This article is a detailed fundamental analysis of Avenue Supermarts covering its business model, competitive advantages, financial statement analysis, key risks, growth opportunities, corporate governance and valuation. the article also explains why dmart trades at such high valuations and why it has underperformed recently. Read the entire article to know more.
Chapters
- Introduction
- Business Model
- Product Portfolio
- Competitive Advantages
- Analysis of financial statements
- DuPont Analysis
- SWOT Analysis
- Corporate Governance
- Valuation
Introduction
Avenue Supermarts is primarily engaged in the business of organized retail and it operates supermarkets under the brand name of D-Mart. It was founded by Indian value investor Radhakishan Damani in 2002 when its first store was opened in powai, Mumbai. The company has its headquarters in Mumbai. it sells a wide range of products from groceries to electronics, apparels and fashion accessories. It got listed on both the stock exchange after it had its IPO in 2017. It had a stellar debut after the stock got listed at more than 100% premium to its issue price.
Business Model
The USP of dmart that attracts its customers towards itself is its value for money offerings through its wide range of products and customer centric approach. And dmart achieves this through cost optimisation, efficient operations and strategic expansion. A detailed analysis of dmart’s business model is presented here:-
- Low- cost operations- as discussed dmart needs to keep its operational cost low so that it can offer products at the cheapest rate. The grocery business of dmart is basically a trading business and hence it cannot charge a premium over there. Moreover, this offerings actually helps bring customer to its stores to whom dmart can pitch high value product and make better margin. So to keep this grocery segment business sustainable dmart has to achieve efficient supply chain management, by bulk purchasing directly from wholesalers, optimising store layout and strategically placing products. Also, dmart doesn’t spends a single penny on advertisement, so it saves a lot of costs there whereas if you see its competitors, they have a considerable ad spend. Also, they have hired a lot of employees on contractual basis so that helps them in saving a lot of costs.
- EDLC & EDLP strategy- Dmart follows a Everyday low cost (EDLC) and Everyday low price (EDLP) strategy (source: AR 2022, pg 32). Under this strategy dmart offers at lowest prices throughout the year that helps it build customer loyalty. And dmart does this so by procuring goods at lowest price from wholesalers. And the wholesaler sells them at the lowest price simply because of two reasons. One, because dmart gives a bulk order at a time. So even if the wholesaler compromises a little bit on the margin side it is able to make up that by selling a huge quantity. And the second reason is that dmart makes payments very quickly as it receives order. You see it’s a common industry practice that retailers buy goods from its suppliers however makes only a part payment of that. So, from a Point of view of wholesaler its working capital is stuck to its creditors. However, when they sell the same goods to dmart they almost instantly receive the money (which you would see in its creditor days) so they can better manage their working capital and hence are willing to compromise a little bit on their margin. For reference, dmart had a creditor days of 10 this year however vmart had a creditor days of 112.
- Store format- Dmart primarily operates in the hypermarket segment with stores typically ranging from a size of 50000-161000 Sq. ft. These stores are strategically located in places where they can target a huge base of middle class and lower middle-class consumers
- In-House Brands- Dmart has been successful in creating its own in-house brands that replaces popular brands. They offer quality products at even more competitive prices, so that they can establish themselves as an alternative. This helps dmart in having better grip over supply chain and enjoy better margins.
- Cluster based store opening approach- dmart doesn’t believe in mindless expansion. Instead, it has a concentrated store opening approach meaning it opens stores at locations which are in close proximity to its already established stores, which you can clearly figure out in this map (source: AR 2022 pg 5). For context, big bazar had about 130 stores in India in 2010 whereas dmart had only 30 at that time. Today dmart is the second largest retail giant in India whereas big bazar has gone bankrupt.
Fig1- Cluster based store opening approach of dmart
Product portfolio
Now let’s have a look at key offerings of dmart. Dmart has 3 main product offerings. The first one being the groceries segment where essential items such as milk, butter, pulses, cereals are being sold. Being a commodity business dmart has the lowest margin in this segment. This segment also contributes 56-57% in sales and earns 12-15% gross margin for the company. Next product segment is non-food items where personal products, cosmetics and toiletries are being sold. Dmart has 20% revenue contribution from this segment and earns 12-30% gross margin from this segment. The final segment is of general merchandise where apparel and toys are sold. It contributes about 23-24% in sales and earns about 25-35% margin. (Source AR 2022, pg7). Clearly this is a high margin high profit segment for dmart and has significant impact in overall companies’ performance.
