Avenue Supermarts – perfect valuation limits upside despite picture perfect execution

Expansion

To augment its existing network of 141 stores (4.4 million sq. feet in total), D-Mart's strategy entails adding 15-20 new outlets every fiscal, primarily in western India, in a cluster-based format. This, in turn, will lead to a high inventory turnover, optimal warehouse management, and savings in logistical expenses.

Omnichannel foray

D-Mart acquired 50.8 percent in Avenue E-commerce Ltd, thus making it a wholly owned subsidiary of the company. By virtue of this move, D-Mart aims to improve its product delivery processes (in Mumbai, to start with) and garner more revenues through its 'D-Mart Ready' brand.

Operating leverage

D-Mart keeps its procurement costs low by sourcing products directly from suppliers. Consequently, the company benefits from economies of scale and reduction in selling prices, both of which not only increase footfalls but also translate to higher gross margins.

Debt repayment

As seen in the exhibit, capex for adding new outlets will be solely utilised from the IPO proceeds. Moreover, debt repayments worth Rs 216 crore should boost earnings.

Outlook

Undoubtedly, though D-Mart remains one of the strongest players in Indian retail, achieving consistent double-digit top-line growth on an already high base with the COCO (company owned company operated) store model will be a tall task given the aggressive outlet additions that it would necessitate.

Nonetheless, even if we consider an average operating income growth in the mid-20s, at 54x FY20 projected earnings, the company’s steep valuation seems to have factored in most of the positives. Therefore, accumulation on price corrections is recommended.

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