Avenue Supermart IPO

Business Model:

While searching a business model I always look for unique business model and honestly D Mart meet this criterion. Now let us discuss the uniqueness of their business.

1.       In retail space, most of the company operate on rent basis which eat up a lot of profit from them due to high and changing rental price but they own or leas in long term agreement (more than 30 years) all their stores. So, this will safe guard the profit margin a lot. This model was much similar what MacD had adopted long ago.

2.       Branded retailer mostly give discount and various offer to attract their retail customer on some particular day where as DMart operate on EDLC/EDLP basis which gives then opportunity to sell their product at low cost every day and inventory turnover time at the lowest. The EDLC/EDLP strategy is based on offering low prices on an everyday basis by achieving low procurement and operations cost rather than as special promotion limited to certain products or to a particular day, week or any other specific period in the year. A much similar model what Walmart is following for decades.

3.       Their product division consist of mostly consumer staples (75% of their revenue) and rest of it was fast moving consumer discretionary (25% of their revenue). Which give them a secular position in this market chain and make them almost recession proof. The products are classified broadly under 3 categories.

a.       Foods: This category includes staples, groceries, fruits & vegetables, snacks & processed foods, dairy & frozen products, beverages and confectionery. In Fiscals 2014, 2015 and 2016, this category constituted 53.28%, 52.84% and 53.06% , respectively of their Revenue from Sales.

b.       Non-Foods (FMCG): This category includes home care products, personal care and toiletries and other over the counter products. In Fiscals 2014, 2015 and 2016, this category constituted 21.49%, 21.22% and 20.58%, respectively of their Revenue from Sales.

c.       General Merchandise & Apparel: This category includes bed & bath products, home appliances, furniture, crockery, utensils, plastic goods, garments and footwear. In Fiscals 2014, 2015 and 2016, this category constituted 25.23%, 25.94% and 26.36%, respectively of their Revenue from Sales.

4.       High operating efficiency and lean cost structures through stringent inventory management using IT systems. Low cost operation management by IT support enabled which help then to achieve low procurement, selling and accounting cost since they are automated. These systems streamline many of their functions including procurement, sales, supply chain and inventory control processes and daily produce updated information to support our business. As a result, they are able to procure their merchandise from their distribution centers or directly from their suppliers and manage their inventory levels efficiently to better respond to their customers ‘changing preferences and needs. With the help of it they are able to achieve Inventory Turnover Ratio under 14.5 on continuous basis.

5.       Value retailing to a well defined target consumer base is their strategy of customer retention. Their customer acquisition and retention strategy is targeted at lower-middle, middle and aspiring upper-middle income consumers, because getting value for money is the most compelling factor in daily shopping decision-making for these income groups. The majority of the products stocked by them are essential products forming part of basic rather than discretionary spending, due to which their business is not materially affected by seasonality or temporarily depressed macro-economic conditions.

6.       They typically follow their pricing strategy for all our products, relying on strong supplier network, efficient supply chain management for procurement and careful product assortment. These measures help them in being recognized as a one-stop retail store chain for daily needs at value for money prices.

7.       Deep knowledge and understanding of optimal product assortment and strong supplier network enabling procurement at predicable and competitive pricing, leading to an overall efficient cycle.

8.       D-Mart is one of the largest and the most profitable retailers in India, with stores spread across eight states, with a majority of them in Maharashtra. The company has 112 stores, as of September 2016, with a total retail space of 3.4 million square feet, located across 41 cities. 63 percent of its revenue came from Maharashtra, followed by Gujarat which contributed 19 percent, while the remaining came from all other geographies.

Growth Strategy:

1.       Enhancing sales volumes by continuing to priorities customer satisfaction through optimal product assortment and offering value for money using EDLC/EDLP strategy.

2.       Further strengthen market position by expanding store network in existing clusters as well as new clusters.

3.       Steady footprint expansion using a distinct store acquisition strategy and ownership model in the under served area and cost efficient with economy of scale implemented in their supply chain model.

4.       The US has 23.5 per square feet of retail space person, compared with 16.4 square feet in Canada and 11.1 square feet in Australia - the next two countries with the highest retail space per capita, according to a Morningstar report from October. India has less than 1 square feet per person .

