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Reliance Industries 31 August 2020 Update | Sector: Oil & Gas Reliance Industries BSE SENSEX S&P CNX 39,467 11,648 CMP: INR2,116 TP: INR2,250 (+6%) Buy The Deal Machine Reliance acquires Future Group’s retail formats; grows its strength in Indian retail sector Stock Info Bloomberg RIL IN Contours of the deal Equity Shares (m) 6,339 In a deal that could well shape the Organized Retail sector in India, RIL, through its M.Cap.(INRb)/(USDb) 13934.7 / 189.3 retail subsidiary, Reliance Retail Venture Limited (RRVL), announced the acquisition 52-Week Range (INR) 2199 / 867 of Future Group’s Grocery and Apparel Retail formats on slump-sale basis at 1, 6, 12 Rel. Per (%) -5/58/64 INR247b. The deal’s equity value stood at INR56b, implying the absorption of 12M Avg Val (INR M) 25802 Free float (%) 50.9 INR191b liabilities. As per our understanding, the deal is likely to be structured in three steps. A) All of Future Group’s businesses would be transferred to Future Financials Snapshot (INR b) Y/E March 2020 2021E 2022E Enterprises (FEL). B) Reliance Industries (RIL) would then acquire the Grocery and Net Sales 5,959 4,882 6,115 Apparel Retail assets from FEL for INR247b. C) FEL would retain the FMCG & EBITDA 881 885 1,269 Apparel brands, the Future Generali Insurance JV, and select real estate assets in Net Profit 431 427 706 Adj. EPS (INR) 67.9 67.4 111.4 which RIL would take an additional 13% stake in two parts for INR28b. EPS Gr. (%) 8.1 -0.8 65.3 BV/Sh. (INR) 715 782 885 Compelling valuation, but limited upside for RIL Ratios RIL is acquiring the retail formats with a combined revenue/EBITDA of Net D:E 0.6 0.5 0.4 INR283b/INR19b on an FY20E basis, implying EV/Sales of 0.9x and EV/EBITDA of RoE (%) 10.2 9.0 13.4 RoCE (%) 8.5 8.3 11.1 13x. This is a compelling valuation given that Big Bazaar, Central, and Brand Factory Payout (%) 11.6 9.3 8.3 are attractive and highly scalable assets, and would derive good profitable growth. Valuations (This is further elaborated in following sections.) We currently ascribe INR3.7t P/E (x) 30.9 31.2 18.8 P/BV (x) 2.9 2.7 2.4 equity value to Reliance Retail with INR580/share. Ascribing 30x EV/EBITDA for EV/EBITDA(x) 18.1 18.1 12.1 Future Group’s incremental EBITDA of INR19b, incremental upside could be EV/Sales (x) 2.7 3.3 2.5 INR51/share, i.e., merely 2%, given RIL’s mammoth market cap. Div. Yield (%) 0.3 0.3 0.4 Shareholding pattern (%) Sizable contribution to the Grocery and Apparel businesses As On Mar-20 Dec-19 Mar-19 In the overall Reliance Retail fold, which has revenue/EBITDA of INR1.63t and Promoter 48.9 48.9 46.2 EBITDA of INR96.5b, Future Group’s combined contribution from Grocery and DII 13.6 13.6 11.8 FII 25.9 26.3 26.2 Apparel Retail is merely ~15%. However, the transaction holds very high relevance Others 11.6 11.2 15.9 if seen from the lens of RIL’s LTL consumer-facing grocery and apparel ventures. FII Includes depository receipts Future Retail (FRL)’s INR210b revenue would be nearly 50% of the total business of Reliance Retail Grocery and on a similar scale excluding Reliance’s B2B Grocery Stock Performance (1-year) Reliance Industr business. Similarly, Future Lifestyle Fashion (FLFL)’s INR63b revenue would be Sensex - Rebased ~57% of RIL’s total Apparel and Fashion business, and much higher against the 2,400 individual Apparel biz. 2,000 1,600 High strategic interest for Reliance Retail 1,200 The deal holds very high strategic interest to RIL as it would aid in three ways: a) enhance footprint, b) offer a good legacy franchise, and c) help build competitive 800 strength. Feb-20 Aug-19 Aug-20 Nov-19 May-20 Research Analyst: Swarnendu Bhushan ([email protected]) / Aliasgar Shakir ([email protected]) Sarfraz Bhimani - Research Analyst ([email protected]) Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital. Reliance Industries Deep footprint: Reliance already has a very wide footprint of ~800 departmental grocery stores, which would increase by 34% (270 FRL department stores). Furthermore, FRL has a good reach in the eastern region, where Reliance Retail has 11% stores. Similarly, FLFL’s Apparel business has >350 stores, which would add 15% to Reliance Retail’s total ~2,400 stores, with some high revenue throughput stores. Good franchisee: Big Bazaar, a pioneer and synonymous with modern retail in India, has been operating for the past two decades. It has been a flagship brand for Future Group, very well performing, with good EBITDA-generating assets. Similarly, Brand Factory, a 365-day discount store, has a very attractive and unique value proposition, often looked upon as rightly following the footsteps of US popular discount store, TJ Max. Additionally, Central, with