Why D-Mart has divided Dalal Street pundits even after growing Q1 profits 6x

Avenue Supermarts Ltd, the parent of supermarket chain D-Mart, has come a long way since its stock market debut about five years ago. As one of the biggest ‘non-tech’ wealth creators on Dalal Street over the last five years, it defied naysayers and its stock price stayed almost on a steady growth track, barring short corrections.

It did not just manage to beat competition from legacy retailers such as Reliance Retail, More, Spencer’s, and Big Bazaar, but also fought the ecommerce juggernaut cutting into consumer behaviour.

So much so, the company has seen its share price rising over six-fold since its debut in 2017. The Covid-19 pandemic did impact its business in the first half of 2020-21, but investors kept running into the counter with trolley loads of money and its stock price more than doubled during the first two waves of the pandemic.

However, the dream run came to an end a few months ago after its stock hit an all-time high last year and has been an underperformer since then. Its value has crumbled by almost a third even as the benchmark indices are down just about 10-12% from their peak.

The stock slid for the first time since it went public, with the broader correction in the market early this year and then sank again when it announced its fourth-quarter earnings with profit just about flat on a low base.

In the first quarter of the current fiscal year, it came up with a good jump in earnings albeit on an even lower base. Standalone profit rocketed to Rs 680 crore for Q1 FY23 from Rs 115 crore in the quarter ended June 30, 2021.

What stumped analysts?

There are two factors playing on the mind of those tracking the company closely.

One is the revenue throughput captured by sales per square feet of store size. Even though the throughput did improve to the best level since the pandemic affected businesses globally, the revenue per sq ft at Rs 33,281 was still around 12% below the pre-pandemic level of over Rs 38,000.

With no disruption in operations in the last quarter, for the first time in the last two years, the throughput was expected to go back to the pre-pandemic level.

To be fair, this is partly due to the shift in strategy by the company where its store size has increased significantly. For instance, the average store size five years ago was around 30,000 sq ft. This has steadily grown since then. The ten stores it added in the last quarter was just twice the size with an average carpet area of 60,000 sq ft. This tends to push the revenue throughput downwards.

Second, the higher margin segment for the company also carries an overhang.

“General merchandise and apparel categories saw relatively better traction than the previous quarter but still had some overhang of the Covid-19 led disruptions and acute inflationary impact. Our discretionary contribution mix of this quarter is yet to reach the pre-pandemic levels but is getting better,” Neville Noronha, CEO and Managing Director, Avenue Supermarts, said after the Q1 results.

He pointed out that high inflation over the last two years hides the possible stress in volume growth for discretionary categories of mass consumption.

“Value growth through positive volume growth of discretionary products in relatively older stores is the best reflection of the strength of the DMart business, competitive impact and the local economy. We have made good progress in this area during the quarter. We will need another quarter of uninterrupted operations to understand this better,” he added.

One brokerage house that has a sell rating on the stock noted: “We suspect this is not just a function of high inflation keeping discretionary purchases in check but also a consequence of a fair challenge to D-MART’s value proposition by deep pocketed peers.”

Should you buy?

On the flip side, there are several analysts who have given a thumbs up on the stock. The positive surprise with the profit margin is one factor that’s keeping them pumped up.

Gross margins, although a tad lower than the pre-pandemic high, is almost at a kissing distance. The EBITDA margin, on the other hand, has already matched the previous best of 10.3%. This was achieved ahead of expected timeline and has pushed some brokerages to upgrade the stock to buy with a higher target price.

Indeed, there are still more brokerages with a buy sign on the stock than those with a sell placard.

The company’s stock is trading at a P/E multiple of around 115x its twelve-month trailing earnings. While this may appear rich, on a two-year forward projected earning, the company is likely trading around 70-75x P/E ratio, which could make it palatable to investors.

The key factor working in the favour of the company is the benefit of doubt that the positives from the recent expansion is yet to fully kick in and that it would pull back its customers for its margin accretive general merchandise and apparel segments. This would be apparent in the current quarter itself as the management itself has also guided.

The sharp correction in the stock does make it look attractive but long-term investors may do better by seeing how the company performs in the second quarter ending September 30 to take a full directional call.

This would show how it's leveraging the large size of stores to generate more sales and also reflect its resilience to the increased competition from peers – both offline and online – in its higher margin segments.