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Allaying concerns of competitive pressure on profitability
Avenue Supermarts’ (AVEU) Q1FY2020 result allays consensus concern of margin pressure in the face of competition from both online and offline grocery retailers. EBITDA margin, even after adjusting for Ind-AS 116 impact, expanded 70bps YoY to 10%, second-highest in 13 quarters. Store expansion acceleration (opened eight stores during the quarter) inspires confidence in AVEU’s ability to capture longterm growth; we estimate addition of >30 stores annually for FY2020 and FY2021 (vs. 20-25 store additions annually over FY2015-19). We see strong tailwinds for the business (huge growth potential in the Indian food & grocery market, sharp value-retail positioning with efficient backend operations and e-commerce initiative), but current valuations offer low margin of safety. Maintain HOLD.
* Pace of store expansion accelerates: Revenue / EBITDA / PAT grew 27% / 41% / 34% YoY respectively. AVEU opened eight stores during the quarter, a large part of it being spillover from the previous quarter, taking the total store count to 184 and the overall retail space to 6.3mn-sqft. It is opening new stores over 45,000-sqft retail space, significantly bigger than the average of 34,000-sqft for the company. We believe larger store size would help AVEU deliver longer runway for growth from its existing stores as well expand margin profile (allocating greater retail space to the higher-margin ‘general merchandise and apparel’ segment in larger stores).
* EBITDA margin expansion ahead of consensus expectations: Reported EBITDA margin expanded 100bps to 10.3%. Even after adjusting for the accounting impact of Ind-AS 116 (recognising D&A and interest cost instead of rental expenses earlier), comparable EBITDA margin expanded 70bps to 10% driven by higher gross margin (+50bps YoY) and operational efficiencies. However, management cautioned against extrapolating this strong margin performance for all of FY2020. Increase in D&A (+86% YoY) and interest cost (+67% YoY) was again primarily driven by the Ind-AS 116 impact.
* Valuation and risks: We increase our earnings estimates by 1-2%; modelling revenue / EBITDA / PAT CAGRs of 30% / 33% / 34% over FY2019-21E. Maintain HOLD with DCF-based target price unchanged at Rs1,400. At our target price, the stock will trade at 52x P/E Mar’21E. Key upside risk is fast turnaround of ecommerce operations, and key downside risk is deceleration in growth due to heavy discounting by competition.
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