Sandeep Singh
Posted online: Monday , September 17, 2007
Organised retailing is here to stay, there’s no question about it. If there’s an investing question related to retailing, it’s this: which retailers will thrive, which ones will die or be swallowed? That’s essentially the call to make while considering buying the shares of Koutons Retail, which manufactures and sells apparels under the brand names Koutons and Charlie Outlaw. Will it thrive or will the arrival of the big retailer kill it?
The numbers show the company, which launched in 1994 but came into its own a decade on, has seen outstanding growth in sales of its shirts, T-shirts, trousers and suits. In the last three years, its sales have increased at a compounded annual rate of 133 per cent, net profit at 239 per cent, margins have improved. Koutons is issuing its shares at a PE of 32.9-36.9, which is stiff. To justify that pricing, it needn’t grow at historic levels, but it still needs to grow 40-50 per cent a year. While the big retailers are settling in, it’s possible. But once hypermarkets have a toehold, companies like Koutons could face the big squeeze.
The modelKoutons is an integrated apparel company. It has 18 manufacturing units, where it makes most of the garments it sells (a small percentage — 15 per cent in 2006-07 — are outsourced. These go to its finishing units, where they are groomed and packaged for sale. Till about five years ago, Koutons relied on distributors for sales. But when it found it had to share shelf space with other brands and it was distributors who called the shots, it shifted to a franchisee model, with the agreement to take back unsold merchandise. As of August 20, Koutons had 999 exclusive outlets — 566 for Koutons and 433 for Charlie Outlaw — in about 300 cities.
“High fashion value for money” is how the IPO prospectus describes the company’s brand positioning. Value for money, we don’t doubt; high fashion, we do. Koutons is a popular middle-end brand. The company sells most of its goods at discount sales — trousers for Rs 500, shirts for Rs 250. That is its strength today, but the same middle-of-the-road positioning could turn out to be its Achilles heel as the retail industry scales up and its dynamics change.
The designsAlthough the branded apparels segment is expanding, competition is heating up, and consolidation is imminent. Experts say the space could get demarcated into two: established brands (for instance, Levi’s and Pepe) and private labels (brands promoted by retailers themselves). Private labels trail established brands today, but that gap is expected to narrow as big retailers expand. Reliance, for instance, is working on its apparel brands, which will be much cheaper than the established brands.
The survivors will be established brands and private labels. Unlike, say, a Levi’s, Koutonsdoesn’t have enduring brand loyalty yet. Unless it manages to build that, it will lose out to big brands from the top and get hammered by the cheaper private labels from the bottom. The challenge before Koutons is to build a brand loyalty. It doesn’t have much time to do so, perhaps two to three years, as big retail is building up.
Koutons has plans, which is partly the reason for this IPO. On the one hand, the company plans to add 140 outlets over the next two years to increase visibility and reach. While men’s wear has been its focus, Koutons recently ventured into women’s wear (brand, Les Femme) and is now planning to get into kids wear (Koutons Jr).
On the other, it is expanding its manufacturing capacity further. The big push for Koutons came in the past two years, when it increased its manufacturing capacity from 600,000 pieces in March 2005 to 12.4 million pieces in March 2007, and its finishing capacity from 3 million to 22.9 million. Although it has unutilised capacity — for 2006-07, capacity utilisation was 22 per cent in manufacturing and 41 per cent in finishing — it’s setting up another manufacturing unit.
The finishIn other words, it has adequate, perhaps excess, manufacturing capabilities. What it needs is more sales, either through its outlets (as it has done so far) or through exports (unexplored). Organised retail has grown at 30 per cent in the last three years, and is expected to match that in the coming three to five years. Koutons should be able to match that rate for the next two to three years. Subsequently, the outlook can get dodgy and margins can come under pressure. That alignment might take longer in the case of Koutons, given its presence in smaller towns, where retailers will take longer to come up.
Koutons sells, but we doubt its ability to sell at a rate that justifies its tall pricing and its ability to keep its long-term competitive advantage. At the upper end of the price band, the stock is priced at a PE of 36.9. By comparison, Zodiac Clothing and Kewal Kiran (owner of brands like Killer, Lawman, easies, Integriti and K-Lounge) trade at 18.9 and 15.8, respectively. Granted, Koutons is bigger and has grown faster than those two, but it’s a stretch to think it can keep doing so to justify these valuations.
Two other things make us uncomfortable. One, the three promoters include chairman D.P.S. Kohli two brothers-in-laws, each of whom hold 22 per cent each. There are no rumblings yet, but family feuds in business make us a sceptic. Two, the promoters don’t seem to share the company’s wealth well with their employees. Koutons has 622 employees, but its three promoters account for 30 per cent of the wage bill, drawing an annual salary of Rs 75 lakh each. By comparison, the 55-year-old executive vice-president who is also in charge of business operations makes just Rs 8.6 lakh a year. That shows it’s a top-driven company, and might not be nimble enough to survive the upcoming big retail onslaught.
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