"People who understand consumer behaviour make more money in the stock market than professional stock pickers who rely on financial numbers. If you like the store, chances are you’ll love the stock." This observation by Peter Lynch is based on the fund manager’s approach to discovering companies based on day-to-day activities. If one were to use this yardstick to pick a stock back home, Bata India will surely fit the bill.

The 77-year-old company is the biggest organised footwear retailer in the country with a market share of 7 per cent of the total Rs 15,712 crore footwear retail market. More importantly, with 1,200 outlets across the country, Bata is shedding its old-format, drab-looking stores and designs for a new international look and feel. Under P M Sinha, the erstwhile chief of Pepsi Foods in India who took over as chairman in 2004, the subsidiary of Bata Shoe Organisation has modelled its business strategy as an FMCG player, rather than a conventional footwear manufacturer. And this move seems to have paid off. Since 2005, sales have grown 42 per cent and profitability has gone up six times. Going ahead, analysts expect Bata’s attempt to exploit the under-penetrated women and kids footwear segments, besides new product lines to drive the company’s revenues.

Huge footprint

Due to low entry barriers and low-cost manufacturers, the domestic footwear market has largely been dominated by the unorganised sector. According to RNCOS, a New Delhi-based industry research firm, in 2008, the organised footwear retail market constituted around 11 per cent of the organised retail market. But things have been changing, for the good.

Aided by rising brand awareness and fashion consciousness, the organised footwear retail segment grew at over 34 per cent between 2004 and 2007 to touch Rs 6,100 crore. “In the same period, the unorganised footwear segment grew by around 2 per cent,” points out Shushmul Maheshwari, chief executive of RNCOS. In fact, the organised market’s volumes are expected to rise to 2.1 billion pairs by the end of 2012, at a growth rate of 8 per cent over 2007-2012.

By target segment, men’s footwear accounts for the largest share at 54 per cent, followed by kids’ and women’s footwear at 32 per cent and 14 per cent, respectively. However, analysts estimate that this composition will get skewed towards children’s and women’s footwear in the near future. “By the end of 2012, the two segments will account for about half of the Indian footwear retail market in volume terms, against 46 per cent in 2008,” says Maheshwari. RNCOS estimates that between 2009 and 2012, men’s footwear will grow at a slower pace of 5.2 per cent as the market is reaching saturation (in terms of penetration). “The growth will be mainly due to the replacement market and not because of an increase in population,” explains Maheshwari.

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Fine fit

Better product mix and manufacturing efficiencies have improved margins

Source: Centrum Research

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Marcelo Villagran, managing director and CEO of Bata India, agrees. “Currently, 40 per cent of our revenues come from men’s wear, but in the coming years the purchasing power of women will change that.” Today, ladies wear contributes 25 per cent to the company’s top line, and children’s wear, sports wear, canvas and others account for the rest.

According to Pranshu Mittal, analyst at Centrum, 90 per cent of purchases take place in the unorganised market largely due to the dressing habits of women, who prioritise style over comfort and durability. “Hence, there is a huge potential for organised retailers to expand in the ladies footwear,” says Mittal. Sensing the changing market dynamics and consumer preferences, Bata has embarked on an aggressive retail expansion.

Store experience

Although discretionary spending could trail as the economy trudges back on track, Bata is using the opportunity to expand and consolidate its presence. The company, which has a 15 per cent share of the organised retail market, has adopted a two-pronged expansion strategy.

Even as it is opening new large-format stores, it is consolidating existing operations by shutting down cash-drain stores. Villagran explains the rationale: “We want to change the concept of footwear shopping with large-format stores. And so we plan to open 60 stores in a year. In the last three years, we opened 200 stores and expect to replicate the number in the coming three years. Simultaneously, we are closing all 600 sq ft stores because we cannot offer the variety we want to. Also these stores could turn unviable in future.” Incidentally, the south is the biggest market for Bata, which has about 300 stores in the region, and it will continue to remain so. “Most of our expansion will be in the southern belt which has some of the country’s biggest cities,” says Villagran. Even as the company continues to expand its retail network, it has managed to reduce rentals per store by 16 per cent through renegotiations.

