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RoIC improvement hangs on recovery of GM & apparel

About the stock: Avenue Supermarts (ASL) operates supermarket chain under ‘DMart’ brand with a core focus on value retailing. D-Mart, through its proven business model, has been able to maintain consistent profitability and remains an exceptional performer in its peer group.

* D-Mart has progressively enhanced its return ratios (RoIC: 20%+) despite being capital intensive (follows ownership model)

* Robust store operating metrics (breakeven in 18-24 months of its operations and one of industry best revenue/sq ft: | 30000+)

Q2FY23: D-Mart reported a subdued operational performance with profitability coming below our/consensus estimates in Q2FY23. Footfalls are yet to recover completely compared to the pre-Covid levels. This is causing a major hindrance for the recovery of its profitable segment (general merchandise & apparel).

* On tepid base, sales up 37% YoY to | 10638 crore (three year CAGR: 21%)

* Discretionary product mix continues to be lower compared to pre-Covid levels leading to lower gross margins (up 20 bps YoY to 15.1%). Higher opex further impacted EBITDA margins, which were at 8.4% (I-direct: 9.4%)

* PAT for the quarter came in at | 685.7 crore (up 64% YoY), aided by tax reversal in respect of earlier years (tax rate: 8.3%)

* Company added 8 new D-Mart outlets taking the total store count to 302 with total business area now at 12.4 million sq ft

What should investors do: ASL has been a consistent compounder with stock price increasing at 35% CAGR in the last five years. D-Mart continues to remain India’s most profitable low cost retailer and a strong play on India’s retail growth story and a key beneficiary of unorganised to organised segment shift. However, we believe current valuations captures most positives.

* Hence, we maintain HOLD recommendation on the stock

Target Price and Valuation: We value ASL at | 4900 i.e. 6x FY24E EV/sales

Key triggers for future price performance:

* We anticipate store addition trajectory to accelerate and bake in 80 incremental store additions (addition of ~ 4.6 mn sq ft) in FY23-24E

* Robust liquidity position and healthy operating cashflows to provide impetus to store addition pace (H1FY23 cash & investments: | 1200+ crore)

* We model revenue, earnings CAGR of 32%, 47%, respectively, in FY22-24E

Alternate Stock Idea: Apart from ASL, in our retail coverage we also like Trent.

* Inherent strength of brands (Westside, Zudio, Zara) and proven business model positions Trent as a key beneficiary of economy unlock theme

* We have a BUY rating with target price of | 1665/share

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