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A year of firefighting

The year FY21, which proved to be a tumultuous year for the Apparel business, impacted ABFRL even more adversely – high leverage and squeezed working capital led to a strain on liquidity. This was well responded with equity infusion and unwinding of working capital as market recovered. Overall revenues declined 40% to INR52.5b, dragging down EBITDA by 54% to INR5.5b (pre-Ind-AS 116 EBITDA loss of INR4b). The company’s prompt cost management led to overall decline of 36% in operating cost, excluding RM (32% on a pre-Ind-AS 116 basis). The Lifestyle Brands / Pantaloons segment saw 41%/47% revenue decline to INR27.5b/INR18.6b, and EBITDA fell 57%/51% to INR3.4b/INR2.7b. Net loss stood at INR7.4b v/s INR1.7b in FY20. The Wholesale Lifestyle segment was impacted by a correction in dealer inventory, while Pantaloons’ mall-dominated presence was affected by stricter restrictions v/s high street stores.

Sharp cost savings, fundraise, and WC cleanup addresses balance sheet cleanup

The high leverage position of INR23.7b at the start of the lockdown in FY20 and squeezed working capital of INR9.1b (38 days) called for strong measures. Along with sharp cost rationalization, the management announced a cumulative equity raise of INR25b, of which INR10b was raised through rights issues (INR2.5b pending) and the remaining INR15b through a 7.8% stake sale to Flipkart on a preferential basis and cleaning up of working capital, thereby reducing it by 78% (4% of sales). This was partly offset by spending of INR5.2b on the acquisition of ethnic wear brands Sabyasachi and Tarun Tahiliani to achieve comfortable net debt of INR5.3b in FY21.

Changing consumption patterns

With restricted movement, consumer shopping behavior saw a clear change – as Apparel categories such as Casuals and Athleisure wear saw healthy growth across formats. The restricted shopping led to 46%/60% lower footfall in Lifestyle Brands / Pantaloons, partly offset by higher conversions – as only serious shoppers visited the stores. Lifestyle Brands being a higher ticket size segment saw 11% decline in like-to-like average selling price (LTL ASP); impacting the average bill value. On the other hand, Pantaloons, which offers value retail proposition, saw an improving average bill value owing to more item sales per bill and a limited impact on LTL ASP. However, these trends may normalize once the market fully recovers.

Sectoral themes in play

The Apparel industry, the second largest retail category in India after Food and Grocery, is seeing healthy recovery. Key business growth trends are playing out: a) the Ethnic Wear market, dominated by unorganized market and lacking international competition, makes up 28% of the Apparel market – this presents a huge opportunity; b) there is increasing prominence of fashionable wear, casual wear, and athleisure wear, driven by a growing young population; c) there is increasing demand in smaller tier towns, led by a growing fashion culture owing to the influence of social media; d) the Women’s Wear and Kids’ Wear markets are growing; and e) there is opportunity in Value Fashion Retail (75% of the market) with the increasing shift from the unorganized market.

Management strategy – growth levers

The Lifestyle Brands business added 380 new stores, reaching 2,379 stores, even in a pandemic hit FY21. It gained market share by enhancing product categories such as ‘WFH’ and increasing digital reach. The segment is expected to add 250 stores annually and would tap higher growth categories (such as Women’s Wear and Kids’ Wear as well as Peter England and Allen Solly small-town formats), reaching revenue/EBITDA of INR54.1b/INR9.7b in FY23 (17%/22% over FY20). Pantaloons added 19 stores in FY21 and plans to add 60 stores in FY22, achieving revenue/EBITDA of INR42.8b/INR8.9b in FY23E (22%/59% over FY20). The Ethnic Wear portfolio has received a boost in the last two years – led by the company’s investments in firms that cater to various categories and price points – but it could take a couple of years to contribute to the bottom line. Subsequently, we estimate consol. revenue/EBITDA of INR106.6b/INR18.9b (56% achieved over FY20), with a 17.7% EBITDA margin (7% on pre-Ind-AS 116) and PAT of INR3.2b.

FY21 cash flow supported by equity infusion and WC unwind; to improve in FY23E

In FY21, the unwinding of squeezed working capital and equity raise supported liquidity, even as the business remained challenging. Operating cash flow at INR11b was supported by INR6.1b unwind of inventory, while capex remained low given the prevalent lockdowns/restrictions in 1HFY21, leading to FCF of INR8.9b. Further equity capital infusion supported the deleveraging, pulling down net debt to INR5.3b in FY21 v/s INR20.9b in FY20. ROEs/ROCEs were impacted by net loss and INR19.9b goodwill – they formed one-third of the capital employed. While operating cash flow may be restricted to INR2.7b in FY22 (due to the impact of the 2nd wave), it should improve significantly in FY23E and accommodate capex of INR3.9b. ROEs/ROIC (excl goodwill) should also improve to 11%/10.3%.

Valuation

We have valued ABFRL on an SOTP basis to arrive at TP of INR270 and retain our Buy rating. We have assigned the Lifestyle Brands segment 15x FY23E EV/EBITDA given its strong brand value. We have assigned 13x FY23E EV/EBITDA for Pantaloons with accelerated growth potential. The other businesses, including Fast Fashion and Innerwear, are still loss-making portfolios, and we thus assign them 1x of FY23E sales. This implies an EV of 14x on FY23E EBITDA. Despite the sharp rally in the last year offering over 50% returns, the stock has trailed in comparison to its peers in the sector primarily due to its high leverage position. With leverage reaching comfortable levels and return ratios / cash flows expected to improve over the next five years, we believe the stock does not fully capture the company’s steady growth potential even after factoring in the losses in Ethnic Wear during the gestation period. Maintain Buy.

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