Competitive Advantage
The business model of dmart creates a vicious advantage cycle which its competitors find difficult to break. Dmart procures goods from its suppliers at the cheapest rate and hence they are able to further sell them in their stores at the cheapest. Since they sell it at the cheapest, they attract huge number of consumers. This sells its products quickly (creating a high inventory turnover ratio) and hence dmart puts a purchase order again to its suppliers. Since, the supplier is assured of huge and timely payment of order it obliges to sell products to dmart at a low margin, since he can make up the lost margin from huge quantity of sales. And when this cycle takes place at a scale of dmart it becomes difficult for other competitors to break into.
Fig 2- Competitive Advantage of Dmart
Analysis of Financial Statements
We have compiled the data of last three-year financial statements in one excel sheet which makes it easier for us to analyse. One can access the sheet here.
Dmart has been quite successful with its business model as its sales and profitability has been compounding at a fast pace. 3 year sales growth cagr in 2023 was 19.87% and profit growth was @ 22.22%. The figures were similar high for other years well. Except FY21 profit compounding was at a rate more than sales growth. Since dmart runs a retail business and as we analysed its business model it can’t have a very high margin.
Fig 3- YOY Sales and Profit growth of Dmart
The EBITDA margin of the business in FY 23 was 8.49%. though the margin was stable throughout. Now as we have looked into profitability, we should look into cash flow from operations to check whether the company has been able to realise its profit in real cash. If we look into profits and CFO of the company, we can see they are comparable. And the CFO/PAT ratio of the company is close to 1 in every financial year which is a good sign. If we look into free cashflow of the business we see it has been negative year. This is understandable as dmart is in expansion mode currently and hence using all its cashflow to fuel its growth. Therfore its not possible for dmart to maintain a positive free cashflow. Now let’s have a look into its balance sheet and start with its profitability ratios. If we look at ROE of the business it is on the lower side. ROE has only been improved in FY23 recorded at 15%, however the number for the past three years were 12,9 and 11 respectively. We will know the reasons in detail when we will do a DuPont analysis. The ROCE of the business has been quite healthy except FY 21, due to reasons like Covid. The borrowings of the business have been quite low hovering between 0.3-0.5 combined with a interest coverage ratio of 25-35 which obviously gives a line of comfort. Next, we look at the solvency ratio of the company. The current ratio of the dmart is around 3. A good current ratio is considered as 1.2-2. Current ratio around 3 means dmart is keeping a large amount of cash in its book for short term. This might not be good as it can use that cash to invest in business to generate higher return on that cash. Next metric is inventory turnover ratio which is a very very important ratio for dmart. Inventory turnover ratio indicates the number of times an inventory is sold in a year and higher the number the better it is. Inventory turnover Ratio is 13.59 for dmart which means dmart has to replenish the items in every 26 days in its shelf. Next comes asset turnover ratio which signifies the asset utilisation efficiency of the business. A good ratio is considered anything of about 2.5 and above. Dmart has asset utilisation ratio of 2.3 which is closed to that magic number. The next important metric is creditor days which means the number of days it takes a business to pay back its trade payables. In this case it is those suppliers from whom dmart procures the goods. Dmart has maintained these number around 8 days. Debtor days is number of days it takes for a business to get paid its trade receivables. It is of few hours for dmart obviously because people make payments instantly to dmart as soon as they buy things and get out of store. Generally, a high creditor day and a low debtor day is preferred to keep cash conversion cycle in control. Cash conversion cycle is the time taken by a business to convert investments in inventories to sale and lower the number, better it is, and this number is also consistent for dmart which is a good sign. Next comes two important CapEx metrics CWIP and Fixed Assets. CWIP gives the amount of capital that a business is investing back into its business and fixed assets is the amount of assets that is owned by the business till date. Promoters hold 74.9%( ceiling at 75%) of the business within which R.K. Damani holds 34.3% ( AR 2022 pg 204). FII holding has gone down over time from 10.42% to 8.17% which isn’t a good sign however DII have increased their stake from 5.98 to 7.49%. However, when we look at the overall institutional ownership in last 4 years, holding has gone down from 65.3% to 62.3% which could one of the reason of underperformance of the share. Promoters have no holdings pledged. The company does not give any divided since it is in growth phase. Now let’s have a look at few business specific metrics for dmart. Dmart has been aggressively investing in its business to increase its store count which has gone up from 214 in FY20 to 284 in FY23. Revenue per square feet area has gone down from 32879 in FY20 to 27454 in FY 23 and this is definitely not a good sign. This might be due to the reason that the stores have opened in recent times only and that it would take a significant time for them to reach its full potential. Next important dmart specific metric is like for like growth. Like for like metric denotes the sales growth of the stores that were developed till last year. This metric ignores the sales occurred due to the capacity expansion happened this year. It is also reported as same stores sales growth by few companies and is an important metric to analyse retail business. The last metric is number of bill cuts which is also on a declining trend and is not a good sign.