Management:

1.       Strong promoter background: When it comes to a name like Radhakishan S. Damani trust on a stock a value investor will hardly look other way, but what if it is the Leadership & Vision of him in a company as a promoter? I would like to leave this questions to be answered by the readers.

2.       Experienced and entrepreneurial management team with a proven track record: Board and senior management have a proven track record and an in-depth understanding of the retail business in India and local consumer preferences. Key members of their senior management team including Ignatius Navil Noronha, Managing Director (who has over 18 years of experience in the FMCG sector) and Ramakant Baheti, Chief Financial Officer and an Executive Director on our Board (who has over 19 years of experience in the finance function) are dedicated to the sustainable growth of their business and have been with them for several years.

3.       High degree of employee ownership: The company have transparent management policies and have implemented employee stock option schemes over the years. They believe continuous development and have invested in our employees through regular training programs to improve skills and service standards, enhance loyalty, reduce attrition rate and increase productivity.

Financial Highlights[in ₹ million]:

1.       Total store count has grown from 75 in Fiscal 2014 to 110 in Fiscal 2016

2.       Total bill cuts, on a standalone basis, increased from 31.84 million in Fiscal 2012 to 43.07 million in Fiscal 2013, 53.40 million in Fiscal 2014, 67.17 million in Fiscal 2015 and 84.68 million in Fiscal 2016, respectively.

3.       LFL growth of 20.28%, 31.63%, 26.06%, 22.43% and 21.49% for Fiscals 2012, 2013, 2014, 2015 and 2016, respectively.

4.       Strong cash flows from operations for the last five Fiscals. In FY16 it stands at ₹4471.39 from ₹653.64 in FY12.

5.       Total revenue has grown at a CAGR of 40.28% from ₹22,224.09 million in Fiscal 2012 to ₹86,061.05 million in Fiscal 2016.

6.       Net profit after tax, as restated has grown at a CAGR of 51.85% from ₹604.06 million in Fiscal 2012 to ₹3,212.07 million in Fiscal 2016.

7.       Fixed Asset Turnover Ratio (computed by dividing revenue from operations by total fixed assets) which was 3.72, 3.96 and 3.95 for Fiscal 2014, 2015 and 2016, respectively.

8.       Long term borrowing stands at ₹9084.69 in FY16 which has increased from ₹2643.19 in FY12.

9       

Subsidiary:

1.       Align Retail Trades Private Limited : ARTPL was incorporated on September 22, 2006 under the Companies Act, 1956 at Mumbai, aharashtra. It is involved in the business of, among others, packing and selling grocery products, spices, dry fruits, etc.

2.       Avenue Food Plaza Private Limited: AFPPL was incorporated on June 8, 2004 under the Companies Act, 1956 at Mumbai, Maharashtra. It is involved in the business of, among others, operating fast food counters at the stores of our Company.

3.       Nahar Seth & Jogani Developers Private Limited: NSJDPL was incorporated on February 21, 2014 under the Companies Act, 1956 at Mumbai, Maharashtra. NSJDPL was originally constituted as a partnership firm, Nahar Seth & Jogani Developers (―NSJD‖) in January 24, 1980 under the provisions of the Indian Partnership Act, 1932. Pursuant to a meeting of the partners of NSJD on October 4, 2013, for the purpose of smooth working, better and effective management and improvement and advancement of business, NSJD was converted into a private company in the name of NSJDPL. NSJDPL is involved in the business of, among others, development of land, construction and development of works of every description on any land and investments in land and properties.

4.       Company also has an associate company, Avenue E-Commerce Limited (AECL), in which they hold a 49.21% stake. AECL has not yet begun operations. It intends to begin e-tailing of food products and groceries, which may compete with the existing business.

Peers Comparison :

1.       Avenue Supermarts owns all its properties which eliminates rental cost. Rental costs typically account for three to eight percent of total expenses of its peer group retailers. In the last 15 years, Avenue Supermarts has opened 112 stores based on a cluster approach, according to its DRHP. It opens new stores within a few kilometre radius of its existing stores and distribution centres targeting densely-populated residential areas with a majority of lower-middle, middle and aspiring upper-middle class consumers. This helps the company reduce the distribution cost and to understand local/regional needs.

