Second Wave to Weaken Apparel Retail Growth, Profitability

Slower recovery in revenue will mean the operating margin of apparel retailers will remain moderate at 4-5 percent for this fiscal, compared with our earlier expectation of 7-8 percent.
Second Wave to Weaken Apparel Retail Growth, Profitability

Temporary store closures, restricted mobility, and curtailed discretionary spending because of the second wave of Covid-19 infections are set to pull down revenue growth of the organized apparel retail sector to 15-20 percent this fiscal. And this revenue growth would be on a low base of last fiscal, which saw a decline of 35-40 percent.
 
Slower recovery in revenue will mean the operating margin of apparel retailers will remain moderate at 4-5 percent for this fiscal, compared with our earlier expectation of 7-8 percent, says CRISIL.
 
Retailers may have to take recourse to additional debt to plug near-term cash-flow mismatches, which could impact their credit quality. 
 
CRISIL assumes staggered easing of localized restrictions and reopening of stores, leading to demand recovery from the second quarter of this fiscal, as the impact of the second wave abates and the vaccination drive gathers pace.
 
Localized restrictions starting from the second half of April this year resulted in pan-India average retail mobility (footfalls to retail stores) falling sharply to 36 percent of the pre-pandemic level 2 in May compared with 77 percent in February. Temporary store closures and constrained mobility have sharply impacted sales of apparel retailers in the first two months of this fiscal, though reopening from June is likely to ignite a gradual recovery.
 
Anuj Sethi, Senior Director, CRISIL Ratings, says, “Revenue this fiscal will only be 70-75 percent of the pre-pandemic level (60 percent in fiscal 2021). Moreover, unlike the first wave that had a higher impact in Tier-I cities, the second wave has spread in Tier-II and III cities and rural areas as well, resulting in a similar impact on departmental and value fashion retailers.”
 
Amid this sharp impact on offline sales, acceleration in online shopping has been a saving grace and bodes well for retailers with omnichannel presence. The share of e-retail sales will likely rise to 8-9 percent this fiscal compared with the pre-pandemic level of 4-5 percent.
 
To clear inventory and attract footfalls, retailers may offer higher discounts, especially during the initial months of reopening of stores, and this could impact profitability. However, renegotiation of rental arrangements and trimming of employee cost, which together account for 20 percent of revenue, will help keep operating margin at 4-5 percent this fiscal, a slight improvement over 3-4 percent last fiscal, but much below the pre-pandemic level of ~9 percent.
 
“Having learned their lessons from the first wave, apparel retailers are better prepared to manage working capital this fiscal. A gradual pace of store addition, coupled with retained proceeds of the equity raise made last fiscal, will help support liquidity. Supported by better performance, interest coverage ratio is likely to improve to 3-3.5 times this fiscal, from ~2 times last fiscal, but remain below the pre-pandemic level of 5 times,” says Gautam Shahi, Director, CRISIL Ratings.
 
Nevertheless, some players with weak balance sheets and modest credit quality may require additional debt to plug cash-flow mismatches in the first half of this fiscal.
 
Going forward, the spread of infections, the ability to renegotiate rentals, and rebound in discretionary demand will be the key monitorable.

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