DuPont Analysis
ROE of dmart has been quite low if we look at the data of financial years from 2020-2022. It was only in 2023 that it has improved somewhat to 15%. The reasons for the low ROE and the improvement can be deduced from DuPont analysis. The dip in ROE in march 2021 was due to drop in net profit margin and asset turnover ratio. This is due to the impact of covid that resulted in shutting it stores and affecting its operations. And the huge improvement of ROE this year is due to increase in its net profit margin which has reverted back to its mean, improvement of asset utilisation ratio. Also the financial leverage of the firm has increased a little bit due to increase of borrowings in its balance sheet. Though rising financial leverage due to increasing debt might always not be good, but for dmart it’s kind of okay since it does not have very high proportion of debt than equity and it has comfortable level of interest coverage ratio. High Financial Leverage always positively impact ROE as ROE is also directly dependent on Financial Leverage.
SWOT Analysis
SWOT analysis is qualitative analysis framework used to assess Strength, Weakness, Opportunity and Threat. It provides a structural framework to assess the current state of business and helps in identifying areas of improvement and risks.
Strength: –
- Strong Brand presence- Avenue Supermarts operates under the strong brand name of “Dmart” which clearly is a strength of the organisation. Consumers relate its brand name with products at deep discount and hence does bulk shopping whenever they visit a dmart store.
- Product availability – Dmart stores has availability of wide range of products from groceries to cosmetics, electronics, apparel and more under one roof catering to a wide range of consumers.
- Efficient supply chain: The company has established an efficient supply chain network, enabling them to maintain a robust inventory management system and ensure timely availability of products.
Weakness: –
- Dependence on third party suppliers- Dmart is dependent on third party suppliers from whom they procure goods to sell further. This can create quality control issues. Other than this sudden events like covid can cause supply chain disruption, sudden hike in procurement cost can increase its operational cost. This can disrupt their EDLC/EDLP strategy and might lose their customer base.
Opportunities: – Dmart has a sea of opportunity ahead of it and that can only explain its abysmally high valuation
- Structural Shift of the industry from unorganised to organised players- Currently the dominant player in this industry are those small mom & pop stores in the locality that rules the market. However, there is a tectonic shift in this industry with consumers moving to buy from organised player like dmart which would definitely benefit them. The organised retail industry is projected to grow at 9% CAGR from 2019-2030. (Ref)
- Huge Middle-class population with rising income- Most of Indian population is below 35 years of age and with the increasing income, some of the substantial part would go to discretionary spending and definitely players like dmart should benefit from it.
Threats: –
- Extreme Competition- Though this industry is poised to grow at a rapid rate, but that has only invited competition in this industry and the competition is fierce. From domestic player to international everyone wants a good share in this industry. Quick commerce brands like zepto, blinkit, swiggy instamart all operate in this segment. Other than that, we shouldn’t forget about the big daddy of this industry Reliance Retail which has a deep pocket promoter family. International player like amazon also has grocery segment of their business in India and legacy corporate houses like Tata’s have quite significant presence with their brand Bigbasket. We have to wait good time to let the dust settle and see who emerges as the winners of the industry.