2.      Avenue Supermarts will have to compete against established players like Future Retail Ltd., V-Mart Retail Ltd., Trent Ltd., Shoppers Stop Ltd., and Aditya Birla Fashion and Retail Ltd. in the listed retail space. The company also has other unlisted retailers like Hypercity Retail (India) Ltd. and Spencer’s Retail Ltd. to compete with. Higher revenue and net profit per square feet does give D-Mart an edge over its peers as the absence of rental costs helps the company deliver higher operating margins. Spencer’s and Hypercity had losses at operating and net profit level in the financial year 2015-16.

3.       Avenue Supermarts revenue has grown at a compounded annual growth rate (CAGR) of 40 percent, while the net profit has grown at CAGR of 52 percent.

4.       Avenue Supermarts balance sheet is stable with lower debt-to-equity ratio and higher return on equity.

5.       Owning all its properties helps the retailer have an asset turnover ratio which puts it third on the list of peers. It also has an edge in inventory turnover ratio which is driven by higher sales.

6.       Asset turnover ratio indicates the efficiency with which a company is using its assets in generating revenue while inventory turnover ratio measures how fast a company is selling its inventory

7.       Wal-Mart Stores and Costco Wholesale are the largest listed retail supermarket chains by market capitalisation. Avenue Supermarts beats the world’s two largest listed retailers on all parameters, except for debt-to-equity.

8.       D-Mart’s average bill value and number of bills generated have been consistently growing over the last five years, while the sales growth from same stores has been around 24 percent.

Risk:

Not many risk as of known but potential ones are listed down.

1.       Accidents happened in any of it’s store.  For which they also have insurance.

2.       Non repayment of Loans and Debenture. Till now the company has a good credit record and pay back history.

3.       High debt level also a risk of equity dilution since there are more expansion plan on the cards.

4.       Key Man risk :- This is a hidden risk which often the Investors tend to ignore and that is about the strong reputation of one single person, here Mr. Radhakrishna Damani. His ability is unquestionable but does D’Mart has a good succession plan ? Will his 3 daughters be able to  continue his legacy? Well we haven’t had an answer yet but considering the family background we should give them the benefit of doubt since we all know a Rose tree can only grew rose even if there are few thorns in it.  

5.       E-Commerce trend is growing and might curb the growth of the Company.

Reason of Issue:

1.       Repayment or prepayment of a portion of loans and redemption or earlier redemption of NCDs availed by our Company.

2.       Construction and purchase of fit outs for new stores. As a part of their strategy, they propose to utilize ₹ 1,879.50 million out of the Net Proceeds towards purchase of fit outs for new stores with an aggregate built-up area of 2,100,000 sq. ft. and utilize ₹ 1,786.50 million to undertake construction of new stores with an aggregate built-up area of 900,000 sq. ft. to be undertaken in Fiscals 2018, 2019 and 2020.

3.       General Corporate Purposes.

Industry Visit by Aryan:

After a long time visited dmart store ...was speaking to the store manager...he said the vintage of the store was about 10 years...average revenue generated per month was over 15+CR's...area about 4000 sq ft...he said  average inventory replenishment is about 15 days...He also said that on an average it takes about 2-3 years for customer traffic to stabilize as location of the store and area of the store makes a difference to footfalls...

currently there wasn't any major impact due to demonetization seen and sales were pretty much stable...fmcg and staples being the highest churners...he also said that currently besides patanjali products being the showstoppers they are also introducing private label brands and certain premium fmcg products on shelf which is seeing good movements...

Also asked him about competition from bigbasket Amazon and online grocery.. He said that while they can coexist..they cannot match the supply chain management moat and the focused business approach that dmart has followed... Ultimately consumer will have to come to the store and see what they're effectively buying... Plus staples is very price sensitive and cutthroat market..so dmart is able to pass on the savings arising out of their business moats to consumers (partly also due to bulk purchases and timely credit management).. This is something online formats cannot afford to do and hence pricing becomes an advantage... He also said expansion strategy by dmart is balanced as they always scout for RE and location potential so effectively abt 90% of stores are owned..(currently they operate about 30 stores with about 5 stores added every year)..very little instance of store closures where it was call on monetizing RE than instance of lower consumer traffic...

