D-Mart: Something Left on the Table or All Soaked In?

Indian equities are a diverse bunch.

 

On one hand you have a Jet Airways or NDTV…sexy as brands but fabulously pointless as investments (thanks to their decade-long range bound share price charts), every once-in-a-while you can find a stock which investors love from day one. A company whose solid fundamentals, an almost workman-like quality, focus on efficiency, complemented by a sober and austere management adding to its aura.

 

D-Mart, a supermarket chain listed (as Avenue Supermarkets Limited) in March 2017 fits that bill. Promoted by veteran Mumbai investor Radhakishan Damani, who directly and indirectly holds more than 80% of the company, the stock has quadrupled since issuance and remains a market favourite.

 

Currently trading at c. INR1,300, almost 70x its 1y forward earnings, DMart’s growing retail base (from 131 stores in 2017 to 176 in 2019, major footprint in Maharashtra & Gujarat but gradually spreading all across), rising ‘per store’ earnings (from INR7.5cr EBITDA per store in 2017 to INR9.3cr per store in 2019), low leverage and ROEs regularly touching high teens is perhaps why investors love it.

 

No doubt it is a robust business! Its “Everyday low cost – Everyday low price” philosophy i.e. to become the lowest priced retailer in the region they operate in, finds phenomenal resonance in the rapidly transforming Indian retail landscape.

 

But Is It Trading At A “Fair” Price?

 

Assessing fundamental value can be a lot of fun. Even more so if done quick-and-dirty and without any skin in the game. You know…spending one Sunday afternoon to put the company’s basic numbers in a spread sheet and get a feel of things.

 

D-Mart currently trades at INR1,292 per share translating into market capitalisation of INR80,991cr, surely places it at the higher end of the retail spectrum. But it does post higher ROEs, while demonstrating discipline with leverage, so why not!?

 

The Future

 

Discounted Cash Flow (DCF) valuation basics: project the free cash flows (FCF) of the company and discount it by a suitable (tricky point, always) weighted discounted rate (or WACC) to get the present enterprise value (EV). Deduct the company’s net debt from EV to calculate its equity value.

 

Let us look at its actuals then to project future FCF.

 

Revenues: D-Mart’s revenues grew by 38.6% in 2017, 26.4% in 2018, and 33.1% in 2019. Slowing, but come on! Newstores take time to gestate. Will simply assume a 1% drop in growth every year for the next 10 years (as the base becomes bigger, growth will slow down), but still a healthy 23% expected growth in 2029 – not bad.

 

EBITDA: EBITDA margin have been roughly between 8-9%. Taking a word from the CEO’s book of 8-8.5% margin as comfortable, let us assume a conservative and stable 8% (considering there has been some margin pressure lately).

 

FCF: Will simply project working capital as proportion of revenues and assume the capex as 1% of revenues (again very conservative). Deducting change in working capital and capex from EBITDA and you have the FCF.

 

Discount Rate: Don’t really have a strong view on suitable discount rates within the Indian retail space…but here are a few references...D-Mart’s cost of debt is around 9%. Considering D-Mart’s ROE is 18%, one can guess its cost of equity would be somewhere in between. As per Prof Damodaran (if you don’t know him and you’ve managed to read so far, it is your loss alone! Now go and cry in shame.), Indian equities currently hold a risk premium of 8.6%. Hence even with a beta of 1.0 for D-Mart, we’re looking at an expected cost of equity of 16%. Considering its low leverage, we can assume D-Mart’s WACC to be circling around 14%, though considering beta in real terms would be more than 1.0, we can lock in around 15%-16%.

 

But wait, let’s plug in our numbers and goal-seek to see how investors view D-Mart’s WACC coming to its current value of INR80,991cr.

 

The answer...drumroll...12.6%! Now that’s optimistic. Too many bubbles?

 

In my view, yes! Think about it. We’ve assumed practically zero margin expansion, gradual growth slowdown, conservative capital spend, a status quoist approach towards working capital, and still need to apply a relatively aggressive 12%-13% discount rate (vs. 15%-16% IMHO or not less than 14% at least) to square with present market value.

 

Don’t think much is left on the table.

 

Nevertheless, enclosing some valuation sensitivities for you to ponder over. Also click here to view the full spread sheet.

 

D-Mart: Something Left on the Table or All Soaked In?

 

D-Mart: Something Left on the Table or All Soaked In?

  

 

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