Towards the end of January, Avenue Supermarts came out with the results for Q3 FY18. Let us have a look at the results. Before we look into the results, I would recommend you to look at the below link which introduces the company.

Financial Analysis

Q3 FY18 (Crores) Q3 FY17 (Crores) Growth (%)
Revenue 4108.47 3347.85 22.74%
Expenses 3723.33 3113.47 19.58%
PBT 385.14 234.38 64.32
PAT 251.76 151.87 65.77%
  • Revenue: The revenue for Q3 FY18 grew by mere 22%. The company attributes this to the base effect. During Q3 FY17 there was demonetization and people had very less cash. So they could not go to the mom and pop stores as these stores predominantly work on cash. So people ended up shopping in Dmart as they could use their Credit/Debit card. So sales were very high in Q3 FY17. Due to higher base effect, Q3 FY18 seems to be projecting relatively lower sales.
  • EBITDA: EBITDA improved by 46.5% to 422 crores. EBITDA margin has improved from 8.6% in Q3FY17 to 10.3% in Q3FY18.
  • Gross Margin: The Company saw the gross margins improve by 140 basis points. Out of this 140 bps, about 50 bps is attributed to GST and 90 bps due to better sales mix (i.e. more focus on apparels and general merchandise). On the increase in gross margins, CEO attributed this predominantly to sales mix. The company has been selling more of apparels and general merchandise and hence the growth in margins. I am happy to see the increase in margins. But I am not too happy looking at the reason for this growth (i.e. more focus on apparels). I recently bought two pairs of Jeans from Dmart and in the first wash the garment started to lose its color. The worst part is the fact that the apparel seller has dyed black color on a blue jeans and with every wash the black dye is peeling off and I have a patchy pair of jeans. I may not buy apparel from Dmart in future. But I will definitely continue to buy other items. Clothing is a tough business as it deals with a person’s lifestyle and moreover it is generally treated as a discretionary item. Anything discretionary, will add an element of cyclicality into the business which I am not very comfortable with.
  • Operating Margin: The operating margin also increased by about 137 bps to 10.3% compared to 8.63% in Q2 FY17.
  • PAT: The PAT grew by 63% due to a favorable sales mix. Additionally the PAT was higher due to lower interest cost. The company would have used the proceeds of IPO to payback the loans and hence the interest cost would be down compared to Q3 FY17. The finance costs has declined by 64.7% year-on-year to 1,096 crore. PAT margin improved to 6.1% in Q3FY18 compared to 4.5% in Q3FY17.
  • The EPS increased by about 49.25% to 4.30 compared to 2.70 in Q3 FY17. The PAT growth and EPS growth show a divergence due to the IPO in Q4 FY17. From Q1 of FY19 we should see the EPS growth and PAT growth to show similar pattern (assuming the ESOPs shall be minimal).
Q3 FY18 Q3 FY17 Growth (%)
EPS 4.30 2.70 49.25%

Expenses

Q3 FY18 (Crores) Q3 FY17 (Crores) Growth (%)
Purchase of Stock in trade 3186.66 2771.14 15%
Employee Benefit expense 70.42 50.38 39.77%
Finance Cost 10.95 31.03 – 64.71%
Other Expense 178.92 164.86 8.52%
  • Purchase of Stock in Trade: As expected this forms the major chunk of expense. Dmart has to buy the items it sells and hence it needs to pay for the goods. The table below shows the purchase of stock in trade as a percentage of total revenue. It is quite evident that as a percentage of revenue, its major expense has come down by a good 520 bps! Clearly the operating margins and profit margins are going up. A very good sign for the company.
Q3 FY18 (%) Q3 FY17 (%) Growth (bps)
Purchase of Stock in trade as a % of revenue 77.55% 82.76% – 521
  • Employee Benefit Expense: We know that the company works on an outsourcing contract model for its in-store staff, however it still needs key employees to run the company. This section reports the salary paid to the employees of the company. The expense for the contract employees is captured in “other expenses”. There seems to be about 40% growth in employee expense. This is optically higher. The table below compares the employee expense as a percentage of revenue we see that as a percentage of revenue it is a mere 1.71 and Y-o-Y this has grown by 20 bps which, according to me, is negligible.
Q3 FY18 (%) Q3 FY17 (%) Growth (bps)
Employee expense as a % of revenue 1.71% 1.50% 20
  • Finance Cost: Finance cost has come down by about 65%. This is predominantly due to the repayment of loans using the proceeds of the IPO. The table below shows the finance cost as a percentage of revenue. Clearly, right now, finance cost is not even worth pondering about. This is a good thing in two ways: lower interest outgo directly has an impact on PAT. Additionally a lower debt level is a good tool to leverage in future, in case the company has to increase its debt to fuel future growth.
Q3 FY18 (%) Q3 FY17 (%) Growth (bps)
Finance Cost as a % of revenue 0.266% 0.92% – 71%
  • Other Expense: Other expense forms a sizeable component of the expenses bracket. This involves contract employee payment, lease rentals, store operation costs like electricity bills, repairs and maintenance, legal fees, travel expenses for key employees etc. In terms of absolute number there seems to be an increase of 8.5% in other expenses. The table below shows the other expenses as a percentage of the overall revenue. Year-on-year the other expense as a percentage of revenue has in-fact decreased by 294 bps.
Q3 FY18 (%) Q3 FY17 (%) Growth (bps)
Other Expense as a % of revenue 4.35% 7.29% – 294

