Avenue Supermarts Ltd’s shares jumped almost 11% on the National Stock Exchange in morning trade on Monday, touching a new 52-week high. Avenue runs the DMart chain of stores. However, the stock gave up all those gains and fell by more than 6 percent later on.
This is after the September quarter results (Q2FY22) announced on Saturday were seen to be broadly better than analysts’ expectations. As such, some profit booking was expected, given the stock’s sharp run-up at a time when there hasn’t been a significant improvement in its business prospects. Note that the DMart stock had risen as much as 25 percent in October ahead of the Q2 results. So far this calendar year, the stock has appreciated by around 80 percent. Needless to say, valuations are expensive and, unsurprisingly, many analysts have made a note of that.
Also read: What should investors do with Avenue Supermarts stock
Edelweiss Securities Ltd analysts said in a report on October 16, “We are downgrading Avenue Supermarts (DMart) from ‘Hold’ to ‘Reduce’ as the stock’s recent run-up and valuation (92 times FY23E EV/Ebitda) have happened without any fundamental change in business prospects.”
EV is enterprise value and is a measure of a firm’s total value. Ebitda is earnings before interest, tax, depreciation and amortisation, a key measure of profitability for companies.
The brokerage added, “The massive opportunity in organised B&M (brick and mortar) grocery size is factored in, and a further re-rating is now dependent on significant strides in its online grocery operations or a step-up in store addition, neither of which is yet visible.”
In an October 17 report, ICICI Securities Ltd analysts said, “Extremely expensive valuations limit our willingness to have a constructive view; stock now trades at 128 times P/E on FY23E.” The broker has downgraded the rating on the DMart stock to ‘Sell’ from ‘Reduce’ with a target price of Rs 4,000 per share. For perspective, the DMart stock currently trades at around Rs 5,000 apiece.
Coming to the Q2 results, as the Covid-19-related lockdown restrictions eased further, DMart saw a good recovery in revenue, which increased by nearly 47% year-on-year (y-o-y). Revenue increased by 13 percent on a two-year compound annual growth rate basis.
Further, gross profit margins expanded to 14.3% after dropping to a multi-quarter low of 12.4 percent in Q1. Even so, the 25 basis points (bps) y-o-y improvement is a tad underwhelming. One basis point is one-hundredth of a percentage point. Margin outlook is decent, however. ICICI Securities said, “We believe that (1) sale of general merchandise would still not have recorded to pre-Covid levels and (2) the benefit of rising staples and FMCG prices is yet to be seen in margins.” FMCG is an abbreviation for fast-moving consumer goods.
DMart’s Ebitda margin expanded by 253 bps y-o-y to 8.8 percent. This represents a striking 436 bps increase sequentially. Even so, a large portion of the margin improvement can be attributed to cost efficiencies. Analysts at JM Financial Institutional Securities Ltd analysts pointed out, “Operating margin, though, is back to ‘normal’ levels (8.8%) without revenue or gross margin entirely getting back there, and this is due to heightened control on costs.” They added, “Total overheads grew just 11% versus two-year-ago levels despite store-counts being 30%+.”
Overall, DMart’s Q2 net profit of Rs 449 crore represents a 113 percent y-o-y increase, helped by a favourable base. Note that net profit was up 35 percent vis-à-vis the September 2019 quarter (Q2FY20).
DMart added eight stores during the quarter, taking the total count to 246. To be sure, the recovery momentum could well continue for DMart in the near future. Investors should watch how margins shape up. Even so, stretched valuations are likely to play spoilsport on further near-term appreciation in the share price.