One company that has caught the fancy of investors over the past year has undoubtedly been Avenue Supermarts. Avenue Supermarts runs the hugely popular discount retail chain Dmart. Owned by the famed and astute investor Radhakishan Damani, the company prides itself in selling items below the MRP price. Yet the company has been able to show consistent profit year after year increasing the shareholder value. Taking a leaf out of the promoter’s mindset, the company strongly believes in being frugal and yet provide a satisfying buying experience to its customers. Let us now look at some of the interesting and fascinating aspects of the company.

Business Model

For an investor to analyze, retail has one of the simplest business models among the different investable sectors. A retailer buys products from distributors and manufacturers at a lower price and sells these products to customers at a higher price. A retailer doesn’t need huge manufacturing capacity or capability. He does not need specialized skills that necessitates skilled manpower. Neither does the company need to be on the cutting edge of technology or acquire/develop patents to protect its IP. An astute management of costs and inventory should see the company perform well for decades. However this is easier said than done. Let us now look at the business model of the company. The business model depicted and described below is my way of looking at the company. It need not reflect the company’s/Management’s/Promoter’s view.

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  • Customer Segments: Avenue Supermart currently caters to urban and Semi urban customers in two major states namely Maharashtra and Gujarat. Additionally it has sizeable presence in Karnataka, Telangana and Andhra Pradesh. The company has minimal presence in Rajasthan, MP, Chhattisgarh, NCR, Daman and Tamilnadu. The company believes in concentrated expansion. 70-75% of new stores are opened in the vicinity of existing stores and 25-30% are opened in new areas. This helps the company in managing its warehouse and inventory in an efficient manner.
  • Value Proposition: Avenue Supermarts operates on the concept of discount retailing on the same lines as that of Walmart and calls it EDLC/EDLP i.e. Every Day Low Cost/Every Day Low Price. The concept being that Dmart will offer products to the customers at a lower price (below the MRP) every single day. In order to make this offer, the company will try to negotiate with distributors and manufacturers and buy the products way below the MRP price. So Every Day Low Price is achieved by lowering the cost rather than taking a hit on the profits. Which means profits are not sacrificed to attain higher revenue. The company also strives to provide variety by offering a plethora of choices in all categories of products and maintain a certain level of quality in its offerings.
  • Channels: Most of the sales for the company are realized via the Brick and Mortar stores (aka offline sales). As of FY17 the company has 131 stores through which it sells the products. Realizing the importance of online sales, the company has started selling items online on dmart.in.
  • Customer Relationships: Customers have minimal interaction with the employees of the Dmart store. People know what they want to buy and they are adept at finding the items in the mart. One will find the employees mainly engaged in two activities (a) Arranging items on the shelf and packing/tagging loose food items (b) Billing the items at the cash counter. Customers do not expect any special assistance from these employees. This becomes quite apparent when you visit any Dmart store. You will notice that most of the employees are busy arranging items on the shelf or helping with weighing and packing loose food items. Few employees would be at the checkout counter and would be billing the items. Many a times you will not see any employee being available to put the items into customer’s bags post the billing process. The customer generally ends up filling their own bags.
  • Revenue Streams:
    • Store based retail: In case of the offline stores, Dmart earns roughly 54% of its revenue by selling food and grocery products. This includes dairy items, groceries, processed foods, frozen foods, beverages etc. About 20% of the revenue is earned by selling non-food FMCG products like home care products (ex: toilet cleaner, bathroom cleaners etc.), personal care products (like shaving creams, lotions etc.), toiletries (ex: Soaps, shampoos, hair oils, tooth paste and brush etc.) and about 26% of the revenue is obtained by selling general merchandise and apparel.

It is intuitive that people spend more on the daily essentials like food and grocery. A research done by Technopak [1] indicates that for the foreseeable future, food and grocery shall remain the major expenditure for the Indian consumers as shown in the table below:

Retail Category Percentage of Total expenditure by Year 2020 (%)
Food and Grocery 66%
Jewelry and Watches 8.05%
Apparel and accessories 7.75%
Consumer Electronics 6.6%
Home and Living 4.35%
Pharmacy and Wellness 2.95%
Footwear 1.2%
  • Online retail: The Company has a website (dmart.in) where people can buy items of their choice. The prices are comparable to those found in the Dmart stores. Currently the online sales are limited to Maharashtra. Hence online footprint is very limited. People have two options to get their items delivered.
    • The first option is called Pick Up Point (PUP) model. The company has currently setup about 40 small shops (of probably around 200 to 600 sq. ft.). Customers can choose one of the shops and their items would be delivered to this shop. Customers can then collect the items from the chosen shop. Customers are not charged any delivery charges if they opt for this option.
    • The second option is the home delivery option. Customers can get the items at their doorstep. However they are charged some amount as delivery charge.
  • Cost Structure: The Company incurs both CAPEX as well as OPEX as a part of its operations.
    • OPEX: The major OPEX is the cost incurred in buying the items from manufacturers/distributors. The other OPEX is the interest expense. Before the company went public, it had a debt of about Rs. 1500 cores hence its interest costs were higher. With partial payment of loans from the proceeds of IPO, the interest costs have come down. The third part of the OPEX is the employee cost. Other than the staff required to run the corporate office and other important functions, the company appears to have outsourced most of its manpower needs at the store level to a 3rd party agency. This has ensured that its employee expenses do not significantly impact the EBITDA.
    • CAPEX: The Company strongly believes in either owning its stores or taking them on a long term lease (30 year lease). Generally when a mart is taken on rent by a retailer, the rentals keep increasing every year. This increases the expenses and puts a pressure on the margins. However, when the company owns the retail space, it is immune to such variables. Hence, Avenue Supermarts has opted for a CAPEX intensive, company-owned retailing model instead of an OPEX heavy rental based model.

Dmart Retail Store Analysis

Now let us look at some numbers related to the retail stores that Dmart operates. These numbers form the bedrock for the P&L numbers for Dmart.

Expansion Track record:

The following numbers capture the growth attained by DMart (with respect to its stores) over the past few years.

  • Store Count: The most important metric for the company is the number of stores. More the number of stores more the sales and hence more the revenue and profits. Since the company owns most of the stores, it has to make a calculated judgement on the viability of constructing a new store. The company looks at the following items while zeroing on a location for its new store [1]: Population density, customer traffic and vehicular traffic, customer accessibility, potential growth of the local population and economy, area development potential and future development trends, estimated spending power of the population and local economy and payback period, estimated on the basis of expected sales potential, strategic benefits, proximity and performance of competitors and store site characteristics. The table below lists the store count over the past six years. We can clearly see that over the past 4 years the company has consistently increased the number of new stores opened by it.
  FY12 FY13 FY14 FY15 FY16 FY17
New Stores opened in the FY 10 7 13 14 21 21
Total Number of Stores at the end of FY 55 62 75 89 110 131

 State wise store count break Down: The table below shows the store breakdown for the top 4 states over the past six years. Clearly the concept of concentrated expansion is visible here. The priority has always been Maharashtra and Gujarat. Other states are slowly joining in.

  FY12 FY13 FY14 FY15 FY16 FY17
Maharashtra 34 40 46 50 58 60
Gujarat 14 14 17 22 26 29
Telangana + Andhra Pradesh 4 5 7 10 16 20
Karnataka 3 3 5 5 6 11

It is quite natural for one to wonder why the company has concentrated majority of its branch expansion plans to these select few states. As noted above the company decides to open its branches based on  population density, potential growth of the local population and economy, area development potential and future development trends, estimated spending power of the population and local economy and payback period. Additionally Technopak research [1] provides an insight into the spending pattern of customers across different states. The table below captures these details. From the table it is quite clear that Maharashtra leads the pack. What puzzles me is the fact that UP and Tamil Nadu show significant spending, yet Dmart has no presence in UP and negligible presence in Tamilnadu.

