In D-Mart shopping cart, valuations look justified

Low-cost operations and merchandise could set the cash registers ringing

In a sector where companies are struggling to generate consistent profits, Avenue Supermarts stands as an outlier. The company, which runs India's most profitable supermarket chain under D-Mart brand, has reported net profits that have grown in each of the last five financial years going back to FY12. If one were to annualise the reported net profit for nine months of FY17, it is well on its way to topping the Rs 500-crore mark for the financial year. 

A consistent track record of profits, a strong management team, and an obsession with keeping costs to the minimum are seen as best to keep profits rolling. Retail (small) investors may subscribe to the company's first issue of shares.

At the lower end of the price band, the company is asking for 35 times its FY17 annualised net profit. While this is at a slight premium to Future Retail (34.2 times FY17 earnings), it is justified given Future's FY17 estimated revenues are 60 per cent more while its net profit is 35 per cent lower than Avenue's numbers. 

Measured expansion and store ownership have helped the company do better than peers. After opening its first store in FY03, it took the company seven years to increase the number to 25, most of which came up in Maharashtra. Instead of spreading its reach all over the country, the company adopted a cluster approach, which translates into more stores in a particular location. This has helped to cut down on distribution costs and more importantly helps predict revenues as the company has a better understanding of local markets and their retail requirements. Given the slow, clustered approach, it is not surprising that more than half its stores and 60 per cent of revenues come from Maharashtra. After 14 years of retail operations, the company has 117 stores, with retail area of 3.57 million square feet.

The store ownership model does away with rentals, which form five per cent of costs for other retailers, and offers flexibility in allocating space to high-margin products. This, coupled with a lean corporate structure (employee costs are just two per cent of sales), helps keep operating costs much lower than those of peers. Lower fixed costs also help company keep pricing of products attractive. The value or pricing for customers is a unique point, which helps clock sales volumes and leads to faster inventory churn as well as high operating leverage. Such a business model gives it a huge cost edge over much larger peers even though its gross margin at 15 per cent is among the lowest in its peer group. While peers are struggling to clock higher-than-single-digit same store sales growth, the company boasts 20 per cent plus number.

Going ahead, the company has a twin strategy of improving revenue and profitability. About 72 per cent of revenue comes from two high-volume categories: Food and non-food fast moving consumer goods (FMCG) category. This is used to get the footfall. Also, it is then used to get some growth in sales in the general merchandise and apparel category, which fetch higher profit margins. Gross margin for general merchandise is in 25-35 per cent range while that of the foods and non-FMCG varies from 12-25 per cent. 

Given that the IPO will help pay down Rs 1,080 crore of overall debt of Rs 1,408 crore as well as utilise Rs 360 crore for setting up new stores, net debt to equity, which stood at 0.74 at the end of first nine months of FY17, will come down to 0.3m and boost the bottom line by Rs 60 crore. The annualised interest costs for FY17 would be Rs 121 crore.