Amazon-Future Retail deal: How the tie-up benefits both the firms

FRL’s store productivity will improve with better utilisation of its assets
The stock of Future Retail (FRL) has been trending up over the last couple of trading sessions, gaining 5 per cent after it announced a partnership with Amazon, which will expand the offline and online presence of both entities.

The company also announced that it will raise debt worth $500 million to fund the purchase of infrastructure assets from Future Enterprises (FEL). Both announcements have been perceived positively by the market.

FRL has entered into a long-term agreement with Amazon India, which will help expand the reach of the former’s retail outlets as well as give a platform for its consumer brands that are housed under Future Consumer. This will make Amazon India the online sales channel for Future Retail stores.

Given its presence and product portfolio, FRL gets 350 million footfalls at its physical stores across the country. An online presence that leverages the existing infrastructure is expected to help drive volumes, improve store productivity and margins. Customers will be able to use both online and offline channels to order items across the groceries, general merchandise, fashion and footwear categories. While packaging and pick-up of products ordered online has already been implemented across 22 stores of Future Retail, it will gradually be rolled out across all retail stores. Analysts at Morgan Stanley believe this is a win-win arrangement arising from a hybrid retail (e-commerce and physical stores) model that will help Amazon lower the cost of fulfilment, given FRL’s large store footprint.

FRL’s store productivity will improve with better utilisation of its assets. For Future Consumer, the deal with Amazon will help build an online distribution channel and increase the share of sales from outside the Future Group network.  The other trigger is the fund infusion and plans to raise debt. The company received Rs 1,500 crore after equity warrants issued by the parent company Future Coupons (FCL) were converted leading to a dilution in FRL’s equity by 7.3 per cent.

Amazon’s 49 per cent stake in FCL will mean it will own 4.9 per cent after the conversion. This, coupled with the raising of $500 million (Rs 3,570 crore) in dollar-denominated bonds will help the company buy infrastructure assets from FEL worth Rs 4,000 crore.

Given that retail stores are owned by FEL, the asset purchase, according to Motilal Oswal Financial Services (MOFSL) would help FRL save Rs 650-700 crore in lease rentals and about Rs 150 crore at the profit before tax level. Further FRL holds Rs 620 crore in advances to FEL, which could be adjusted against asset payments.

While the funds raised should help bring down lease costs, net debt is expected to go up to just under Rs 2,000 crore. This will lead to an increase in net debt to operating profit moving up to 1.4 times financial year 2020-21 (FY21) estimates, while return on capital employed is expected to go down five percentage points to 13 per cent. Analysts at MOFSL, however, believe that the asset purchase is a major step towards saving costs and creating a transparent balance sheet compared to cross holding of assets among group entities, which was the case earlier.

These steps should help rub off on stock price. Unlike some of its peers such as Aditya Birla Fashion Retail, Trent, and Avenue Supermarts that have delivered returns upwards of 15 per cent in calendar year 2019, Future Retail has underperformed shedding nearly quarter of its value last year.

At the current price, the stock is trading at an attractive 19 times its FY21 earnings estimates and eight times enterprise value to operating profit. However, investors need a long-term horizon as the near term could see soft operating performance.

Macroeconomic slowdown, shifting of festival sales to September quarter, and aggression by online e-tailers are expected to keep Future Retail’s same store sales growth for the December quarter at the lower single digits.

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