Avenue Supermart: a compounding machine?

bheeshma · October 12, 2017, 5:51am

Disc - i am neither invested in Dmart or Infosys

However, in my opinion , it would be unwise to look at historical growth rates extending too far back into the past. As long as Infy was expected to grow at 25% - 30% + , it commanded the valuations it commanded. Over time mgt has given a lower guidance and the prices have adjusted to this. The numbers also have reflected this. In the last 5 years profit growth has been 11.49%, 3 yrs - 10.44%, the recent yr - 6.4% & the recent june qtr - 1.4%.

When earnings are expected to grow at a rate than is significantly less than the long term inflation rate , the PE ratio has a tendency to remain very low even for companies with a strong balance sheet and lots of cash flows in stark contrast to the teenage version of infy which was doing an earnings multiple of 300. But those were exciting times for the IT sector.

This low PE further creates an optical illusion of value that is incorrect. The flip of course is a company that is expected to grow at rates significantly exceeding the long term inflation rate. These kind of companies have a high PE which again creates an optical illusion of overvaluation.

A few years back, i was given an example by an investor on not relying too much on historical growth rates which has stuck with me and is part of my “akal khaata account”. Imagine a company over 20 yrs. This company has grown exponentially only in 1 yr , 20 years ago. In that one year ( 20 years ago) profits grew by 119 times. After that it has been a degrowing every year.

Yet if you do a 20 yr growth rate , the 20 yr CAGR comes to 26% & at that rate it would appear undervalued - again an optical illusion. Obviously, this is an extreme example but it helped me in improving my thought process.

Please take these views as a theory and my personal views. As with all theories they are peppered with my biases that i cant shake despite my best efforts. I acknowledge that. But under the investment process i now follow - i have found better performance in high PE stocks & therefore - unsolicited as they maybe - i have a tendency to share these views spontaneously.

Best
Bheeshma

Akhil_7306 · October 12, 2017, 8:30am

Hi Bheeshma,

I can see your logic of growth rates justifying valuations. But just for once look at Infosys with an open mind. After March 2000, take ANY year and date that you like(with good growth) and try to calculate the returns given by the stock from March 2000 till that date(take either 2007(bull market peak) or 2010). You’ll find that the returns were mediocre at best.

SlownSteady · October 12, 2017, 8:49am

Why are we calling this a compounder while this stock has not even completed a year in the market?

Valuations are very high considering PE for wal-mart is 20. Even Wal-Mart is disrupted by Amazon. Amazon is already in India. How is D-Mart going to compete with Amazon.

Also retail theme has already played in India and we know how that ended (Pantaloon, V Mart etc). What is different this time with D-Mart?

All these questions have prevented me from investing in this stock. Am sure if so many PEs are investing, this would be backed up by solid numbers. It’s just that I am not convinced and could very well be wrong!

bharti_vishal · October 12, 2017, 10:15am

If you hold the stock… enjoy the ride. Bhaav bhagwaan hai. Valuations does seem stretched historically… but remember it has high level of certainty to grow at 30-40% plus for long period of time with far superior margins than industry peers… markets love growth. it could also be that market knows something which we don’t(results are coming shortly)

furkanalam · October 12, 2017, 2:17pm

My 2 cents, the valuations of D-Mart are too high. There is no way this can be justified.

Those who invested at lower levels good for them but in no way its a value buy at current levels.

People are factoring a decade of strong growth ignoring any possibility of lean period or economic disruptions or competition from online players or many other factors. Just amazing to see reports factoring in 10 year forward earnings.

But agree company has very good fundamentals , good management and i would have loved to have this in my portfolio if markets gave me a chance

Disc - Not invested

grohal · October 12, 2017, 2:28pm

In the best case scenario if DMART grow at 35% for 10 years. Earings will grow 20 times. If we assume the PE after 10 years to be 30, the returns CAGR will be around 15%. Which is decent but then risk is can it maintain 35% growth for 10 years.

shaswat49 · October 12, 2017, 2:54pm

@SlownSteady D-Mart is not competing with Amazon unless Amazon starts their offline retail store. They both are completely different in every segment.

Coming to the point what’s so different about D-mart other than V mart and N mart is that D-Mart owns most of the stores which reduces their Opex and which gives them the priority to solely focus on profit by selling retail items. The best thing to do is, go and check out your nearest D-Mart retail store on weekdays and see how much crowd you’re finding.