 State Retail Spending in 2016 (US $ billion)
Maharashtra 94
Gujarat 39
Telangana + Andhra Pradesh 49
Karnataka 40
UP 44
Tamil Nadu 49
West Bengal 29
  • Retail Business area: As the store count increases the total retail space increases as well. The table below captures the increase in cumulative store space. We can notice that with every passing year the company has been increasing the total retail area at a faster pace.
  FY12 (in Million Sq Ft) FY13 (in Million Sq Ft) FY14 (in Million Sq Ft) FY15 (in Million Sq Ft) FY16 (in Million Sq Ft) FY17 (in Million Sq Ft)
Total Retail business area 1.55 1.76 2.14 2.66 3.33 4.06
New Area Added during the FY 0.21 0.38 0.52 0.67 0.73
  • Revenue per Sq. Ft of Business area: Now, increasing the retail space automatically increases the revenue. This fact is a no-brainer. But the kicker is when the company is able to earn more per square feet of the area. From the table below we can observe that the company is able to achieve higher revenue per sq. ft. every single year over the past six years! It means two things: (a) More people are coming to Dmart store thereby increasing the revenue per sq. ft. and/or (b) People are buying more items and hence there is an increase in revenue per sq. ft.
  FY12 (in Rs.) FY13 (in Rs.) FY14 (in Rs.) FY15 (in Rs.) FY16 (in Rs.) FY17 (in Rs.)
Revenue from sales per Sq. ft. of the mart space 15,324 20,116 23,419 26,388 28,136 31,120
Growth in revenue per sq. ft. (%) 31.27% 16.41% 12.67% 6.62% 10.6%

Inventory Turnover Ratio:

A very important metric for a retail company is the inventory turnover ratio. This is the ratio of revenue to the average inventory. Let us assume that the revenue for a company is Rs. 10,000 and its average inventory is also Rs. 10,000. The Inventory turnover ratio is 1 which means in the entire year the company was able to sell each of its product only once. On the other hand if the revenue of the company was 90,000 and the average inventory was Rs 10,000 then the inventory turnover ratio was 9 which means the company was able to clear off its inventory 9 times during the year. So higher the inventory turnover ratio, more is the sales for the company. The table below shows the inventory turnover ratio for the company over the past few years. The table also shows the number of days for which the inventory was in hand (i.e. in the store). This value averages around 25 days. Hence, on an average, the entire inventory is emptied once every 25 days.

  FY13 FY14 FY15 FY16 FY17
Inventory turnover ratio 15 15 14.4 14.4 14.9
Inventory on Hand (in days) 24.3 days 24.3 days 25.3 days 25.3 days 24.5 days

P&L Analysis

Let us now look at the P&L numbers for the company. The table below shows the numbers for the past five years. The revenue growth has been decent and in mid-thirties. EBITDA growth has been in forties and PAT growth has been impressive and is in fifties. Even the numbers for H1 FY18 have been pretty decent and the company has managed to retain the PAT growth in the fifties. Heartening to see a discount retailer making very healthy profit growth consistently for the past five years.

The most interesting numbers are the EBITDA margin and the PAT margin. Over the past five years leading up to H1 FY18, the EBITDA margin has increased by close to 190 bps to 8.73%. The PAT margin on the other hand has increased by 236 bps. By the way we should also note that the operating margin (i.e. EBIT) for Q2 FY18 was 8.61%. For a discount retailer who strives to provide 6% discount over MRP, achieving an operating margin of 8.61% after factoring in all the store level discounts is indeed noteworthy!

FY13 FY14 FY15 FY16 FY17 FY18 (H1)
Revenue (Crores) 3,327 4,670 6,419 8,575 11881 7,106
Revenue Growth (%) 40.36% 37.45% 33.58% 38.55% 30.8%
EBITDA (Crores) 227 354 474 677 995 621
EBITDA Growth (%) 55.94% 33.89% 42.82% 46.97% 32.8%
EBITDA Margin (%) 6.82% 7.58% 7.38% 7.89% 8.37% 8.73%
PAT (Crores) 93 160 211 318 483 366
PAT Growth (%) 72.04% 31.87% 50.71% 52.88% 56.3%
PAT Margin (%) 2.79% 3.42% 3.28% 3.70% 4.06% 5.15%

Balance Sheet Analysis

Let us now look at the assets and liabilities for Avenue Supermart over the past five years. I am listing only the important items in order not to delve over minor items or items of non-interest.

  FY12 (Crores) FY13 (Crores) FY14 (Crores) FY15 (Crores) FY16 (Crores) FY17 (Crores)
Liabilities
Shareholder funds (Share Capital + reserves + Surplus) 681.69 789.54 955.58 1199.22 1520.42 3841.78
Long Term Borrowings 264.32 371.16 456.83 713.77 908.46 980.92
Short Term Borrowings 63.33 62.36 54.65 43.68 129.69 138.84
Trade Payables 64.36 94.38 122.58 118.5 191.8 260.66
Other Current Liabilities (including financial liabilities like term loans and NCDs maturing in the current FY) 89.77 134.60 170.13 215.03 276.99 527.39
Assets
Tangible assets (Marts, machinery, Fitouts) 777.29 921.58 1168.06 1524.08 2089.17 2543.93
Capital work in progress (Tangible assets) 84.93 118.10 88.78 98.11 81.68 152.89
Long Term Loans and advances 35.52 52.62 42.58 80.16 107.36 ~ 88
Inventories 195.73 276.22 378.32 539.60 671.86 947.90
Current Assets (Bank Balances) 47.91 61.61 55.41 38.84 35.09 1884.27
  • Liabilities:
    • Shareholder funds: With respect to liabilities, the major liability for the company has always been the Shareholder funds. For the company it is a liability but with respect to shareholders, to an extent, it adds comfort as shareholder equity contributes to the net worth of the company.
    • Long Term Borrowings: As the company has grown over the years the long term borrowings have increased as well. The borrowings would include both term loans and the NCDs. The borrowings are generally done to buy real estate, build the marts and buy the fitouts for these marts. In FY17 the borrowing seem to have tapered down. However this might not give a true picture because, if you look at other current liabilities they have suddenly spiked in FY17. So essentially, many term loans and NCDs would have matured in FY17 leading to an increase in the current liabilities.
    • Short term borrowings: The short term borrowings (to meet the working capital requirements) have always been less for the company.
    • Trade Payables: Trade payables number is merely a snapshot of a particular day when the data was sampled. Hence one cannot infer much from these numbers. The trend however indicates that as the company has grown, its liability to pay to its vendors has also increased.
    • Other Current Liabilities: This pre-dominantly would include the term loans and NCDs that shall mature in that particular financial year.
  • Assets:
    • Tangible assets: Tangible assets includes the stores, machinery and the fitouts within the stores. These tangible assets form a major part of the total assets of the company. The numbers below show the percentages:
      • FY12: Tangible assets (of 777.29 crores) makes up 65% of total assets (1190.8 crores)
      • FY13: Tangible assets (of 921.58 crores) makes up 61% of total assets (1492.1 crores)
      • FY14: Tangible assets (of 1168.06 crores) makes up 64% of total assets (1807.6 crores)
      • FY15: Tangible assets (of 1524.08 crores) makes up 64% of total assets (2354.8 crores)
      • FY16: Tangible assets (of 2089.17 crores) makes up 67% of total assets (3100.01 crores)
      • FY17: Tangible assets (of 2543.93 crores) makes up 43% of total assets (5822.51 crores). Note that FY17 numbers are an aberration because the assets increased due to the money received from the proceeds of IPO.
    • Capital work in progress: Again this number is due to the current construction, commissioning of new marts. So these numbers would eventually add up to the tangible assets.
    • Long Term loan and advances: I am assuming these are the loans given to vendors and other similar items.
    • Inventories: This is self-explanatory. This again is a snapshot of that particular day when the inventory related data was sampled. However the trend of the numbers over the years indicates that the company has been stocking more items as it has grown in size.
    • Current assets (Bank Balances): I would not have added this item for analysis as the amount is not very significant. However the FY17 numbers skewed up the value. Current assets suddenly increased in FY17 due to the IPO proceeds received by the company. I believe this value should drop by the end of FY18 and slowly come down further as the IPO proceeds are utilized by FY20.

In summary, the liabilities are predominantly shareholder funds and few borrowing (that should come down as loans are repaid using IPO proceeds). The assets are predominantly the tangible assets and inventories. Overall the balance sheet looks very healthy.

Cash Flow Analysis

In the entire analysis of Dmart, the only place where I felt uncomfortable was the cash flow analysis. To me, the numbers right from FY12 till FY17 were NOT good. The company seems to have positive cash flow but the main contributor to this is actually the borrowings either as a term loan or NCD or commercial paper. I think towards the end of FY17 the company reached a point where its borrowings became uncomfortable and hence, I believe, the company might have been forced to go for an IPO to reduce its debt burden. Without much ado let us first look at the numbers and then we can dissect the numbers. Again note that I am not going to list out all the items from the cash flow statement. Let us look at only the important numbers.

