Avenue Supermart: a compounding machine?

(Mridul) #84

Some simple calculation on 26% CAGR to multiply the principal 10 times in 10 years.

D-Mart currently is growing at around 35-40% pa.
Trailing p./e is close to 117.

Assumptions -

It will grow at an average of 25-30% pa for next 10 years. Say, 35-40% for first 3-4 years and then growth slowing down to 20-25-30% for next 5-6 years. (for sake of mental models)

Its ROE/ROCE is close to 18%/22% at the moment, while the growth is much higher. So at some point in time, they are going to raise capital to fuel this amazing growth. (Let’s assume, it won;t need any, and it will improve its ROE/ROCE with time to 25-26%).

Page Industries (best example i can think of for such high p/e multiples with high growth), is trading at 55-60 p/e and is now growing close to 20-25%. Yes, a different segment, but we don’;t have d-mart like businesses in India which we can compare with. People have compared it with Walmart obviously because of similar business model and amazing growth over long term. Noteworthy, suggested Walmart exit multiples is ~ 18 times.

Valuation vis a vis growth -

Now, if we apply 26% CAGR growth to say it will grow its EPS 10 times in 10 years, but p/e which is currently at 117, will reduce to 55-60 times trailing in 10 years; this means p/e will become half in 10 years, while EPS growth being 10 times. This means valuation will multiply by 5 times in next 10 years. Therefore, despite EPS growing 10 times, valuation will only grow by 5 times in 10 years. This gives valuation growth CAGR ~ 14-15% pa.

Now, in this mental model, i am assuming lots of things such as improvement in ROE/ROCE such that it will fund its growth through internal accruals, growth estimates, profitability not falling, p/e at 55-60 times after 10 years, no black swans. So, at this valuation, what one is going to get is a 14-15% CAGR return in next 10 years

I don’t think it can remain at over 100 times trailing valuation for long. P/e would come down despite good growth. Hence despite being a very good business, it would remain an average stock at these valuations.

(Bheeshma Sanghani, PhD) #85

Hi @Mridul

The PE is also sensitive to the capital structure of the company. Small changes in the capital structure of the company can have big changes in the fair PE given that growth assumptions pan out as expected over time. It has an enviable interest coverage ratio of 13 ( based on the latest June qtr) . The business can easily operate safely at a coverage ratio of 5-6 and still be considered safe. So there is a huge scope of improvement there in my opinion. A slight increase in the days payable will also impact the capital structure meaningfully. These factors make Dmart an interesting company to study!


(Mridul) #86

@bheeshma - They can certainly raise debt as you said for expansion, if need be. Though, in my opinion, what matters the most is growth visibility. Currently, it is trading at 50 p/e 2 year forward. I have not doubt about the sustainability of business model here (it is a good company, as i said). But is it a good stock if one buys at cmp is the question.

There are different arguments that can be put and people often quote Buffet and Munger saying buying a great/fair company at fair/great valuation. But still, even if we assume 25% growth over next 10 years on average, and assuming market awards 60 p/e this will only give 14-15% CAGR return from here.

And imagine, everything great is priced in here (that IT WILL GROW). Any hiccups, and it could be thrashed like any other growth stock.

If we look at Page/Eicher, p/es are eventually contracting despite tremendous growth rates. Runway for these companies is still huge. So, questions is that what value one gets from here looking 10 years forward.

I know this is just a mental model for growth/valuation, and lots of things are subjective (such as p/e). May be a future cash flow model would be more suited to gauze the valuation here.

(Peabody) #87

Both of you are right. But the fact that there is no comparison in the indian market and if it grows 25-30% consistently , with ace promoters,excellent cash flows- PE may not be a barrier (Ex -Gruh Finance). As a Country India is growing very fast. Comparing to Walmart multiples is not right (it is over the hill)

(Mridul) #88

How i look at it is like this -

D-mart follows asset heavy model, and thus requires big capital up front in order to grow at the rates they have been growing (in order to launch more stores).

They managed to grow till 2017 through internal accruals and debt, but now in order to bring down their cost of capital and at the same time to fuel the growth by opening more stores, they came looking for public money (IPO). They raised close to 1350 cr of which they intend to clear 1000 cr debt and rest for opening around 25 new stores. This was equity dilution as Promoters didn’t sell their stake (great).

Now, their SSGR (Same store sales growth) is close to 21%. So, to grow at 40-50%, they have to keep opening new stores (curse of retail!). hence, the IPO proceeds are just sufficient to open 20-25 more stores after which they will have to again dilute or raise debt. Their asset heavy model would not be successful otherwise. Dilution at such astronomical valuations is good for existing investors, no doubt, so they will dilute.

Sometimes i wonder why a street-smart investor like Mr. Damani priced Avenue Supermarts at 290 at just 30 multiples, He has been in the stock market for over 3 decades. If such was the premium, why he priced this so cheap? He is not here for charity ;-)! Probably he didn’t have an idea and is as surprised as i am ;-)? We are in the middle of a very good bull market, so it was accordingly ‘over-priced’ at 290 (at least was said so).

(Furkan Alam) #89

@Mridul - I was doing some similar future projections on the company. If it grows its EPS by 25% over the next 10 years, the returns would be a 18% CAGR(considering in the 10th year the P/E is 60). See table below. Obviously there could be many things which can lead to lesser growth as here we are projecting 10 years, which no one can predict.

On the debt part as the company mostly owns its properties, it is true they will have to take on debt as their operating cash flows might not be able to fund the capex. It needs to be seen how they manage their expansions in the next few years to get more idea. That can be seen with increasing debt over last 3 years.But the advantage they get is zero rentals which could help them in commanding better margins than the industry.

Though entering this company at a lower multiple is ideal. I am not invested and waiting for an opportunity.