Also, the question here is not whether D-Mart will survive or not, the question is, D-Mart is currently trading with PE almost 180, is it worth buying for a long term?

manivannan.g · October 12, 2017, 2:58pm

Until last month, I was working for an e-com giant. They are aggressively preparing themselves to focus on the grocery section with a HUUUUGE war chest. How does D-Mart and Big bazaar gonna compete with their discounts ? if they can compete with them and provide the growth for which the current PE is demanding… how is that gonna happen ? As far as i think, this is a tough ask.

At present situation, even a one bad year will make the stock worse. Of course it will bounce, since it has good management, but the situation might be different.

This is my opinion backing with source. I welcome different opinions.

Amazon:
https://www.ft.com/content/8d1d40ce-54b3-11e7-9fed-c19e2700005f (Sometimes this not opening, so posting as pdf file)
Amazon gears up for assault on India’s grocery sector.pdf (828.4 KB)

Flipkart:

Alibaba:

Disc: Not invested

nikhildoshi · October 12, 2017, 6:00pm

Why do think other chain don’t follow this strategy (acquiring real estate)?

Can we honestly think that only dmart see the advantages of saving on rentals?

There are many reasons retail chains do not prefer buying real estate.

Google - should I buy or rent new store

And you will get tons of information.

Few reasons -

Very High initial capital expenditure - the amount of money that is used to buy land can be used to open more store, thus enabling faster expansion
You need to manage property - local compliance, maintenance and other headaches
The point you mentioned that they solely focus on selling retail items, won’t apply to dmart but to other chain store since they are not busy managing the property
Responsibility for bringing your own footfall

There are many other reasons as well.

SlownSteady · October 12, 2017, 9:32pm

With Amazon buying out Whole Foods, it is not an online player anymore. It has announced its intention to play the entire value chain. Amazon is called retail killer here in Australia. So the disruption is going to be real something like Reliance Jio.

Also you cannot expect a retailer to own all its stores. It will either affect growth rates or affect equity dilution as you need deep pockets to own every store. Finally, as you said it all comes down to valuations. If it was expensive during IPO, it looks insane now.

suhagpatel · October 13, 2017, 2:52am

Posting the snapshot from recent moneylife article on fair value. Thought its similar to what you have been saying here. Check the Fair value section.

Not saying that Dmart will follow the same path as far as stock performance goes. Just found synergy with your details above.

Disc : Invested in Dmart since IPO.

bheeshma · October 13, 2017, 10:18am

There are some other factors to bear in mind as well when looking at Dmart & its expansion plans. In the housing for all mission and specifically in the urban component - an addition of 20 million urban homes is planned - specifically for catering to the housing needs of the LIG segment.

The main aim is to provide housing at a very low cost in areas that are some distance away from the city municipal limits ( about 20 to 50 kms away ), and monetize the land which currently has no monetary value. This will have the dual benefit of reducing the population density ( one of the highest in the world amongst the most populous countries) and also help in providing a pucca home to the LIG segment.

This will also have the impact of a substantial relocation of the population to these locations and in the not so distant future one can see the creation of new urban agglomerations in the outskirts of the city.

Giving you an example of pune - in the recent 3 years there have been several new micromarkets that have grown due to this migration - Kiwale, Manjari, Pirangut, Kirkitwadi to name a few and the housing for all mission has not even taken off yet. These micromarkets contain a population of 2L- 3L

The hyperlocal strategy followed by Dmart ensures that it is very fast in opening stores in response to local population shifts. Its average store size is 32000 Sqft and most are owned standalone stores. This creates an advantage as the socio economic characteristics of the population match with the demographic Dmart serves and the catchement size is large enough for Dmart but not large enough to attract malls where most large format stores are situated - creating a sustainable albeit temporary monopoly.

This is a very interesting strategy as instead of going to tier-1 & tier-2 cities - Dmart focuses on the newly created tier-1 & tier 2 micromarkets of large cities. Obviously, for this strategy to work the state needs to have more land than the population, else the population will have nowhere to shift and buildup within the city

If you look at this table from the census data there are some interesting data points for the key areas where Dmart operates - Maharashtra & Gujarat forming the main base + growing into Andhra Pradesh, Rajasthan, MP, Karnataka & Chattisgarh. In all these states the % of land is significantly more than the population. Of particular note is WB & UP where it is not present where the % of land is way below its population size. giving further support to this observation.

