Whose flywheel is broken?
The COVID-19 pandemic playing havoc in the high fixed cost retail sector is a foregone conclusion. More important is to assess which business model survives an extended version of the pandemic. This led us to assess multiple COGS of the proverbial retail flywheel: (1) store exposure to most impacted districts, (2) impact on GMs, cost of retailing and fixed cost cover, (3) fear-inflicted shifts in consumer behaviour and consequent habit formation and (4) selection and discounting trends. Note: We restrict our scope to the Food & Grocery (F&G) space in this report. DMART's (RECO: SELL) footfall pain is likely to spill over in 2Q as well, as (1) its store exposure to most affected districts remains high (67% of stores). Hence, footfall cuts are likely to remain steep, and higher AoVs will not be enough to make up for the footfall cuts. (2) Org. top-up formats were already struggling even pre-COVID; the pandemic is likely to cause further stress on their cost of retailing and respective cash cover for fixed cost absorption. Meanwhile, e-grocers have been scaling up nicely in some of these catchments.
* Soldier down – DMART most exposed, but well-covered: While most grocers are likely to see severe footfall cuts, our district-wise store map (~600 districts) on COVID-19 severity, population density and per capita income suggests that ~45% of D-MART's stores are located in seven of the most populated/impacted districts (Mumbai, Pune, Thane, Kalyan, Ahmedabad, Bangalore and Hyderabad). Also, D-MART's significantly higher footfall density per store (base) vs peers (2,824 bill cuts per store/day) likely means that the delta loss in footfalls, at least momentarily (1HFY21), will remain the highest among peers (note: D-MART's revenue declined 34% YoY in 1QFY21). That said, its recent fund raise makes it among the most well-capitalised grocers from a fixed-cost cover point of view, while peers remain precariously placed on this front.
* …Managing discounts well to restrict the bottom-line pain: D-MART has smartly reduced its discounts across its product portfolio to reduce the impact on profitability as, during the pandemic, assortment availability is likely to take precedence over value/discounts for a consumer.
* Is COVID-19 e-grocers' 'demonetisation moment'? Probably Yes! (1) Consumers' obvious predisposition for safety during the pandemic, (2) income uncertainty, (3) shift from unpackaged to packaged food and sporadic availability of national brands have fed into the surge in private label consumption across categories, (ergo, AoVs for e-grocers have spiked). Also, first-time users sampling e-grocer services have significantly jumped. We suspect the stickiness to the platforms once sampled is likely to be high. Note: AOVs for top e-grocers is up 40-50% in 1Q, giving a significant fillip to their unit economics (refer: a case study on Grofers).
* Pandemic to make organised F&G even more top-heavy: Online grocery purchases are likely to increase during the pandemic as consumers seek safety. This, in turn, is likely to put pressure on the cost of retailing for the industry as investments in online fulfilment capabilities increasingly becomes imperative. Most retailers today have bare-bone investments in the same, given (1) weak cash position, and (2) risk of bleeding further. Note: Most grocers don't make a profit spread in India. Hence, we expect the pandemic to expedite the process of consolidation in F&G.
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