In summary, growth in expenses is less compared to the growth in revenue. This seems to have resulted in an increase in the EBITDA and hence the operating margins have gone up. I am very pleased to see that the company is on the path of improved efficiency and hence higher shareholder value creation.

Utilization of IPO Proceeds

The company came up with the IPO in Q4 FY17 and by Q1 FY18 the company had utilized most of the money earmarked for repayment of loans and the General corporate expenses. Since then the company has not spent further on these two items. It has been slowly been nibbling on the 2nd item i.e. the money kept aside for construction of fitouts for new stores. Since the company has gone slow in its store expansion in FY18, it has not been able to utilize this amount. I am expecting Q4 to see store expansions and hence this amount being partly utilized by the end of Q4 FY18.

IPO Plan (Crores) Utilized as of Q3 FY18 (Crores) Utilized as of Q2 FY18 (Crores) Utilized as of Q1 FY18 (Crores)
Repayment of NCDs/Term Loans 1080 864 864 864
Construction of fitouts for new stores 366.6 45.9 9.89 0
General Corporate purposes 423.4 419.79 418.27 417.45

Balance Sheet Analysis (As of Q2 FY18)

The company seems to be providing the balance sheet details on a half yearly basis. Hence I do not have the balance sheet details as of Q3 FY18. My observations below are based on Q2 FY18. Please note that I am highlighting only the important aspects of the balance sheet. I am also limiting to standalone numbers (as Q2 FY18 results provide details only for the standalone)

Q2 FY18 (Crores) End of FY17 (Crores) End of FY16 (Crores)
Assets (Non-Current)
Property plant and Equipment 2665.89 2515.58 2061.26
Capital work in progress  (i.e. new stores under construction) 288.22 152.89 81.68
Investment Properties (i.e. properties owned and rented by Dmart to other companies/entities) 26.91 27.37 13.65
Investment in Subsidiaries (ex: E-Commerce) 44.28 36.61 15.99
Assets (Current)
Inventories 1257.83 933.15 660.20
Trade Receivables (?? Why does a retailer like Dmart have trade receivables?) 44.71 20.99 8.37
Other Current Assets (mostly Advances given to suppliers) 135.83 57.82 47.77
Liabilities (Non-Current)
Shareholder Equity 4213.66 3837.06 1511.86
Borrowings (NCD and Term loans) 389.00 980.92 908.46
Liabilities (Current)
Current Borrowings 33.03 122.66 113.49
Trade payables 401.19 266.75 200.46
Others (currently maturing NCD and Term loans) 133.64 492.83 253.52

The balance sheet shows some interesting set of numbers. Let us try to analyze these numbers.

Assets:

  • Property plant and Equipment: Between FY16 and FY17 we saw close to 450 crores of money additionally being spent on building new stores. But between end of FY17 and H2, about 150 crores has been spent on new store additions. As indicated by the company, it had opened only 5 stores as of Q2. Hence it explains the lower addition of stores.
  • Capital work in progress: Simultaneously we notice that the capital work in progress is much higher between end of FY17 and Q2 FY18. This means that all the pending stores are still under construction. Some of this capital used for ‘work in progress’ would have got completed in Q3 (5 stores) and some of it would get over by Q4. The balance sheet at the end of FY18 should show us better numbers.
  • Current Assets: Inventories: We see that over the years the level of inventory has gone up. Even though inventory numbers are a snapshot of a particular day, a higher number for inventory clearly shows that the company is stocking more which means that the store count is increasing and in each store the company is stocking more items for sales
    • The Inventory numbers should be looked at, in conjunction with Trade-payables. There is an increase in inventories and at the same time there is an increase in trade-payables as well. I would have expected this and the numbers seem to be in-line.

