The Avenue Supermarts stock, which runs the retail chain under the D-Mart brand, has been hitting new highs on a regular basis on strong operational performance and expectation that the company will continue to post robust net profit growth over the next two to three years. The stock has already gained 63 per cent since listing. Including family holdings, its founder, and promoter, Radhakishan Damani is worth over Rs 53,000 crore now and is among the richest individuals in India. While the business is doing well and its prospects remain good, the question is, is the sharp run up in the price a function of irrational exuberance or is there substance to the investor demand for India’s most profitable retailer? Analysts have a piece of advice.
Says an analyst at a domestic brokerage. “I don’t think people are looking at one year forward earnings. The reason for the sharp run in price could be low floating stock, 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 3-5 year holding period.”
While analysts believe the company will be able to grow its net profit by 35-40 per cent annually over the FY17-20 period, they cannot justify current valuations. Says Latika Chopra of J P Morgan in a 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 FY18/19 price to earnings estimates respectively are well pricing in the optimism." Since the report was published, the stock has risen sharply taking the valuations to 85 and 63 times FY18 and FY19 estimates, respectively.
Comparison with other retailers also does not lend any comfort. Though their business models are different, India-listed Future Retail which is largely apparel led (while D-Mart is grocery led) trades at 37 times its FY18 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, other analysts say that in terms of valuations Walmart would be 0.6 times enterprise value to sales while D-Mart even if we are to take two years forward estimates would be 3 times on this metric. While the growth opportunity is there, these kind of valuations were never there for Walmart even in its earlier years, says an analyst.
Market experts say that the company needs to match investor expectations as far as scaling up of its operations is concerned but without compromising on growth. So far, the company has done a good job on the execution front.
With revenues just under Rs 12,000 crore, the retailer is the country’s second largest in the listed space after Future Retail. While revenues over the last five years have grown at 39 per cent annually, higher operational efficiencies and a tight control over costs helped its operating profit and net profit grow faster at 47-52 per cent. 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 in the 21 to 31 per cent range which has been a key differentiating factor as compared to other retailers. Growth thus has not only come from expansion but also on an organic basis.
Despite the growth, analysts do not want to pay more for the stock now because they believe the market is ignoring a few risks.
Analysts say the company has grown so far with a focus on the cluster approach which entails opening of new stores within a radius of a few kilometres of existing stores and distribution centres. This concentrated strategy leads to cost efficiencies due to economies of scale in supply chain and inventory management. This 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 of scale both in the terms of one large distribution centre as well as the related issue of logistics. This could impact margins, says an analyst pointing to the 50 basis points year-on-year fall in the metric in the June quarter. One of the reasons for the same was higher employee costs on account of new manpower for new stores added in the March quarter of 2017.
The other pressure point on margins could be higher marketing and advertising expenditure as the company moves from being a regional player to one with pan India ambitions. Maintaining or improving margins under such circumstances could be difficult, say analysts.
The other risk analysts are wary of is the capex on expansion. Given that they have an ownership model, availability of good quality real estate will be a problem. While so far, they have got it right in Maharashtra and Gujarat, good quality real estate at a good price may be difficult to sustain, says an analyst. With the company chasing growth, annual capex of about Rs 650 crore could move up putting pressure on cash flows. 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 investments,” says an analyst.