The shift in the population distribution due to housing for all, in my opinion, is a very interesting pattern and has the potential to hugely benefit Dmart amongst the retail players

Best
Bheeshma
Views invited

Source for table : http://censusindia.gov.in/2011-prov-results/data_files/india/Final_PPT_2011chapter7.pdf

SlownSteady · October 13, 2017, 10:42am

My only question would be what is preventing other retail players from following the same strategy. As more players follow this idea, more the competition and less the margins. Even a small disappointment in earning would shatter Dmart price at this level.

furkanalam · October 13, 2017, 11:08am

Exactly how could buying real estate to reduce rentals be a supersmart strategy. And why couldnt anyone else follow the same strategy. What will happen when they expand the stores. Isn’t this a asset heavy model. Capex intensive. There are both pros and cons for this strategy.

How would they compete with online marketplaces and retailers, who would offer lower prices due to their asset light model. Home delivery companies have sprung up everywhere offering groceries at very competitive prices…how would that affect them …

Why cant others source at the same price as they do if they have the volume and big pockets…

If they keep growing this way…wouldnt it attract other players with big pockets…And what is DMart’s moat which cannot be breached at just a hundred stores…

These are some important disruption points down the road…

Even a value investor like RK Damani couldnt have imagined the current valuations. Its just ridiculously high.

bheeshma · October 13, 2017, 4:05pm

Hi @SlownSteady

The retail market in India is large enough for all kinds of interesting possibilities. why other retail players have not followed the same strategy as Dmart yet and whats stopping them is a good question! I am also perplexed because the model adopted by Dmart seems operationally easy to follow for an outsider.

But the fact is while Dmart is very profitable doing 30,000 sqft stores others with larger formats are loss making or have low profitability, so maybe it is something to do with the correct format that is suited for a large and complex country like India.

Dmart has 131 stores as on March 17. The store format followed by Dmart is a supermarket. Just that this supermarket has immense buying power unmatched (at least currently) by any supermarket chain in India - including online grocery stores. Dmart is essentially a large Kirana store.

Its main competitors is the mass of local kirana stores still serve 98% of Indias requirements. There are an estimate 12 million of them in India. One way to get a sense of the opportunity size is to convert them into 'Dmart equivalents". ( 1 Dmart equivalent is 30,000 Sqft )

Assuming that an average Kirana store is 150 sqft, 12 million stores would be 60,000 Dmart equivalents. Assuming conservatively that Dmart takes 5% share from them would mean 3000 additional Dmart stores from the current 131 stores.

The total PAT of Dmart in 2017 is 483cr , translating to an avg profit of 3.68 cr per store. One could possibly do the math for 3000 addn stores.

Dmart opened 14 stores Q4 17 or an avg of 4.6 stores per month or 21 stores in FY17 at 1.75 per month. Whatever run rate you take it will take a long long time before Dmart runs out of stores to open up making it a structurally sound growth story that one can bank upon. In addition Dmart SSG is currently at 21.2% (they call it like for like growth )

In these kind of bets where the size of opportunity is humongous it would be unadvisable to rely on PE ratios alone to make investments.

On a different note, the market cap of all listed retail companies is 1.47L cr while the market cap of FMCG is 11.56L crores. Even a cyclical sector like cement has a market cap of 3.51L crores. A sector in distress Pharma commands a market cap of 7.3L crores while IT is at 12.2L crores. Globally retail giants occupy a significant portion of the market cap so one can also do a thought experiment here.

My two cents
Bheeshma

nikhildoshi · October 13, 2017, 6:16pm

This model is in fact operationally difficult as they need a team / management personnel to manage local compliance, security and maintenance management.

Also there’s risk of choosing wrong location, companies usually build store by factoring 10 - 15 years of future growth. In this scenario, they also consider the growth of surrounding / catchment area.
It might happen that catchment area doesn’t grow as per original expectation and now retail chain is stuck with dead locations.

It might also happen that due to change in local law that area become unattractive.
Eg. Allocation of nearby area dump yard or Cremation ground can significantly damage property value.
Few bad incidents such as rape or death may also that tag that particular area as bad retail locations.
Another example - Dharavi in mumbai perceive as low area, even though not all part of Dharavi is bad for retail.

IMO, this model is relatively difficult compared to leasing a store.

nikhildoshi · October 13, 2017, 6:42pm

IMO, The answer to above question lies in execution.

Right store size / format concept is tried by Biyani many times. He has explained his thoughts regarding this in his book, It happened in India.

So I don’t think right store was size can be a major reason.

Two most important factors that I find very important in retail are - employees cost and inventory days.
Please check attached screen shot for more details.

Dmart hire contractors who in turn hire employees. I believe in this one of the key differences between dmart and other retailers.