  FY12 (Crores) FY13 (Crores) FY14 (Crores) FY15 (Crores) FY16 (Crores) FY17 (Crores)
Cash flow from Operating Activities:
Net Profit Before tax 88.73 141.13 244.85 322.64 492.89 760
Depreciation and Amortization 37.46 45.78 57.01 81.54 98.42 127.81
Tax Paid 28.50 36.73 75.01 99.98 164.13 258.61
Net Cash Generated from Operating Activities (A) 65.36 127.09 198.14 222.01 447.13 457.84
Cash flow from Investing Activities
Sale of Current Investment 140.32 194.32 644.58 2904.47 3336.54
Purchase of Current Investment -85.41 -184.56 -643.88 -2901.39 -3335.19 -2.30 (net)
Purchase of property, stores, equipment -183.28 -239.43 -271.69 -477.42 -648.05 -645.01
Net Cash used/gobbled up in Investing activities (B) -128.91 -230.88 -270.17 -473.88 -658.33 -2484.17 (includes IPO money)
Cash flow from Financing Activities
Money obtained by taking Term Loans 125.31 199.82 215.00 295.00 0 200
Money obtained by issuing NCD 0 0 0 200 350 250
Money obtained by issuing commercial paper 0 0 0 0 500 0
Repayment of Term loans + Unsecured loans -46.65 -73.46 -130.13 -221.22 -147.42 -155.30
Finance Cost (i.e. Interest Paid) -24.94 -42.16 -55.23 -62.06 -81.63 -120.33
Money Raised in IPO 0 0 0 0 0 1840.61
Net Cash Generated from Financing Activities (C) 93.49 117.53 65.23 234.45 208.18 2025.25
             
Net Increase or Decrease in Cash and Cash Equivalents (A + B + C) 29.94 13.74 -6.8 -17.4 -3.01 -1.07
Total Cash and Cash Equivalents 47.68 61.43 54.63 37.21 34.20 32.92
  • Cash flow from operating activities: We notice that the company has always had a positive net cash generated from operating activities (after deducting the taxes). That is good (and expected).
  • Cash flow from investing activities: This is the point of worry. EVERY SINGLE YEAR since 2012 the company has put its money in creating tangible assets like marts and their fitouts (which is good) however the amount of money spent in creating these tangible assets have ALWAYS been more than its profits generated from operating activities. This leads us to the 3rd section below.
  • Cash flow from financing activities: Since the company has been putting more money in building tangible assets compared to its net profits, this additional money has to come from somewhere else. This deficit in money is covered from borrowings via term loans, issuance of NCD and commercial paper. So the growth in tangible assets has always come partly by profits and partly from the borrowings. As the company has grown from FY12 to FY17 so have the debt numbers. I believe the company reached a stage in FY17 when these numbers might have become higher than the tolerance limit of the management. So the management might have taken the decision to go for IPO. The IPO had two objectives:
    • Reduce the debt
    • Garner money for future store expansion so that the company does not have to look at debt for store expansion for some time in the near future.
  • Total cash and cash equivalents: You will notice that the company had cash flow accruals in FY13 after that the cash numbers have always been coming down.

My Prediction with respect to cash flow:

  • Due to the IPO proceeds, the company should be borrowing less and paying back the loans in FY18. So one should ideally see a huge positive cash flow for FY18
  • The IPO proceeds will take 2 more years to be absorbed. So the company will keep using this amount to increase its tangible assets. So cash flow might be net positive in FY19 and FY20 as well.
  • By FY20 the promotors have to bring down their stake in the company from 82% to 75% (in order to comply with SEBI guidelines). By early FY20 the company would have used up its IPO proceeds. So, I feel, the company may come out with a follow on offer of sale of shares in late FY19 or early FY20 that will help in bringing down the promoter holding to 75% and also give the company the needed money to expand further without incurring additional debt. Hence, I believe, we should expect some equity dilution around FY19 or FY20.
  • Also I believe from here on, the cash flow should remain positive and the cash should keep increasing assuming the company targets a realistic growth in its store footprint. However, if the company opts for a huge increase in its retail footprint then the year-on-year cash flow can turn negative. But I think the management will stay prudent and go with a calibrated and guarded expansion.

Initial Public Offering (IPO)

Avenue Supermarts came out with the IPO in March of 2017. 6,25,41,806 shares at the face value of Rs. 10 were available/offered.  The money garnered through the IPO is planned to be used for the following purpose:

  • To pay back the loans and redeem the NCDs to the tune of Rs. 1080 crores. At the time of the IPO the company had outstanding borrowings of 1500.49 crores. This Rs. 1500 crores debt can be split into term loans and NCDs as below:
    • 800 crores of NCDs. The company planned to clear up to 600 crores from the proceeds of the IPO.
    • 200 crores of Term loan from HSBC. The company plans to pay back this entire amount from the proceeds of the IPO
    • 443 crores of Term loans with other banks (like HDFC Bank, Kotak Mahindra Bank).
  • To use the proceeds towards building new Marts. The amount collected through the IPO for this purpose is Rs. 366.62 crores. The amount shall be used for the following purpose:
    • 187.95 crores shall be used to build fitouts for the new stores. This amount will help in making the fitouts for 2.1 million square feet of retail space by 2020.
    • 178.65 crores shall be used to construct new stores. This will roughly build nine hundred thousand square feet of new retail space by 2020.
  • Other Miscellaneous expenses for example payment of salary and allowances, purchase of inventory etc.

The money shall not be spent in one shot. Instead it shall be used over a period of three years as shown in the table below.

  Amount obtained in IPO (Crores) Proceeds to be used in FY18 (Crores) Proceeds to be used in FY19 (Crores) Proceeds to be used in FY20 (Crores)
To repay/prepay Loans and redeem NCD 1080 625 320 135
To construct new Dmart stores 366.62 79.974 143.313 143.313

Note: When the company says that it is planning to spend 187.95 crores on the fitouts, it is actually referring to the following items:

  • Supply and Installation of Mechanical, Electrical and Plumbing items within the stores.
  • Furniture, Fixtures, Storage racks, display material, trolleys for the retail stores.
  • Supply and Installation of Lifts within the stores.
  • Supply and Installation of IT equipment, Software, Security systems etc. for the retail stores.

Shareholding

A higher promotor shareholding is always a healthy sign. It gives comfort to minority shareholders that promotors have their skin in the game. Given below is the shareholding pattern as of Q1 FY18. With 82% shareholding, the promotors of Dmart have a huge stake in the game right now. However as per regulations, promotors have to reduce their share-holding to 75% or less within three years of listing. So, in another two years the promoters have to pare their holding (either by selling their shares or increasing the equity with a QIP or follow on offer). You will notice that out of the different types of investors listed below, only the retail investors are the ones that generally create the free float. Since they form a mere 8% of the total shareholding, the amount of free float is currently limited.

Shareholder Percentage of Shareholding (%)
Promoter 82%
Company CEO 2%
Domestic Institutional Investors 4%
Foreign Institutional Investors 4%
Retail Investors 8%

My Visits to Dmart Stores

There are couple of Dmart stores near my house. Below are my observations made over a period of four weeks. A general observation was the fact that almost all items were at a discount in Dmart. Some items like beverages, select personal care items (like Nivea products) and loose products (like rice, wheat etc.) had higher discounts. Very few items are sold at MRP, for example, few products from Patanjali did not have a discount on the MRP price.

Week 1:

  • Saturday: This was my first visit to Dmart in a very long time. I reached the store at the opening time. I didn’t see people thronging into DMart nor did I find many people inside the mart. I spent about an hour. The crowd was similar to what I generally see in Big Bazaar. Loose Items (Dal, Peanuts, and Rice) seemed to attract many people. Checkout counters were more or less empty with very few counters open. The security was not courteous at all. Staff was courteous though. I noticed that it was tough to find a staff member for any clarifications. I noticed that the staff was busy with product placement and assortment even when the customers were trickling in. So one keeps getting blocked by the staff with their carts as they try to arrange the items on shelves. Note that this D-Mart store has started its operations recently. I bought an assortment of packed and loose food items and toiletries and I got a discount of about 25%.
  • Sunday: Visited another Dmart store. This time I went in the evening. The first thing that hit me was the sea of people. The store was packed with people both on the ground floor that has the grocery and food items as well as on the first floor that has the cloths, footwear, utensils, plastic containers, toys, home improvement items (bedsheets, pillow covers) and few appliances. I could see both packed trolleys and half-filled trolleys. I picked few items and when I went to the payment counter I realized the futility. There were probably 10-12 counters and each counter had at least 20 people lined up with their trolleys. I dropped my basked and decided to come the next day. I came out impressed with the way Dmart has rekindled the desire of shopping among the people.