What makes D-Mart unique?

Factor 1: Ownership of all Properties – Avenue Supermarts currently owns all its properties which eliminates rental cost. Rental costs typically account ~ 3 % – 8% for peers. It operates predominantly on an ownership model (including long-term lease arrangements, where lease period is more than 30 years and the building is owned by it) rather than on a rental model.

Factor 2: Revenue Per Square Feet – This is the real big difference between a great business and a mediocre one. A Great business sweats its assets a lot more than the mediocre one. D-mart, Reliance Retail and Future Retail (Big Bazaar) have broadly the same product portfolio but D-mart does sales of 28,136 per Sq. feet whereas Reliance and Future do half of that at 13,901 Per Sq Feet and 12,914 Respectively.

Factor 3: Inventory Turnover – If there was one Ratio that we could have looked at and judged a Retail franchise, that would be Inventory Turnover. D-mart kills competition here, its like the Zara of FMCG Retail. D-mart Inventory Turnover is 14.18 (26 days) v/s 4.9x (75 Days) for Future Retail.

Factor 4: Shift from Unorganized to Organized – We expect a very large shift from unorganized sector to organized sector, Organized retail is expected to grow at 21% whereas unorganized retail is expected to grow at 11.7%. We believe post GST, the pace of shift from unorganized to organized will be faster which will benefit D-Mart.

Factor 5: Growth led by Same Store Growth Plus Expansion – D-Mart’s Same store growth in last 3 years has been an astonishing with 26%, 22% and 21% for FY 2014,2015, and 2016. They plan to add 2.1 Million Square feet or about 70 new stores by 2020 (Assuming every story is 30-35k Sq Feet). D-mart has been the fastest growing retailer and increased revenues from 2200 Crores in 2012 to 8,600 crores in 2016

Factor 6: Gross Margins – D-mart has the lowest Gross margin among all Players and still has the highest operating margin, making it a Moat. In a commodity business, the most efficient player wins, D-mart has show how selling its goods with economies of scale makes a it superb business model. D-Marts Gross margins are only 52% whereas Future Group its 65%, showing D-mart is passing the cost benefit to its customers and selling it cheaper than peers which ensures higher revenue per sq. feet.

Factor 7: Employee Cost – D-Mart has the Least number of Employees per square foot i.e. 1 employee for 800 Square feet whereas competitors have 1 employee for every 400-500 Sq. Feet (you don’t need someone to help you buy Maggi, do you?). This makes D-mart far more efficient compared to competition.

Factor 8: Return on Equity – By now i am sure you understood D-mart’s business model,You might be thinking that D-mart is a asset heavy business as it doesn’t rent properties rather it buys them, but D-mart has shown that even after having a very heavy asset base it has managed to deliver 20%+ Return on equity.

Factor 9: Comparison with Global Peers – D-Marts model is similar to that of Walmart, with a lot of owned stores, very high inventory turnover and low debt on balance sheet. Costco a members only wholesaler which has created immense value in last decade also a model of Economies of Scale. Zara and Walmart have proven that the only way to great value in retail is sell cheap and increase your Inventory turnover.

Global Peers

Stallion’s View: D-Mart is a Consumer facing business who has cost leadership as it pays all his suppliers within 15 days against a cash discount, passes this cost benefit to customers with lowest gross margins in the Industry at 52%. D-Mart has been Smart with its cost management compared to its peers, and even after being a asset heavy business model its ROE is more than 20%+ .D- Mart is Expected to come with a Valuation of 18,000 or about 40x FY2017 PE.D-mart has a strong Business model, Longevity and Growth on its side. The organized Retail is expected to grow at 21% for next 10 years, which ensures D-Mart won’t trade at cheap valuations for a long long time.

How DMart became a solid, homegrown regional supermarket chain in India

Ritu Bhattacharjee works as a sales executive at an automobile dealership in South Mumbai and lives with her husband and six-year-old son in Powai in the geographical centre of Mumbai. “I love it here!” she says. “There is nothing that is not available in our neighbourhood. Restaurants, stores, cafes, bookshops, everything is just a two-minute walk away from our place. And ever since DMart opened, life is perfect. I don’t have to go anywhere else for grocery shopping. When asked about another supermarket closeby that pre-existed DMart, she dismisses it with a wave of a hand. “They don’t keep many things that I want. But DMart! Sometimes I wonder if they’ve placed a spycam inside my house. How do they know exactly what I’m looking for?” she laughs.

