Dmart Ltd – Excellent Business With Stratospheric Valuation
Company Name – Avenue Supermarkets Limited (DMart)
Current Share Price – INR 3,678 (January 16, 2023)
Market Cap – INR 2,38,274 cr
1. What is interesting about the stock?
We have seen the popular series on Harshad Mehta – Scam 1992. Do you remember the character – Maheswari played by Paresh Gantara (see the above pic). It is supposedly based on veteran investor - Radhakishan Damani. He became India's retail king after the March 2017 IPO of his supermarket chain DMart. Let’s briefly understand the industry before we get into DMart.
India’s retail sector is experiencing exponential growth and is expected to reach USD 1.5 trillion by 2030 from USD 0.8 trillion in 2020. India is largely an unorganized retail market. However, the organized retail market has increased by ~50% between 2012-2020 to its current value of nearly 12% of total retail. Modern retail is expected to grow at a 15% CAGR to reach 18% by 2025. DMart is a prominent player in organized grocery retail.
DMart was founded by Radhakrishna Damani in 2002 who has been a distinguished investor in the Indian equity markets since the 1990s. DMart focuses on the value segment following Walmart’s philosophy of Everyday Low Cost which translates to the Every Day Low Price (EDLP) business model for customers. Company has organically grown to around 280 stores with revenue and PAT increasing by almost 2x over the last 4 years ending March 31, 2022. Business is expected to grow 20-25% in the next 4-5 years driven by a higher share of the organized sector and higher disposable income.
Key competitive advantages of the Company are:
Consistent focus on EDLP – drives customer loyalty
Cluster-based growth; a company can build scale in logistics and improve negotiating leverage with FMCG brands
Superior unit economics is driven by high sales per sq ft (2-3x of competition), strong same-store sales growth, and lowest opex as % of revenue. High sales per sq ft are owing to fast inventory turns or low inventory days
Experienced management team
On an overall basis, DMart has a solid business that is expected to grow in the next few years. So, far so good.
Then isn’t it a BAAP – Buy At Any Price story? Picture abhi baki hai mere dost – investors need to factor in that the competitive dynamics are heating up in the industry and valuation is so stretched that they will have to ally with Space X or Blue Origin to open stores on Mars (you are getting the drift!) to justify it.
DMart is facing competition from four very well-capitalized giants:
Reliance Retail – market leader & well-funded player in the process of acquiring Future Retail which would leapfrog its grocery footprint in addition to improving its logistics capabilities
Amazon (More) – Global e-commerce market leader with a strong presence and increasingly moving towards an omnichannel approach with the acquisition of Whole Foods in the US and More stores in India
Walmart (Flipkart) – Largest offline retailer in the world which also owns Flipkart – an incumbent market leader in Indian e-commerce
Tatas (Trent and BigBasket) – Tata have made its intentions clear with the USD 1 billion acquisition of Big Basket (the largest online grocery player)
India’s organized retail market may be able to sustain 2/3 of national players, with others being regional players. Capital dumping is likely to take center stage going forward with players aiming for market grab (similar to land grab). Global/domestic retailers Amazon, Walmart-backed Flipkart, and Reliance Retail have significantly strengthened their war chests for investments in the supply chain, fulfillment capabilities, and pricing/selection. An inkling of this can already be seen in the reducing selection/pricing arbitrage of DMart over these biggies. Grocery is going to be the focal point, with one of the highest velocities of daily transactions, for all players having Super App ambitions.
The industry is expected to see brutal competition.
2. Key Historical Financials
Revenue had fallen in FY21 due to COVID-19 and has recovered strongly in FY22 and Q3FY23 with 28% and 26% growth respectively on a YoY basis
Company delivered Like for Like (LFL) growth of ~17% in FY22 in the stores which have been operational for more than 24 months
EBITDA margin has also expanded in FY22 to 8.1% from 7.2% in FY21; the margin has further expanded to 8.8% for TTM
Typically, Q3 is the strongest quarter for the Company. Q3FY22 was exceptionally strong and hence revenue growth is high but the EBITDA margins have come down from 9.4% to 8.3% in Q3FY23
Company opened 50 stores in FY22 - depressing the net profit (due to higher depreciation) and cash flow convertibility (CFO/EBITDA) due to an increase in the inventory level
ROCE/ROE has come down from 20%/16% in FY20 to 16%/12% in FY22
3. What is my view on company valuation?
DMart currently trades at an EV/EBITDA (TTM) ratio of c. 64x and a P/E (TTM) ratio of c. 102x. Now that’s super-rich! This is when the share price has declined ~15% in the last 12 months.
Some of the analysts/investors give the argument of DMart’s higher expected growth rate justifying the valuation. I would agree with them. Let’s use the PEG ratio to arrive at the valuation as it will adjust for DMart’s higher growth rate.
Comparable PEG ratios for US giants like Amazon, Walmart, and Costco are ~2.5x. Using a PEG ratio of 2.5x, a growth rate of 22.5%, and a margin of safety (20%), the PE ratio comes to c. 45x (2.5 X 22.5 X 80%) compared to the current valuation of 102x. So, the price using this ratio is almost 1/2 of the current price.
Factors not considered in this price are high competitive pressures expected in the industry.
It may not be the case that the share price comes down to the fair value. Stock could have a time correction (flat) over a long period till the fundamentals catch up with the elevated share price. It has been the case for the last 12 months when the valuation multiple has come down from ~150x to 100x.
4. What are the risks to the investment analysis?
Risks to the analysis are:
High liquidity in the stock market, low public float, and the perception of being a BAAP stock – can push the price higher in the short/medium term
Acquisition by a large player like Walmart – to jumpstart their offline growth in India (low probability given recession fears in the US)
Roll-up strategy by DMart where they acquire unorganized players at an attractive valuation (very difficult to execute)
About the Author
I have over 17 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.
I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.