Week 2:

  • Monday: I went back to the same Dmart shop that I visited the previous day. Landed at 10:30 AM and as expected, there were fewer people. Housewives, couples and retirees. There were about 50 people buying grocery and an equal number of people sifting through the cloths. I picked the items that I had planned to buy and roamed around for some time and then made an exit. At the cash counter there were about seven counters open with one or two customers at each of the counters. I bought toiletries (that I needed), toys (bought more than what I needed), dry fruits (that could have been avoided) and cloths (that were definitely not needed). I saved about 20% on MRP (as claimed on the bill). I came home and cursed myself for the extra items I bought that I did not need. By the way I was reading an article the other day on Dmart and I stumbled on the following, and I quote:

“The trick lies in driving footfalls through grocery and then selling higher margin items such as toys, crockery, garments, home appliances and footwear,” says Noronha. “It’s the groceries that get shoppers in, but the general merchandise that drives our profits,” adds Baheti

How true. Though I cursed myself for overspending, as a customer, I will probably go back again as the overspending was triggered by me (no fault of Dmart you see :-)) and the “minimum 6% off on MRP” is appealing. If one looks at the price of products one would be surprised at the affordability of the items. For example, foils to keep documents starting at Rs 15, water bottles start at Rs 19, Kitchen towels for Rs 20, Pillow covers (palatial kinds with golden embroidery) for Rs 49 , Wooden assembling toys for Rs 49, T-Shirts starting at Rs 100, Rip offs of Lego toys starting at Rs 149, Bedsheets for Rs 149, Collection of Full Arm shirts starting at 149, Sweatshirts starting at 149, Tava and Pans starting at Rs 149, Jeans starting at Rs. 300, Shoes (that look like the woodland shoes) at Rs. 350. The list goes on and on. As I said, Dmart seems to be providing an impetus to the middle class to open up their purse.

  • Saturday: I was back to the first Dmart that I had visited on Saturday of week 1. However this time I went in the evening. The mart had moderate crowd. I could easily move around both in grocery section (Ground floor) as well as cloths and utensils section (First floor). About 10-12 cash counters were open and I could see 2-3 people waiting for billing in each of the counters. It looks like there is a gestation period for newer Dmart. As the word of mouth spreads, more and more people come in to shop.
  • Sunday: I went to the second Dmart store that I visited on Sunday of Week 1. I went in the morning to check the crowd. I was at the mart by 10:30 am. The store was not crowded and it was pretty easy to move around. I picked up couple of food items and strolled around for about 30 minutes. By 11 AM the crowd had started to build up. I made my way to the cash counter and found 4-5 cash counters open with 4-5 customers at each of the counter. I realized that the best time to buy anything in the older Dmart stores is to come in the mornings.

Week 3:

  • Saturday: This time I went to the second Dmart (i.e. the older one). I went in the afternoon. I wanted to have a look at the buying pattern of people. I noticed that people shop for the entire week and hence buy items in large quantity. Wheat atta is generally bought in 5 Kg and 10 Kg pack. Tea is generally bought in half and 1 kg packs. Many people buy the loose items (like loose rice, ragi floor, peanuts, poha etc.) as they are cheaper compared to the packed ones (I believe loose items have 0% GST). I saw many carts with clothes, shoes, utensils which indicates that people are interested in items beyond grocery. Many items are bought in duplicates for example 2 packets of chips, 2 packets of toothpaste, 2 packets of baby diapers etc. With regards to diapers, I noticed Momy Poko pants are a big hit among customers.

Week 4:

  • Saturday: I went to the first Dmart (i.e. the new one). I went in the evening. My intention was to buy some items for the week and also to corroborate my observations from week 3 on bulk buying behavior. The parking is not very big and I saw people patiently waiting outside the mart in their cars till they got a parking slot. I did see moderate crowd this time. As noted in week 3, many people opted for loose items. The weekly buying pattern was observed in this dmart as well, people had loaded their carts with larger quantities of the items. Again I noticed that people were buying items in multiple quantities like 4 packs of floor cleaners, 2 packs of toothpaste, 5 or 10 Kg packs of wheat atta. Loose items were preferred here as well (In this Dmart I noticed that rice was by default sold as loose i.e. I did not see Premia branded rice, so I had no option but to take the loose rice). I got a discount of close to 27% on MRP and I had a grin on my face 🙂
  • Sunday: I went to the second Dmart (i.e. the older one). I went in the evening. As expected the store was full. About 13-15 checkout counters were open with 7-8 customers in the queue at each of the counters. The aim of my visit was to check the customer profile as well as to check the buying patterns again. One thing I notice is that most of the people come with their family. However people with baskets could be spotted as singles. I am now pretty convinced that people coming to Dmart prefer to buy items either in large quantity or in multiple quantity. Again, wheat atta is mostly bought in 5-10 Kg packets. Biscuits are invariable bought in multiples or as large packets (the biggest packet of Parle G which is 12 inch x 12 inch). Baby diapers are mostly bought in big packets (64 piece large packets). Corn flakes packets are generally bought in large packets. People also love the loose items (loose rice, sugar, poha, even Jaggary) probably due to the higher discounts on loose items. I saw some premia spice shelves were empty and people were complaining about the non-availability of the spices. I also noticed that the cold dairy items and frozen food items were very limited and the racks for these were shoved at a corner. I did not find many people buying these Cold/Frozen items. I noticed that the trolleys are generally full which points to the ‘once-a-week’ shopping pattern. Another interesting thing I noted was the patience of the people in the queue. I did not find anyone making a fuss.

After 4 weeks of shop hopping I was impressed with the concept of ‘discount over MRP’ that Dmart has managed to introduce/market in India. I was also impressed with the reaction of the people to this concept of discount retailing. Despite having a “Janata Bazaar” kind of look-and-feel, people from different strata come over and buy items in bulk. Dmart is indeed a replica of Walmart that Sam Walton created. Dmart seems to have the ethos of the Walmart that Sam Walton envisioned.

Risks

Let us now look at the risks that any (potential) investor should be aware of. I believe that there are two major risks with respect to Avenue Supermarts:

  • Business Risk: Competition from both online and offline retailers
  • Valuation Risk: Current valuations may not give comfort to either a value investor or a growth investor.

Business Risk: Competition

For any business the major risk is its competition. Cut throat competition can result in loss of business and/or pricing pressure. In case of Dmart there are two major competitors:

  • Online retailers and
  • Brick and Mortar Retailers.

Let us look at both these competitors.

Competition 1: Online Retail (Amazon, Big basket etc)

Dmart faces a major risk from online retailers like Amazon or Big baskets. They can hit the company where it matters the most i.e. price. Online retailers have many inherent advantages compared to Brick and Mortar retailers. Online retailers do not have to worry about paying store rentals. Rent is a major OPEX for offline retailers. Online retailers have to merely ensure that they have sufficient warehouses at close proximity to the customers in order to deliver the items within a reasonable amount of time. Online retailers do not need to replicate the items. For example, if Dmart has 100 stores and if it wants to sell Britannia biscuits then it will have to stock Britannia biscuits in all of its 100 stores even if customers may not buy the biscuit in all the 100 stores. Whereas online retailers have to stock only at their warehouses. Additionally, online retailers do not have to buy the items beforehand. They can simply show the item as being available and stock limited supplies of the product. When the actual order is received, the company can procure from the distributor and supply it to the customers. Another major advantage of online retailing is the fact that customers can shop from the comfort of their home. To understand the advantage of this comfort, one should go to an established Dmart outlet on a Sunday evening. Right from the point of finding a parking space till you come out of the checkout queue you will find a sea of people. You will end up pulling out your hairs in frustration. Also note that since you are buying online, you can buy at any time of the day. However if you want to buy items from Dmart store, you need to wait for the store to open. Another interesting aspect of online retail is the customized discount. A company like Amazon can analyze your buying pattern and offer you customized discount in order to entice you into buying items. An offline retailer cannot even fathom such a concept.

