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Gross margin disappoints amid a steady revenue recovery

* The revenue recovery in DMART has been much better than that during the previous lockdown, growing 33% YoY (13% below pre-COVID levels). Gross margin declined by 110bp YoY, despite the base quarter having seen a severe impact on the margin accretive Discretionary category due to COVID-19.

* We have largely maintained our estimates and expect a buoyant recovery from 2QFY22 onwards, factoring in 24% revenue/PAT CAGR over FY20-23E. We see a limited upside given the rich valuations. We maintain our Neutral rating.

YoY performance much better in 1QFY22

* Consolidated revenue grew 33.5% YoY to INR51.8b. Standalone revenue stood at INR50.5b, 13% below pre-COVID (1QFY20) levels and 5% below our estimate. Adjusting for 46% footprint additions (54 store additions) in the last eight quarters, LTL revenue is estimated to be 60% of 1QFY20 levels.

* We estimate non-Discretionary (Food and non-Food FMCG, 77% mix)/Discretionary revenues to have recovered to 95%/ 60% of pre-Covid levels (1QFy20), respectively, much better than other Apparel retailers.

* Gross profit grew 23% YoY (29% below pre-COVID levels), but gross margin fell 110bp YoY to 13.1% (est. 15.4%). This is disappointing as the base quarter (1QFY21) saw a severe impact on the margin accretive Discretionary category due to COVID-19.

* EBITDA rose 100.6% YoY to INR2.2b (26% below our estimate and 62% below pre-COVID levels). EBITDA margin improved 140bp YoY to 4.3% (160bp below our estimate).

* PAT rose 137.9% YoY to INR0.9b (45% below our estimate). PAT margin stood at 1.8% (+81bp YoY) due to a weak gross margin.

* DMART added four stores during 1QFY22 v/s our expectation of two stores. Our expectation for FY22 is 30 stores, implying an additional 26 stores over the next nine months.

Recovery in place

* Our channel checks suggest that the non-Discretionary category has seen a healthy recovery to nearly pre-COVID levels once the lockdowns was lifted.

* DMART may target 39 store additions in FY22: The management had indicated that it will add 59 stores over FY20-22. It has added 20 stores in FY21. It may look to add 39 stores in FY22, implying 35 store additions over the next nine months, provided there are no further restrictions.

* The management indicated that inventory levels are gradually normalizing. It believes that a store needs at least 45 days of unhindered operations to return to pre-COVID sales momentum.

* Revenue for its subsidiary (D-Mart Ready) has grown by ~2x YoY to INR1.5b, (~3% of consolidated revenue), with EBITDA turning profitable at INR30m.

Valuation and view.

* We expect DMART to deliver FY20-23E revenue/PAT CAGR of 24% each, factoring in 30/40 store additions and ~50% SSSG in FY22E/FY23E. Unlike other retailers, grocery retailers like DMART have seen a swift recovery once COVIDrelated restrictions were lifted and a healthy margin improvement.

* The stock is trading at rich valuations (55.3x FY23E EV/EBIDA and 87.4x FY23E P/E).

* Expensive valuations; risk of a moderation in growth, owing to strong traction for online retailers in a post-COVID world; and the presence of deep pocket players like Amazon and Reliance Retail restricts the near-term upside.

* We value DMART at 52x FY23E EV/EBITDA (which is around its average multiple of ~57x). We retain our Neutral rating and TP of INR3,220 per share.

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