Happy navratri everyone. Navratri and the various forms in which it is celebrated across india signifies battle. The battle of good over evil with the good emerging victorious.
The conscious reduction of gross margins by 2.1% ahead of the festive season which all retailers plan for should be viewed as a strategic move. The net effect is the improvement of sales and further reduction in the expense ratio. Lowering prices ahead of the festive season may hit Dmart margins a little bit but the effect it will have on the margins of other retailers is far more dramatic and potentially life threatening to them as Dmart expense ratio at 7.4% is the lowest in the industry.
Dmart uses gross margins as a strategic tool and its cost structure allows it to lower prices as and when required.
In a near commodity like marketplace, prices of products are set at the cost of the NEXT most cost efficient competitor. In dmarts case the healthy improvement in the cost structure should be seen as a precursor to a more sustained earnings growth.
In my view, these are all strategic moves ahead of a very competitive festive season.
As you have said the prices are set at cost of next most cost-efficient competitor, is the margin reduction not a sign of increasing competition⌠may be from online / offline⌠against private labels which are cheap⌠or against retails (online) which are offering investorâs money (losses) to reduce prices⌠how can one fight profitably with such competition?
Point to think is that is this margin reduction is permanent/long-term (maybe 3-4 years) in nature or is it just to attract festive season demand?
I personally feel it is a mid to long-term issue since such price cuts were not taken by the company in previous years.
Hi @bheeshma, this is almost clear the they are preparing themselves for upcoming festive sessions as per âchange in inventoriesâ parameter .How to know that Gross margin is effected due to lowering prices ? Is there any way to get that from income statement other than Management Commentary.
Edited Note: Got the answer on expense ratio on net.
Though no argument on valuation taking a beating, but the problem in this case isnât with company but with marketâs expecations on margins. Dmartâs management has been very upfront and candid in sharing that they donât want to âMAXIMISEâ profits but âOPTIMISEâ profits. Their core value proposition to consumer is the âlowest price everydayâ and they donât want compromise on that to meet marketâs expecations. In fact, the core philosophy here is somewhat similar to Jeff Bezos - âCustomer should be at center of every moveâ and the rest will be taken care of.
Stock will take a beating becasue the so called âconsensus estimates ( read #ME2 estimates) will take a beatingâ. Later the initiation on the stock by brokerage houses, higher the expectations they set to justify their bullish ratings.
Fellow member ,Can you help me out how to calculate maintenance capex (Stay in Buisness Capex) for Dmart? Is it will be equal to Depreciation and Amortization ?I want it to calculate cash profits of dmart in 2017-18?
Good documentary. I was surprised to find out that a major chunk of CostCoâs profits come from their membership fees, not from product margins. Their margins are pretty low. The narrator mentioned that CostCo just about breaks even on most products. I donât know how true this is. If it is true then it is a very interesting business model.
@bheeshma Thanks for your help on checking the store count. Do you also have insight into why more stores are added in H2 rather than H1 and that too specially in the 4Q i.e. is there any business reason or seasonality factor involved ?
I donât the reason behind this but my guess it that stores will need some time for customers to get used to maybe 7-8 months. H2 is typically the festive season and one wants the catchement to be fully aware about the store, prices and products well in advance so store openings are timed accordingly to best suit purchase behaviour skipping summers and monsoons.
A good way to assess what has led to the contraction in gross margins is to look at the purchase/sales ratio. My thesis is that that in anticipation of the festive season , dmart has stocked inventory in advance but hasnt sold it just yet. This difference in the extra purchases made but not sold increases the COGS due to the way it is accounted.
The purchase to sales ratio for Dmart has varied in a tight band of 86% to 88% over several years and it is mean reverting.
The gross margins for Dmart have been improving due to scale and net margins have been improving due to lower expense ratios due to this scale. As you sell more , you get better purchase deals. The movements in the gross margin are just due this timing of inventory ordering and should revert as they have in the past.
In my view, one should try and see if gross margins revert, like they have unfailingly done in the past before concluding some structural problem with margins as alluded to in the numerous articles.
Extra inventory shouldnât really affect margins, except to the extent it increases finance costs or reduces other income due to lesser cash/cash equivalents, right?
The formula for COGS is Opening Inventory + Purchases - Closing Inventory = COGS.
If Purchases increases due to some reason the COGS also increases. So the idea is to use the Purchase/Sales ratio to derive what is the ânormalâ purchase level. Ofc if the P/S ratio increases more than the normalized band, one surely has reasons to believe that buying costs have increased and then there would be a structural issue that would most certainly impact margins. However, dont see that yet in Dmart.
I beg to disagree. If inventory is built up for the upcoming festival season, the Closing Stock would also increase, hence reducing the COGS.
It is Cost of Goods SOLD, so if something is unsold at the end of the period, it doesnât reduce the profits.
I donât agree with the Purchases argument for reduction in GM.
Letâs assume a company has an inventory of 10 items, for simplicity lets assume that each item costs Rs.1 so the total inventory value is Rs.10. Let this be the opening inventory. During the quarter, letâs say they sold 3 items from this inventory but they expect great sales next quarter, so they replenish the inventory by 5 more items.
So irrespective of what the Purchases made in the quarter are, the COGS will not change because the Closing inventory already reflects the Purchases made.
I think there is some confusion here. The idea is to look at the normalized level of Purchase Value and then look at changes in the Value of inventories of stock in trade which is the adjusting entry to arrive at COGS. This is how it is represented in the books of accounts.
As far as the decrease in Gross margin is concerned, the other costs ( not the material cost) involved in stocking ahead of the festive season are loaded onto the COGS. COGS also includes total costs of bringing inventory in. This has the impact of increasing the per unit cost and should get normalized in the coming periods.
Dmart follows the average cost method of valuing inventory so over a period of time costs tend to get averaged out. Inventory is a rather large asset for Dmart and the fixed cost component COGS does decrease margins ahead of the the festive period and then averages out.
Any extra costs will, by definition NOT loaded on to the COGS, since they will be adjusted in Closing Stock. For example, costs incurred in bringing the inventory to the warehouse, for example, are generally added to the cost of the goods. So it will be reflected in Closing Stock as well.
If at all you want to argue that the extra inventory adds some extra expenses (not directly attributable to getting the goods to the warehouse or stores) which will be added to Other Expenses line items, or are indirectly reducing Other Income due to reduced cash-on-hand, that still makes sense.
But please stop with the COGS argument now
Regards,
I must add that if they do follow average cost method, some impact may be there on the gross margins, assuming the extra inventory bought late in the period costs meaningfully more, and that they havenât increased selling price in the reported period to compensate for the extra costs of goods lately procured.
Yes they follow the weighted average cost for valuing inventory. The argument is that cogs will increase temporarily due to extra costs loaded and then normalize as the festive season plays out. Its just business as usual in my view. Due to the accounting method followed by Dmart for valuing inventory, the entire closing stock gets revalued at these elevated levels and hence the COGS is impacted as well.
I think you mean the entire closing stock gets revalued at DEPRESSED levels, hence increasing the COGS, hence reducing gross profits/margins. The actual cost of Closing Stock is more than that which is reported, as per you.
It would be interesting if someone can do the math and deduce if this theory can account for the lower margins. The quantum of closing stock in relation to sales, how much it would have to undervalued in the books to account for the lower margins, etc. My hunch is that it would not make a big difference.
Even if your theory is true, it would mean Dmart would have to increase prices in the next period (to maintain margins), which could impact sales.
