DMart
DMart is an emerging national supermarket chain, with a strong focus on value retailing. Its
mission is to provide the best value for its customers so that every rupee they spend on shopping
gives them more value for money than they would get anywhere else. It opened its first store in
2002.
DMart operates stores that are between 20k to 30k square feet in size. It currently operates 196
stores with more presence in the West and South India. It took ~13 years to open the first 100
stores. It opened the next 100 stores in four years. It is yet to shut down a single store.
DMart's core target is households with a monthly income of less than 50k per month. Around
65% of the Indian population is lower middle class, middle class, and upper-middle-class could
become customers of DMart.
DMart generates 51% of its revenue from food and grocery, 20% from FMCG (non-food), and
the remaining 29% from general merchandise. Gross margins for foods (10-15%) and non-food
FMCG (2-3%) are low. However, the gross margins for general merchandise (30%) is much
higher. Food and FMCG drive footfalls, whereas general merchandise drive profits.
What is the competitive advantage of DMart?
How can DMart with a low gross margin of 15% generate more operating margins than other
retailers? Costco earns all its profits from membership fees. DMart doesn't charge any
membership fees. How on earth can DMart generate such high operating margins?
DMart low cost advantages stem from the following:
Cluster expansion: It uses Walmart's playbook by creating a cluster of stores within a region
where it has a deep understanding of customers and serves their needs well. You get supply
chain efficiency when you open multiple stores within a 50-kilometer radius. Neville Noronha,
CEO of DMart, says that "If you have a good concentration of stores and if you have your own
fleet and if you can push your truck to do more trips per day, that is where you get the benefit
of logistics which globally all retailers do. In India the efficiency is only 50 kms due to traffic,
compared to foreign countries which have a reach of 200-300 kms.”
Running the ship tight: DMart reduces its operating costs by owning the underlying real
estate or entering into long-term lease agreements. It pays its vendor early (~10 days),
compared to its peers (~70 days). In exchange, it receives discounts from its vendors. It uses a
lot of contractors in its stores, around 80%, which helps to manage costs effectively. DMart’s
operating expenses (~7%) are 3x lower than its peers (~20%).
Patience, Assortment, Empowerment, and Tinkering: DMart is a conservative
company. They focus on making their stores profitable before expanding further. This is why
they haven't closed a single store in the last ~18 years. Its sales-per-square-feet of ~36,000 is
2.5x compared to its peers. It has mastered the art of assortment with broader categories but
limited SKUs in each, leading to better utilization of shelf space. Its inventory turn is ~30%
higher than that of the best-in-class players like Costco.
DMart doesn't make managers run behind metrics. Store managers are empowered to make
their own decisions. It leverages technology to know what's and what isn't selling in all its stores
every minute. Retail business is different from the CPG business as the cause and effect feedback
loop is tight. DMart experiments a lot, learns from it, and continues to improve.
Can eCommerce disrupt the business model of DMart?
DMart compounded its sales at 37% and profits at 47% in the last seven years. Can this dream
run continue despite eCommerce giants like Amazon, Flipkart, and JioMart with its recent
partnership with Facebook? I think that the brick-and-mortar players like DMart can continue
to thrive along with eCommerce players because of the following reasons:
Pie is too big for multiple players to grow: The retail industry in India has a long runway
for growth. In any country, retail is 30-35% of GDP. The share of organized retail is low (12%),
and DMart’s share of retail is minuscule (0.4%).
There is no winner-take-all in the physical retail store business. Walmart, Costco, Target, and
several retailers in the US are doing well. There’s no reason to think that it will play out
differently in India.
[source: CBRE]
eCommerce is yet to disrupt the food and groceries business globally: eCommerce
penetration is high in non-perishable categories, like consumer electronics and books, that are
highly standardized with high value to weight ratio.
Food is perishable, with the quality of items degrading with time and transportation. They are
easier to store inside stores than distribution centers. It is expensive to transport food as the
value to weight ratio is low.
Arbitrage in the food and groceries category is much better for the brick-and-mortar compared
to eCommerce players. This is the reason why we still see vendors on Indian streets selling fruits
and vegetables and players like Aldi thriving in developed economies.
In real life 1*10 isn’t equal to 10*1: Great copywriters are good at deeply understanding
human behaviour and psychology. They use that understanding to create compelling content
that can help companies generate billions of dollars. One such copywriter is Rory Sutherland. In
his masterpiece, Alchemy, Sutherland writes:
Online shopping is a very good way for ten people to buy one thing, but it is not a good way for
one person to buy ten things. Try and buy ten different things simultaneously online and it
turns chaotic. Items arrive on four separate days, vans appear at your house at different times
and one delivery always fails. By contrast, the great thing about Walmart, which investors
tend to overlook, is that people turn up, buy 47 different things and then transport them home
at their own expense. Amazon can be a very big business selling one thing to 47 people, but if it
can’t sell 47 things to one person, there’s a ceiling to how large it can be.
What if the customer buying habits change drastically due to COVID 19 that they start using
online delivery services like Bigbasket? I don’t know what Bigbasket charges, but I did order
online using Instacart. A couple of observations (a) Instacart purchased these items from
brick-and-mortar retailers (b) I paid ~25% more than what it would cost had I visited the store.
DMart’s management is keeping a close watch on how eCommerce, especially in the food
segment, is evolving. They are experimenting with DMart Fresh, its online delivery channel.
They are yet to see any signs of disruption.
How to think about DMart’s valuation?
DMart is selling at a TTM P/E multiple of 120. What the hell — a retailer selling for 120 times
earnings? Ok, their earnings could be depressed as 1/3rd of their stores are less than three years
old. Its EV/Sales ratio is 6. Is that expensive? Even in the hay days, Walmart EV/Sales was
between 1 and 2.
What IRR would an investor make by buying DMart at the current levels and holding it for the
next ten years? The only way to figure this out is to run a DCF model. I heard Rajeev Thakkar,
Director of PPFAS Mutual Fund, tell that DCF to us is sort of like the Hubble Telescope, you
turn it a fraction of an inch and you're in a different galaxy.
The above model is naive. It assumes that DMart can continue to grow through cash flows
generated from its operations. Future outcomes could be way off from my assumptions. Do your
own homework before buying the stock.
Based on the above assumptions, an investor can expect an IRR of ~7%. DMart should open 40
stores, twice the current store opening rate, every year for the next 10 years. Can it grow while
maintaining its low cost advantages? Will it be able to thrive coexisting with eCommerce
players? Time will tell.
Disclaimer: I don’t own shares of DMart. This is not a recommendation to buy, sell, or hold. I
am not a SEBI registered analyst. I wrote this document to organize my thoughts and deepen my
understanding about the company and the industry. I am sharing it so that you can learn
something from this.
References
1. DMart investor relations
2. DMart IPO filing document
3. Ambit Capital and other brokerage research reports
4. The value chain constraint
Author : Jana Vembunarayanan
Website : https://janav.wordpress.com
Twitter : @jvembuna