I have listed above, some of the things that I believe are the inherent advantages for an online retailer compared to an offline retailer and these inherent advantages can have a material impact on any offline retailer. I have read opinion from many people and they believe that due to these inherent advantages, companies like Amazon can cannibalize the sales of Dmart. To support this conjecture they cite the current state of Walmart vis-à-vis Amazon. I can empathize with this line of thought, but I believe, this cannibalization threat may not materialize in the foreseeable future. There are multiple reasons for this:

  • When Amazon came in, Walmart was already a behemoth covering vast expanse of US. So Walmart had a lot to lose when a new entrant arrived with an entirely different business model.
  • In spite of Amazon’s sales, Walmart, even today, grows at a moderate pace every single year. This clearly indicates that discount retail has space for more than one player and more than one business model. It is another story that Walmart shareholders have not benefitted over the past 17 years due to constant PE contraction. By the way as per the article [8], 95% of the Americans shopped at Walmart (both offline and online store) in 2016 compared to 42% of Americans shopping on Amazon. Considering that America is the bastion for Amazon, doesn’t this trivia provide something to ponder about! Also in the article [9] I noticed that as per a survey done by Euromonitor in 2014, only 10% of Americans shopped online which is interesting!
  • In defense of the bleak business outlook for offline retail, one can also show the recent store closures in US. But when you look at the closures, you will notice that most of the store closures are seen for retailers who were selling discretionary items and aspirational brands ex: Macy’s. The discount and bulk retailers like Walmart, Safeway, Costco, and Sam’s Club are still chugging along despite bleak outlook for the retail sector.
  • Back home, In India, the major chunk of retail is unorganized retail. Over the next few years, I believe, both Amazon and Dmart will nibble into this segment rather than eating into each other’s pie. Hence I believe that the next decade of retail in India may not be a migration from Offline to Online. Rather it will be a migration from unorganized retail to organized retail which should benefit both Amazon and Dmart.

Dmart seems to realize the importance of online retail. It has ventured into online retail on an experimental basis. I was curious to check how Dmart fares against Amazon and Big basket (price wise). So I decided to check the price difference between Dmart, Amazon and Big Basket. I chose few items across grocery, toiletries, and other items. I checked the prices on different days. Below are the numbers. Please note the following:

  • The lowest price for an item is highlighted in bold.
  • Some items were not available on one of the three websites. These are marked as NA in the table below.
  • I limited myself to branded products so that we can compare the products against the MRP. However note that the MRP is also not a fixed number and varies slightly across the websites :). In case of different MRPs, I have taken the MRP shown on Dmart website as the default value.
  • The items chosen by me are random and I did not selectively pick them to tilt the numbers in favor of a specific company. I have tried to cover items that span most of the categories.
  • There were many popular products that I had to drop from the list as it was available only on one website. Even if the product were to be available I would not find the item with the same weight (gm) or capacity (ml or l) on all the three websites. I feel that websites sometimes do not list products where their margins are less or they are not able to provide discounts. So it is tough to find products that are popular and also available on all the three websites.
Item Day X Day Y (11th December 2017) Day Z (18th December 2017) Day P (26th December 2017)
MRP Dmart Amazon BigBasket Dmart Amazon BigBasket Dmart Amazon BigBasket Dmart Amazon BigBasket
Parle Hide & Seek (120 gm) 30 23 120 ! 26 23 230 ! 26.40 23 26 26.40 23 26 26.40
Maggi Noodles Family pack (840 g) 135 115 128.25 NA 115 128.25 NA 119 135 (with subscribe and save 128.25) NA 119 135 124.80 (12x70gm option)
Borges Rigate Wheat Pasta (500 g) 195 118 99 99 97 99 99 125 135 (with subscribe and save 128.25) 99 125 125 (with subscribe and save 118.25) 99
Fortune Sunlite Refined Sunflower Oil (1L) 115 90 81 87 90 84 95 93 86 95 90 82 88
Leonardo Olive Pomace Oil (5L) 2999 1399 1549 NA 1399 1519.05 1727 (out of stock) 1550 1599 (Subscribe and save 1519.05) NA 1550 1599 (Subscribe and save 1519.05) NA
Lay’s Classic Salted Chips (95 g) 35 30 35 35 30 35 35 30 35 35 30 (Sour cream & Onion) 32 (Sour cream & Onion) 35 (Sour cream & Onion)
Kissan Fresh Tomato Ketchup (950 g) 125 90 99 99 90 95 105 85 105 102.83 93 99 105
Saffola Masala Oats Veggie Twist (400 g) 145 105 130 130 120 130 130 120 130 (Subscribe and save 123.50) 130 120 130 (Subscribe and save 123.50) 130
Kissan Mixed Fruit Jam (200 g) 60 56.4 60 60 115 (500 g) 122 (500 g) 122.20 (500 g) 115 (500 g) 122 (500 g) 122.20 (500 g) 110 (500 g) 122 (500 g) 120.90 (500 g)
Amul Ghee, Pure (1 L Tin) 505 474 470 499 474 470 499 474 505 515 474 505 515
Medimix Ayurvedic Sandal Soap (4+1) 200 165 200 NA 165 200 NA 165 200 NA 165 200 NA
Dove Cream Beauty Bathing Bar (3x100g) 172 152 155 132 152 157 157 152 157 157 148 147 147
Nivea Smooth Milk Body Lotion (400 ml) 369 227 288 293.76 227 247 (lightning deal) else 288 342 227 247 (lightning deal) else 288 292.44 226 241 (with Subscribe and save 228.95 ) 258.30
Vicco Turmeric Skin Cream (70 g) 220 206.80 220 220 206.8 220 220 206.80 220 220 206.8 220 220
Pond’s Silk Cream (55 g or 55 ml) 105 88 99.75 NA 88 89.25 NA 88 105 89 88 89.25 89
Vaseline Intensive Care Cocoa Glow (300 ml) 285 193 185 185.25 193 185 256.50 193 213 (Subscribe and save 202.35) 213.75 215 213.80 (Subscribe and save 203.11) 242.25
Parachute Coconut Oil (1L) 350 332 320 318 332 320 318 325 328 (subscribe and save 311.60) 308.68 325 328 (subscribe and save 311.60) 328
Head & Shoulders Anti-Hairfall Shampoo (675ml) 485 296 335 407 296 335 407.40 296 407 378 296 340 360
Colgate Strong Teeth Calci-Lock Toothpaste (300 gm) 300 117 110 110.5 117 123 (with coupon 116.85) 123.50 117 123 123.50 117 123 123.50
Dabur Red Toothpaste (300 g) 142 117 120 120.7 127 142 127.80 127 128 127.80 127 128 127.80
Mamy Poko Extra Absorb Pants – Large (48 pieces) 699 489 555 615.12 489 615 (with subscribe and save 584.25) NA 489 615 (Subscribe and save 584.25) NA 524 524 (Subscribe and save 497.80) NA
Axe Signature Intense Body Perfume (122 ml) 225 191 157.50 191.25 191 180 (with subscribe and save 171) 225 191 180 (with subscribe and save 171) 225 191 180 (with subscribe and save 171) 191.25
Surf Excel Easy Wash Detergent Powder (4 kg) 479 390 409 409 390 451 (with subscribe and save 428.45) 450.26 450 410 (with subscribe and save 389.50) 410 405 430 (with Subscribe and save 408.5) 430
Rin Detergent Bar (4×250 g) 60 55 60 NA 55 60 NA 53 60 NA 52 60 NA
Vanish Liquid Stain Remover (400 ml) 99 90 89 99 93 93 99 93 99 99 93 93 99
Brooke Bond Red Label Tea (1 Kg) 410 370 335 335 370 333 385.40 359 350 428.5 359 339 385.40
Real Fruit Power Mixed Fruit (1L) 99 74 84 87 74 84 93.06 74 99 (from other sources) 88.88 18 (Orange 200 ml) 20 (Orange 200 ml) 20 (Orange 200 ml)

Below are some of my conclusions based on the prices quoted on the websites of Amazon, Bigbasket and Dmart:

  • Day X:
    • Out of 27 products, Dmart had lowest price on 17 products (i.e. ~ 63% of the products). Amazon had lowest price on 6 products (i.e. ~22% of the products) and Big Basket had lowest price on 2 products (i.e. ~ 7.5% of the products). For two products, both Amazon and Big Basket had similar lowest price (i.e. ~7.5%).
    • Big basket and Amazon seem to benchmark each other on prices on many products (though I am not sure who is benchmarking whom).
  • Day Y:
    • Out of 27 products, Dmart had lowest price on 20 products (i.e. ~74% of the products). Amazon had lowest price on 5 products (i.e. ~18.5% of the products) and Big Basket had lowest price on 1 product (i.e. ~ 3.7% of the products). On one product both Dmart and Amazon had lowest price.
    • Out of these 27 products, Dmart changed the price on 2 products between Day X and Day Y. Amazon on the other hand changed price on 13 products and Big Basket changed the price on 14 products. This shows that the prices are more dynamic on Amazon and Big Basket.
  • Day Z:
    • Out of 27 products, Dmart had lowest price on 20 products (i.e. ~74% of the products). Amazon had lowest price on 5 products (i.e. ~18.5% of the products) and Big Basket had lowest price on 2 products (i.e. 7.5% of the products).
    • Out of these 27 products, Dmart changed the price on 9 products between Day Y and Day Z. Amazon on the other hand changed prices on 16 products and Big Basket changed the price on 10 products.
  • Day P:
    • Out of 27 products, Dmart had lowest price on 16 products (i.e. ~ 59% of the products). Amazon had lowest price on 6 products ( i.e. ~ 22% of products) and Big basket had lowest price on 1 product( i.e. 3.7% of the products). On 1 product (i.e. ~3.7% of products) both Dmart and Amazon had lowest price. On 2 products (i.e. ~7% of products) both Amazon and Big Basket had the lowest price.
    • Between Day Z and Day P, Dmart changed the price on 8 products. Amazon changed the price on 13 products and Big Basket changed price on 10 products.

Overall you will notice that Dmart had the lowest price on more than 60% of the products over the observation period of 4 days spanning over a month.

Now, let us look at some numbers with respect to online retailing in India. The table below lists the different categories where online retail has a presence and the revenue numbers for each of these categories [1]. You will notice that Food and Grocery has negligible presence in online retail in 2016 and may see a decent growth by 2020. Yet, as a part of the total food and Grocery sails, the numbers for online retail for Food and Groceries would remain negligible.

  FY16 FY20 (Estimated)
Category Total sales (US $ bln) Online pie (US $ bln) Online sales as a % of total sales Total sales (US $ bln) Online pie (US $ bln) Online sales as a % of total sales
Electronics 35 5.25 – 5.95 15-17% 63 15.8 – 26.5 25-42%
Apparel & Lifestyle 49 2.9 – 3.45 6-7% 74 10 – 14.8 13.5-20%
Home and Living 26.5 0.53 2% 41.75 3 – 5.85 7.5-14%
Food and Grocery 413 0.12 0.03% 634 1.2 – 2.85 0.2-0.45%

Competition 2: Brick and Mortar Retailers

The other risk for Dmart is from the other Brick and Mortar retailers. Let us now look at some numbers for the brink-and-mortar retailers vis-à-vis Dmart to understand the competition.

Store Footprint: The table below lists the store footprint for all the major brick-and-mortar retailers [1]. From the table we can see that Dmart currently has much smaller footprint compared to its peers. Also the store size for Dmart is smaller compared to the Hypermarts from its peers.

Group/Retailer Store Count in 2012 Store Count in 2016 Average Store Size in Sq. ft. (in 2016)
Dmart 55 110 28,000 – 32,000
Future Group / Bharati/ Raheja(Big Bazaar, Easy Day, Hypercity) 337 517 43,000 – 45,000 (for Big Bazaar)
Reliance (Reliance Fresh, Reliance Mart, Reliance Super) 471 657 40,000 – 45,000 (for Reliance Mart)
Aditya Birla Group (More, More Megastore) 491 506 40,000 – 45,000 (for More Megastore)
Trent/Tata Group (Star Bazaar, Star Market, Star Daily) 7 26 45,000 – 55,000 (for Star Bazaar)
Spencer’s Hypermarket and Supermarket 121 22,000 – 25,000 (for Spencer Hypermarket)

Average Sales per Sq. Ft: The table below shows the average sales per square feet. There is one point to note though. Hypermarkets are generally large and stock lot of products. Hence their sales per sq. ft. would be less. On the other hand Supermarkets (like Dmart) are relatively smaller compared to Hypermarkets and they predominantly sell food and groceries. Since people need more Food and Groceries, the turnover for Supermarkets would be higher and hence they show higher sales per sq. ft. From the table it is clear that in absolute number terms, Dmart beats all the players both in 2012 and in 2016. However in terms of growth in sales per sq. ft. only Spencer’s has shown better growth compared to Dmart.

Group/Retailer Sales Per Sq. Ft. in 2012 (Rs.) Sales Per Sq. Ft. in 2016 (Rs.) Growth in Sales per sq. ft. 2012-2016 (%)
Dmart 12000 – 12500 28,000 -30,000 136%
Future Group / Bharati/ Raheja(Big Bazaar, Easy Day, Hypercity) 5,500 – 6,500 (Big Bazaar) 9,500 – 10,500 (Big Bazaar) 66% (Big Bazaar)

 
Reliance (Reliance Fresh, Reliance Mart, Reliance Super) 5,000 – 6,000 (Reliance Mart)

 

 8,500 – 9,500 (Reliance Mart) 63.63% (Reliance Mart)

89% (Reliance Fresh)
Aditya Birla Group (More, More Megastore) 4,500 – 5,500 (More Megastore) 8,500 – 9,500 (More Megastore) 80% (More Megastore)

54% (More)
Trent/Tata Group (Star Bazaar, Star Market, Star Daily) 6,500 – 7,500 (Star Bazaar) 11,000 – 13,000 (Star Bazaar) 71.42% (Star Bazaar)
Spencer’s Hypermarket and Supermarket 6,000 – 7,000 (Hypermarket) 16,000 – 17,000 (Hypermarket) 153% (Hypermart)

Revenue numbers for B&M Retailers: The table below shows the revenue numbers for the B&M retailers [1]. You will notice that the growth in revenue is commensurate with the growth in average sales per sq. ft. that we saw above. The group that has higher average sales per sq. ft., managed to have higher revenue numbers. Again Dmart is better than all the other retailers. What surprised me was the revenue numbers of Reliance Group. Revenue for reliance from its retail arm seems to be less. I was expecting more from reliance. Spencer’s was even more disappointing (considering that spencer’s has shown excellent improvement in revenue per sq. ft. I was expecting higher revenues for Spencer’s)!

Group/Retailer Revenue in 2012 (Crores) Revenue in 2016 (Crores) Growth in revenue 2012-2016 (%)
Dmart 2,350 8,650 268.08%
Future Group / Bharati/ Raheja(Big Bazaar, Easy Day, Hypercity) 5,695 12,025 111.15%
Reliance (Reliance Fresh, Reliance Mart, Reliance Super) 2,600 6,650 155.76%
Aditya Birla Group (More, More Megastore) 1,400 1,850 32.14%
Spencer’s Hypermarket and Supermarket 1,200 1,850 54.15

Valuation Risk:

The valuations of Avenue Supermarts appear to be beyond comprehension. For a value conscious investors, the valuations might have reached the stratosphere. Even for a growth oriented investor, the valuations may seem to be way above the comfort zone. I don’t think there is any previous precedence from retail sector for such high valuations. Hence the apprehensions on valuations is quite justified.

Whenever I start writing my opinion about valuations, I get a little uneasy. I strongly believe that valuations are extremely subjective and its meaning differs from person-to-person. Hence I refrain from giving my opinion on the current and/or future valuation of the company. I shall limit myself to the business aspects and the financial numbers of Avenue Supermarts.

Scope for Future Growth for Retail Sector

To know if Avenue Supermarts has a future we need to judge the following:

  • Does the Retail sector has scope for future growth?
  • Does organized retail within the retail sector have scope of future growth?
  • Within the retail sector does Grocery have scope for future growth?

Let us look at each of these points. The table below shows the retail sector growth in the past and the predicted growth by FY20 [1]. The first row provides information on the total private consumption in India. We can notice that it has increased over the past five years and is projected to increase till FY20. The second row shows the contribution of retail part to the total private consumption. Even the retail part has increased over the years and is predicted to increase from $ 616 billion to $960 billion by FY20. Hence retail sector seems to have good growth potential in the near future.

  FY12 (US $bn) FY16 (US $bn) FY20 (US $bn)
Total Private Consumption 760 1262 2000
Retail Pie out of the total private consumption 386 616 960
Retail as a portion of total private consumption 50.78% 48.81% 48%

Now out of the entire retail pie, how much is the organized retail section? The table below provides some answers to this question. We can clearly see that organized retail has grown over the past 4-5 years and will grow in the next 2-3 years. The interesting aspect is the last row which shows the growth CAGR. Organized retail is predicted to grow at a faster pace till FY20 compared to the growth seen till FY16. So the scope for growth as well as growth rate shall be higher in future.

