Will D-Mart live up to the Street's expectations?

All near-term positives that make Avenue Supermarts an outlier in the retail sector are priced in

The stock of Avenue Supermarts, operator of the retail chain under the D-Mart brand, has been hitting new highs on a regular basis. This has been due to strong performance and expectation of continued robust net profit growth over the next two to three years. 

The stock has gained 63 per cent since listing. Including family holdings, founder and promoter Radhakishan Damani is now worth nearly Rs 53,000 crore, making him among the richest in India. While the business is doing well and the prospects are good, is the sharp run-up a function of irrational exuberance? Or is there substance to the investor demand for India’s most profitable retailer?

An analyst at a domestic brokerage says, “I don’t think people are looking at one-year forward earnings. The reason for the sharp run could be low floating stock, a strong business model, promoter quality and the scarcity premium such businesses bring, among others. On a fundamental basis, the one-year forward estimates cannot be justified. Those buying now are looking at a scalable business from a three-five year holding period.”

Analysts believe D-Mart will be able to grow its net profit by 35-40 per cent annually during FY17-20 but say they cannot justify the current valuations. Says Latika Chopra of JP Morgan in an August 18 report, “While we acknowledge the opportunity for healthy earnings growth (estimated at 40 per cent over FY17-20), valuations at 75 times and 56 times the FY18/19 price to earnings estimates, respectively, are well pricing in the optimism." Since then, the stock has risen sharply, taking the valuations further up to 85 and 63 times the FY18 and FY19 estimates, respectively. 

Comparisons with other retailers also do not lend comfort. Though their business models are different, Future Retail (largely apparel-led, while D-Mart is grocery-led) trades at 37 times its FY18 estimated earnings. Given similar business models, some analysts say in the Indian context, D-Mart could be the next Walmart; so, one should get into the stock, irrespective of the price. However, others say Walmart would be 0.6 times its enterprise value to sales. D-Mart, even if two-year forward estimates are taken, would be three times on this metric. While the growth opportunity is there, such valuations were never there for Walmart in its earlier years, says an analyst.

Market experts say D-Mart needs to match investor expectations on scaling-up of its operations but without compromising on growth. So far, it has done a good job on execution. With annual revenue just under Rs 12,000 crore, it is India’s second largest listed retailer, after Future Retail.

While revenue over the past five years has grown 39 per cent annually, higher operational efficiencies and tight cost control helped its operating profit and net profit grow faster, at 47-52 per cent yearly.

Though part of the revenue growth has been a function of expansion, with store count and retail area more than doubling, it is the same-store sales growth performance (21-31 per cent yearly) which has been a key differentiating factor. 

Despite the growth, analysts believe the market is ignoring a few risks. So far, D-Mart has grown with a focus on the cluster approach. This entails opening of new stores within a radius of a few kilometres of existing ones and distribution centres.

This leads to cost efficiencies, due to economies of scale in supply chain and inventory management. It worked well in Maharashtra and Gujarat, which have about 70 per cent of its stores. 

However, new stores in new states could have an issue on scale, both in terms of one large distribution centre and on logistics. This could impact margins, says an analyst, pointing to the 50 basis points year-on-year fall in this metric in the June quarter. One reason was higher employee cost, due to the new personnel needed for the new stores added in the March quarter. 
 

The other pressure point on margins could be higher marketing and advertising expenditure, as D-Mart moves from being a regional player to one with pan-India ambitions.
Maintaining or improving margins under such circumstances could be difficult, is the feeling. 

The other risk analysts are wary of is the capital expenditure on expansion. With its ownership model, availability of good-quality real estate might be a problem.

They have got it right in Maharashtra and Gujarat so far but good-quality real estate at a good price might be difficult to sustain, says an analyst. With D-Mart chasing growth, the annual capex of about Rs 650 crore could move up, putting pressure on cash flow. 

The other risk is any escalation of investments in the e-commerce space. “If they are looking at growing big in that field, it would require a lot of investment,” says an analyst.