Vishal Khandelwal

Statutory Warning: This report may cause a reaction, and acting on it can be injurious to your wealth.

Note: This StockTalk analysis has been written by Manish Sharma.

“Putting ideas on paper forces you to think things through.” – Shelby Davis Sr.

There has been a lot of interest among investors about Bata India stock (Bata henceforth). This analysis is a basic attempt to understand the key dynamics of the business and the possible weaknesses or competitive threats that might affect the performance of the company. Normal disclaimer that goes along with all the reports of StockTalk apply here as well; please do your own due diligence.

Macro Overview of Footwear Industry
Before looking into the performance of the company, let’s take a brief look at the overall industry framework in which the company operates.

The Indian footwear market is currently growing at a rate of 12% per year. Of the total market size, 40% is in the organized segment also known as branded segment, and rural market accounts for 75% of the overall consumption.

Thus, the industry is dominated by unorganized players and rural market is holding fort. Nevertheless, with 40% of the market being controlled by organized players, footwear is the second most organized retail category in India, after watches.

Here are some other key stats…

• India’s per capita shoe consumption has gone up from 1.4 shoes a year in 2004 to 2.2 shoes per year in 2010, so the market is definitely in a growth phase
• India is the second largest footwear manufacturer in the world after China
• The overall footwear retail market (in terms of value) is classified as follows:
  1. Men’s footwear accounts for 48%
  2. Women’s footwear accounts for 41%
  3. Children’s footwear accounts for the remaining 11%

About Bata India
Bata is a name that needs no introduction to Indians. The company has established itself as India’s largest footwear retailer. Bata India Limited (Bata) is a 52% subsidiary of the Netherlands-based Bata BV.

It is one of the largest footwear manufacturers in India and sells a wide range of canvas, rubber, leather, and plastic footwear. The company has a licensed capacity of 628 lakh pairs per annum spread across its five manufacturing units at Batanagar (Kolkata), Faridabad (Haryana), Bataganj (Bihar), Peenya (near Bangalore), and Hosur (Tamil Nadu). The company has one tannery at Mokameghat (Bihar).

As per its latest annual report, the company is relying mostly on domestic leather for production and imports constitute a very small part of raw materials.

Bata sells over 50 million pairs of shoes every year. South India is a major market for Bata, from where it earns around 40% of its revenue. The company is the market leader in South, with 16% share of the organized footwear market. Of the overall revenue, it derives nearly 85% through retail networks, 14% from non-retail channels (dealers/institutional/industrial sales) and remaining 1% through exports. Thus, the domestic market is the mainstay as far as revenues are concerned.

Here is the category revenue break-up:

• 70% leather and leather alike footwear
• 19% rubber/canvas footwear
• 7% plastic footwear and
• 4% accessories, garments, etc.

Bata is earning a major chunk of its revenue from leather products that is a high margin business as compared to rubber sandals and hawai chappals. This augurs well for the company. Accessories and garments have been recent additions, but it is unlikely that this category will grow considering the huge competition already present in the market.

Of the total revenue earned from leather footwear:

• Men’s segment contributed 40-45%
• Women’s segment 25-30%
• Kids segment 11-13%
• Sports segment 15% (approx.)

The executive shoes range for men’s segment has helped Bata in taking the pole position in organised shoes category. But the company lags its competitors in the kids’ and sportswear segments. It is trying to increase its market share in the women’s segment, but it will not be a cakewalk given the competition in this category as well.

According to market studies, nearly 75% of the market for women and kids’ footwear is unorganized. In its 2011 annual report, Bata India’s Chairman also stated that the organised footwear brands have less penetration in the ladies footwear segment mainly due to the complex buying behaviour of Indian women. As such the business model is unlikely to change easily.

Marketing Analysis
Bata being a retail company, it is better to make an attempt to assess the company’s strength on Kotler’s 4Ps of marketing – Product, Price, Place and Promotion.

Product: Bata has positioned itself as a one-stop family store for all footwear and related products. It provides to vast consumers various footwear lines under both international and national brands such as Hush Puppies, Marie Claire, Mocassino, Ambassador, Comfit, School, Quovadis, North Star, Scholl’s, Weinbrenner, Bubble Gummers, Baby Bubble, and Power.

Since shoe is a need-based product, there will always be a demand. But of late there is more effort on the part of company to focus on the premium range considering the growing consumerism. Although Bata does not enjoy the kind of monopoly it had during the late 1980s, considering its long history, high brand recall and extensive product portfolio, it is one of the formidable players.

