May 4, 2017 7:27 pm JST

Avenue Supermarts jolts India's retail sector with record valuation, profits

MUMBAI (Nikkei Markets) -- Brick-and-mortar stores may be having a tough time in many countries but in India, a no-frills grocery chain has become the toast of investors after a spectacular debut and continued gains that have eclipsed many established stock market performers.

The rise and rise of Avenue Supermarts is testimony to the draw of a profitable, narrowly focused business model in a youthful sector that's grown higgledy-piggledy and where many companies are yet to find their niche.

The question that's now engaging industry watchers is whether Avenue can continue to grow fast enough to justify its price. While the company, which operates the D-Mart brand of stores across the country, has demographics and smart management on its side, the hurdles to its growth are also substantial. Top of the list is the challenge of acquiring land for new stores, given the intense competition for good plots and the torturous processes involved.

In a recent report, J.P. Morgan described Avenue as the most expensive retail stock in the world, trading at 56 times its profit outlook for the current fiscal year that began April 1. That's well above global names such as Costco in the U.S. and E-Mart, the largest retailer in South Korea. At home, Avenue's smaller rival V-Mart carries a price-earnings ratio of 35 times while Trent, owned by Tata Group, trades at 44 times, J. P. Morgan said.

Last week, Kotak Institutional Equities became the first brokerage to pour cold water on Avenue with a sell rating. Describing its valuation at 46 times profit for next fiscal year as a "steep" premium to global peers, the brokerage said the pace of Avenue's store additions could slow while same-store sales growth could moderate over the next three years. Kotak values Avenue at a more moderate trading multiple of 36 times and has a target price of 580 rupees ($9) a share, more than 23% below the stock's closing price on Wednesday.

"Only time will tell," whether early investors in Avenue will make money, said Sanjiv Bhasin, executive vice president for market and corporate affairs at Mumbai-based brokerage IIFL. "Even blue-chip Indian stocks don't command such a premium. Why would I give a retail outlet a 55 or 65 times trading multiple?" Bhasin said.

Avenue's track record is one reason for investor enthusiasm.

In the fiscal year that ended in March 2016, the company reported a more than 51% jump in net profit to 3.21 billion rupees as revenue increased 33%. Company data show profit multiplied five times over the past four years and that makes Avenue the most profitable retail chain in India, according to brokerages. By contrast, Future Retail, India's largest chain with more than 700 stores in diverse categories, reported a net profit of 145.5 million rupees on revenue of 68.45 billion rupees for the same year. Avenue is due to report earnings for the quarter and the just-ended fiscal year on Saturday.

"Food retailing is about format and execution and in our view Avenue has been able to achieve this combination well," J. P. Morgan said.

The company's initial public offer in March drew bids for more than 100 times the shares on offer. The total value of bids placed by institutions for shares in the IPO exceeded their equity investments in all of 2016.

Mumbai-based Avenue raised roughly $286 million through the offering. The stock debuted at more than twice the issue price on March 21 and has since rallied 18%.

The IPO has more than doubled the net worth of founder Radhakishnan Damani, a media-shy entrepreneur who grew up in a one-room Mumbai apartment, to $6.4 billion, according to a Forbes report. The Damani family owns 82% of the shares in Avenue based on exchange data.

Damani, who made his millions in the stock market, opened the first D-Mart store in 2002 in Powai, a fast-growing suburb in the northeast of Mumbai.

A typical D-Mart outlet occupies some 30,300 square feet and sells apparel, electronics, and staples, including fresh food and dry goods.

"It's not a very sophisticated place," said a former Mumbai resident and regular D-Mart shopper. "But it's cheaper than anywhere else and the ambience is such that the middle class and lower middle class can feel at home."

J. P. Morgan forecasts Avenue's profits to grow at an average annual rate of 34% in the fiscal years between 2017 and 2020 while Kotak pegs a compounded average annual profit growth rate of 40% for the same period based on 35-36 new store additions over the period.

Although most Indians continue to frequent the ubiquitous mom-and-pop grocery store, chains like D-Mart are catching on as urban shoppers warm to the conveniences of organized retail, such as air-conditioned outlets and parking facilities.

Their popularity is expected to grow as incomes increase, swelling the ranks of the middle class. According to PwC, India's middle class population, with an annual household income of 300,000 to 850,000 rupees, is expected to hit 300 million by 2021 from 170 million in 2010. Consumer spending is expected to jump two-fold to $2 trillion by 2020, said retail consultancy Technopak Advisors. Retail consumption stood at $616 billion last year, of which food and groceries accounted for more than 67%.

There are now 118 D-Mart stores in 10 states across the country. Most outlets are in the western states of Maharashtra, home to Mumbai, and Gujarat - sales from these two states account for 80% of the total. That makes it imperative for the company to expand to the rest of the country at a faster pace, say analysts.

However, not only is land becoming scarce in cities and major towns, red tape means it can take up to six years to get the necessary licenses and open a store. Many D-Mart outlets, especially in Mumbai, were set up when land prices were cheap. Renewing the leases at prevailing market rates could undermine the company's strategy of improving profits by checking costs.

And then there is the competition, which has been galvanized by the investor response to Avenue.

"The other companies...have been reckless in launching multiple formats in new geographies," said Arvind Singhal, managing director of Technopak Advisors. "But competition won't sit tight," he said.

Future Retail, which listed last July, has already started restructuring its business. The company operates six retail brands, including Big Bazaar, Easy Day and Heritage Foods as well as a home solutions store HomeTown and electronics retailer eZone.

Last week, Future Retail said it is hiving off its home retailing businesses into a separate entity in order to focus on the mainstay food grocery and apparel segment.

--Dhanya Ann Thoppil

--Nikkei Markets is a real-time financial news service for South East Asia's markets published by Nikkei NewsRise Asia Pte Ltd, a Nikkei and NewsRise joint venture company. Nikkei Markets provides wide companies coverage in the region, including the Nikkei's Asia300 companies.

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