  FY12 (US $bn) FY16 (US $bn) FY20 (US $bn)
Retail Sales 386 616 960
Organized retail portion out of the total retail sales 27 55 115
Organized retail as a percentage of total retail sales 7% 9% 12%
Growth CAGR for Organized retail 19-20% 21-22%

Now let us try to dissect the organized retail pie and try to judge if food and grocery retail has scope for growth. The table below (from the Technopak survey [1]) gives a very interesting insight. Avenue Supermarts competes in the Food and Grocery space which has the maximum retail spending and it has the least penetration by the organized retail players. This clearly shows that there is huge opportunity for growth for all organized retail players who are in the Food and grocery business (like Big Bazaar/Food Bazaar, Reliance Fresh, Dmart, More, Star Bazaar). The scope of growth looks staggering! Note that the below numbers are for FY16 (i.e. we are looking at the split up for the $55 billion dollars organized retail portion).

Sector Retail sales (US $bn) in 2016 Organized retail portion out of the total retail sales (US $bn) in 2016 Organized retail as a percentage of total retail sales
Food and Grocery 413 13 3%
Apparel and Accessories 49.25 10.85 22%
jewelry and Watches 46.8 12.65 27%
Consumer Durables (Fridge, TV, Washing machines, Oven etc.) 35 8.78 25%
Home and Living 26 2.6 10%
Pharmacy and Wellness 17.8 1.8 10%
Footwear 7.4 3 40%

In summary,

  • There is scope for retail sector.
  • There is scope for growth for organized retail within the retail sector pie.
  • And there is scope for growth for food and grocery within the retail sector.

Crystal Ball Gazing for Avenue Supermarts

The management does not give any forward looking statements. Neither do we have any material in the public domain to dissect and analyze the future potential of the company. However based on the information gathered from the RHP document, I come to the following conclusion:

  • By the end of FY17 the company had total retail space of 4.06 million square feet. Using the IPO proceeds, the company plans to add additional 2.1 million square feet space by FY20. Hence, by FY20 the company can potentially have total retail space to the tune of about 6.16 million square feet.
  • As of FY17 the company was earning a revenue per sq. ft. of about Rs. 31,120.

Now, let us take three scenarios:

  • Base case scenario: Let us assume that the revenue per square feet stays at Rs. 31,120 till FY20.
  • Worst case scenario: Let us assume that the revenue per square feet drops by 10% and goes down to Rs. 28,000 by FY20.
  • Best case scenario: Let us assume that the revenue per square feet increases by 15% to about Rs. 35,750 by FY20. Over the past couple of years the revenue per square feet has increased by about 6% and 10%. I have a feeling that beyond this point it may not increase at this pace. So assuming a 5% increase every year, I have taken 15% as the increase in revenue per square feet till FY20.

Now probable revenue by end of FY20 for the three cases assuming 6.16 million sq. ft. of retail space would be as below:

  Average Case (Crores) Worst Case (Crores) Best Case (Crores)
Revenue estimates by FY20 19169.92 17248 22022

Now we need to predict the PAT and EPS numbers for FY20. To do that let me assume the following:

  • The PAT as a percentage of revenue for the six months ending 30-09-2017 is: 5.14%. Note that for the six months ending 30-09-2016 it was 4.31%. Let us assume that the PAT as a percentage of revenue stays at 5.14%
  • The number of outstanding shares as of Q2 FY18 is 62.40845 crore. Let as assume that the company does not issue any fresh equity shares till the end of FY20.

So the PAT numbers by FY20 could be as below:

  Average Case (Crores) Worst Case (Crores) Best Case (Crores)
PAT estimates by FY20 in Crores (assuming PAT margin of 5.14%) 985.33 886.54 1131.93

Assuming the number of shares to be 62.40845 crores and the PAT as calculated above, the EPS for the average case, worst case and best case would be:

  Average Case Worst Case Best Case
EPS estimates by FY20 15.8 14.2 18.1

Super Bullish Case: I have also calculated a bullish case. In the above calculations, I have taken the PAT margins at 5.14%. However compared to FY16, the PAT margins have increased by 83 bps. Assuming that PAT margins keep increasing by 60 bps for the next 3 years the PAT margin by the end of FY20 would be roughly 7%. With this assumption, the PAT and EPS estimates for the bullish scenario would be as below:

  Super Bullish Case
PAT estimates by FY20 in Crores (assuming PAT margin of 7% and revenue of 22022 crores) 1541.54
EPS estimate by FY20 24.7

 

Now you can assume a PE multiple of your choice and estimate the share price by the end of FY20 for the average case, worst case, best case and super bullish case.

How I wish it was so easy to predict the future. For any of the above calculations to pan out the way I project, all the stars have to be aligned in one direction for the next 3 years! I seriously doubt it. So please take the above analysis merely as a guiding factor. I have a right to be wrong and I am generally right when I feel I can go wrong 😀 .

Summary

I wanted to delve on the above points in a short summary here, but then I felt that it would be better to discuss the most important aspect that anyone would be interested i.e. Dmart khareedna hai ki nahi (Should I buy Dmart stock or not). Instead of me telling my opinion it would be good if each person decides objectively whether it makes sense to invest one’s time and money in Dmart. I have compiled some questions one can ask oneself and come to a conclusion. In the table below the columns 2, 3 and 4 mean the following:

  • Column 2: A set of questions that need to be asked. These are some of the questions that I felt one can ask oneself. Please add more if you feel the questions are not complete.
  • Column 3: Maximum marks/weightage that each question deserves. I have given the maximum weightage that I felt were appropriate for the questions. Please modify based on your priorities.
  • Column 4: The marks you feel Dmart deserves for each of the questions. So rate Dmart for each of the questions in this column.

Finally after allotting the marks, add all the marks from column 3. If the total is more than a threshold that you have set then the company deserves your time and money else probably one should move on. One way to organize the threshold bands could be as given below:

  • Marks obtained < 60 : Dmart does not deserve my time or money. I will drop it.
  • Marks obtained is between 61 to 75: Dmart deserves my time. I will keep tracking the company and possibly invest when it meets my criteria
  • Marks obtained is between 76 to 90: Dmart deserves my time and money. I will start investing (or I will remain invested and probably add more) and keep monitoring.
  • Marks obtained is between 91 to 100: Dmart needs focused attention as well as higher allocation on an urgent basis. Let me invest my time and money on a higher priority.
S. No. Question to be asked to oneself Maximum Marks Marks Obtained
1

Does the Company have a competent Management

Marks Range: (5 = Management is competent to 0 = Management is not competent)

 5
2

Does organized retail have a long runway

Marks Range: (5 = Organized Retail has a long runway to 0 = Organized Retail does not have a long runway)

  • Unorganized v/s organized
  • Scope of growth for organized retail

i.e. ask yourself if you are looking at the right sector

 5
3

Does Dmart have a long runway?

Marks Range: (5 = Dmart has a long runway to 0 = Dmart does not have a long runway)

Ask yourself if there is scope for future expansion (number of stores etc)

 5
4

Is Dmart better than its peers (limit yourself to offline retailers)?

Marks Range: ( 5= Dmart is better to 0 = Dmart is not better)

i.e. ask yourself if Dmart is the right company to look for, in the brick and mortar segment of retail.

 5
5

Do the P&L numbers look sustainable and are you satisfied with the numbers and see a possibility of future growth in P&L numbers?

Marks Range: (5 = P&L numbers are sustainable to 0 = P&L numbers are not sustainable)

How about the cashflow numbers and the balance sheet numbers? Are you satisfied with the numbers?

 5
6

Is Dmart focusing on the right products to sell?

Marks Range: (5 = Dmart is focusing on right products to 0 = Dmart is not focusing on the right products)

Is discount retailing the correct way to approach organized retail?

Is the approach to concentrate more on food and groceries the right thing?

 5
7

Is it the right price to invest in the Company?

Marks Range: (10 = This is the right price to 0 = This is not the right price)

Things one could ask oneself

  • At this market cap can the share price go up by, say 10 times in 10 years
  • The profits and EPS are growing at say 40%. Does a forward PE of 100 make sense?
  • Compared to peers it is trading at a very high PE. Does it merit the premium?
  • Can’t other companies replicate this model thereby hitting the premium that the company commands right now?
 10
8

How comfortable are you to wait for the fundamentals to catch up with the PE?

