Earnings estimates for FY18-20 raised 15-30%; Upgraded to ‘Buy’; TP rises to Rs 1,600 from Rs 900 with rollover to Jan, 2018
Avenue Supermarts (Dmart) continued with strong growth momentum and registered revenue of `41 bn (+22.6% y-o-y); growth trajectory was slightly lower than its usual run rate due to higher base and GST impact on revenue recognition (ii) Ebitda margin expanded by 167bp to 10.3% leading to Ebitda growth of 46% y-o-y driven by mix, operating leverage and GST impact on revenue classification. Of the 137bps gross margin expansion, 50 bps was due to GST impact and 90bps was due to mix impact. (iii) PAT increased by c66% y-o-y to Rs 2.5 bn. (iv) Company added 5 new stores in Q3FY18 to take overall store count to 141 as of 31 Dec, 2017.
(v) Overall Ebitda and earnings were significantly above consensus expectations.
Investment case remains compelling
(i) Avenue is tracking ahead of our estimates: Revenue and earnings growth has continued its impressive momentum, led by strong SSSG, revenue mix improvement and operating leverage. Despite a modest network rollout, earnings growth has averaged 59% in the last three quarters. We increase our earnings estimates by 15-30% for FY18-20e.
(ii) Multi-decade compounding opportunity: Grocery and general retail in our view is one of the best compounding stories running into decades. Of the $413bn market size, only 2-3% is organised. The organised pie is growing at c20% CAGR, nearly twice that of traditional trade.
(iii) Dmart’s value proposition is formidable: Dmart with its “every day low prices” strategy and its efficient operations ensures very impressive Ebitda margin despite a low gross margin. We think this model is very scalable and Avenue will be able to capture value from the structural growth ahead of its competition.
(iv) Pace of network rollout will accelerate value creation: So far pace of network rollout has been slow, but in our view FY19 should also see acceleration in the store rollout. Network rollout trajectory in our view is most sensitive lever for its value creation.
(v) Post our estimate changes, valuation is not ahead of long term fundamentals: Current valuation embeds in 18-19% long term earnings growth expectations, while in our view, with network rollout opportunity and revenue mix opportunity, Dmart can sustainably exceed 25% earnings growth CAGR.
We have revised our long-term estimates for network roll-out and Ebitda margins and increased terminal growth rate by 50bp, following consistent strong results. This increases our FY18e-20e earnings estimates by 15%-30%. We have also rolled our valuation base forward from July 2017 to January 2018. These changes in estimates coupled with rolling forward of our valuation results in a higher fair value target price of Rs 1,600 (from Rs 900).
Valuation and risks
We use DCF methodology to derive our target price of `1,600. We use a cost of equity of 11% which includes a risk-free rate (RFR) of 2.5%, a market risk premium (MRP) of 6.5%, a beta of 1.3 (all unchanged), and a higher terminal growth of 4.5% (from 4.0%). Our TP implies upside of 38%, thus we upgrade our rating from Hold to Buy.