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Chic growth

Ladies and kids footwear categories are expected to grow at a faster rate

Source: Images Retail, Centrum Research

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In the current year, Bata has already opened 65 stores with a minimum size of 3,000 sq ft. Of the 1,200 stores, 200 are large-format outlets and will sport a new look with extended timings. Some stores are being operated by former employees on management franchise contracts, while others are run by private owners. The management believes the stores will become a one-stop for all its brands whether Hush Puppies, Dr Scholl’s (licensed from Wolverine Worldwide and Dr Scholl’s), School Mate, Bubble Gummers, Sandak, Marie Clarie, Haute Couture, Evalite, Ambassador, North Star, Power, or Weinbrenner. Bata is also growing the chain of its premium brand, Hush Puppies, through exclusive outlets. At present it has six such stores. Though the company also retails Reebok brands, Villagran rules out similar third-party brand alliances. “We have enough of our in-house brands to showcase.”

Chasing footfalls

India has among the lowest per capita footwear consumption at 1.34 pairs a person and an average footwear price of Rs 96. But that will change as consumers demand value offerings in basic consumer goods and ramp up discretionary spend. Keeping this in view, Bata is looking at a better product mix and introducing premium products.

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Price matters

Average sales price for Bata has increased over the years

Source: Bata Annual Report, Centrum Research

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Mittal feels the company has successfully managed to phase out its low-cost variants (Bata sold its ‘Hawai’ brand to a Brazilian firm for Rs 3.90 crore in 2008) and increased its average sales price by 15.7 per cent, even as sales grew 7.2 per cent over CY04-CY07. The average selling price has gone up from Rs 51 in 2004 to Rs 270 currently.

According to Mittal, though Bata has a presence in leather, rubber and plastic footwear, the company plans to focus on leather as it is a high value and better margin product. “We estimate the proportion of leather to increase to 67 per cent by next year from 63 per cent in 2008. The introduction of high-end variants across categories will see the average sale price of footwear increase 11 per cent over CY08-10 to Rs 301,” says Mittal.

To ensure that the average consumer spend stays high, Bata has been churning designs all through the year. More importantly, Maheshwari of RNCOS says that since ladies are highly fashion conscious, the design collection has to be contemporary. Villagran understands that. “We will introduce 700 designs every six months across all brands,” says the 66-year-old. Besides its premium men’s footwear brand, Hush Puppies, Bata is also wooing ladies with its Marie Claire brand, which has a price range of Rs 599 to Rs 1,599. To back up this strategy, the company has set up an in-house design team and has roped in Rani Mukherjee as a brand ambassador.

Big boots

While retail accounts for 80 per cent of Bata India’s sales, the company is also looking at exploiting the high-margin institutional business, particularly safety shoes for industrial use and the defence forces.

As Bata’s retail strategy entails high design churn, low production volumes of a particular design results in higher manpower and overhead costs. In order to reduce the higher costs resulting from low volumes, and to utilise existing capacities, the company will concentrate on manufacturing bulk shoe-line and industrial footwear, feels Mittal. Bata has already sought enlistment as a supplier to the armed forces, which require 12 million pairs of boots every year. That would be a big break, as only unorganised players have been suppliers to the armed forces thus far. The company has set up a dedicated team, headed by a former army man, to pursue this segment.

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Right steps

Top line growth is expected to be robust

in Rs cr	FY08	FY09E	FY10E
Sales	987.7	1,101.60	1,268.70
Change (%)	13.8	11.5	15.1
Ebitda	93.9	112.6	144.8
Change (%)	48.8	19.9	28.5
Net profit	59	65	84.9
Change (%)	45.4	10.1	30.5
EPS (Rs)	9.1	10.1	13.2
Book value (Rs)	46.2	57.9	68
ROE (%)	21.2	20.5	22.8
P/E (x)*	19.5	17.8	13.6

Source: Bloomberg; *at Rs 179

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Mittal believes that the retail expansion and the push in the industrial segment will kick up volumes. “Fuelled by new stores, remodelling of old stores and addition of industrial shoes, revenues will grow 16 per cent over the next two years,” says Mittal. More importantly, efforts on the front-end are being supplemented by back-end engineering, primarily through cost controls.

Lean and mean

Bata’s turnaround from a loss-making unit has not been easy. The company, which was prone to labour wrangles, managed to cut its workforce by offering VRS in the last four years. Thus, staff cost as a percentage of sales fell to 16 per cent in the current year (in the third quarter ended September 2009) from 26.7 per cent five years ago.

Despite the addition of marketing personnel in the retail ramp-up, Bata’s staff strength is expected to increase at a relatively slower pace. Staff costs in absolute terms increased 12 per cent to Rs 42 crore in the third quarter on account of the retail expansion, but declined as a percentage of sales by 59 bps y-o-y to 16 per cent.

