Retail: Stable credit profile despite economic headwinds

Fitch Ratings has come out with its report on Indian retail.

Stable Outlook: Fitch Ratings` outlook for the Indian retail sector in 2012 is stable. Sales growth driven by space additions and inflation coupled with stable margins, better working-capital management and flexibility to defer or make expansion plans less aggressive are expected by Fitch to result in the stable credit profile for Fitch-rated companies.

Economic Headwinds: Fitch expects retailers to be exposed to economic headwinds leading to a decline in consumer`s discretionary spending because of higher inflation and interest rates. Fitch lowered its real GDP growth projections from 8.5% to 7.0% for the financial year ending 2012 (FY12) and from 8.0% to 7.5% for FY13.

Sales Growth to Remain: Fitch expects revenue growth to be supported by inflation and space additions. The agency believes that there is a direct correlation between inflation and same-store-sales growth (SSSG) and the recent trend of decline in SSSG could potentially be due to the inability to drive volume growth. Volume growth concerns may be partially off-set against extended discounting periods. However, discounting may not be able to bridge volume growth concerns for products linked to discretionary spending.

Stable Margins: Fitch expects operating margins for most of the larger retailers to remain stable backed by sales growth and improvements in the overall procurement and operating cost structure, due to benefits of scale. Recent price increases, softening raw-material costs (cotton) and lower rental expenses are expected to off-set margin pressures resulting from discounting.

Improved Working-Capital Management: Fitch expects overall working-capital management to improve led by lower inventory days and lower outflow because of lease rental deposits. Lower procurement costs and discounting would help churn higher inventory while making its expansion policy less aggressive would ensure lower lease deposits.

Lower Liquidity Risks: Fitch expects most retailers to generate negative cash flow from operations (CFO) over 2012. However, the deficit is expected to be lower than the previous years backed by stable margins and slightly improved working-capital management. Companies may limit expansion plans. This in turn is expected to prevent any material deterioration in financial leverage and coverage ratios for most retailers and potential exposure to refinancing risk.

What Could Change the Outlook?

No Positive Change Expected: Fitch does not expect any positive triggers in the immediate term and believes that when foreign direct investment is allowed, it would benefit Indian retailers over the next two to three years.

Stretched Liquidity: Deteriorating economic conditions worse than expected by Fitch that affect overall revenue growth and sharp margin contraction would adversely affect retailers

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