Operating margins of organised brick and mortar retailers are expected to improve by 100 basis points (bps) from about 6 per cent over next two financial years, according to a report. The profits are riding on online retailers going slow on discounts to reduce cash burn, benefits from the implementation of Goods and Services Tax (GST), and increasing store productivity, a Crisil report said. “We see the profitability of brick and mortar retailers improving as competitive intensity from online rivals and service tax on rent gets set off in the GST regime,” said Anuj Sethi, Senior Director, Crisil Ratings. “And as growth rises, so will revenue per square feet, which, in turn, will improve their fixed-cost absorption ability,” he added.
Further, the pace of store expansion is also expected to increase over the medium-term to cater to the increasing demand. Besides, the Department of Industrial Policy and Promotion (DIPP) regulation in March, which restricts discounting and vendor concentration, has been favourable for brick and mortar retailers.
Consequently, online retailers have gradually lowering share of discounts as well as losses, which has led to moderation in their growth, it noted. Also, under GST, retailers will be able to set off service tax on rent against taxes on goods. Rent is one of their largest cost components, ranging between 5-6 per cent of sales.
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The offline retail sector will also benefit from rationalisation of logistics costs because of flexibility in procurement and seamless movement of goods facilitated by the implementation of GST, the report noted.
Revenue growth of the organised retail sector is expected to improve to 14-16 per cent annually in the next two fiscals compared with 13 per cent compounded annual growth rate seen between fiscals 2015 and 2017.
As growth and profitability look up, Crisil expects capital expenditure (capex) of brick and mortar retailers would increase by 15-20 per cent over next two fiscals compared to capex incurred in past two fiscals. Despite increase in capex, which will be part debt funded, improving operating metrics and better cash generation will continue to support the credit profiles of retailers, Crisil said.