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Delay in recovery of GM, apparel subdues margins…

About the stock: Avenue Supermarts (ASL) operates supermarket chain under the ‘D-Mart’ brand with 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+)

Q3FY23: D-Mart reported a weak operational performance with profitability coming below our/consensus estimates. Discretionary non-FMCG business (general merchandise & apparel), which yields better margins, continued to perform below expectations and led to a moderation of profitability

* Sales grew 25% YoY to | 11504 crore (three year CAGR: 19%)

* Discretionary product mix continues to be lower vs. pre-Covid levels leading to lower gross margins (down 60 bps YoY to 14.8%). Higher opex further impacted EBITDA margins, which were at 8.3% (I-direct estimate: 8.8%)

* PAT for the quarter came in at | 589.6 crore (up mere 7% YoY)

* The company added four new D-Mart outlets taking the total store count to 306 with total business area now at 12.6 million sq ft

What should investors do? ASL has been a consistent compounder with the stock price increasing at 27% CAGR in the last five years. However, since the last one year, the stock has delivered negative returns (~12%) owing to revenue trajectory tapering down a bit to 19-20% (vs. 25-30%) and product mix change leading to lower than expected margins. D-Mart continues to remain India’s most profitable low cost retailer, a strong play on India’s retail growth story and a key beneficiary of unorganised to organised segment shift. We introduce FY25E estimates and bake in earnings CAGR of 22% in FY23-25E (vs. CAGR of 24% witnessed in FY20-23E).

* We maintain HOLD recommendation on the stock

Target Price and Valuation: We value ASL at | 4000 i.e. 4x FY25E EV/Sales

Key triggers for future price performance:

* We anticipate store addition trajectory will accelerate and bake in 115 incremental store additions (addition of ~ 6.2 mn sq. ft.) in FY23-25E

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

* Recovery in GM & apparel segment (~25% of revenues) to shore up margins with subsequent improvement in RoIC: 24% (up 260 bps)

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

* We have a BUY rating with target price of | 1730/share

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