Good times ahead in 2011 for Indian retailers, says Fitch

CHENNAI - Credit rating agency Fitch expects the 2011 outlook for the Indian retail sector to be stable with a positive bias owing to buoyant sales, improved working capital management and stable margins.

According to Fitch, the retailers will add up debt to fund expansion as companies focus on cementing their market share and retail footprint.

Debt levels are likely to be supported by higher operating profits, and consequently leverage levels should remain stable and are likely to improve.

Fitch expects liquidity to remain comfortable for 2011, led by efficient working capital management.

Improvements are expected from better inventory management and lower lease deposit levels.

In 2011, Fitch believes that ongoing inventory management will reduce overall cash conversion cycles.

The credit rating agency expects Indian retail companies to adopt measures such as increasing the proportion of bought out sales (where inventory is held on vendors’ books whilst being physically on the shop floor), increased use of franchise stores and streamlining supply chain operations to reduce their overall inventory levels.

Cash flow from operations of most companies will continue to remain negative, although the cash flow deficit is expected to reduce, thereby reducing pressure on liquidity.

According to Fitch, the operating margins are likely to remain largely stable with potential small improvements and is dependent on company’s choice of product category.

This, in addition to economies of scale, private label sales mix and discounts from suppliers, will help strengthen margins.

The shift towards a revenue-sharing rental model, although expected to cap commitments in the downturn, will require companies to share upside in the upturn.

Most retailers have announced strong capital expenditure plans for 2011. The execution risk for larger retailers is likely to be lower as the pace of space expansion in relation to current scale reduces. However, smaller players and newer entrants are likely to be more aggressive.

Oversupply of retail space (21 million square feet between 2011 and 2012) should allow retailers to negotiate lower amounts placed as deposits with lessors as part of their lease agreements, which should help them enhance their overall liquidity, Fitch said in its report.

Fitch estimates strong annual gross domestic product growth of above 8.5 percent for India over 2010-2012 which augurs well for consumer expenditure.

Ratings in the sector would be negatively affected by a sharp economic downturn, which would depress overall consumer spending.

Retailers would be affected by a fall in same-store sales as well as margin contraction. The extent of the impact on individual companies will differ based on their capital structure, expansion plans and funding structure.