Ritu is one of thousands of women in the city of Mumbai and now, other cities as well, who find not just satisfaction but actual deliverance in DMart. They have no hesitation in extolling its virtues. And their praise is almost identical. “D-Mart has everything we want. The offers at DMart are unbelievable.”

“This is the only supermarket in India where the customer is not bothered about the ambience of the store. Her entire attention is centres on filling up her shopping trolley without a care in the world,” said a global retail leader from Wal-Mart, after visiting a DMart store in Mumbai in 2008. “We know for a fact that when a customer is completely sure she is getting the best value, she lets her guard down, she buys more and in the bargain, the store wins,” he puns with a deadpan face.

DMart wasn’t conceived through a grand business strategy, but merely as a hunch that was backed by its promoter, RK Damani. And yet, it is acknowledged as a successful, solid, homegrown regional supermarket chain in India. It stands tall amongst large corporate and multinational supermarket chains, in its markets. How did this happen? How did a humble, unadvertised, unsung and relatively unplanned venture did more than a shade better than more organised competitors? How does it remain the market leader in its catchments year after year? Obviously, there is something this supermarket does smarter than many bigger, wiser supermarket teams.

The story of DMart began almost 14 years ago in the dusty streets of Mumbai and upcountry Maharashtra where its promoters walked the supermarkets and co-operative stores of the time and observed the contents of the shopping trolleys to gain an understanding of what the customer bought and what she rejected. All operational wisdom was gleaned from the supermarket ‘street’, while philosophically, it was clear that the store must follow the principles laid down by Sam Walton. Wal-Mart had treated some fundamentals as gospel and if they could succeed with their simple approach to retail, there was no reason for a store in India not to do so. In a very basic way, therefore, all DMart did was to watch the customer trolley and read everything about Sam Walton and Wal-Mart. Nothing else was strategically important. The strategy paid off in spades. DMart’s ‘Give ‘em what they want’ approach to retailing has customers lining up at their doors.

Our work at understanding and decoding DMart led to some simple clues and points of view about each of the three constituencies of retail – the customers, the vendors and the employees.

DMart started in a very simple way in New Bombay. By supermarket standards, the first store, which also acted as a pilot for the business, located in a 4,000 square feet premises, was tiny. But the principles it developed then have stood the test of both time and scale. The business was in no hurry to create behemoths. Instead it patiently went about laying down the first principles of this fledgling business, and creating the core DMart point of view about the three ‘constituencies’ of retail. Now the simple formula that makes DMart tick is shared and intuitively understood as invaluable in the large organisation. Probably this simplicity has helped it scale nicely while staying lean as an organisation. One of the cornerstones of DMart’s continued success is how it has retained its frugal outlook to retail through all market upheavals and internal changes over the years.

From his stock investor days, RK Damani, or RK, as he is popularly known, had the habit of forming strong, informed points of views about what mattered for success and single-mindedly pursuing the chosen path. He pursued the same mindset in the retail business. One of his biggest success sutras was that of prioritising with a vengeance. “If there are 10 principles or acts needed to run the business, I would pick the two or three that mattered the most and then drive them to be a market beater in those things. It is okay for me if I am even below average in the other seven things,” he says confidently. Running with what matters the most and staying the course has obviously been a winning strategy for DMart. It is therefore worth examining the most important components of each of the three constituencies, the customer, the employee and the vendor, for DMart.

