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To focus on growth, expand the e-commerce business

DMART hosted an analyst meet to discussing the ongoing market conditions, its new larger store strategy, remodeling of ecommerce business and the growth outlook

Is the sluggish recovery or higher store sizes hurting sales productivity and gross margin?

Revenue/sq. ft. has been sluggish (-8% CAGR) over the last three years. The management sees little cause for concern as the Mass Discretionary segment (27% of revenue) is yet to fully recover. It appeared optimistic that high bill values have partly compensated for the lower footfalls and cut in bill sizes. The higher store size has pulled down revenue productivity, but it gives DMART an opportunity to increase product offerings to the mass value customer, thus increasing its wallet share. It also offers a longer term growth visibility. Being on an ownership model, the lower revenue/sq. ft. in the initial period is less concerning as the benefits of long-term high ROIC far outpace the lower throughput

In no hurry to scale up its online presence

Despite the mushrooming of several Online Grocery players, with some achieving sizeable scale, the management appears in no hurry to scale up its online presence. The Online segment attracts both value and convenience-oriented customers. DMART continues to focus on the value customer, through its pricing and product offering. Even though it is yet to turn profitable, the management is now much more constructive on the business, with plans to: a) build new fulfillment centers in close proximity to debottleneck capacity, b) emphasize on home delivery wherever viable, and c) drive scale to improve economics in the Online Grocery business. It also plans to leverage its offline store locations and sourcing strength to drive unit economics. However, it is yet to see clarity on profitability. The management doesn’t believe this has impacted its offline store business.

Building internal capabilities to drive store additions, but wary of changing market conditions

The last few quarters have seen strong store additions, ahead of our estimate, despite the COVID-led disruptions. The last five years too saw an increase in the number of store additions to maintain the pace of growth. The management acknowledged that with scale this can be a challenge, given the changing Real Estate market dynamics, even it has built internal capabilities. It targets higher store additions going forward. We have factored in cumulative store additions of 135 stores over FY22-24E, at a footprint CAGR of 18%.

Long-term margin trends to be maintained

Gross margin has not fully recovered in 1QFY23, down 10bp from pre-COVID levels (1QFY20), due to a sluggish performance in the Discretionary category. The management said the same may be capped at 15% over the long term. The lower cost of retailing at present has partly insulated the impact of lower revenue productivity, but margin can recover as revenue reaches normalized levels.

Key highlights from the management interaction

* The recovery in the Merchandise and Apparel segment remains muted as the Mass product category sees a postponement in demand due to spending pressures. The management expects a promising recovery within this segment as the situation normalizes.

* The management plans to expand its e-commerce presence in smaller cities by focusing on the home delivery model and using its physical infrastructure (offline stores) as pick-up points.

* The pace of store additions continues as the company identifies various expansion opportunities. DMART will focus on opening larger format stores.

Valuation and view

* The strong growth in DMART’s footprint and cost optimization has led to a healthy EBITDA/PAT CAGR of 15%/18% over FY19-22.

* Revenue per sq. ft. remains under pressure due to the impact of inflation on the Discretionary category and higher store sizes.

* We factor in an EBITDA/PAT CAGR of 37%/50% over FY22-24, with a footprint CAGR of 18%.

* We are cognizant of the prominence of new-age grocery models, rich valuations, and weak revenue/sq. ft. over the last few quarters. Subsequently, we maintain our Neutral rating with a TP of INR3,740.

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