Price: Bata has adopted a multi-pricing strategy by providing to its customers a value proposition strategy. It has moved away from the classic ‘Bata Pricing’ approach because it is now targeting the high-end customers along with the middle-class segment that is its main target audience. The present pricing approach where Bata is promoting various sub-brands under its umbrella brand has helped in projecting it as a family brand as well as a fashion brand.

Place: Bata has a strong distribution network, which is one of the strengths of the company. It has a retail network of over 1,200 stores and around 30,000 dealers. The company is on an expansion spree. In the last five years, it has opened 350 stores and renovated 200 existing stores. The company has also decided to be more visible in shopping malls, open up to the franchisee model and also create the shop-in-shop experience in multi-brand stores.

Promotion: Bata does not promote much by advertising. The selling & distribution expenses don’t account for a major cost. Unlike its competitor brand Liberty that has enrolled Hrithik Roshan for brand endorsement, Bata is not following that approach for promotion as of now. Thus, it is saving on exorbitant TV advertising cost.

Bata is mainly promoting through point-of-purchase material. It has revamped its stores to look more contemporary, shedding its age old image. It is also re-positioning itself as a market-driven, fashion-conscious lifestyle brand with an emphasis on service and production.

Financial Analysis
As seen from the table below, there is constant improvement in financial profile of the company driven by steady increase in Sales at an average annual rate of 16%. There is also a sustained improvement in net profit margins, which increased from around 5% in 2007 to over 9% in 2012. This has led to sharp increase in profits that jumped up nearly 4 times in these last 5 years (2007-12).

Between 2007 and 2012, Bata employed an average capital of Rs 4,327 million in the business and earned revenue of Rs 10,047 million.

And though the profits have grown at an average annual rate of 29% between 2007 and 2012, profit growth has not been steady all these years.

The net profit growth dropped to just 10% in 2009, and then it shot up over the next two years, to finally see a fall in 2012. It will be interesting to see how the company fares in the current slowdown (2013).

Nevertheless, as mentioned in the annual report, Bata has taken the following actions to improve its margins:

1. Cost rationalisation: Bata’s margins have improved because of rationalisation of employee cost, closing down of non-performing stores, and through outsourcing of several functions.

2. Outsourcing: Over the last 5-6 years, Bata has increased the outsourcing of labour-intensive work while retaining machine related operations. Increasing focus on outsourcing of labour-intensive operations has led to rationalization of employee cost and continuous improvement in profitability.

3. Business restructuring: Bata launched a massive restructuring exercise in the year 2006. It closed down 363 cash-drain stores and remodelled about 300 stores in the last 5 years. As a result, revenue per store increased from Rs 50 lakh in 2006 to more than Rs 100 lakh in 2011.

In addition to these factors, significant value was unlocked from the exit from the real estate project at Batanagar, Kolkata.

Capital Management

• Bata has achieved growth in profitability without diluting equity or by incurring debt.
• Entire capital expenditure in 2010 and 2011 has been funded through internal accruals.
• Bata also had cash and bank balances of Rs 156 crore at the end of 2012.
• Current ratio has shown consistent improvement; it was around 2x in 2012
• Being a retail business, the inventory comprise mainly of finished goods. The growth in inventory is not very alarming and is keeping in tune with the sales growth.
• The current production is comfortably below the installed capacity, so no major capex is expected soon.
• There is a small contingent liability of Rs 47 crore that has declined from Rs 64 crore from the corresponding two years.

Return on Equity
Charlie Munger, Vice Chairman of Berkshire Hathaway has said the following on the importance of return on equity on shareholder return…

If the business earns six percent on capital over forty years and you hold it for that forty years, you are not going to make much different than a six percent return.

With increased profitability, little capex requirements and dividend payments, Bata has managed to increase its return on equity from 20% to 25%.

Further, the Du-Pont analysis shows that Bata has not relied on financial leverage to increase its ROE.

It has gradually increased its net margin to improve its profitability, which is a good thing. Net profit margin acts as a safety cushion; the lower the margin, the less room for error.

Since margin has gone up, the asset turnover remains stable. The asset turnover ratio tends to be inversely related to the net profit margin; i.e., the higher the net profit margin, the lower the asset turnover (for most businesses; either it’s a high margin business or a high volume business).

Nevertheless, an asset turnover of around 3x augurs well for the company.

So Far So Good
While, all the financials and business performance discussed so far indicate a positive story for Bata, it’s important to note that things were not so hunky dory always.

Bata has had a history of losses and the company came out of woods not once but twice.

First time in 1996, Bata achieved a turnaround by posting a positive bottomline of Rs 4 crore. Earlier, the company had decided to wean away from traditional strongholds in the middle and lower footwear segment to woo the premium segment…a strategy that backfired resulting in the huge losses.

