Preparing for normalcy; bringing back lost customers
DMart hosted its annual analyst call, discussing in detail the current business environment, growth opportunity, online strategy, and means to combat the resurgence of strong online players. DMart re-emphasized its uniqueness in terms of right pricing and assortment. Furthermore, it highlighted creating a certain positioning and customer affinity that is ensuring swift recovery from the pandemic-led lockdown. Here are the key takeaways:
Swift recovery from lockdown
DMart has reopened most stores, and sales have reached ~80% across assortments as customer traffic is gradually returning to stores given the brand’s value offering. However, the profile of customers has changed to lower middle and middle class v/s upper middle class, which is still wary of stepping out and therefore prefers to shop online.
Growth trajectory remains strong
Same-store sales growth (SSSG) has fallen but is not concerning, excluding the high base of last year and select low-performing stores. We think longer term SSSG should normalize to the high single digits. Management indicated that in terms of store adds, it aims to make up for the lost period of lockdown with ~59 store additions over FY21–22 (the next six quarters). The company has set various targets for the coming year. A) It plans to add 70–80% stores in existing markets given its better understanding and cost efficiency in these markets. B) It would focus on larger sized stores, predominantly in semi-urban and lower tier cities, that may have slightly sluggish metrics in the near term, but bring longer term growth, operating leverage, premiumization, and thus ROIC. C) It would continue property acquisitions unabated, as it did even in the last four months of lockdown.
Online strategy and competition
The focus and presence of DMart Ready has increased over the last two years. Management still believes in the growth opportunity of the brick-and-mortar model, along with its cost and price competitiveness. It is cognizant of the scale achieved by online players, their deep pockets, and their market-building ability. However, it believes online is still restricted to the urban markets, where DMart Ready offers both delivery and pick-up options at more attractive pricing v/s online and would wait for the model to turn profitable. The company is agile and could take price action in merely two hours, keeping track of competitor pricing on a daily basis.
Would continue to pass on cost efficiency
Improving scale, assortment from larger sized stores, and supply chain efficiency are aiding margin improvement. However, the company would continue to pass it on to consumers to maintain the lowest cost / price competitiveness in the market with both offline/online players.
Notes from peer online retailer
BigBasket are astounding Online players are growing significantly, with BigBasket’s monthly orders having jumped to INR7.2–7.3b in Jul’20, i.e., ~INR90b annually, which is 30–50% of the top offline grocery retailers. This indicates 3x growth v/s the last fiscal and 2x v/s Jan’20. BigBasket is seeing very high customer retention, with a huge number of repeat orders (creating customer loyalty) in grocery, typically the slowest to move online. High-margin new categories, increased efficiency measures, and end-to-end digitization are aiding profitability. The key point of contention is whether this would sustain once normalcy resumes.
Consistent performer, but SSSG, ROIC may normalize
The massive growth opportunity in the Grocery space, coupled with DMart’s cost competitiveness, provides huge runway for growth. While the pace of growth may moderate due to the high scale, it could still achieve healthy growth of 20–25%. With 5–10% revenue from new stores and SSSG moderation at 10–15%, revenue and PAT should grow at 20–25% v/s ~30% in the last five years. The company highlighted that fixed asset turnover has remained intact. However, capex/sq. ft. has increased significantly by >4x in the last five years as we believe new stores may be coming up in locations with higher real estate prices. With SSSG moderating and capex/sq. ft. increasing, ROIC could moderate to the high teens from upwards of 20% previously.
Valuation and view
We value DMart at an FY22E EV/EBITDA multiple of 42x, maintaining TP of INR2,000. The recent price correction, expectation of swift recovery post COVID-19, and continued cost/price competitiveness should hold the company in good stead. However, a) the growing scale of online retailers, including the prominence of deeppocket players such as Amazon and Reliance Retail, and b) the potential moderation in growth and the return profile may restrict a re-rating. Thus, we value DMart at a 35% discount to the three-year average EV/EBITDA multiple of 65x, implying 7% downside. We upgrade from SELL to NEUTRAL.
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