Tesco move could lead to re-rating of Trent

After Tuesday's seven per cent rise, the Trent stock jumped another 10.7 per cent to closed at Rs 1,181 on Wednesday, after the world's second-largest retailer by profits, Tesco, announced its intention of taking up a 50 per cent stake in Trent's subsidiary, Trent Hypermarket.

Analysts say the first investment in a supermarket by a foreign chain, after market hours on Tuesday, is a win-win for both companies. Says Nikhil Vora, managing director, IDFC Securities, "The deal, an extension of their existing relationship, is a positive for both companies as well as the sector and indicates government policies are not prohibitive to investment. Given the potential, the deal is a fantastic investment at reasonable valuations for Tesco. While so far Tesco was a back-end supplier, the equity investment will ensure stickiness.”

While Trent Hypermarket runs 16 stores, the investment is for the 12 stores in Maharashtra and Karnataka which allow foreign direct investment (FDI) in multi-brand retail. While Trent has formats ranging from department stores, book stores and specialty stores, the investment in the hypermarket is an indication of the potential of that space.

Abhishek Ranganathan and Neha Garg of PhillipCapital say the conviction of Tesco to invest in the franchise of Star Bazaar (owned by Trent Hypermarket) is a reflection of the success this model has achieved (and could furtherachieve) and will result in a re-rating of this business. The analysts have maintained their target price of Rs 1,209.

Deven Choksey of KR Choksey says the investment by a more experienced retailer will help Trent in its expansion programme and we could see not just local but cross-border products from the Tesco stable being retailed through the various stores.

For its department store format, Westside, the company's efforts to improve its merchandising mix, introduce value-added products and streamline its supply chain have helped improve its profitability. In fact, for the September quarter, the company was able to improve its operating margins from 1.8 per cent to 5.7 per cent on the back of operating efficiencies and leverage. Analysts believe the company will be able to sustain these margins, given better merchandise mix and higher realisations.

While pre-deal valuations at 1.2 times enterprise value/sales is at a premium to peer Shopper's Stop's valuation of about 0.8 times (both based on FY14 estimates), the higher multiple could be on account of lower debt for the smaller retailer, with a debt to equity ratio of 0.1 times.