- Online Presence- A good chunk of retail business is being carried out online in India and dmart don’t have a great online presence. It supplies its product to consumers located to places only close to existing warehouse. Hence it definitely misses out on opportunities in areas out of its current business operations . Below is compiled list of apps with their user base according to data taken as on 26th June,23.
| App Name |
Downloads |
| Blinkit |
10M+ |
| Bigbasket |
10M+ |
| Jiomart |
50M+ |
| Swiggy (food app+instamart) |
100M+ |
| Zepto |
10M+ |
| Dmart Ready |
10M+ |
Table- Popular Quick commerce Apps and their user base (dt-26th june,2023)
Corporate Governance
Corporate Governance essentially involves balancing the interests of various stakeholders of the Company such as shareholders, management, customers, suppliers, financiers, government, regulators and the community. The main objective of corporate governance is to ensure that the company operates in a transparent, accountable, and ethical manner, with the best interests of shareholders and stakeholders in mind. Effective corporate governance helps build trust and confidence among shareholders, investors, employees, and the wider public.
Board of Directors (Source- AR2022, Pg29)
- Ignatius N. Noronha- CEO
- Ramakant Baheti- Group CFO
- Elvin Machado- Whole Time Director
- Niladri Deb- CFO
- Manjri Chandak- Non Executive Director
- Ramesh Damani- Independent Director & Chairman
- Chandrakant Bhave- Independent Director
- Kalpana Unadkat- Independent Director
Audit Committee
- Mr. Chandrashekhar Bhave – Chairman
- Mr. Ramesh Damani – Member
- Ms. Kalpana Unadkat – Member
- Mrs. Manjri Chandak – Member
Nomination committee
- Mr. Chandrashekhar Bhave – Chairman
- Mr. Ramesh Damani – Member
- Mrs. Manjri Chandak – Member
Auditors- S R B C & Co LLP Chartered Accountants
You can see the composition of board of dmart. Ignatius Noronha is their CEO and CFO is Niladri Deb. They have three independent directors in their board and one of them is the famous value investor Ramesh Damani. We did a google search to check whether anyways Ramesh Damani is related with Radhakrishan Damani (obviously because of the same surname and R.K.Damani being a value investor himself) however we couldn’t establish any and hence concluded that it’s okay for him to be an independent director. Independent director comprises of 37.5% of the board. According to SEBI, if chairman is a non-executive director then independent directors should hold at least 33% of the board composition and otherwise should hold 50%. one can read details of the other two independent directors published on page 221. R.K.Damani doesn’t hold any position in the board hence this is a professionally managed company. The composition of other board is also in accordance to SEBI rules and regulation.
Risk Management & Internal Controls
The company has adequate risk management in place. Dmart has segmented this in two parts : Capital Risk and Financial Risk. The Company’s capital risk management policy, as stated in the annual report, can be summarized as this. According to the company’s annual report, its capital risk management policy aims to maximize shareholder value by considering various components of capital, including issued equity, securities premium, and equity reserves. The company adjusts its capital structure based on economic conditions and financial covenants. Notably, it raised capital through an IPO in FY2017 and a QIP in FY2020. A portion of the proceeds from these offerings was utilized to repay borrowings, resulting in a substantial reduction in the company’s debt. The company’s capital structure is guided by board-approved policies and undergoes regular reviews to align with funding requirements and is assessed using various metrics.
The Group’s financial risk management report highlights its principal financial liabilities, including borrowings and payables, used to support operations. Financial assets mainly consist of receivables and cash equivalents. Market risks such as interest rate fluctuations and currency exchange rate volatility are considered. The Group actively manages credit risk, primarily from trade receivables, and monitors liquidity risk to ensure timely and cost-effective settlements.