(Peabody) #90

Good points. Why diluting Equity is beneficial. This is not a finance company.By taking debt they should be better off to some extent

(Mridul) #91

@Peabody - One should see what is beneficial for the existing shareholders…trade-off b/w debt or equity dilution.

In laymen terms - If someone is invested at 300 and the dilution happens at 900, it is much more beneficial for existing investors (invested at 300), lesser beneficial for investors invested at 600, and even lesser for those invested at 800. This applies to financial companies as well as other companies. Think, if someone wants to buy a stake at 900, it would have to pay 3 times that of the person who invested at 300 to get same number of shares. So, the company gets 3 times more fund while diluting the eps just 1/3.

Now, one then needs to look at the trade-off between dilution and raising debt. I think they will dilute, reason being they want to clear the existing debt through IPO money (some 1000 cr). If they plan to raise further debt, why are they clearing this existing debt now? It is at reasonable 9-10%. So, my hunch, just clearing debt now to raise it again in 1 year doesn’t make much sense! In any case, raising money through debt or through equity will effect cash flows/eps, which we are not taking into consideration while projecting the growth and valuation model for next 10 years.

(Bheeshma Sanghani, PhD) #92

Just an observation i wanted to share - while not specific to Dmart but certainly pertinent. Debt can be used an a effective tool to increase market cap as the amount of debt repaid immediately seems to get converted to additional market cap ( the multiples may vary ).

A company that can service debt many times over can take on additional debt and repay it back after some time and that seems to be valued more than if the same company had not taken on any debt at all. These capitalization games are a valid way to increase shareholder wealth.

(Value Seeker) #93

An opposite view :slight_smile:

We should account for increasing competition and risk to this business model from e-Commerce over the coming years. While the “Walmart” model is being bandied about w.r.t. to D-Mart, given Indian geography and philosophy (i.e. mindset) my personal belief is that it will not likely materialise. So in my head the scenario playing out is that when D-Mart hits the inflection point (trigger for me is when they enter/ start online mart) that is when the fight will really begin and open up across many fronts.

I think they will be hard pressed to manage an omni channel strategy. And hence, the discounting we need to do for current valuations should be much higher…

(Saji John) #94

So that we can exit at that point?

(Mridul) #95

Opposite? Mine us jyst a mental model to see logic behind the valuation vis a vis growth. I clearly said there are unknowns like competition, etc which are nit embedded in my simple model. What i tried to show was that at such overvaluation, despite growing at such steep cagr, valuation appreciation wd be average. And that too when there are no black swans or big change on the gameboard in terms of business model…amazon retail venture…

(newrb) #96

It will be interesting to see how amazon will impact D-mart. So far, whenever I step in to D-mart in Bangalore, there is always good number of people in the store. The discounts are quite good. Options for a given item are limited though. I think they have a long runway. Valuation is another matter altogether.

(Value Seeker) #97

The narrative will start changing much before then. The timing of a concrete (time bound) announcement will be the culmination. Whether the re-rating happens over time (i.e. gradually) or more sharply is anybody’s guess. How you want to play (exit/ load up) depends on your story for the business and the numbers at that point. Personally, I am biased on this as a “story stock” . I am in the opposite camp for now i.e not a Walmart or a every day low price/ low cost Indian Amazon of groceries! Again, these are the ravings of my own mind :slight_smile: …take with a pinch/ pound of salt!

Disclosure: Not invested currently and no plans to change that for now

(Bheeshma Sanghani, PhD) #98

All sectors and cos within that sector run into rough weather at some point in time. During these times its the balance sheet that comes to their rescue. Companies that spend time, money and effort in creating a formidable balance sheet escape the onslaught and become stronger ( talebs antifragility argument). Companies with weak balance sheets perish rather quickly. It is in this context that i believe one must look at businesses in retail. I think balance sheets are one of the most overlooked areas when analysing a company and contribute enormously to the longevity of a business. Growth is important yes but when your immune system is weak even a small cough can turn into a raging disease if you dont take adequate preventive measures. Just an analogy!

(Vivek) #99

Hi All,
I would like to have views on how one can take a Call on the stock(dmart ) when its the top holding in portfolio with 12% allocation and trading at very expensive valuations. I am really in a dilemma as to what would be the right thing to do in such a scenario?
I am confused as to should we sell it just because its trading at high valuations $10 Billion as of tooday? My buying price is IPO Levels.
Earlier I did a mistake by selling of Edelweiss just because It went up too fast price wise and sold off my holdings just to see it go up again by another 70-100% so kind of confused as the same mistake can be commited here as there is nothing in my view that has changed in the business and is growing. I do accept that from here maybe it can do only 15% CAGR only, but I am okay with such returns and NOT expecting 25-30% CAGR kind of returns.

I would really like to here views of experienced investors as to how such situations are normally dealt with. Any guidence is highly appreciated!
Note : I am not asking for buy/sell calls, I am more interested in the thought process of how such situations are handled.


(ravi) #100

Are you renter of the stock or owner of the business? If you can answer that, you should get your eventual answer. One should be mentally prepared to see no returns for next 2 years from the stock. If that’s ok, then life’s good.

(saumya) #101

Mridul bhai superp calculation.
Its a great business but above avg type stock

(newrb) #102

I would not sell. My thinking being - d-mart kind of growth is very rare in the market today. Earnings are yet to catch up in most industries. Free float is low. As a result any new supply gets absorbed quickly. I would enjoy the ride mentally keeping myself ready that any time I may have to sell 20% lower.

(VK) #103

According to you, the time has already come (before ipo itself :)). Dmart.in is their ecommerce channel. But this is owned by promoter in personal capacity - may be to ring fence damage if any