a unique blend of own brands, is a profitable lifestyle fashion retail chain. In the Retail business, scale is critical, and achieving sustainable profits proves challenging. Therefore, if Reliance Retail could manage integration, this should be the biggest advantage. Building competitive strength: The deal would take Reliance Retail’s market share to 38% of organized grocery retail from 22% earlier. The Organized Grocery market, with the only other player being DMart, has now virtually turned into a duopoly market. Reliance targets deep penetration in this space, and DMart focuses on the cluster approach. With the entry of giants such as Amazon, Flipkart, and other online players, the cumulative size of the Online Grocery market, once ignored for its non-viability, has now reached an estimated stellar scale of INR200–250b. This may be viewed as the third dominant force in the Retail market. This deal should further aid Reliance in its online venture Jiomart. Through this, the company aims to create a hub-and- spoke model using its deep network of stores as an inventory sourcing warehouse. Future Group’s shareholders have limited benefit The existing Future Group shareholders’ share-swap deal indicates ~50% upside arbitrage. However, the residual business, following the slump sale and equity infusion adjustments, leaves merely INR4.2b EBITDA, with net debt of INR23b. At an 8x EV/EBITDA, it is left with merely INR9b equity value. This is against a 96% dilution from the share-swap deal at other Future Group entities, leaving nothing on the table for existing minority shareholders. FEL now a play on FMCG and apparel sourcing for Reliance Retail FRL and FLFL have garnered nearly 30% plus revenue from private labels, and can now leverage the deep network of Reliance Retail. However, given that the former would generate over 80–90% revenue from a single customer, clearly, this could put pressure on margins. Future Group also holds an insurance JV and other real estate assets. Another way to look at it is Reliance Retail plans to invest INR28b for a 13% stake in two separate preferential and warrant issues, implying an enterprise value of INR252b. However, just INR4.2b EBITDA from the FMCG and Apparel businesses and insurance JV could result in limited valuation upside. 31 August 2020 2 Reliance Industries Structure of Reliance Retail’s acquisition of Future Group’s businesses The deal between Reliance Retail and Future Group is structured in three steps. A) All of the businesses of Future Group would be transferred to FEL via a share-swap deal. B) RIL would then acquire the Grocery and Apparel Retail assets from FEL for INR247b. C) FEL would retain the FMCG and Apparel brands, the Future Generali Insurance JV, and select real estate assets, in which RIL would take an additional 13% stake in two parts for INR28b. Future Group would merge its existing listed companies – FRL, FLFL, FSCSL, FCONSUMER, and FMNL – via a share-swap deal, and only FEL would be listed on the exchanges. This would lead to the dilution of ~96% for the existing shareholders of FEL as its equity shares would increase to 12b from 500m. Optically, the share-swap deal implies a massive >50% upside; however, the business in FEL leaves limited earnings to offer any material valuation to FEL. Thereafter, RRVL, through subsidiary Reliance Retail & Fashion Ltd, would acquire the Grocery and Apparel Retail formats, along with the Wholesale, Logistics, and Warehousing verticals of the Future Group companies – Future Supply Chain and FEL. Future Group would transfer its flagship retail format, Big Bazaar; other key businesses, FBB, Central, Brand Factory, and Future Supply Chain Solutions; and other smaller businesses via a slump sale for a total amount of INR247b. This includes equity value of INR57b, implying debt of INR191b toward these businesses. In the third part of the deal, FEL would be left with the FMCG and Apparel businesses (Future Consumer and Apparel production of FLFL), along with JVs in the Life Insurance businesses. RRVL would take a 13.1% stake in FEL after the slump sale by paying INR28b in two separate transactions. Thus, FEL would be valued at an equity value of INR227b and net debt of INR23b, taking the total EV to FEL to INR250b, post the slump sale of its key businesses. Exhibit 1: Sales and EBITDA for businesses sold to RRVL (INR b) FY20 Revenue FY20 EBITDA FLFL 60.5 4 FRL 209.6 11.5 FMNL 1.2 0.5 FSCSL 11.4 2.536 Total Revenue 282.7 19.0 Exhibit 2: Slump sale of Future Group companies to RRVL Acquisition value for slump sale, EV (INR b) 247.13 Equity Value (INR b) 56.54 Debt value (INR b) 190.59 Valuation of Future Group
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