Subsidiaries of the company
Dmart has total 5 subsidiaries which somewhat does backward integration of the business. Dmart has shared their business performance in the annual report on which we will have a look. Align retail trades is involved in packaging and selling of groceries. Dmart owns 100% in this company. It did a sales of 1587cr this year vs 1298cr last year. Net profit of the company was 17.15cr vs 15.8cr last year. Next company is avenue food plaza in which dmart owns 100% stake too. This company operates food stall in dmart stores. It did a business of 43cr vs 14.91cr last year and had a profit of 31lakh vs loss of 1.3cr. Avenue e commerce (dmart Ready), operates the e-commerce business and delivers to 500 pin codes in the country. It had a turnover of 1667cr vs 791cr and booked a loss of 142cr vs 80c last year. Next company is Nagar Seth and Jogani Developers which is in the business of real estate development. It had a turnover of 75 lakhs (same both each year) and a profit of 55 lakhs vs 53 lakhs. Dmart owns 99.86% in the e commerce business and 90% in the real estate business. And the last subsidiary is reflect wholesale. Dmart owns 100% in this however its business operations has not started till date.
Shareholding of directors
Ramesh Damani holds 0.02% in this business. We generally prefer independent directors to not have any holding otherwise it causes a conflict of interest. Its ceo has 2.02% holding in the business which values to 4500cr. He hasn’t opted for any ESOPs last year. R. Baheti owns .4% that translates to a value of 1100cr and E. Machado owns 0.05%, which values to 100cr almost. Its CEO took a salary of 4.5cr which is 0.30% of the PAT and is well below the prescribed ceiling.
Auditors Report
The auditors have confirmed that the financial statements show a true and fair value. Company has given 1.21cr as audit fees. Auditors in their report has revealed that avenue has invested 492cr in its e-commerce and it’s in continued loss. Other than this dmart has 2586cr worth of inventory in its warehouse and out of that 21cr is slow moving. The list of pending tax litigations are given on page 101.
Related Party Transactions
Next comes one of the most important sections of corporate governance report and that it is related party transactions. The name of the related parties and their relationship is given in the report in page no 131-132 and the details of the transaction is given on page 188-189. I have calculated only the big transactions and summed them up and the amount comes to 3939.28 crore which is 12% of the sales. This is a red flag as an analyst for me as I prefer to go with companies that has at most 5% of their sales as related party transaction. On top of it I found some interesting related party transactions with few companies which aren’t subsidiaries of avenue Supermarts. The first company being 7 apple hotels private limited. I tried to dig little deep and found on zauba corp website that one of its director is Mr. R.K.Damani himself. The next company derive trading and resorts also has R.K.Damani as one of its shareholder. The next company Damani estate and finances also has R.K.damani as director. This kind of transactions create doubt in the mind of investor. One should always connect with company and get details about this transactions.
Valuation
Since dmart has negative free cashflow we applied a scenario basis framework to value dmart.
Bull case scenario
We assume that Dmart’s profits will grow at a compound annual growth rate (CAGR) of 20% over the next 10 years. Assuming that the market will give Dmart a price-to-earnings (PE) ratio of 50x after 10 years, let’s do some calculations. Currently, Dmart’s profit is 2,378 crore rupees. If we project the profit to grow at a 20% CAGR, it will reach 14,724 crore rupees after 10 years. Multiplying this by 50 gives us a valuation of 7,36,200 crore rupees. Dmart’s current valuation is 2.23 lakh crore rupees. Therefore, if Dmart can achieve a 20% growth in profits over the next 10 years, we can expect a 13% CAGR in the share price.
Base Case Scenario:
Now let’s consider the base case scenario. We assume that Dmart’s profits will grow at a CAGR of 15% and the market will assign a PE ratio of 40x after 10 years. In this case, Dmart’s net profit will be 9,620 crore rupees after 10 years, resulting in a valuation of 3,84,800 crore rupees. Based on this valuation, the share price will increase at a CAGR of 5.6%.
Worst Case Scenario:
In the worst case scenario, we assume that Dmart’s profits will grow at a CAGR of 10% and the market will assign a PE ratio of 30x after 10 years. Performing scenario analysis, Dmart’s profit will reach 6,167 crore rupees after 10 years, and its market cap will be 1,85,010 crore rupees. Based on this, the share price will decline by -1.85% annually over the next 10 year.
Interpretation
However good might be dmart business model or however great might it have a growth potential; this kind of exorbitant high valuation doesn’t leave margin of safety for investors on table. Even in the best-case scenario one can earn 13% Cagr which is anyways close to the index returns subject to everything goes well. However please remember this is NOT a buy/sell recommendation from my end as I am Not Sebi Registered.
Do let me know how you feel the article. All constructive criticism are welcomed.
