the valuation could be lower if the estimated sales of these 12 stores are higher than our estimate of Rs 8 bn. The post money equity value (including 4 stores wholly owned by Trent valued at 1x Sales) of this deal works out to be Rs15 bn.

Trent's equity investment in THL as on FY 13 was Rs3 bn in addition to preferential shares of Rs1.5 bn and the balance sheet of THL had net assets (including working capital) of Rs2.5 bn.

This business will now be accounted for a JV (after the necessary approvals); consequently, the financial performance of this entity would be accounted for proportionately in Trent's books. Moreover, the company will have to de-merge 4 stores out of its portfolio into a separate entity.

However, the implications of change in the Central Government and any changes towards the FDI policy remain to be seen.

We reiterate our belief that this deal on fructification will bring in operational efficacies over a period of time to the Star Bazaar format in form of -a) Gross Margin expansion led by sourcing ability & private labels b) Improved Sales density due to product mix, led by scientific methods/loyalty card analytics led by Dunhumby c) better absorption of store level fixed costs as well as corporate overheads as business attains scale d) continued efficiencies on distribution and improvement in store fill thus improving sales density and e) the involvement of Tesco operationally and financially in THL will improve the cash flow of the parent company and thus enhance the potential investments into the Westside Format, which has successfully repositioned itself. Maintain BUY.

Source : Equity Bulls

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