Corporate Finance 12 April 2005 www.fitchratings.com India Retail Ratings Short-Term Rating Long-Term Rating Shopper's Stop Ltd F1(ind) - Pantaloon Retail India Ltd F1(ind) - Select International Retail Ratings Region Short- Term Rating Long- Term Rating Asda Group Ltd GBR F1+ AA- Boots Group Plc GBR F2 A- Carrefour FRA F1 A+ Costco Wholesale Corp. USA F1 A+ Gap, Inc. (The) USA - BBB- Home Depot Inc. (The) USA F1+ AA J Sainsbury Plc GBR F3 BBB Marks and Spencer Group PLC GBR F2 BBB+ Metro AG DEU F3 BBB Sears, Roebuck and Co. USA - BB Analysts Priyamvada Balaji +91 22 5637 0920 priyamvada.balaji@fitchratings.com A Vasanth +91 22 5637 0920 a.vasanth@fitchratings.com R Jayakumar +91 22 5637 0920 r.jayakumar@fitchratings.com Related Research Fitch Special Report: Indian Retailing – Birth Pangs, August 2003, available on www.fitchindia.com. Contents Executive Summary.1 Industry Overview and Key Drivers 2 Growth Backed by Fundamentals 2 Market Size Estimates.2 Market Structure.3 Evolving Formats 3 Other Key Industry Trends.4 Performance of Key Retailers 5 Outlook 7 Company Reports Shopper's Stop Limited.8 Pantaloon Retail (India) Limited.9 Trent Limited.10 Foodworld Supermarkets Ltd.11 Appendix 1: Retail Format Analysis....... 12 Appendix 2: Business Summary of Few Key Retailers in India.14 ? Executive Summary Growth in Indian retail has been driven by the country's economic fundamentals over the past few years, including an increase in the proportion of upper income households, rising consumption expenditure and greater use of credit cards. Consumers are showing a growing preference for organised retail, resulting in increased penetration, from around 1% of total retail consumption in 1999 to nearly 3% in 2004 (or some INR280billion), and Fitch Ratings believes that this could rise to about 8%-10% over the next five years. Organised retail continues to be focused on food & groceries and apparel. Key players have continued to customise their formats to better service their target markets. For example, the hypermarket format has rapidly gained popularity and is likely to expand the fastest, albeit largely confined to India's bigger cities. Competition in the supermarkets segment is likely to intensify, squeezing margins. Gaining critical mass and promoting private labels will be critical to profitability. The department store format is likely to show strong growth, again largely restricted to the larger cities. Speciality retail is also evolving in categories such as durables and jewellery, but remains in its infancy. Retailers are using a combination of better bargaining power with suppliers, investments in supply-chain infrastructure to improve inventory management and the promotion of private labels to enhance margins. Larger retailers like Shopper's Stop Ltd ("Shopper's Stop") and Pantaloon Retail India Limited ("PRL") have realised operational efficiencies, as reflected in their financial performance. The rapid development of malls in India over the past few years in the major cities is expected to continue in the medium term and benefit retailers by increasing the availability of retail-focused real estate. The financial flexibility of larger retailers has improved significantly over the past two years with new financing sources becoming available. The industry is thus gaining acceptance within the investor community. However, the pace of expansion has resulted in negative free cash flows for most retailers as internal accruals have proved insufficient to meet expansion plans. Sector growth prospects are likely to be limited by factors such as restrictions on FDI (foreign direct investment), the lack of a uniform tax structure, increasing pressure on infrastructure in key consumer markets and a shortage of quality real estate. However, the government has attempted to alleviate these issues, proposing various regulatory changes (e.g. VAT legislation and FDI specifically for construction), which should prove beneficial in the medium to long term. Special Report Indian Retailing: Investing for Growth Corporate Finance Indian Retailing: Investing for Growth: April 2005 2 ? Industry Overview and Key Drivers Historically, the Indian retail sector has been dominated by small independent players such as the local kirana stores (traditional, small-format, neighbourhood grocery stores) and "mom and pop" outlets. During the 1990s, organised retail gained increased acceptance, which has since accelerated. For instance, in 2003 alone, an estimated 10m sqft was added to organised retailing in India, higher than the additional retail space added in aggregate in the preceding decade. Over the past few years, the Indian retail sector has been characterised by: ? larger store formats; ? rapid expansion across formats by existing players; and ? more players with a variety of formats. The key growth drivers for organised retail are: ? growth in per capita income and household consumption; ? changing demographics and improved standards of living; ? changing consumption patterns and accessibility to low-cost consumer credit; ? infrastructure improvements and increased availability of retail space; and ? access to capital markets and other sources of financing. ? Growth Backed by Fundamentals The Indian retail industry has been driven by strong growth in the country's economic fundamentals over the past few years, as detailed in Table 1. Table 1: Macroeconomics, India 12 Months to end March 2002 2003 2004 Change (%) GDP* (INRbn) 20,815 22,549 25,198 11.7 Per Capita Income* (INR) 19,922 21,249 23,352 9.9 Per Capita PFCE** (INR) 14,327 15,013 16,419 9.4 Index of Industrial Production 167.0 176.6 188.7 6.9 WPI (Avg. of 52 Weeks) 161.3 166.8 175.9 5.5 *At current prices and at factor cost ** Private Final Consumption Expenditure per capita Source: Ministry of Statistics There has been a substantial increase in private consumption expenditure as well as disposable incomes, driven by growth in per capita income. Fitch expects growth in the number of upper income households to sustain the momentum in the retail industry. With higher growth expected in urban high-income households, the focus will remain on the larger cities. In addition, the surge in consumer credit has also played a part in increasing consumer consumption. According to the Reserve Bank of India ("RBI") retail lending proved the mainstay and a key profit driver for banks over the past few years, with the retail portfolio accounting for 21.5% of total loans in March 2004, or INR1,890bn, which included credit card receivables (INR61.7bn), consumer durable loans (INR62.6bn) and other personal loans (INR871.7bn); the remainder comprised housing loans. Table 3: Credit Card Statistics in India 12 Months to end March 2003 2004 Change (%) Transaction Volumes (000) 44,559 97,405 119 Transaction Value (INRm) 75,538 172,680 129 Avg. Transaction Size (INR) 1,695 1,773 5 Source: Reserve Bank of India, Market Sources The increased penetration of credit cards is likely to have a positive impact on the retail industry, given: ? increased consumer expenditure due to interest- free credit periods offered by credit card issuers; ? greater ease of purchase; ? meaningful data on consumption patterns resulting in customised inventory stocking by the retailer and hence, improved efficiencies; ? valuable data for manufacturers on consumer preferences and demographics; and ? greater operational efficiency, i.e. reduced checkout times, etc, at the store level. Realising the importance of credit cards, retailers are teaming up with credit card issuers to offer special incentives to co-branded cardholders. Examples include the Shopper's Stop/Citibank First Citizens card and the Big Bazaar/ICICI Bank co-branded card. ? Market Size Estimates The total domestic retail market was estimated at around INR9,300bn in FY04 and growing at 4%-6% p.a. in real terms. Organised retail has benefited from Table 2: Income Distribution Households (m) 12 Months to end March 1996 2002 2007e CAGR (%) >INR215,000 p.a. 1.2 2.6 5.2 14.9 Urban (%) 66.7 73.1 76.9 INR45,000-INR215,000 32.8 46.4 75.5 10.2 Urban (%) 50.6 57.1 54.0 INR22,000-INR45,000 54.1 74.4 81.7 1.9 INR16,000-22,000 44.0 33.1 20.2 -9.4