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Aggressive expansion with improved cash flow

We pored over Trent’s FY24 annual report to get insights about its performance and other developments. Here are the key takeaways:

Stellar performance continues

Trent continued to report strong standalone/consolidated revenue growth of 55%/50% YoY to INR119b/INR124b in FY24, aided by 51% YoY area addition and +10% LFL growth. Despite a slight contraction in standalone gross margin by 20bp (due to higher Zudio mix), EBITDA margin (pre Ind-AS) improved to 11.7% (up 300bp YoY), aided by lower ad spending and operating leverage. Standalone adj. PAT improved to INR10.3b (vs. INR5.5b in FY23). In addition, the Booker subsidiary and Star (JV) losses have narrowed. As a result, consolidated PAT surged to INR10.4b (vs. INR4b in FY23). On the standalone basis, Trent generated FCF of INR4b (vs. –INR275m in FY23), and RoCE improved to 21% (vs. 12% in FY23), backed by improved profitability and asset turns.

Profitability improves for standalone formats; Zara moderates

Standalone revenue growth was fueled by Zudio’s stellar performance (revenue up 95% YoY to ~INR69b), well supported by Westside (revenue up 20% YoY to ~INR50b). Growth was aided by store additions of 18/193/10 for Westside/ Zudio/Other formats. The company has also increased the average store area by ~16%/19% YoY to 19.4k/9.2k for Westside/Zudio. As per our calculations, both the formats reported ~INR12k/~INR18k sales per sqft, which, along with healthy LFL (+10%) and operating leverage, led to 15%/9% pre-IndAS EBITDA margin. Zara revenue grew 8% YoY to INR28b, led by store addition (+15% YoY; 3 stores). Growth in revenue per store moderated to 3% YoY. A contraction in GM by 130bp led to a decline in EBITDAM by 110bp YoY to 15.2%. As a result, dividend received from Zara moderated to INR737m (vs. INR1.46b in FY23). However, the format is funding its growth capex and working capital from internal accruals, with strong RoIC of 47% in FY24.

Star: Strong LFL, but yet to garner EBITDA level profitability

Star revenue grew 21% YoY to INR22b, largely led by 27% LFL growth. Despite an improvement in GM (+150bp YoY), Star posted EBITDA of INR255m (vs. INR1.7b in FY23) and margins of only 1%, which could be due to the reclassification of lease liability and the cost of modification of stores. Trent has funded the losses mainly through the issue of equity (by Trent and Tesco). This could be the reason Star added only three stores in FY24, taking the total count to 66 stores. For the last two years, the company has been constantly optimizing the format. The management indicated to add 20-25 stores in FY25 by following the cluster strategy to expand and focus on its own brands. We believe Star Bazaar might need funds for its expansion for a year, but going forward it may fund its growth internally as the size of the grocery market is INR76t, which provides tailwinds for the sector. Improved traction in productivity with higher margins could drive the next leg of growth.

Healthy return ratios with improved profitability

Return ratios improved in FY24, thanks to healthy profitability and FCF generation of INR3.7b/INR4b on the consolidated/standalone basis. Standalone RoE/RoCE/RoIC improved to 27%/21%/26% (vs. 22%/12%/15% in FY23). Our format-wise financial working (see exhibit 10) indicates that Westside clocked healthy RoIC of 26% and Zudio’s EBITDA margin/RoIC improved to 9%/25%. Zara’s EBITDA margin/RoIC declined 110bp/9pp YoY to 15%/47%, while Star Bazaar posted ROIC of -12.5%. Trent operates on a strong consolidated net cash position of INR5.1b despite aggressive store additions over the last few years. The cash conversion cycle improved to 27 days (vs. 34 days in FY23), led by a reduction in inventory/payable days to 48/23 (vs. 63/30 in FY23). Trent has effectively managed its debt levels while continuing to pursue its growth objectives.

Valuation and view: Growth levers explain premium valuation; retain BUY

* The discretionary category continues to see muted demand, but Trent has far outpaced the industry. The company delivered industry-leading LFL growth of +10% and hence gained market share over other retailers in the apparel segment (especially in value format).

* Further, despite aggressive store addition, Trent has limited balance sheet risk or weakness in operations. Trent’s industry-leading revenue growth is mainly driven by: 1) strong SSSG and productivity, 2) healthy footprint additions, and 3) Zudio’s strong value proposition.

* Trent’s successful store performance, healthy store economics, and aggressive growth strategy offer a huge runway for growth over the next three to five years.

* We estimate a CAGR of 36%/34% in standalone revenue/EBITDA over FY24-26, led by 20% store addition and healthy SSSG, which explain the premium valuation for the stock. We have ascribed 57x to standalone business, 2x EV/sales to Star Bazaar, and 15x EV/EBITDA to Zara to arrive at our TP of INR5,800. Adjusting Star and Zara value, the stock is trading at 88x FY26E EPS for the standalone business. Weak demand in tier 2-3 cites and a slow turnaround of Star could be the key risks going forward. Retain BUY.

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