The Risks Avenue Supermarts, India’s Most-Expensive Large Cap, Faces

Avenue Supermarts Ltd. trades at 101 times its estimated earnings for 2020-21, the highest among the top 100 large caps defined by the Association of Mutual Funds in India. Shares of the operator of D-Mart supermarket chain have rallied 25% so far this year when the benchmark Nifty 50 is nearly 27% down despite recovering from the worst selloff in more than decade. Avenue Supermarts is the only non-Nifty stock to have a market capitalisation of Rs 1.5 lakh crore.

The supermarket chain, known for offering knockdown prices on everything from lentils to laundry power, benefited mostly from panic buying of household essentials after India confined its 1.3 billion people at their homes to prevent the pathogen from spreading. The stock rally also led to a surge in Damani’s net worth while that of his peers shrunk.

What Aided The Rally

The stock commanded a high valuation on account of expectations of better growth than peers despite the disruptions caused by the virus outbreak.

The company’s revenue rose 24% year-on-year in the fiscal ended March 2020. Even as its sales declined in April, a consensus estimate of analysts tracked by Bloomberg peg growth at 15% for the ongoing financial year. The company’s profit is expected to rise 17% during the period.

According to HSBC Securities, D-Mart stood out in terms of “being consumer centric”. “Its discounting remains as aggressive as it was before, with product availability on shelves highlighting its sharp execution and efficient supply chain,” the investment firm said as it hiked its price target for the stock to Rs 2,800 apiece from Rs 2,300. The company’s ample liquidity put it in a favourable position to “fuel its store expansion in a cost-effective manner”, it said in a report.

HSBC retained its bullish stance after the company’s fourth-quarter earnings. Goldman Sachs, too, maintained a ‘buy’ rating with a target price of Rs 2,530 apiece.

Still, the average of 12-month price targets tracked by Bloomberg implies a downside of 7.5% as the recent rally pushed up the current stock price above the consensus estimate. Only seven of the 24 analysts tracking the stock have a ‘buy’ rating, while 10 recommend a ‘sell’. The remaining suggest a ‘hold’.

What Are The Risks

Steep Valuations

The stock’s premium valuation leaves a little room for error in the company’s performance. Its consensus earnings per share was cut by 4% from a week ago to Rs 23.7.

Sales of Avenue Supermarts dropped 45% year-on-year in April, with pressure on gross margin. That’s mainly because it couldn’t sell apparel and general merchandise, accounting for 28% of the company’s revenue, as the pandemic stalled most operations, according to an earnings statement.

Till last month, the company was running only half its stores, selling just essential items, leading to a decline in footfalls. Even as more outlets are opening up after India eased restrictions, the company said “the challenges are likely to continue in the current financial year”.

While the consensus revenue growth is pegged at 15% for the ongoing fiscal, it’s half of the company’s five-year average. And as growth recedes, operating margin may also face some pressure.

According to Ambit Capital, Avenue Supermarts trades above its fair of Rs 2,300 apiece. It expects the company’s sales per square foot—a metric used by retail companies to determine the amount of revenue generated per square foot of retail space—to fall as customer billings dropped amid the lockdown. Also, D-Mart is less established in e-commerce compared to peers and in times of the pandemic, this can be a disadvantage, the brokerage said. It had a ‘buy’ rating on the stock before the fourth-quarter earnings but has now kept it ‘under review’ as it sees “limited catalysts to upgrade earnings” in the near-term.

Covid-19 Hits Biggest Store Clusters

A third of Avenue Supermarts’ 214 stores are in Maharashtra, the worst hit state by the pandemic. Gujarat—the state with third highest Covid-19 cases—has 17% of the company’s outlets.

Damani’s supermarket chain acknowledged that business in these geographies will continue to face challenges, should lockdowns be extended.

Store Expansion To Take A Hit

The company’s new store openings will be impacted as construction activity will commence with some lag due to non-availability of labour and material, and the onset of monsoon from mid-June in most parts of the country, according to its earnings statement.

Kotak Institutional Equities estimates the company to add 24 stores in the ongoing fiscal against a forecast of 30 earlier. That’s because the brokerage expects almost nil land acquisition and construction activity in the quarter ending June. There may be some downside to this estimate if construction activity takes longer to resume, it said in a report.