D-Mart: Margins disappoint; accumulate on dips

In Q2 FY19, topline grew sharply on the back of new stores, healthy traction at the same-store level and higher sale volumes. Due to stiff competition, prices were reduced across categories, which caused gross margin to contract.

This, in turn, impacted EBITDA (earnings before interest, tax, depreciation and amortisation) margin, notwithstanding the benefits of operational efficiencies. Higher depreciation charges (in respect of new outlets added), no significant reduction in financing costs, a sharp decline in other income and a marginal increase in tax rate year-on-year (YoY) led to a dip in bottomline margin.

Revenue drivers

Around 25-30 stores will be added each year in the coming years. Though the company has traditionally followed an ‘owned store’ model until now, it may consider adoption of the ‘leased store’ model too in connection with some outlets. Historical trends suggest that store additions tend to accelerate in H2 FY19.

D-Mart Ready, the company’s home delivery online platform cum order collection centre, is gradually expanding its reach from metros and tier 1 cities.

Margin drivers

Network expansion, in most cases, will be undertaken in a cluster format, wherein new stores will be situated 100-200 kilometres from the current ones. This will keep distribution expenses in check.

Efforts are underway to tweak the product mix in favour of non-food items since margins are higher.

Of the Rs 1,870 crore received through proceeds from its public offer back in March last year, Rs 181 crore will be utilised to repay long-term debt.

By consolidating its supply chain, procuring consumables (fruits, vegetables, dairy) directly from the source and paying suppliers quickly, the company will continue to optimise its working capital cycle.

Outlook and valuation

Network augmentation, supply channel consolidation, the ability to attract high store footfalls through the ‘everyday low cost, everyday low price’ scheme, debt reduction and robust fundamentals work in favour of India’s most highly valued retailer.

However, some risks should not to be overlooked. For instance, in food and grocery businesses, high operating margin, as seen earlier, may not be sustainable for extended periods of time since price sensitivity for such products is high at the buyers’ end.

The likes of Reliance Retail and Big Bazaar, among India’s financially strong retailers, have been rapidly upping the ante in terms of geographical expansion and aggressive pricing. Setting up new stores involves a high gestation period and a corresponding spike in overheads.

Though D-Mart is a robust brand in its own right, it remains to be seen as to how the company manages to gain incremental market share without any major dent in margins. Amid the ongoing volatility in the financial markets, the stock has seen a steep 20.5 percent correction from its 52-week high.

At 64 times its 2-year forward earnings, D-Mart’s valuations are substantially elevated compared to its peers (V-Mart, Trent, V2 Retail), whose operating margins are in a similar range. Given the limited room for re-rating and possibilities of margin moderation in due course, we advise buying on further declines.

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