In order to cut its losses, the company even sold off its corporate headquarters for Rs 19.5 crore.

Then, the company again suffered a series of losses. For three successive years (2002-2004) it posted net loss of Rs 74 crore, Rs 26 crore and Rs 63 crore respectively. Sales suffered due to workers’ agitation at its factory in Batanagar over the issue of wages.

The company had to weather serious labour issues. In the three rounds of VRS offered around 2004, Bata reduced its employee count by 1,600. Apart from VRS, a turnaround strategy was undertaken which included focus on mass consumption products, flexible marketing, tighter cost controls, and better asset management.

Key Challenges
Here are the key challenges worth noting in case of Bata’s business…

• Highly competitive industry characterized by strong presence of the unorganized sector and intensifying competition in the organized segment, likely to keep margins under pressure.
• Significant price volatility in raw materials, especially in imports due to recent rupee depreciation, which may affect margins if the company is unable to pass on the increase in raw material prices to the customers, especially in the low-end segment.
• It is also facing stiff competition from imports from countries like China, Indonesia, Thailand, Vietnam & Brazil, because their products are more competitive as compared to India.
• Bata also faces headwinds with the entry of MNCs in the domestic market. Already many international brands are available in India after the opening of FDI in retail. International brands like Clarks, Pavers and other players have been making their presence felt at malls, high street locales, and airports and also online. India is on the cusp of consumption growth, recent slowdown notwithstanding. Bata has been trying to push its premium range and this strategy will be tested severely with the onslaught of FDI in retail.
• It is often seen that many retail players often struggle to strike a balance between increasing their bottomline and maintaining volume growth. Uncertain business and economic environment, drying up of capital inflow and ever increasing competition collectively pose serious challenges to the established players in the market.

Valuations
100% of the information you have about a company represents the past, and 100% of a stock’s valuation depends on the future.

Ideally, I would have liked to end my analysis over here. I am with Asif here who while reviewing Gruh Finance did not elaborate much on valuation part.

After all, we are putting a statutory warning at the start and not giving a valuation target can be the ideal way to prevent any biases creeping into the mind of investors regarding evaluation of the stock.

But still, I have tried to value Bata’s business, and you may consider this the trickiest part of my analysis.

But first I would digress a bit.

Warren Buffett wrote the following in his 1993 letters to Berkshire shareholders – “There’s no business like shoe business.”

This was in the context of the purchase of Dexter shoes that Buffett made this statement. He further wrote to the shareholders that I can assure you that it is a business that needs no fixing; it is one of the best-managed companies that Charlie and he have had seen in their business lifetimes. Berkshire paid US$ 433 million for Dexter Shoes. Rather than use cash, Buffett used Berkshire Class A stock to fund the purchase.

But, 15-years later (2008), this is what Buffett said about Dexter…

To date, Dexter is the worst deal that I’ve made. What I had assessed as durable competitive advantage vanished within a few years.

Now I am not comparing Dexter Shoes with Bata. The point I am trying to make is that everybody, even the investing greats, can be wrong in their judgement of business. And it is sometime difficult to assess the future performance of even a simple business.

Anyways, Bata is currently trading at Rs 815 (as on Sept. 2), and with shares outstanding of 6.4 crore, it has a market capitalization of around Rs 5,200 crore.

After deducting cash value of Rs 154 crore, we get an Enterprise Value of around Rs 5,050 crore. With profit before tax (PBT) of Rs 250 crore, we get a pre-tax yield of 5% (250 divided by 5050).

This is half of the yield available on the benchmark Govt. bond at present. Also, at current price level, the P/E ratio comes to around 30x, which is again on a higher side. Price-to-Free Cash Flow is also around 40x.

Overall, the stock seems fairly rich in valuation on traditional parameters. In fact valuing the stock on the basis of last 10 year average EPS, we get a figure of around Rs 330 per share. However, it must be noted that past figures would have been affected by macro environment like interest rates, low market base etc.

I have not used traditional DCF and Dividend Discount Model. The company has started giving dividend since 2007 and it is too short a period to assess the longevity of dividends.

Also, the company is in an expansion mode and so it is better to reinvest the capital into the business and earn superior returns for shareholders. Also the trouble with discounted cash flow or dividend discount is that most of the value is from year four or five into the future and not the next few years.

It is difficult enough to predict future especially for a growth business like Bata. Changes in the assumptions for the later years can substantially alter today’s value.

Disclaimer: I, Manish Sharma, am not invested in Bata shares, but I wear Bata shoes so I might be biased in my analysis. 🙂

Readers are advised to do their own independent assessment before taking any decision. You can expect some errors or forward looking statements, so do your own research as well.