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V-Mart Retail IPO Review By Naman Sec (Avoid)

Review By Naman Securities and Finance Pvt. Ltd on February 4, 2013

V Mart Retail Ltd. (V Mart) is looking to raise Rs 88-97 crs through an IPO for expanding its retail presence and to provide an exit to its investor, Naman Finance and Investment Pvt. Ltd. The issue which opened on the 1st of February, (open till 5th of February), was subscribed 0.02 times in the retail category on the first day. The price band is fixed at Rs 195 to Rs 215 per share. In this post, I elaborate my 'Avoid' recommendation to the IPO.

V Mart is a value retailer, with product offerings ranging from apparels to general merchandise. It has successfully increased its proportion of revenues from the higher margin apparel segment and reduced its revenue share of the low margin food and grocery segment. The apparel segment, which enjoys gross margins of ~35%,  contributed to nearly 70% of the total revenues as of November 2012. V Mart stores are concentrated in the cities of Uttar Pradesh, Bihar, Rajasthan, Gujarat, Madhya Pradesh and Delhi. V Mart provides a 'departmental store' experience in the Tier III cities in India, where organised retail presence is extremely low. The management's strategy of opening stores in clusters, i.e. within a distance of 100-150 kms from the existing stores serves them well in terms of optimizing the logistics and advertising costs. Its focus on Tier III cities helps the company in keeping occupancy costs low. Consequently, the company has managed to clock ~ 10-11% EBITDA margins (FY11-12) as compared to the pan India retailers like Pantaloons and Shoppers Stop, which reported EBITDA margins in the range of 2-5% in the last two fiscal years.  Nevertheless, with an average store size of ~ 8000 sq. ft and average billing of Rs 400-500, it ranks well below these players in terms of scale of operations and brand strength.

There are ~60 V Mart stores operational and the management intends to use Rs 70 crs from the issue proceeds to double the store count. It plans to establish presence in Assam, West Bengal, and Jharkhand apart from strengthening its retail store count in existing states. Hence, the focus is clear -- get a first mover advantage in cities where organised retail penetration is minimal. This strategy serves well as can be concluded from the trend of the average sales per sq.feet -- for FY12 and till November 2012, the average sales per sq. feet gradually has shown a declining trend from the Tier III cities to the Metro cities. This is quite understandable as the organised retail penetration is significantly higher in the metro cities, thereby translating to intense competition for V Mart.

The company has targeted opening 25 stores each in FY14 and FY15, which in my opinion, is aggressive given that in the past five years it has opened an average of 12 stores per annum. Hence, the utilization of the IPO proceeds may well be spread over the next three to four years, thereby suppressing RoE post the IPO for the coming two fiscal years.

Corporate governance pointers

The management has declared three bonus issues in the past, with the latest one, in the ratio of 9:10, being declared just before the IPO in June 2012. The company has also declared dividends of 4% in the past two years. It is a family run business; the Senior Vice President (Operations and Marketing) belongs to the promoters family.

Lessons to learn from Vishal Mega Mart

The fact that Mr. Lalit Agarwal, one of the promoters of V Mart, is the brother of Mr. Ram Chandra Agarwal, the promoter of Vishal Mega Mart (Source: media reports) should have no bearing on the analysis of this IPO. However, the business model of both these companies is similar in nature -- value retailers with focus on non-metro cities. Vishal Mega Mart never recovered from the slowdown in the retail sector in FY09, its networth got eroded in FY10, revenues slumped from ~1000 crs turnover in FY11 to Rs 42 crs in FY12. Early signs of the downfall were visible in FY08 when working capital days increased to 205 days from 156 days in FY07. The promoter of Vishal Mega mart opened stores at an aggressive pace, funded through debt, and did not build adequate supply chain and IT infrastructure to support the increase in store count. This is the key lesson for his brother to keep in mind and for investors to guard against!

Conclusion / Investment Strategy

Valuations expensive; Avoid the IPO

At the upper end of the price band of Rs 215, the PE multiple based on my FY13 EPS estimates (post IPO) stands at 16.1x for V Mart, similar to Pantaloon's PE multiple, based on EPS estimates for year ending December 2012. Shoppers Stop operates as a premium retailer and trades at significantly higher multiple owing to brand strength, promoter track record, pan India presence and expectation of strong growth. Trent too, trades at high multiples owing to similar reasons, except that it does not operate as premium retailer. Hence, Pantaloons is the only comparable listed player.

In my opinion, V Mart should trade at least at a 20-22% discount to Pantaloon's PE multiple given: i) Pantaloon is nearly 55 times the size of V Mart in terms of revenues! ii) It has a pan India presence, while V Mart stores are clustered in the northern and north eastern regions iii) Increasingly, large players are adapting to small sized retail formats to penetrate into the untapped demand potential in the Tier III cities. V Mart faces the threat of intense competition, if resource rich large retailers increase their store presence in the Tier III cities. iv) Management's ability to scale up their operations with adequate warehouses and supply chain infrastructure will be the key factor to look out for.

Hence, at a PE multiple of 13 to 13.5x, I arrive at a fair value in the range of Rs 175-Rs 180, indicating a downside of ~15% from the upper price band of Rs 215. Thus, I recommend avoiding the IPO.

Reviewer recommends Avoid to the issue.

Review By Naman Securities and Finance Pvt. Ltd on February 4, 2013