The 10% stake sale in its branded apparel business not only upped the expectations about Arvind Ltd but also of its peer Aditya Birla Fashion and Retail Ltd.
The deal values Arvind’s brand business at 22-24 times one-year forward EV/Ebitda. That is higher than what the Street was assigning and triggered gains in the stock, which is up around 15% from when the deal was announced. (EV/Ebitda is enterprise value to earnings before interest tax depreciation and amortization. It is a measure of the value of the stock and the company.)
Compared to Arvind, Aditya Birla Fashion’s brands business is said to be more mature, as Arvind still has brands that are in the investment phase. So Aditya Birla Fashion should get superior valuations, analysts at Edelweiss Securities Ltd argue. “Considering overall brand size, better penetration, better return ratios (Madura’s RoCE of 46% versus Arvind brands ~7%), we believe Aditya Birla Fashion should command better multiples,” Edelweiss said in a note. “At current market price, the Aditya Birla Fashion stock trades at 16.7x FY19E EV/Ebitda. With the Arvind deal at richer valuations, we expect this to aid re-rating of Aditya Birla Fashion’s business too.” Madura is the apparel brand unit of Aditya Birla Fashion. RoCE is a return on capital employed.
For Arvind, the stake sale transaction will strengthen its financial position through debt reduction and infusion of funds for investments. As profitability improves and the brands business becomes self-sustaining, the stock can re-rate and it may even pave the way for a separate listing, ICICI Securities Ltd says. “We believe that, as in the case of Arvind Infrastructure, Arvind Lifestyle & Brands could also be possibly carved out as a separate listed entity in the foreseeable future which would unlock value for minority shareholders,” ICICI Securities said in a note.
These expectations have driven up the stock. While it is up 49% from a year ago, the valuation and the current Street expectations could be affected if the company does not deliver on the brand’s business. Despite strong growth, the unit generates single digit margins and trails peers like Aditya Birla Fashion on a full-year basis (2015-16).
As the brands business attains economies of scale, Arvind expects profitability to improve. But that is easier said than done. Its power brands are doing well, clocking double-digit margins. The trouble is with emerging brands where it continues to lose money and requires investments. A breakthrough here can create enduring value for the shareholders.
