DMart: Motilal Oswal upgrades stock to 'buy', sees 16% upside – 6 key reasons

Despite the Indian benchmark indices edging towards their all-time highs, some large-cap stocks are still struggling to gain momentum, and Avenue Supermarts, that operates the retail chain of DMart, is one such stock that has been on a downward spiral over the last nine months.

The company's shares tumbled 13% in CY22, in contrast to the 4.33% rally observed in the Nifty 50 index. This marked the stock's first yearly loss since its listing in 2017. The downward trend has persisted in FY23, with a drop of 10.75% so far, causing the stock to trade at ₹3,632 levels.

From its 52-week high of ₹5,900 apiece, marked in October 2021, the stock has dropped 38.5% to date. The stock's weak performance, according to analysts was attributed to weak SSSG growth. 

However, there is a potential for a turnaround in the stock's performance, according to projections made by brokerage firm Motilal Oswal. The brokerage has identified six key factors that could potentially drive a pullback in the stock's trajectory.

Strong footprint addition in last few years

According to Motilal Oswal, DMart has shown remarkable growth in expanding its footprint despite the challenges posed by COVID-19. While many other retailers struggled to grow their presence, DMart achieved a robust 20% CAGR in area addition from FY20 to FY23, resulting in a 19% increase in revenue. It is noteworthy that DMart operates on an ownership model, making this growth even more impressive.

However, SSSG (same-store sales growth) was weak due to the addition of big stores in the last few years (average store size up 23% over FY19–23), which pulled down store productivity, and weak discretionary demand in the value category reduced its share to 23% from 27% in FY20, the brokerage noted.

Nevertheless, the brokerage anticipates a recovery in SSSG in FY24, driven by factors such as easing general inflation, cost reduction in raw materials, and the potential revival of discretionary demand.

Additionally, the company has adopted a revised store strategy, shifting towards opening larger stores since FY19/20. These stores, which have completed their initial 3–4-year cycles, are expected to contribute to store productivity and attract more footfalls, providing further growth opportunities, as highlighted by the brokerage.

Good cost control in a weak SSSG environment

Despite weak SSSG, the brokerage said the company has managed to protect its EBITDA margin, unlike other retailers, which have seen a 200–450 basis point margin hit.

DMart is one of the few retailers to have retained cost efficiencies achieved during the COVID period and benefited from the economies of larger stores. Gross margin was affected by the softness in the margin-accretive discretionary category, offsetting price inflation gains.

Yet, it has managed to achieve an EBITDA margin closer to the normal pre-COVID level. This is evident from its SG&A and employee costs, which declined 2% per square foot over FY20–23 to ₹2,264 in FY23, cushioning the 2% drop in revenue productivity, the brokerage noted.

When SSSG recovers, strong cost control could help DMart improve its margin by 30–50 bps or pass on the gains to drive higher offtake, it stated.

Competitive position intact

Despite the recent aggressiveness of online and quick commerce platforms, the brokerage pointed out that DMart consistently remains one of the most competitive grocery retailers, along with JioMart (Reliance Fresh), with 6% lower pricing (vs. average basket value of nine players) over the last 12 months.

Based on Motilal Oswal's monthly grocery price monitor, DMart's basket value of ₹8,500 in May 2023 was slightly higher than JioMart but 8% cheaper than pure-play online retailers like Zepto, Dunzo, Big Basket, etc. This highlights DMart's cost competitiveness in comparison to aggressive online players.

"As per our price monitor, four times in the last 12 months, it had the cheapest basket value with the widest breadth of the lowest price products. This looks commendable, as DMART has protected its margins while maintaining its competitive edge," said the brokerage.

Online business: not burning cash, but well prepared

DMart Ready has expanded its footprint to 22 cities with store metrics that are close to breakeven. It operates on the next-day delivery model, unlike other quick-service e-grocers, which have lower fill rates and delivery sizes and mostly cater to daily needs instead of monthly grocery orders, it highlighted.

“As per Redseer, the online industry reached a sizeable $8 billion scale in 2022 and is expected to see a 33% CAGR over 2022–2025 (reaching $19 billion by 2025), but most online players have found it difficult to achieve profitability. DMart Ready, on the other hand, has a well-managed model. Although it has not grown rapidly due to weak economics in the online business, it is prepared for any growth opportunities,” said Motilal Oswal.

Long runway for growth

DMart's well-oiled business model with a strong focus on low procurement costs, cost savings from supply chain efficiencies, and rental savings through the ownership model has created a deep moat and a virtuous cycle of growth, the brokerage highlighted.

In the food and grocery business, with wafer-thin margins (15% gross margin), this helps create a highly competitive offering, thus pushing store productivity much ahead of peers and offering a long runway for growth.

The brokerage believes that DMart's SSSG and earnings revision cycle are closer to bottoming out. Tailwinds from robust store additions and consistent cost efficiency could play a key role in SSSG recovery. Subsequently, it estimates a revenue and PAT CAGR of 27% and 29% over FY23–25.

Healthy balance sheet and cash flow

DMart’s new stores in many virgin markets with an ownership model need lower investments and allow it to leverage growth for the long term. The lean working capital cycle and asset turns have enabled it to garner 18–20% ROIC consistently over the last five years (barring COVID impact), according to the brokerage.

The company's healthy annual OCF of ₹11.7 billion and ₹21.8 billion in FY24E and FY25E should help to add a 16% footprint through internal accruals, thus offering a self-funded long runway for growth, it added.

Upgraded to ‘Buy’

DMart has consistently achieved impressive growth, margins, and return on capital employed (ROCE), despite its asset-heavy model. The brokerage emphasised that this supports its higher valuations as compared to competitors.

Over the past five years, DMart has traded at 60x EV/EBITDA and 99x PE ratios. After a 25% correction since September 2022, the stock is now trading at 36x EV/EBITDA and 58x PE on FY25E, offering a 30% discount to historical multiples.

Motilal Oswal believes SSSG improvements in FY24 should boost valuation multiples. It valued the stock at 40x FY25E EV/EBITDA and an implied P/E of 64x on June 2025, setting a target price of ₹4,200 apiece, upgrading the stock to a 'buy' recommendation. This target price implies a 16% upside for the stock.

25 analysts polled by MintGenie on average have a 'hold' call on the stock

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.