Fashion & Lifestyle - From a disruptor's lens - HDFC Securities

Mr. Jay Gandhi, Institutional Research Analyst, HDFC Securities

In this instalment of the 'From a Disruptor's Lens' series, we assess key vitals of offline apparel (Previous edition tracked F&G). The sight isn't pretty! Short of a few disciplined operators, most categories (especially their tails) perfectly fit our 'Prone-to-Disruption' framework. Meanwhile, e-tailers have evidently stepped up efforts on (1) broadening their online stack (i.e. online consumer lifetime value (LTV) continues to increase with reducing CAC), (2) improving F&L profitability and (3) expanding footprint. This can be vetted by India's rising relevance in global e-tailers' topline, profitability and capital allocation decisions. Against this backdrop, it is prudent to limit investment exposure to highly disciplined value retailers (largely off-limits to e-tail) such as V-MART and re-capitalised brands with reasonable consumer pull (ABFRL).

Focus on F&L segment rises, online stack becomes more potent: Along with the increasing F&L skew in revenue mix, e-tailers have stepped up efforts to improve profitability of their F&L verticals. GMs for e-tailers have significantly improved (4-13pp over FY17-20) due to increasing (a) sourcing margins on private labels and partner brands and (b) skew of fresh brand assortment. This, is partly a consequence of weak offline retailers attempting to release cash from working capital (note: contribution margins for both e-tailers - Amazon and Flipkart - are now in the positive). This, along with their ever-increasing cloud/3P commission/ad-based services, is making the online stack more potent with time.

Why is this important? Cash flows from e-tailers' non-core operations can be used to woo brands, private label vendors, and 3P sellers alike with better terms-of-trade in exchange for better sourcing margins and fresher assortment (Myntra is a classic case in point). This, in turn, increases e-tailers' competitiveness vis-à-vis traditional formats (multi-brand department stores and weak brands/private labels) and leads to higher consumer traffic/conversion rates. Voila! E-tail's flywheel begins to work!

'Prone-to-Disruption' framework remains validated: Our 'prone-to-Disruption' framework for offline F&L retailers (low differentiation and sales velocity + high AoV + high GM and cost structures + increasing vendor support = market share loss to e-tailers) remains validated. 3P department stores, ethnic wear, and weak brands seem most prone to disruption on this equation, while value fashion seems off-limits for e-tailers. FY17-20 category-wise performance and FY21 recovery corroborates this trend.

COVID-19 second wave - final nail in the coffin for the tail! Given the weak cash positions, sinking profitability, and debilitating working capital woes across category tails, the second wave of lockdowns could prove fatal for many. Even stronger ones are likely to report a second round of sub-optimal performance. Based on our store map, Maharashtra and Delhi (both partially locked down) account for 25-40% of stores across all formats (ex-value fashion). Revenue exposure could be as high as 40-60% (HSIE). The most exposed companies in our coverage are STOP and TCNS Clothing.

Slim pickings! Amidst imminent disruption, deteriorating unit economics and second wave-led pains, investors have slim pickings across the F&L space. It is prudent to restrict exposure to highly disciplined value retailers such as V-MART (TP: 2,800/sh; implying 22xFY23 EV/EBITDA, Reco: ADD) and re-capitalised brands with reasonable consumer pull like ABFRL (TP: 200/sh, implying 14x FY23 EV/EBITDA, Reco: BUY). Trent remains a good biz at extra-ordinary valuations. Maintain SELL (TP: 585/sh, implying 26x FY23 EV/EBITDA; stock currently trades at 34x FY23 EV/EBITDA).

Source : Equity Bulls

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