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Well placed for earnings revival

DMART has grown its revenues and earnings at a robust CAGR of 23% and 24% over the last five years. After growing the topline at this scorching pace and achieving a turnover of INR 430b, it has just about scratched the surface in our view. We believe it has a long runway for growth as the modern retail space is still in its infancy in India. Weak SSSG has weighed on DMART’s stock price performance in the recent past. In this report, we highlight key catalysts that can accelerate the growth from hereon and discuss our thesis for Rating upgrade.

Strong footprint addition in last few years

While most retailers found it difficult to expand their footprint in the last three years due to Covid, DMART, despite operating on an ownership model, clocked a strong 20% CAGR in area addition over FY20-23, translating into 19% revenue growth. However, SSSG was weak due to: 1) the addition of big stores in the last few years (average store size up 23% over FY19-23), which pulled down store productivity; and 2) weak discretionary demand in the value category, which reduced its share to 23% from 27% in FY20., However, we believe SSSG is set to recover in FY24, due to the following factors: 1) easing general inflation, along with RM cost reduction, may help to revive discretionary demand; 2) a change in the company’s store strategy — earlier smaller 30-35k sqft stores would mature in 3-4 years and see their SSSG peak out, so the company has started to open larger stores since FY19/20, which continue to contribute even after completing their 3-4 year cycles. Those stores are now in the base and will start contributing to store productivity, with further room to grow footfalls.

Good cost control in weak SSSG environment

Despite weak SSSG, DMART has managed to protect its EBITDA margin, unlike other retailers, which have seen a 200-450bp margin hit. DMART is one of the few retailers to have retained cost efficiencies achieved during the Covid period and benefited from the economies of larger stores. Gross margin was affected by the softness in the margin-accretive discretionary category, offsetting price inflation gains. Yet, it has managed to achieve EBITDA margin closer to the normal pre-Covid level. This is evident from its SG&A and employee costs, which declined 2% per sqft over FY20-23 to INR2,264 in FY23, cushioning the 2% drop in revenue productivity. When SSSG recovers, strong cost control could help DMART improve its margin by 30-50bp or pass on the gains to drive higher offtake.

Competitive position intact

Despite the recent aggressiveness of online/quick commerce platforms, DMART remains one of the most competitive grocery retailers, along with JioMart (Reliance Fresh), with 6% lower pricing (vs. average basket value of nine players) consistently over the last 12 months. As per our monthly grocery price monitor, in May’23, DMART at INR8,500 (basket value) was marginally above JioMart but was 8% cheaper than the pure-play online retailers (such as Zepto, Dunzo, Big Basket, etc.) highlighting its cost competiveness against the aggressive online players. As per our price monitor, four times in the last 12 months, it had the cheapest basket value with the widest breadth of the lowest price products. This looks commendable, as DMART has protected its margins, yet maintaining its competitive edge.

Online business – not burning cash but well prepared

DMart Ready has expanded its footprint to 22 cities with store metrics that are close to breakeven. It operates on the next-day delivery model, unlike other quick-service e-grocers, which have lower fill rates and delivery size, mostly catering to daily needs instead of monthly grocery orders. As per Redseer, the online industry reached a sizeable USD8b scale in 2022 and is expected to see a 33% CAGR over 2022-2025 (reaching USD19b by 2025), but most online players have found it difficult to achieve profitability. DMart Ready, on the other hand, has a wellmanaged model. Although it has not grown rapidly due to weak economics in the online business, it is prepared for any growth opportunities.

Long runway for growth

DMART’s well-oiled business model with a strong focus on low procurement costs, cost savings from supply chain efficiencies and rental savings through the ownership model has created a deep moat and a virtuous cycle of growth. In the food and grocery business with wafer-thin margins (15% gross margin), this helps create a highly competitive offering, thus pushing store productivity much ahead of peers and offering a long runway for growth. We believe DMART’s SSSG and earnings revision cycle are closer to bottoming out. Tailwinds from robust store additions and consistent cost efficiency could play a key role in SSSG recovery. Subsequently, we estimate a revenue/PAT CAGR of 27%/29% over FY23-25.

Healthy balance sheet and cash flow

DMart’s new stores in many virgin markets with an ownership model need lower investments and allow it to leverage growth for the long term. The lean working capital cycle and asset turns have enabled it to garner 18-20% ROIC consistently over the last five years (barring COVID impact). Its healthy annual OCF of INR11.7b/ INR21.8b in FY24E/FY25E should help to add 16% footprint through internal accruals, thus offering a self-funded long runway for growth.

Valuation and view: Reaching closer to sanity

DMart’s remarkable consistency in achieving industry-leading growth, margins and ROCE despite having a relatively asset-heavy model warrants rich valuations. In the last five years, it has traded at 60x EV/EBITDA and 99x PE. After a 25% correction since Sept’22, DMART is now trading at 36x EV/EBITDA and 58x PE on FY25E, which represents a 30% discount to historical multiples. This is mainly attributed to weak SSSG in the recent past. We believe that concerns about a growing online grocery market are unwarranted, as the share of both online and modern retail is miniscule in the total grocery market, and the market opportunity is huge. We believe SSSG improvements in FY24 should boost valuation multiples. We value DMART at 40x FY25E EV/EBITDA and an implied P/E of 64x on Jun’25 to arrive at a TP of INR 4,200. This reconciles with our three-stage DCF valuation, building long-term cash flows and assuming a 4% terminal growth rate and 11.5% cost of capital. We upgrade the stock to BUY.

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