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METRO Cash & Carry - A good deal at a reasonable valuation

Reliance Retail Ventures Limited (RRVL) recently announced the acquisition of 100% stake in METRO Cash & Carry India Private Limited (METRO India). Below are the key highlights of the proposed transaction:

Deal contours

RRVL, a subsidiary of Reliance Industries Ltd, announced signing of a definitive agreement to acquire 100% equity stake in METRO Cash & Carry India Pvt. Ltd. for a cash consideration of INR28.5b. This implies a valuation of 0.4x EV/Sales and 22x EV/EBITDA on an FY22 basis, which is at a significantly better valuation compared to previous acquisitions in the grocery space at ~1x EV/sales.

Metro a stable company at close to breakeven to contribute ~15% of topline

* Metro has a revenue/EBITDA of INR70b/INR1.3b with a net loss of INR0.5b. This is expected to add ~15% to the current B2B and grocery segment for RIL (estimated to be about INR450b in FY22).

* Although the company has been present in India since 2003, it has not been able to significantly increase its footprint over the last five to seven years. Over FY19-22, it has grown revenue merely at 2%, garnering about 11% gross margin and 2% EBITDA margin (FY20-22) with a net loss of INR200-500m. Further, it has added only six stores in the last four years over FY18-22. While the format has remained closer to break-even levels, with a loss of INR0.5b in FY22, RIL can turn the segment profitable through improved scale and synergies/efficiencies across supply chain networks, technology platforms, and sourcing capabilities.

Acquisition to help improve the reach

Reliance has about 52 B2B stores branded as “Reliance Market” stores, catering to the kiranas and other institutional customers. Through this acquisition, Reliance Retail would get access to an additional 31 large format stores of METRO India located in prime locations across key cities. This would drive up Reliance’s store count to 83 in addition to getting a large base of registered kiranas and other institutional customers of over 3 million, out of which, 1m are frequent customers.

Additional impetus to new commerce and FMCG

The acquisition should further strengthen RRVL’s new commerce with increased footprint, adding logistics advantage. Reliance Retail’s recent foray into FMCG business would get further impetus with an estimated revenue scale of over INR600b in FY23. Metro too has a wide range of own brands that should add value to the business.

Valuation

Assuming that Metro Cash and Carry can achieve about ~7% (Pre IND-AS 116) EBITDA margin, under Reliance Retail’s fold, it could add enterprise value of INR167.5b at 40x EV/EBITDA (Reliance Retail SOTP) after adjusting for INR28.5b cash consideration. This adds about 2% to overall Reliance market cap. This could also add significantly to its improved reach and ability to serve customers. We reiterate our Buy rating on the stock with a TP of INR2,875 on SOTP basis, valuing a.) the Refining and Petrochem at INR724/share (7.5x EV/EBITDA), b.) RJio at INR960/share (18x EV/EBITDA) and c.) Reliance Retail at INR1271/share, adjusted for minority stake sale on one year forward basis.

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