Rentals likely to shatter margin mantra in India

MUMBAI: It’s margins, margins and margins in the retail business. As big players such as Bharti, Reliance kick-start operations and start spreading their wings across cities and towns, what is sinking in is that ultimately it’s margins that matter.

The extra sales earned from opening a new store should leave a scoop of margin after removing its operating costs. But somebody is playing a party pooper in the Indian retail story: Rental costs.

Rents have risen substantially — 50-75% in the last one year in Delhi and Mumbai as supply is not keeping up with demand. Rents are as high as Rs 800 per square feet per month in places such as South Delhi while they have reached around Rs 70 to Rs 180 in Gurgaon.

Indian retailers are paying rent anywhere from 3-7% of its sales, as per an ETIG study. This is in stark contrast with international retailers such as Wal-Mart, Home Depot who pay less than 1% of their sales on rent. Rents represent an increasing share of Indian retail players’ overall sales.

From 5.1% for the year ended March 05, rental expenses represented 5.8% as of March ‘06 for top retailers Shopper’s Stop, Piramyd, Pantaloon, Provogue and Trent. In contrast, as per Bloomberg data, Wal-Mart Stores pay 0.65% of its sales as rent, Home Depot 1%, Tesco 0.58%, JC Penny 1.64%, Sears Holdings 4.89% and Target Corp 0.31%.

“Wal-Mart as a strategy prefers small towns where land and rental costs are lesser and same is increasingly being seen for Tesco which is now coming with hyper markets. In contrast, Indian retailers have first established foothold in top metros and are now moving to smaller towns and hence the difference,” says Arvind Singhal, chairman of Technopak Advisors.

Indian players, however, expect sales to pick up to justify higher rental costs. “The increase in rent as a percentage of sales can partly be explained by the fact that many Indian retail players are expanding very rapidly,” said Nikhil Chaturvedi, managing director, Provogue. Pantaloon Retail is planning to scale up nearly 10 times to 30 million square feet of retail space by 2010.

Reliance is looking at 100 million square feet of retail space in the next three to four years. Shopper’s Stop is on course to touch 1.5 million square feet of space with around 39 stores by FY ‘08, as per reports. “Considering that it takes around six months for a new store’s revenues to stabilise, the ratio of rent to sales is increasing steadily for most retail players,” points out Mr Chaturvedi.

Many players have already blocked space for future expansion plans at fixed rates and hence are relatively on a safer ground. Pantaloon Retail, for instance, has booked 10 million square feet of space at an average rate of Rs 40-45 per square feet per month. Similarly, Provogue has locked in space at rates ranging from Rs 70 to Rs 120 per square feet per month.

“Rents will represent less than 6% of our overall revenues because Provogue also supplies to larger retail players, a business which does not incur any rental expenses. But if one takes into account our retail business alone, rent would represent around 14% of the revenues from our exclusive stores,” said Mr Chaturvedi. “However, while rates should continue to grow for the next three years, a correction is expected, “ said Mr Shrikhande, CEO, Shopper’s Stop.

According to industry experts, 5% of sales is about the reasonable rate to pay as rent in the Indian context. “As opposed to international players, Indian retailers save on employee costs, cost of shrinkage and administrative cost involved in handling returned goods,” said Mr Singhal. “The benchmarks are different for different formats. For large formats, they can range between 5% to 10 % & for speciality it can go up to 15%,” adds Mr Shrikhande.