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Food & Grocery

From a disruptor’s lens

The view from a disruptor’s lens is a salivating one as short of a few well-capitalised operators, the organised Food & Grocery ecosystem remains (1) profitless, (2) cash-strapped and (3) supported by increasing crutches (high gross margins, inefficient cost structures and increasing vendor support). Our read-through across the ecosystem suggests (1) the phase of capital dumping by global/domestic biggies may soon be upon us, (2) selection/pricing arbitrage vis-a-vis industry bellwether DMART continues to shrink, (3) margin cracks are imminent and (4) Reliance Retail-FRL combination could change the complexion of competition in top Indian districts.

* Capital dumping is likely to take center-stage: Global/domestic retailers Amazon, Walmart-backed Flipkart and Reliance Retail (refer link) have significantly strengthened their war chests for investments in 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. Fulfillment/supply chain investments of Amazon’s F&G unit (adj. for scale) is already >6x that of DMART’s (Comparison: DMART Ready vs Amazon). Former remains aggressive on footprint expansion.

* Margin crack for ecosystem is imminent: Over FY15-20, despite low competitive intensity, most organised grocers’ sales velocity (1-4% CAGR) has undershot inflation, signaling a gradual but structural footfall reduction. Most (1) continue to hide behind high gross margins as cost of retailing remains inefficient and (2) have bare-bone investments in online fulfilment capabilities. Moreover, as subsidised home delivery becomes table stakes, even the best (D-MART) may get arm-twisted into bringing a part of online fulfillment costs on their books (not factored in, remains a risk to estimates). Thus, the imperative to remain competitive (reducing GMs) + rising cost of retailing is likely to crack operational margins for the ecosystem over FY21-25.This has played out globally too (Walmart’s CY15-20 margin crack).

* Reliance + Future Retail > DMART in store density: Post integration and, if executed well, the Reliance Retail + FRL store network is likely to get nearly as dense as DMART’s (Refer table) in the latter’s key markets (HSIE: 48% of DMART’s stores, 65-70% of revenue). These markets are the most populated/over-retailed districts in India with high PCI. Hence, the rise in competitive intensity/price action and near-zero sourcing margin arbitrage seems to be a foregone conclusion. The high population density in these districts could help fulfill JioMART orders within controlled costs too.

* Meanwhile, well-funded e-grocers are scaling up nicely: Even pre-COVID19, e-grocers had been scaling up nicely. The concoction of (1) higher AoVs and GMs (3) lower CACs and (4) better national brands representation has changed the complexion of online grocers’ P&L during the pandemic.

* Survivors don’t offer any margin of safety: While consolidation in F&G is imminent, survivors (DMART) do not offer any margin of safety at 75x+ FY23 P/E. DMART’s growth is likely to be healthy (21/23/23% revenue/EBITDA/PAT CAGR), largely underpinned by network expansion. Alas, pressure on sales velocity and margins remains probabilistically high as deep-pocketed operators enter DMART’s key catchments. We maintain our SELL recommendation on DMART with a DCF-based TP: 2,160/sh – implying 34x FY23 EV/EBITDA + 2x FY23 sales for e-comm. Note: we currently have an SOTP-based fair value of Rs. 3,743bn for RRVL, implying 20x FY23 EV/EBITDA + 3x FY23 sales for its e-comm business.

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