Krishna Karwa Moneycontrol Research
Highlights:
- The stock offers significant short-term upside and is expected to trade at premium valuations thereafter
- Store additions and foray into new areas will drive revenue growth
- Margins would be predominantly influenced by power brands and benefits of scale
- Stiff competition and high advertisement spends are the key risks
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Arvind Fashions Ltd (AFL) is one of India’s largest lifestyle product retailers. It sources nearly 33 million pieces of garments every year and sells 51 types of products across categories.
Some of the world’s leading brands are licensed in AFL’s name:-
After listing at a steep discount on the exchanges, the stock offers significant upside in the short-term. A robust brand portfolio, network augmentation, diversification into new segments and economies of scale in value fashion should help AFL command rich valuations in the long run.
Why consider?
Network expansion on the cards
- To achieve sales of Rs 8,000 crore by FY22-end, 150-200 stores will be added over the next three years across three formats – power brands, emerging brands and speciality retail
- Capex of Rs 100 crore will be incurred for this purpose, which would be funded primarily through internal accruals
- Advertisement budgets are slated to increase from 4 percent of sales (in the past) to 5.5 percent going forward
- By virtue of these measures, the management aims to achieve the following:-
Going online
- In a bid to strengthen the omnichannel, investments are being made in scaling up digital platforms such as NNNOW.com. Simultaneously, integration of e-commerce marketplaces (ie. Amazon and Flipkart) with brick-and-mortar stores is underway
Asset-light model
- In power and emerging brands, some of the new outlets may be franchise-operated
- AFL outsources all manufacturing activities to third party suppliers and Arvind
- AFL acts as a retailer that sources apparel from brands and sells the same to buyers. This business model is less capital-intensive compared to a typical textile business, which involves both manufacturing and sale
‘Unlimited’: A big growth opportunity
- In India, the branded value fashion market is growing at a CAGR of 24 percent. It is estimated to reach a size of $12 billion by 2020.
- AFL has a strong portfolio of brands in this domain. Its private labels include Ruggers, NEWPORT, Excalibur, ELLE, Cherokee, Karigari and ANAHI
- Arvind's expertise in the fibre-to-garment manufacturing and supply chain processes can be leveraged by AFL to achieve economies of scale
- Periodic introduction of new designs will be prioritised to facilitate high asset turns
- The management targets increasing the store count to 200 by FY22-end, as against 90 stores at present
- The aim is to operate at 6-7 percent EBITDA margins in three years from now
New areas being explored
- AFL is intensifying marketing spends in connection with high-value innerwear, kidswear and beauty products
- Considering the huge potential in this space, AFL has a lot to look forward to
- Compared to menswear, where demand can be somewhat seasonal by nature (H2 of a fiscal year tends to be better than H1), the three verticals are comparatively steady in terms of revenue accruals
India’s industry prospects are favourable because:-
- Men’s casual wear market in India is likely to reach the $12 billion mark by 2022, growing at a CAGR of 18 percent
- Urbanisation is picking up pace
- Per capita disposable incomes are growing
- Organised retail channels are growing in smaller regions of the country
Risks
- Competition from Indian and foreign brands is intensifying. This results in extended end-of-season-sale periods and difficulties in passing on high raw material costs
- Change in e-commerce FDI guidelines in December 2018 is likely to impact discounts and exclusive offerings on Amazon and Flipkart
- Inability to normalise advertisement spends (as a percentage of sales) and low inventory turns could dent margins
Peer comparison
A glance at the exhibits below indicates that AFL’s financials have shown significant improvement in the last 2-3 years, with revenues growing by more than 20 percent YoY. Though the company’s margins aren’t industry-leading as yet, the YoY uptick in this regard is worth taking note of.
The positives are reflected in AFL’s valuations:-
Outlook
In due course, we expect AFL to trade at a premium on similar lines as most other retail stocks. The company has shown consistent top-line growth and margin accretion in recent quarters. Its brands and products are well-entrenched pan-India.
AFL listed at a price considerably lower than its fair value, which, in our view, should have been in the range of Rs 1,000-1,200. Therefore, the stock should continue hitting the 5 percent upper circuit until the street discovers its fair price.
After this, AFL’s valuations, in all likelihood, may remain elevated. However, if the company can continue its trend of delivering strong earnings, the prospects of a further re-rating cannot be ruled out.
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(Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here)
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