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Sign of improved performance; Rural pain still persist

* VMART delivered a healthy 2QFY23 performance, despite a weak market environment. Improved revenue productivity and margin drove revenue/ PAT growth of 50%/2.6x YoY (27% revenue growth excluding Unlimited), backed by higher prices and tailwinds from the growth in South India.

* The pain in rural India, coupled with a slow onset of the winter season and abrupt rainfall (which resulted in a crop damage), will persist over the next few quarters. We have factored in a revenue/EBITDA CAGR of 37%/49% over FY22-24. The turnaround in the rural business, with price corrections, will be key. We maintain our Buy rating.

EBITDA improves by 450bp; Unlimited continues to see good traction

* Revenue grew 50% YoY and 60% from 2QFY20 levels (pre-COVID) to INR5.1b (in line). This was led by: a) revenue contribution of 21% from Unlimited stores in 2QFY23, and b) 10%/70% new store additions in VMART Consolidated in 2QFY22/2QFY20.

* Revenue, excluding Unlimited, grew 27% over 2QFY20 levels to INR4b, whereas total stores stood at 326 (38% rise over the same period).

* Revenue per sq. ft. was still 7% below pre-COVID levels at INR1,450 in 2QFY23. In 1QFY23, the same was 25% below pre-COVID (1QFY20) levels. Hence, the gap has now shrunk to 7% in 2Q v/s 25% in 1QFY23.

* Gross margin expanded by 560bp YoY and 510bp from 2QFY20 levels to 36.3% (360bp above our estimate) due to higher margin in Unlimited and the recent price hikes.

* Gross profit improved by 77% YoY and 88% from pre-COVID levels to INR1.8b (12% above our estimate).

* Controlled employee and other expenses resulted in an 160% YoY (370% from 2QFY20 levels) improvement in EBITDA to INR536m (notable beat).

* EBITDA margin improved by 700bp from 2QFY20 levels and 450bp YoY to 10.6% in 2QFY23 (490bp beat).

* Finance cost doubled to INR279m from 2QFY20 levels (13% beat).

* Net loss reduced to INR113m (est. INR240m) from INR141m/INR180m in 2QFY22/2QFY20.

* VMART opened 16 new stores and closed two stores in 2QFY23, taking its total store count to 405. New store additions stood at 12/2 for VMART/Unlimited in 2QFY23, taking its total count to 326/79 stores.

Highlights from the management commentary

* Inflation is still impacting demand from Tier II, III, and IV cities. Geographically, the eastern belt of India, including eastern Uttar Pradesh, is struggling. However, the response from South India remains good.

* Unlimited posted LFL sales of 15-16% YoY, led by a better demand environment in South India, v/s 10% for VMART. The management is targeting 55-60 store additions in FY23.

* Out of the ASP increase of 27%, 20% is higher prices and 7% is mix improvement due to Unlimited. The management expects to garner a gross margin of 33-34% on account of higher prices.

* The company will not be spending more than 15-20% of EBITDA in the LimeRoad business, and has laid out plans for the next four years.

Valuation and view

South India constitutes 20% of the sales mix, aiding growth and margin. However, pain in East India persists. With a cut in the average selling price, the festive and upcoming winter season can usher a revival in demand.

* We have revised up FY23/FY24 EBITDA estimate by 12%/4%, building in a revenue/EBITDA CAGR of 37%/49% over FY22-24, backed by a recovery in demand and strong store additions.

* In the medium to long term, given the huge growth opportunity in the Value Fashion segment and VMART’s strong execution capability, it has the potential to sustainably garner double-digit revenue growth for a prolonged period, backed by SSSG and new store additions.

* It has a strong competitive position, given its low price points, cost leadership, strong liquidity, and prudent inventory management.

* We arrive at our TP of INR3,950, assigning 18x EV/EBITDA on a Mar’24 basis. We maintain our Buy rating.

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