The D-Mart point of view for the three constituencies

1.       The Indian customer, who shops at air-conditioned stores, does not run her family’s grocery needs on a tight budget. While supermarket customers are, by and large, well-to-do people, yet everyone wants to save money. People with money buy more, to achieve higher savings. DMart’s pricing is designed for the customers to save more across everything she buys. However, those who buy bigger packs save even more. It’s as simple as that! The merchandise department of DMart, its buyers, act more like agents of the customer and not of the company. This is in line with Sam Walton’s description of his merchandise department. If the buyers buy better, they can sell cheaper. The very fundamental principle of ‘what you receive, you pass on’ is almost biblical in its simplicity. If buyers negotiate a good price with vendors, DMart passes on the benefits to the customers, in the process communicating a message of care and protection. “Even when you are not looking, not careful, you’ll still save money with us” seems to be the unstated subtext in its communication. How can any customer resist such a message of genuine concern? It follows that the customer will let her guard down and fill her trolley with reckless abandon. After all, DMart has her back and she knows it. One of RK’s old beliefs is, if she saves well, she’ll overlook other flaws in the offering. There are many aspects to a customer facing business. A well-lit and designed shopfloor with smart adjacencies and category flows, polite staff, proper communication, attractive displays, weekly, monthly promotion cycles, so on and so forth. DMart could have tried to focus on all these and more. It didn’t because then it would have lost its edge. It only looked at how much the customer saves, and became a market leader in that, much to the shopper’s joy. She bought more. “Also, she’ll tell others about us and therefore we’ll not need any marketing!” chuckles RK.

2.       Store employees or associates are first generation retail workers in India. Self-service retail is still in its early stages of evolution. Combine this with the fact that culturally, in India, service and servitude have often been treated as one and the same, and it becomes obvious that introducing a service-oriented format in our country is a mammoth task. Workers and servers in all walks of life come from a different class and socio-economic background than the people they serve. They are largely untrained and often uneducated or first generation learners, their parents being employed in small factories or as work hands in small businesses. Nothing in the environment or upbringing of these new retail associates therefore prepares them for a customer facing service job. The service culture is entering our environment, but it will take a generation to become firmly entrenched as part of our society. Until that happens, what is it that a customer-facing business needs to do? Can it afford to depend on this class of workers to generate customer satisfaction? The obvious answer is no. From this point of view, DMart has built a cadre of simple, hardworking store people who ensure fully stocked shelves, clean price communication and efficient check-outs and not much beyond in customer service. Well, selling simple grocery items at fixed prices does not require much people-based service, in any case. The simplicity of the shopfloor associates is offset by state-of-the-art, global standard store equipment. Be it flooring, shelves, trolleys, scanners – all hardware and connectivity deployed at the stores is expensive, best in class. Not many things therefore need skilled, smart manpower. Equally significantly, the associates have no sales targets. Clearly, the organisation does not depend on its associates for its sales. It allows its systems and basic principle of simplicity to do that for it. DMart seems to live its ‘self-service’ dharna, diligently. While staff are amply trained and rewarded, this is not where the company has chosen to place its sales focus on.

3.       Vendors, who deliver goods and get paid by retailers, are small and medium traders, micro-entrepreneurs, by a vast majority.  Even when supermarkets buy goods made by reputed MNCs, the real last-mile seller is often a distributor named Agarwal & Sons, for example. Small traders in India, as a rule, are always short on capital and perpetually stressed about their working capital situation. DMart decided to be a market beater by paying faster than market norms to its vendors. Quickly, they became known as the best pay masters in town. In spite of being tough negotiators, every vendor wanted them to succeed, for this very reason. Vendors did many small things in their power to ensure DMart got the best availability and deals.  Vendors are known to advise and tip off the buyer teams, often, with market intelligence. DMart has ensured an ecosystem that’s very helpful in winning the complexities of the supermarket business, with this simple vendor insight. It also helps to have a liberal stock holding policy the way DMart does, in a growing market like India.

The Indian customer is intuitively frugal and also traditionally underserved. When she sees a hardworking store like DMart that empowers her, saves money and has a no-nonsense outlook, she overlooks and forgives the no frills, often cheerless, warehouse like store setting.

Going forward, from being a regional retailer, as it expands into other parts of the country, DMart has to grapple with the fact that India is more like a continent than a homogeneous market. Food tastes and preferences and buying behaviour change every 100 kilometres. Assortments, work cultures and therefore overall management will need to get complex. A simple business model based on insights about the three constituencies of retail and a trusting, forgiving customer will stand in good stead when DMart begins to engage with greater complexity.

It is a well-known fact that in most large markets, the biggest retailer is the discount supermarket and in many cases, it is a local player and not a multinational. DMart with its stable fundamentals is well-placed to play for that spot, for now at least!