Marks Range: (5 = I am patient to 0 = I don’t have patience.)

If the company is able to sustain the current PE then you might see a stock price growth that would be inline with the Profit growth or EPS growth. However, if company is not able to sustain the current PE then there could be two results:

Time wise correction: The share price remains at these levels and the PE corrects. So the company will keep showing profit growth but PE will come down.

Price wise correction: The share price shall come down and PE corrects at a steeper pace. This could happen if the growth slows down or the market believes it is paying a very high premium. This would mean a price dip for many quarters followed by a recovery to the current market price which could take many quarters.

Are you comfortable with Time wise or price wise correction (if such a thing happens)?

 5
9

Is Online retail a threat to the Company?

Marks Range: (10 = No threat at all to 0 = Major threat.)

Things one could ask oneself

  • Are Amazon, Flipkart, Big-basket, Groffers a threat to Dmart’s offline stores?
  • Isn’t online retail better as they don’t have to spend on rentals, stores etc. They need to have warehouses though (For grocery selling they may need more warehouses for immediate delivery)
  • Online retailers don’t have to replicate the inventory across all the stores.
  • Online retailers don’t have to buy all the inventory beforehand.
  • In case of online retailing, people can shop from their home and avoid the store crowd.
  • In case of online retailing people can buy at any time of the day.
  • Online retailers can study the buying patterns and customize the discounts to customers based on their past purchases.
  • Every new offline retail store needs new employees. This is not the case with online retail. So, in case of online retail employee costs do not linearly increase with scale whereas for offline retailer it does.
  • However online has a time lag as they need to deliver to your home. Are customers ok with this?
  • Also, ask yourself if food and grocery is a good use case for online retail.
 10
10

Can Dmart sell online viably and successfully?

Marks Range: (10 = Dmart shall be successful to 0 = Dmart will fail in online model)

Things one could ask oneself.

  • Does Dmart have a brand recall? I.e. will people think of Dmart when they shop online?
  • Does Dmart have loyalty of people so that whenever Dmart decides to go online big time, people will buy from Dmart.
  • Does Dmart have the marketing heft to market itself as an online retailer as well?
  • Are there any barriers that Dmar might face before it goes online in a big way (technological, logistics or otherwise)?
  • Does Dmart’s concept of pick up points (PUP) have merit and will people accept and adopt it.
  • Will Dmart be able to match prices with the other online retailers?
  • Will Dmart be able to replicate the PUP concept across all the regions where it operates?
  • Will people be ok to pay Rs. 49 or 3% as delivery charges to get their items delivered to their home?
 10
11

Will the promoters maintain a substantial stake in Dmart?

Marks Range: (5 = promotors shall maintain to 0 = promotors will not maintain a substantial stake)

If the promoters maintain a substantial equity in the company they have a reason to ensure the success of the company. Do you see the promoters maintaining their pie of Dmart shares at a significantly higher level for an extended period of time (say 10 years)?

Note: Current promoter holding is at 82%. As per SEBI, all listed companies should ensure their promoters do not hold shares more than 75% within 3 years of listing. So one should expect some promoter dilution in future.

 5
12

Will the share capital be maintained at a steady level to ensure the company is EPS accretive (EPS grows as the profits grow)?

Marks Range: (5 = no dilution expected to 0 = Constant dilution expected)

The company may decide to raise money from capital market for various reasons ex: to build new marts, to pay off the interests on loans (Dmart is taking a 1000 crore loan to buy land to build new marts), to reduce operating costs etc. Do you foresee such a situation?

 5
13

Are you ok to not get a dividend or live with a very low dividend?

Marks Range: (5 = I am ok with no dividends to 0 = I am not ok with zero dividends)

Since Dmart is a discount retailer, cash is very important for its growth especially when it owns most of its retail stores. It may find the idea of dividend distribution an unattractive option for an extended period of time. This decision could be due to better investment opportunities or due to dividend distribution tax or some other reason. In the best case it may declare dividends but the amount might turn out to be meagre. How comfortable are you with this situation.

 5
14

Is the employee expense policy conducive for the growth of the company?

Marks Range: (5 = I like the employee policy to 0 = I don’t like the employee policy)

I believe Dmart uses third party agency for its employee requirements at the store level. This reduces the cost but may increase the attrition levels. Do you fell ok with the employee expense policy?

 5
15

Are you comfortable with the Asset heavy retail model?

Marks Range: (5 = Like the Dmart model to 0 = hate Dmart’s model)

  • Almost all Indian retailers operate with asset light model (i.e. they lease the store space rather than owning it).
  • But Dmart works with asset heavy model. They either own most of their stores or they have taken them on long lease.
  • Asset light companies take a hit on their OPEX by paying rent whereas asset heavy companies like DMART take a hit on CAPEX.
  • Asset light companies risk the possibility of higher OPEX as rentals keep increasing whereas asset heavy companies save on the OPEX. But they need to have a dedicated setup to manage their assets (property maintenance, interface with government) etc.
 5
16

Do you foresee the below items as a risk?

Marks Range: (10 = These are not risks at all to 0 = These are valid risks)

Avenue supermart believes the following are some of the risk factors for its operations [1].

  • It is not able to sustain its Every Day Low Cost/Every Day Low Price model
  • It might run out of inventory and not able to replenish on time due to various factors like: supplier disruption, calamities, strike etc.
  • Risk of not selling stock leading to expired products that may need to be discarded and hence leading to a loss.
  • Bad choice of store location leading to less than expected revenue/footfalls.
  • Bad choice of products in the store leading to locked working capital in unsold goods. Due to diversity in India the company may need to stock region specific items. It may go wrong in its analysis on customer tastes.
  • Concentration risk as most of the stores are in two states.
  • Litigations due to defective products (ex: someone falls sick after consuming items sold from Dmart). Any other litigations (ex: Land related disputes, employees filing cases, supplier filing cases due to non-payment)
  • If the promotor or key management personnel leave the company.
 10

References

  1. Avenue Supermarts Red Herring Prospectus
  2. Avenue Supermarts Annual report FY17
  3. Avenue Supermarts Quarterly Results post IPO

Other links of interest

  1. http://csinvesting.org/wp-content/uploads/2012/08/amzn-valuexvail-2012-josh-tarasoff1.pdf
  2. http://www.forbesindia.com/article/boardroom/dmart-the-juggernaut-continues-to-roll-for-indias-value-shop/48457/1
  3. https://www.bloombergquint.com/markets/2017/03/09/bargain-hunting-by-wives-turns-d-mart-owner-radhakishan-damani-a-billionaire
  4. Competition (Future Group): http://www.livemint.com/Companies/sG5E40fOgjM5f3OS6Z7AEP/The-reorganization-of-Future-Group.html
  5. Future Group (some interesting insights into Future Consumer Enterprises Limited) http://www.businesstoday.in/opinion/interviews/we-have-the-cash-flow-to-make-growth-happen-says-kishore-biyani/story/265983.html
  6. https://www.outlookbusiness.com/markets/trend/retail-stock-therapy-part-1-4034
  7. https://www.outlookbusiness.com/markets/trend/retail-stock-therapy-part-2-4040
  8. https://www.cnbc.com/2017/04/12/nearly-every-american-spent-money-at-wal-mart-last-year.html
  9. http://www.mit.edu/~afc/papers/Cavallo_Online_Offline.pdf
  10. https://www.cbinsights.com/research/direct-to-consumer-retail-strategies/
  11. Competition (Future Group): https://www.outlookbusiness.com/the-big-story/lead-story/what-biyanis-future-looks-like-4015
  12. https://www.outlookbusiness.com/markets/feature/make-way-for-the-new-king-of-retail-3492

Disclaimer

I am not a SEBI registered research analyst. The information provided above is my subjective view based on what I have read on different websites, annual reports, and quarterly reports of various companies which I assume to be accurate. The above information should not be treated as an offer/advise to purchase a specific stock/investment instrument. Since these are my subjective opinions, I could be wrong in my understanding or presentation of information. I do not claim that the above information is complete or can be relied upon as such. I cannot be held responsible for any loss or damage caused due to any inadvertent error in the above information. I will not be liable for investment decisions made by readers of this article based on the above information. I am not an investment advisor. I may or may not have position in the above company. Please consult your investment advisor for all your investment needs.