Shishir Asthana Moneycontrol Research
Avenue Supermarts, better known by the D-Mart brand of stores that it runs, broke many records on the day it listed, bestowing more than 100 percent in returns to the lucky few who were allotted shares. But the key question in the mind of investors is: How justified is this valuation?
Based purely on price to earnings valuation, it would take a brave heart to buy the stock at current levels. At a price of Rs 645 the stock is trading at 77 times it current fiscal’s profit. At these levels there is very little margin of safety for the investors. It is highly doubtful that the canny investor Radhakishan Damani, who turned retailer as the promoter of Avenue Supermarts, would have picked up a company at these valuations.
Many experts have been quoted as saying that the share price is unlikely to come down anytime soon. But that does not mean that it might go higher, the stock can remain in a range till fundamentals catch up with the stock price. This has been observed in other IPOs which tapped the market at high valuations as in the case of diagnostics companies like Dr Lal Pathlabs and Thyrocare Technologies.
A reason for companies like D-Mart and the diagnostic players getting a higher valuation is probably because there are few other players in the space they operate in. Thus long-term investors are willing to chip in on a regular basis to keep the price out of the reach of smaller investors who generally do not have the patience to wait it out.
In the case of D-Mart too, the nearest competitor, Kishore Biyani’s Future Retail, is nowhere as efficient as D-Mart though it’s a much bigger player with various formats of retail stores. Despite being the poster boy of organized retail for a long time, Future Retail’s operational efficiency is nowhere close to that of D-Mart’s.
Take a look at inventory turnover ratio, a measure which tells how many times the goods on the racks are churned in a year. For D-Mart the ratio stands at 14 times while for Future Retail, based on the merged entity numbers in a Morgan Stanley report it is only two times. This means that while D-Mart is replenishing its stock every 26 days, Future Retail does it every six months.
So is Future Retail earning a high margin by holding on to its inventory for such a long time? Not really. Future Retail enjoys an operating margin of 3.2 percent as compared to 7.9 percent for D-Mart. Rental expenses eat away most of the margin for Future Retail as compared to D-Mart which prefers to acquire and build its own malls rather than use rental space.
But how good is Future Retail in using its huge mall space? Future Retail earns a revenue of nearly Rs 13,000 per square metre off its retail space, while D-Mart earns Rs 24,000 per square metre.
So does Future Retail have a better debt-equity ratio than that of D-Mart? Well, they are comparable. For FY17 Future Retail has a debt-equity ratio of 0.6 while that of D-Mart is 0.7. However, D-Mart will be using the proceeds of this issue to retire most of its debt. They ratio will then be skewed considerably in favour of D-Mart.
For an investor the ultimate number to be monitored is the return on equity (RoE) which measures the ability of the company to generate profit from its shareholders investment. Here too, D-Mart scores over Future Retail. As compared to a RoE of 15.5 percent for Future Retail, D-Mart has a RoE of 21.1 percent.
In terms of valuation, analysts expect Future Retail to post an EPS of Rs 7 for the current fiscal, discounting its current price of Rs 263 by 37 times as compared to 77 for D-Mart. But D-Mart has a faster growth rate and a more efficient business model which will always give it a premium over other players.
A similar valuation difference is visible in airline space. Interglobe Aviation (IndiGo), an efficient player in the sector, trades at a historic PE of 17 as compared to Jet Airways, an all-service airline, which has a PE of 9. Markets always give a better rating for an efficiently managed company. It seems the valuations difference between the two retail companies is here to stay, unless Future Retail tightens its belt.
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