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Improved profitability led by cost management

* Avenue Supermarts (DMART)’s consol EBITDA/PAT grew 26%/24% YoY on strong store adds, with revenue coming in 35% above pre-COVID levels (3QFY20). Lower cost of retailing has aided a 60bp improvement in the EBITDA margin since the pre-COVID quarter (3QFY20).

* We factor in a robust FY22E–24E EBITDA/PAT CAGR of 46%, with a strong footprint addition – as we see limited impact on growth despite the COVID19 impact over the last 4–6 quarters. This enables the stock to operate at ~2x PEG. However, we are cognizant of the prominence of new-age grocery models and rich valuations. We maintain our Neutral rating, with TP of INR4,500.

Revenue up 22.2% YoY despite SSSG languishing

* Consolidated/Standalone revenue grew 22% YoY to INR92.2b/INR90.7b, as strong store additions aided a revenue jump to 34% above pre-COVID levels (3QFY20).

* Same-store sales growth (SSSG) continues to languish: With nearly 34%/48% store/footprint adds over the last eight quarters, SSSG works flattish against our expectation of 10%. This is largely due to a lower sales contribution from the General Merchandise and Apparel businesses, while Essentials and FMCG are faring better, as indicated by the management.

* Consolidated gross margins at 15.4% saw a minor 10bps contraction YoY (v/s est. 15.6%), largely on account of deterioration in the mix. Subsequently, gross profit grew 21.5% YoY to INR14.2b.

* Aided by revenue growth, EBITDA grew 25.7% YoY to INR8.7b (in-line), with a 30bp YoY margin improvement to 9.4%.

* PAT came in at INR5.5b, up 23.6% YoY (in-line), partly offset by lower other income, with PAT margins at 6% (+10bps YoY).

* Revenue at its subsidiary (DMart Ready) was up 39.7% YoY to INR1.5b (~2% of consolidated revenue), while EBITDA loss stood at INR17m v/s INR22m YoY.

Strong store additions; EBITDA margins improve v/s pre-COVID levels, aided by lower cost of retailing

* Store additions remained strong with 17 store adds (v/s est 9 store adds), reaching 263 stores in 3QFY22. It has now added 29 stores in 9MFY22, against our estimates of 30 stores for FY22 and the company guidance of 38 store adds. The strong store additions in 3QFY22 are in line with the ~70% additions seen over the past few fiscals in later part of the year.

* Cost optimization since the pre-COVID period improves EBITDA margin: The EBITDA margin in 3QFY22 improved 80bp/60bp on a standalone/consolidated basis from the pre-COVID quarter (3QFY20), primarily on lower cost of retailing. This offset the pressure seen on the gross margin due to weakness in the margin-accretive Discretionary category.

* The management indicated that overall gross margins were marginally lower due to mix deterioration. The General Merchandise and Apparel businesses are seeing a relatively lower sales contribution, while Essentials and FMCG are faring better.

Valuation and view

* Unlike other retail categories, grocery retailers such as DMART have seen a limited impact and swift recovery from COVID-19, with healthy margin improvement – as ~75% of the business remains non-discretionary.

* DMart’s remarkable 29%/44% revenue/footprint growth v/s 3QFY20 (pre-COVID levels) and cost optimization led PAT growth of 43.9% during this period have been remarkable.

* We expect DMart to deliver an FY22E–24E revenue/PAT CAGR of 38%/46%, factoring in an 18% footprint addition.

* However, online retail has grown in prominence in the last couple of years. Moreover, the market size has increased nearly 3–4x to ~INR400b, led by a) a significant change in the business model, b) the presence of deep-pocketed players (such as Amazon and Reliance Retail), and c) the overlapping of local markets. These factors have made us cautious considering DMART continues to focus on the brick-and-mortar model.

* The stock is trading at rich valuations of 72x/115x EV-to-EBITDA / P/E on FY23E, tracing the earnings growth trajectory. We maintain our Neutral rating, with TP of INR4,500, valuing DMART on FY24E EV-to-EBITDA of 52x (a ~20% discount to its three-year average multiple).

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