Operating margins of organised brick & mortar (B&M) retailers are expected to improve by 100 basis points(bps) from about 6% over next two fiscals riding on three tailwinds: online retailers going slow on discounts to reduce cash burn, benefits from the implementation of Goods & Services Tax (GST), and increasing store productivity.
 

Operating margins of organised brick & mortar (B&M) retailers are expected to improve by 100 basis points (bps) from about 6% over next two fiscals riding on three tailwinds: online retailers going slow on discounts to reduce cash burn, benefits from the implementation of Goods & Services Tax (GST), and increasing store productivity.
 

Further, the pace of store expansion is also expected to increase over the medium term to cater to the increasing demand. Despite this, Crisil expects the credit profiles of its rated B&M retailers to remain steady, driven by better-operating metrics and adequate debt metrics.
 

Crisil has outstanding ratings on 86 B&M retailers including 27 large (more than Rs. 500 crore revenue), 22mid-sized (Rs. 100 crores to Rs. 500 crore revenue) and 37 small ones.
 

India’s top three online retailers lost more than Rs. 30 crore per day – or Rs. 11,000 crore1 in fiscal 2016 –because of large-scale discounts and aggressive marketing. Besides, the Department of Industrial Policy &Promotion (DIPP) regulation in March 2016, which restricts discounting and vendor concentration, has been favourable for B&M retailers. Consequently, online retailers have been gradually focusing on lowering share of discounts as well as losses, which has led to a moderation in their growth.
 

Also, under GST, B&M retailers will be able to set off service tax on rent against taxes on goods. Rent is one of their largest cost components, ranging between 5-6% of sales. The B&M retail sector will also benefit from rationalisation of logistics costs because of flexibility in procurement and seamless movement of goods facilitated by the implementation of GST.
 

Revenue growth of the organised B&M retail sector is expected to improve to 14-16% annually in the next two fiscals compared with 13% compounded annual growth rate seen between fiscals 2015 and 2017. Also, over the past two fiscals, annual sales per square feet has increased 15% from Rs. 12,000 to Rs. 13,800 for a sample of 10 large B&M retailers. Crisil believes that continuation of this trend would result in better store productivity and improved operating leverage.
 

Says Anuj Sethi, Senior Director, Crisil Ratings, “We see the profitability of B&M retailers improving as competitive intensity (from online rivals) moderates and service tax on rent gets set off in the GST regime. And as growth rises, so will revenue per square feet, which, in turn, will improve their fixed-cost absorption ability. That will provide at least 100 bps positive delta to operating margins for B&M retailers.”
 

As growth and profitability look up, Crisil expects capital expenditure (capex) of B&M retailers would increase by 15-20% over next two fiscals compared to capex incurred in past two fiscals. Despite the increase in capex, which will be part debt funded, improving operating metrics and better cash generation will continue to support the credit profiles of retailers.
 

Says Amit Bhave, Director, Crisil Ratings, “The credit profiles of organised Crisil rated B&M retailers have benefited from the improved scale of business, better cash generation, continued promoter support, and prudent capex in the recent past. For instance, the debt/EBITDA (earnings before interest, tax, depreciation and amortisation) ratio improved to about 3 times in fiscal 2017, compared with 4 times in fiscal 2015, supported by a 50-60 bps increase in EBITDA margins and prudent management of debt levels.”
 

The improvement in credit profiles is reflected in the credit ratio (upgrades to downgrades) for Crisil’s rated B&M retailer portfolio, remaining above 1 time in past four fiscals; this trend is likely to be sustained over the medium term.