The company has also been outsourcing manufacturing. The proportion of third-party footwear purchases increased from 38 per cent in 2004 to 46 per cent in 2007. Mittal estimates this proportion will increase further to 55 per cent by next year. Analysts think that this will enable the company to focus on marketing and limit its manufacturing only to select, highly profitable, footwear.

Profitability will also get a boost when the burden of the VRS amortisation costs on the P&L account ends by March 2010

It is not surprising that these initiatives have improved the company’s operating profit margin to 9.8 per cent in the third quarter, although lower than the 11 per cent seen in the second quarter, which was the highest margins in the last five years. Mittal, however, believes the company will maintain its margins at 11 per cent driven by a better product mix and continued savings from cost cutting.

Importantly, going forward, Bata will finance its expansion through internal accruals and not through debt. “We surely want to grow, but not at the expense of the bottom line,” explains Villagran. That’s music to analysts’ ears. Analysts estimate net profit to grow by 10 per cent and 30 per cent in CY09 and CY10, respectively.

Importantly, Suman Memani, analyst with Religare Hichens Harrison, feels profitability will also get a boost when the burden of VRS amortisation cost ends by March 2010. “Till date the hit to cash flows, post 2004, was Rs 42 crore. This year alone they have taken a hit on the Profit & Loss by Rs 5 crore,” says Memani. Once the burden is off, the return on equity is expected to improve from 20 per cent in 2008 to 24 per cent by 2011, aided by superior net profit margins and asset turnover.

Analysts also expect Bata to maintain its healthy payout ratio at around 30 per cent over the next three years. During the past decade, though the company skipped dividends between 2001 and 2006 owing to poor results, in the subsequent two years it paid 20 per cent and 25 per cent respectively. Apart from the free cash flows, the Street believes that the company will also see inflows from its real estate business.

Of the 309 acres at Batanagar in Kolkata, 262 acres have been transferred to Riverbank Developers, a special purpose entity, to build an integrated township. Phase I of the project, which has 10 buildings, is nearly completed. Though Villagran refused to divulge financial details about the project, market sources say that the management is looking to sell 15 million sq ft at an average price of Rs 2,000 a sq ft. “That would mean cash flows of Rs 3,000 crore, though this will happen over phases,” says Religare’s Memani.

Analysts believe that the surplus cash could to be used either for a higher dividend payout and/or equity buyback. But going by chairman Sinha’s comments at the 75th AGM, it is unlikely that there will be any surprise. “We need the cash to expand and grow the business. A higher dividend or issue of bonus shares is not possible unless we grow the business,” Sinha had told shareholders.

So far so good

Acknowledging the sustained turnaround, the stock hit a high of Rs 292 in early 2008, but came off in the wake of the financial tsunami later in the year. Given that the company has managed to keep its top line growing in trying times, the stock has more than doubled from its December 2008 lows to Rs 184 (December 4). Currently, Fidelity’s India Focus Fund holds 9 per cent and Life insurance Corporation holds 8 per cent in the company.

Mittal, who had initiated a buy on Bata last December, feels that the challenge for Bata now will be to live up to the growth expectations. “Incremental sales have to come in as the company is consolidating its existing outlets to make way for big format stores. So while existing customers are coming to the new outlets, the challenge is to report higher footfalls in the coming quarters,” says Mittal. That will be a tough task, though not an impossible one, feels Maheshwari of RNCOS. “No one can beat Bata in its reach, but where it lacks is brand recognition. Bata has never been seen as an aspirational brand, so the company needs to aggressively pitch itself against other brands and that will take time,” says Maheshwari.

Jagdeep Kapoor, chairman and managing director of Samsika marketing consultancy, agrees. “The beauty of the brand is that it is seen as trustworthy, but it needs to connect with the youth. That would mean that the mother brand, Bata, has to look more trendy and youthful. Mere advertising and celebrity endorsements won’t work unless it creates an overwhelming brand pull,” says Kapoor.

Notwithstanding the shortcomings, analysts feel Bata is a good play on the India consumption story. Besides, the stock looks attractive at a PE of 14x its CY10 earnings. There’s one reason for caution though. “Bata has the potential to be a high growth stock if it effectively caters to the aspirational expectations of buyers, but the risk is that it could end up as a moderate growth company like any another FMCG player,” says Mittal.