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Is Radhakishan Damani Led DMart Share Price Target Justified?

Founder and CEO, Transfin.
Apr 11, 2020 5:08 AM 3 min read
Editorial

DMart share price (supermarket chain listed as "Avenue Supermarts Limited" on the stock exchange), promoted by veteran Mumbai investor Radhakishan Damani, who directly and indirectly holds more than 80% of the company, has rallied more than 30% year-to-date, in spite of going below year start level in between due to the wider market impact of the coronavirus. So much so, that being a top retail player, some experts consider it a potential multibagger amid the pandemic.

 

Owing to the stock's massive popularity amongst investors, promoter Radhakishan Damani's net worth also surged almost 11% this year to $10.7bn, singling him out as the billionaire with most gains among the 12 richest Indians whose wealth is tracked by the Bloomberg Billionaires Index.

 

With its major footprint in Maharashtra and Gujarat, the company with 196 stores (as at December 2019), expects to open 30 more stores every year through its cluster approach.

 

And as millions of Indians look to hoard groceries and other every day essentials amidst the lockdown, DMart's “Everyday low cost – Everyday low price” philosophy, that is, to become the lowest priced retailer in the region they operate in makes for a lucrative choice. High discounting, enabled by DMart's comparatively healthy operating profit margin (7.5% in FY19) vis-a-vis peers, sharp focus on non-discretionary products, less variety (perfect for a pandemic!), low home delivery charges, and minimal advertising expense comprise its competitive advantage.

 

So, DMart's prospects seem bright as Future Group, which runs India’s second-largest retail chain by revenue, Big Bazaar, saw shares of its publicly-traded retail unit nosedive 80% this year amid mounting debt woes.

 

Nevertheless, the big question is if the company, trading at INR 2,393 per share (c. 120x 1y forward earnings), justifiable?

 

Let's look at the positives in the apocalyptic scenario where DMart's demand dissapears:

(note: stop thinking like an equity investor, start thinking like a lender!

  1. Low financial leverage
  2. Strong lean operations
  3. Pandemic friendly product suite (less variety, non-discretionary)
  4. Low fixed cost base (i.e. Can ramp down operations relatively easily when disruption hits)
  5. Most stores are owned and operated (hardly any lease obligations!)
  6. Solid cash generation

 Now potential cons:

  1. Exposed to Maharashtra (close to 40% stores) - region most affected by the virus
  2. Largely an offline player. Very nascent in ecommerce (less than 1% revenue) 
  3. Expensive

 

Out of cons, effects of supply chain disruption in Maharashtra are impossible to predict in timing and shape, so we can ignore and hope they are hedged by the positives. Gearing towards offline as a negative is not the most relevant point in India, at least in the medium term. 

 

That leaves us with DMart's current share price of INR 2,393. If we assume the same revenue growth for 2020 as in 2019 (performance of 3 quarters to-date plus expectation of hoarding in Q4 point that it is achievable) and assume a Net Income margin of 5.0% (vs. 4.5% in 2019), we are still looking at a 1y forward PE of 117.5x (way above peers).

 

Assuming a 10y CAGR of 30% in revenues, driven by a 9% annual growth in number of stores (think 30 stores per year is too ambitious in the short to medium term - we assume a run rate of 20-25 stores per year, hitting 30 stores per year by year 7), equivalent capex (starting with 5% of sales, in line with historic actuals, gradually tapering down to 1%), and working capital requirement growing in-line with sales and expenses, and lastly further optimized leverage, we came up with the below sensitivity: 

 

DMart Share Price Sensitivity (WACC vs. LT growth)
DMart Share Price Sensitivity (WACC vs. LT growth)

 

As per our model, the assumed cost of capital would have to be below 13% to square the value with the current share price. Considering India's country risk premium would have only increased in the past few weeks (Damodaran puts us at 9.49% as per his latest update), anything less than 15% seems rich.

 

But considering the company's strong fundamentals, focused and relevant product suite, and lastly clean financials with fixed dependencies, it seems more a case of flight to quality which assumes some level of "survivorship" hypothesis. Translation: investors expect DMart to be one of the last men standing, well positioned for future consolidation and monopoly building. 

 

So it is expensive, yes. Fairly valued, no. But understandable, yes. 

 

FIN.

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