Can D-Mart modify its ownership model?

D-Mart bucked trend in India by choosing a cluster approach for densely populated residential areas

Euphoria around the Avenue Supermarts (D-Mart) initial public offering (IPO) of equity that saw 104 times more demand than the shares on offer might have overlooked a critical factor in the company’s growth so far. Namely, the predominant ownership model for its stores.

The company had rapid growth in recent years, with 112 stores as of September 2016, from one in 2002. Though rapid, the net profit grew to Rs 321 crore in 2015-16 from Rs 60 crore in 2011-12, a compounded annual rate of 51.8 per cent. This, however, has been largely dependent on the predominant ownership model it chose. Including long-term lease arrangements, where the period is more than 30 years and the building is owned by the company. This is different from the rental model its peers, including Future Retail and Reliance Retail, chose. 

"Retail is a low-margin business. So, it is very important to not only keep the cost low but predictable," says Pinakiranjan Mishra, partner and sector leader at consutancy EY. 

Many of the successful retailers of the world have chosen the ownership model. US-based Wal-Mart, Dutch retail chain Ikea and American fast food chain McDonald’s have thrived on it. Many Indian retailers have, however, chosen a rental model due to the high real estate cost in India. However, when rental cost became unviable, they needed to relocate the stores, which meant a decline in same-store sales (SSS) growth. 

"It is also a location-sensitive business. Global retailers sometimes own their stores and, in some cases, even the entire mall, to create value for the retail destination, save cost and ensure predictability of cost," says Mishra.

D-Mart bucked the trend in India by choosing a cluster approach for densely populated residential areas having a majority of lower middle and middle class consumers, instead of high-street addresses. Many times, it bought land at underdeveloped locations close to such a cluster and built the property. Then, offering an ‘every day low price (EDLP)’ and every day low cost (EDLC)’, it got regular customers. Who made the store a shoppers' destination.

This is a time and capital consuming approach than renting space in developed localities. In hindsight, it helped the company in improving SSS, while peers struggled to remain at locations where rental increased sharply.

"Real estate is an asset for the company. When we are making a 22-23 per cent return on capital, why should we lease properties?" says Ramakanth Baheti, finance head at Avenue Supermarts. D-Mart had tangible assets of Rs 2,300 crore as on end-December.

Owning assets does not by itself ensure that stores achieve break-even faster. The company achieves this through further minimising operating costs. Beside the predominant ownership model, it procures goods directly from vendors and manufacturers, employing an efficient logistics and distribution system, and maintaining a strong focus on product assortment to minimise inventory build, supported by efficient store operations.

"While others pay lease rents, we pay interest," says Baheti. The company has debt of Rs 1,400 crore, with a 9-9.5 per cent average cost of funds. The company treats its real estate as plant and machinery, and does not plan to unlock its value.

However, in its draft prospectus (DRHP) for the IPO, it says the ownership model requires greater capital for opening of each store, due to which it might not be able to expand at its historical rates. The objective of the IPO seems in sync with this. The offer, likely to be priced at the top end of the price band of Rs 295-299 a share, will be Rs 1,840 crore. Of this, Rs 1,080 crore will be used to retire debt and Rs 367 crore for setting up of new stores. It also shows that having grown till now from internal accrual and debt, it is now looking for public money to bring down its cost of capital for future growth through the ownership model. 

“D-Mart will struggle in the coming years to continue with its predominant ownership model,” says Arvind K Singhal, chairman, Technopak Advisors, which prepared a sector report at the request of D-Mart. “Availability of real estate at an affordable price is now a question. Going forward, they might have a higher mix of rentals to maintain revenue growth.”