DMart : Assumptions Rationale

As the financial year for companies draws to a close (31st March being the last day for the Financial Year), and new targets get set for the upcoming year, the rigmarole of achieving higher sales numbers / targets continues. This is typically how companies grow. Nothing wrong with that!!

If, however, you are in sales and have been able to achieve this year’s targets, next year targets would get increased considering the achievement in the base year. However, there is a fallacy in setting the target:

What are the assumptions which need to prove correct for next year’s targets to fructify?

This question needs a thoughtful answer, since often, the base year’s targets are achieved by a very large non-recurring client win, a regulatory change leading to increased business, decline in the supply of a good or a service leading to abrupt price increase, leading to increase in revenue, amalgamation of businesses, etc.

If you were to evaluate your stock holdings in the same light of the above question, you may get your answer – what are the assumptions which need to prove correct for the stock price to appreciate post you having bought the same, OR, when do you SELL the stock?

Buying a stock should fulfil some of the parameters viz. understandable business, sustainable cash flows, good management, ROCE and ROE upwards of 15% + or a certain threshold as per your risk aversion, low or zero debt and at a price, providing you margin of safety. Post buying the stock, if all the above parameters continue to prevail, then obviously one must hold on to the stock.

Selling a stock is difficult, since you need to psychologically refute your earlier BUY decision, either because You were Wrong (very difficult to accept) OR, the stock has become over-valued as compared to its intrinsic value.

Below is an attempt to evaluate Avenue Supermart (aka DMart) in the light of assumptions which need to play out for the stock price to appreciate or SELL:

– Since FY 14 to FY 18, Revenue from operations, EBITDA and Profit After Tax had increased by 26%, 39% and 62% YoY respectively. Can this trend continue? After all, Net Profit grew only by 2.1% in Q3, 2019 Vs Q3, 2018.

– The company has been able to continuously offer daily low prices pursuant to its Every Day Low Cost/ Every Day Low Price (‘EDLC/EDLP’) pricing strategy to maintain its competitive advantage. Will this strategy continue to hold good? In 2016, the company’s strategy was adversely affected its suppliers increased their prices.

– The company has been able to withstand the competition against e-commerce companies until now. Did DMart company really have competition with them in the initial years? Flipkart, Big Basket and Amazon have recently started to put a dent on the brick and mortar retail companies, by offering Foods & Beverages (F&B is 50% of DMart’s product category) or by going the offline route.

– The company has enjoyed tremendous success in owning stores or attaining long-term leases, both at very attractive prices / rates. Would DMart be able to replicate this cost advantage in terms of stores? Seems to be a remote possibility, as the company ventures into newer locations, cost of ownership has increased significantly as compared to historical years.

Will DMart be able to carve out a successful e-commerce strategy? After all, Navil Noronha, CEO of DMart has confessed -” We are just feeling our feet in the eco-system, E-commerce is our limitation; we understand very little here. We are trying to understand this.”

– At INR 91,809 crores (~USD 13.1 Billion), the company is valued at 100x of its trailing net profit. Do you think such a high valuation is sustainable? For valuation to remain at such high levels or increase, Growth (in terms of Revenue, profit and cash flows) needs to be higher and Risk (in terms of cost, and capital expenditure), needs to be lower as compared to the past.

Here, both, past assumptions as well as the stock price in relation to its intrinsic value do not seem to be holding up.

After all, it is never easy to provide justification for a lower sales target next year.

Disclaimer: Please note that these are my personal views. While, I am a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.

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