DMart stock heads south amid margin concerns; analysts cut rating

Over half the analysts now have a 'sell' rating as they feel valuation is too high

Even after posting good revenue growth in the September quarter, most analysts have reduced their rating on the stock of Avenue Supermarts.

The entity operates DMart, the food and grocery chain. The rating downgrade is due to profit margin concern. Analysts also feel earnings are not strong enough to justify the higher stock valuation — after Monday's fall of 5.5 per cent on the BSE, it is still nearly 63 times the estimated FY20 earnings.

The shares ended the day’s trade at Rs 1,333.15 and this fall eroded Rs 48.4 billion of the company's market capitalisation. So far this year, the shares are up by around 13 per cent. A little over half the analysts who track Avenue Supermarts have recommended a ‘sell/reduce’ rating for the stock; a third maintain a 'buy' rating. The others have a 'neutral' or ‘hold’ rating.

In the September quarter (second or Q2 of this financial year), Avenue Supermarts reported year-on-year revenue growth of 38.9 per cent, highest in seven quarters. Earnings before interest, taxes, depreciation and amortisation (Ebitda) and profit after tax (PAT) grew 22.6 per cent and 18.2 per cent, respectively. Though largely in line with expectations, analysts felt the company's strategy of being a low-cost supplier meant the Ebitda margin (eight per cent, as compared to 9.1 per cent in Q2 a year before) was not sustainable. The PAT margin was 4.6 per cent, compared to 5.4 per cent in Q2 of FY18.

“In the recent analysts meet, the management had highlighted that the high Ebitda margin might not be sustainable, as the company plans to priorities price competitiveness versus margin improvement,” said analysts at Motilal Oswal Securities.

Edelweiss Securities felt, “After four-five quarters of expansion, gross and Ebitda margins dipped 180 basis points and 106 bps (year-on-year), respectively. Considering the price cuts and increasing competition, gross margin compression and limited Ebitda margin expansion would be expected. The company’s focus is also on revenue growth, rather than margin expansion.”

Abneesh Roy, analyst with Edelweiss, also raised concern about the slow rate of addition of new stores. The company added three in the second quarter and only five during the first half of the financial year.

However, some analysts say DMart had added the bulk of its new stores towards the end of the past financial year and this could be expected this year, too. The company had added 24 stores in FY18, of which 14 were in the final quarter. The management had indicated the aim was to add 25-30 annually.

“Total store count rose from 131 in FY17 to 155 in FY18, and at a 16 per cent compounded annual rate over FY13-18. To reach 25 stores (more this year), DMart needs to add 20 in the year’s second half, against the five it added in the first half,” Motilal Oswal analysts say.

New stores take at least 12-15 months to break even. With the bulk of these expected in the second half, the margins are expected to continue under pressure.

Edelweiss analysts feel the management’s increasing focus on sales growth comes with the rising competitive intensity from Big Bazaar, Reliance Retail, Big Basket and the Walmart-Flipkart deal, among others. Amazon, too, has been making inroads into the offline retail space in India, much like its US strategy. Samara Capital and Amazon are set to buy Aditya Birla Group’s food and grocery retail chain, More.

DMart is one of the few retailers in India that have sustained a robust same-store sales growth (SSSG) of over 20 per cent (except in FY18). It operates on an “everyday low cost, everyday low prices” model, aiming to procure at a competitive price, using operational and distribution efficiency. Shoppers become loyal, it is believed, due to the low prices, similar to US chain Walmart.

“In our view, the SSSG momentum will come off from the over 20 per cent mark to 15–18 per cent, year-on-year, over the next two–three years, led by maturity of older stores,” feels Edelweiss.

Analysts, however, expect the new stores to fuel overall revenue growth. D-Mart is also expected to continue to benefit from favourable rates from FMCG companies considering creditors’ payables are mere 8–10 days, they said.