Stock Idea : Zodiac Clothing

>> Sunday, August 23, 2009

Shareholders can stay invested in the stock of Zodiac Clothing, which is among the premium players in the retail space, catering primarily to luxury formalwear for men. At Rs 295, the stock trades at a multiple of 17 times standalone four-quarter trailing per share earnings, at a premium to a good number of retail peers. Zodiac commands a substantial brand recall, and has design offices across countries to pick up on trends.

A low debt equity ratio, high operating margins, and quick movement of inventory bode well for the premium retailer. However, considering the company’s premium bent, declining sales growth and higher valuations, fresh investments may not be made at this level.

Brand equity
The company’s flagship brand ‘Zodiac’ is an established name catering to formal menswear, reaching out to older men. In an effort to branch out and reach a wider segment of customers, Zodiac launched two more brands that have been successful.

‘ZOD!’ is a brand aimed at party and club wear for young men, while ‘Z3’ is meant for casual wear, but could be used as office wear, again for young men.

All three are luxury brands. Related accessories such as ties, cuff-links and belts are also marketed by Zodiac, and the company is contemplating entering men’s footwear, which constitutes the majority of the Indian footwear market. Zodiac has a design studio in Mumbai with support from design and sales offices in London, New York and Dusseldorf (Germany).

Store count
Zodiac currently has a retail network of more than 1,200 stores in multi-brand outlets besides 69 (as of March 2009) own stores, including overseas outlets in Dubai. All the exclusive brand outlets are owned by the company and not franchised. This has thus translated into higher depreciation, which has kept pace with sales growth.

Deviating from strategies followed by its retail peers, Zodiac has not, and does not plan to, increase store count through franchisees. Franchising has been the preferred expansion method in this industry for some time since it requires minimal capital investment on the part of the retailer, reduced rentals and store maintenance.

Zodiac, though, is not beset by the funding woes plaguing most retailers and can therefore meet capital requirements quite easily. It operates on a debt-equity ratio of 0.21 times, a high interest cover of 11 times, a positive operating cash flow, and has reserves of Rs 87 crore to draw on.

Margin performance
Operating margins stand at 11.4 per cent for 2008-09, higher when compared with a good many of the company’s retail peers. Even so, margins have dropped from the 16.5 per cent in the preceding year, primarily due to losses on foreign exchange fluctuations.

Given its high own-store count, depreciation and taxes cut net profit margins to 5.7 per cent, though this is still higher than peers. In fact, operating and net profit margins improved to 13 and 7 per cent, respectively, in the June 2009 quarter on the backs of lower raw material costs. In terms of inventory turnover, at 5.67 times sales in FY-09, Zodiac has not only managed to improve on this count over the previous year but is also among the better performers in the retail space.

Working capital too has seen a faster rotation in the past three years, perhaps one key reason why it has managed with little borrowing for operations.

Diminishing sales growth
Superior margins notwithstanding, sales growth has been on the wane, even as consumer spending staged a revival. From a 23 per cent growth in the September 2008 quarter over the same period the preceding year, sales growth progressively declined, slipping to a 3 per cent growth in the June 2009 quarter. Added to declining sales growth, increased expenditure resulted in profits dropping 24 per cent in 2008-09.

Zodiac also has an export component; exports constitute a good 36 per cent of revenues. Even with domestic sales outpacing international sales, and the company’s efforts to keep up with changing fashion trends for the international market, it is still open to slackening global demand and forex fluctuations.

In the domestic market itself, recovery in consumer spending has centred on value-for-money products, leaving premium players such as Zodiac still searching for sales. However, the festival season is now on, and Zodiac has traditionally clocked a healthy sales growth during the September and December quarters.

If Zodiac has to capture a larger piece of the retail apparel market through diversification — either into value retail or women’s and kids’ apparel — it may yet face challenges as a result of its premium, masculine positioning in consumers’ minds.
Source : Hindu Business Line

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