Liabilities:

  • Shareholder Equity: The major liability for the company is the shareholder equity! From the perspective of a company, it is a liability, but for a shareholder it might be a good news to know that the net-worth of the company is its major liability (Close to 80% of the total liability is shareholder equity)!
  • Borrowings: The other happy news as of Q2 FY18 is the fact that the non-current borrowings have come down. From close to 980 crores at the end of Q4 FY17 the borrowings have dropped to 389 crores in Q2 FY18. This shows that most of the money from the IPO that was earmarked for repayment of loans has been paid back.
    • These non-current borrowings should be looked in-conjunction with “Other” current liabilities. We can notice that at the end of Q4 FY17 the company had huge non-current liabilities (980 crores) as well as huge current liability (490 crores). Using the IPO proceeds the company has brought down these loans. So as of Q2 FY18, the non-current liabilities is at 389 crores and current liabilities is 133 crores.
    • So the company is now light as far as borrowings is concerned. But the joy may not last long. I remember reading somewhere that the company plans to increase its debt by about 1000 crores to buy land for its new stores (Apparently the money raised by the company in IPO can be used to construct the stores but may not be used to buy land. I am not able to find the source for this information though).

Overall I am quite satisfied with the current asset-liability numbers.

Future Growth

In an interesting discussion with Business standard, Neville opened up on his thoughts on store expansion. He feels that the company is not opening stores at the rate he would have expected. In FY18, till Q3 the company has opened only 10 stores. He believes the company should be opening about 30 stores per year for the foreseeable future. But the cost of owning the stores is increasing and the company would like to look at long term (30 year) leased space for expansion. He is comfortable with 80:20 ratio of owned v/s leased stores. The thought process is on the same lines as that of Walmart where the ratio of company owned to leased store is around 80:20. Additionally the company clarified that it would like to expand only in existing markets and would not like to venture in new markets in the near future.

With respect to scope of growth and competitors in Brick-and-Mortar, the company sees a huge demand for B&M sales and Neville sees room for many retailers. As we saw in my analysis of Dmart, organized retail makes up a miniscule part of the entire retail ecosystem and there is scope for growth for retail sector.

With respect to e-commerce, Dmart completes a year of operation of its ecommerce foray. In this one year the company has learnt the following:

  • E-commerce is a challenging business compared to Brick and Mortar. Specifically in case of Grocery business people may not be looking at price alone. If you are buying one or two products then you are price sensitive. But when you are filling up your e-cart with 20-30 grocery items then you may not look at price alone. You may start looking at other services as well (ex: delivery time, ease of using the online portal etc). The company realizes that it will have to look at e-commerce holistically and not just concentrate on the price point.
  • The company believes that e-commerce makes sense to them only in urban areas where they are facing real estate price escalations. Beyond metros and urban areas, it expects B&M stores to dominate sales.

Dmart does not foresee the ecommerce business adding significant revenue to its business. The company currently is in e-commerce because it has to be in the business and it wants to learn as it expands its online business.

On Private label business the company does not want to concentrate on owning private labels. It wants to be a seller of products manufactured by others. It does have private labels like Primea but the company is not actively pursuing this space.

Summary

  • Revenue growth was less than my expectation. The company attributes it to higher base effect.
  • Gross margin and operating margins have increased which is a very heartening sign. I hope that the company can continue to show better numbers. The company wants to increase the number of leased stores to improve its store growth rate. This will increase its OPEX and the operating margin might come down. Let us hope the management takes an informed judgement and balances its growth ambition vis-a-vis OPEX.
  • PAT growth was very encouraging. This is predominantly due to a better sales mix (apparels and general merchandise) and lower interest cost. I would have loved to see the PAT growth due to higher margins and efficiency in grocery sales rather than discretionary items. Grocery sales are eternal, dependable, and a basic necessity.
  • Balance sheet looks good. Let us wait for Q4 numbers to get a better picture.
  • Going by Walmart growth story, I believe there is humongous growth opportunity for the company however one should keep an eye on Reliance retail for the curve balls.

References

  • Quarterly results for Q3 FY18
  • News Articles post the Q3 FY18 results.

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.