Other major dmart competitor are -

Biyani group - change in strategy every couple of years, so there’s lack of focus and execution is very poor
Spencer - again check screen shot. Spencer doesn’t position itself as discount retailer and thus doesn’t directly compete with dmart (though it may seem that way)

Trent - Trent star Bazaar was positioned as discount retailer, however Tata lacks the focus that’s needed for retail (it was evident in Chroma, Westside and all other formats as well)

So IMO dmart is only retailer who is focused solely on discounts retailing. (their promoter has no other focus in retail like tatas or goenka or Biyani).

This focus helps them to do the job better than rest and thus they are able to get better prices than everyone and in turn, able to offer lower prices as well.

But as of now, customers have no TRUE alternative when they look for discount retailers. That’s why consumers visit dmart frequently.

This picture might change if there are many alternatives.

ekveer · October 13, 2017, 9:23pm

My 2 cents based on observations on US and Indian retail/eCommerce industry.

Amazon bought whole foods in USA as they cannot grow beyond a point with pure eCommerce. The whole reason amazon bought whole foods is for increasing their home delivery of fresh groceries foot print which cannot be grown beyond a point in eCommerce model.

Now, walmart is trying with a new strategy of click and pick/collect which means buy online and pick it up in local online store. I personally like this model as I know I get better prices in this model as a customer as I am avoiding the delivery part. This is not a new strategy but they are putting more efforts for this model. Not just walmart, lot of other companies are trying this model.

If I am not wrong, amazon is also piloting a pick-up and return in collaboration with kohls in USA. Amazon has started physical books stores in some universities in USA. Amazon is also piloting a check-out less grocery stores in USA and they are called Amazon Go stores.

The reason I am telling these is to make a point that eCommerce can only grow to a extent without retail store presence and in India, the extent of growth of pure eCommerce may be much smaller than what we have seen in USA because of several India specific challenges. For all those who say that eCommerce can kill DMart, what is stopping DMart to start home delivery within certain miles from their stores or even offer click and pick facility? This is a low hanging fruit for DMart.

Having said that, for all those skeptics who think that owning a store comes with several challenges should read about McDonald’s. McDonald’s own the real estate for most of its stores and there are tons of articles on this on the internet and they are very successful in doing this. I think DMart is adopting this methodology. If DMart doesnt own the stores, Irrespective of their growth lease prices will go up by certain value every year and these ever increasing lease prices may not go well for their profitability and keeping the prices down for the customer.

DMart or for that matter all retail companies have humongous opportunity in front of them with a very very long runway and so far only DMart got the strategy right in India. There is scarcity premium for less floating stock, scarcity premium for being the only company that got the strategy right and on top of everything, its growing at a pace very few companies in India can match and it is growing in a consistent, predictable and financially responsible manner.

Please check P/E of some quality companies command in India and their growth. Asian Paints is growing at 10% roughly and commands a PE of 60 and there are numerous example like that. Everyone talk about PB of Gruh Finance for a lot of time and it only keeps going up. Everyone did DCF of Page Industries and how many got it right and how many are able to hold the stock based on their DCF calculation? Only reason I am comparing these (Asian Paints, Gruh Finance, Page Industries) with DMart is under my assumption that DMart is fundamentally as good as Asian Paints, Gruh Finance, Page Industries.

In my view, most of the quality companies which rely on domestic consumption story in India always remain expensive.

bheeshma · October 14, 2017, 11:04am

results out September Qtr

http://www.bseindia.com/xml-data/corpfiling/AttachLive/0e6abd7c-21fb-4986-bba0-960d980aa500.pdf

EPS Sept 17 vs EPS Sept 16 up by 46.6% ( 3.02 vs 2.06 )
Net Profit Sept 17 vs Sept 16 up by 65% , (19102.26L v/s 11564.82L)
Revenue up by 26%
4 stores added in Q2 taking the tally to 136

http://www.bseindia.com/xml-data/corpfiling/AttachLive/3b117a52-3da6-4c85-837a-517a33f99825.pdf

Best
Bheeshma

empower_the_lo_ · October 14, 2017, 2:39pm

We should take into account the hardwork that D-mart management has done during last decade.
From 1 store in Mumbai to 150+ stores now, during a decade has called for a lot of business acumen and organic growth.
This is the reason they are able to own the stores and maintain the Capex load.
Other groups like Future orTatas are taking easy credit to run their stores and maintain decent profits.
One has to do a hard-work for a decade to be in the position that D-mart is currently in.
This No one WANTS to do !! That can be a reason why other groups are not trying this.
Everyone wants quick money these days.