Q2FY24 Review: Avenue Supermarts: DMart - Adjusting valuation for asset ownership

19 Oct 2023 , 12:20 PM

DMart, trading at ~75x FY25 EPS is one of the most expensive Consumer stocks trading at 11%/29% premium to other stocks, such as Titan and Vedant Fashions (VFL). While there are valid reasons why DMart should trade at a premium, the business model of owning stores vs renting for most of the other retailers, understates DMart’s premium due to higher profit margins, on account of savings on rental costs. If analysts of IIFL Capital Services adjust for this, DMart’s PE is nearly 100x, albeit with a higher FCFF due to lower capex. The company owns assets in order to secure location for long term and to prevent the possibility of high rental increases on lease rentals, but the strategy slows down growth. Maintain REDUCE, TP Rs3,500. 

DMart trades at a high PE: 

Growing at high teens, DMart trades at a PE of 74x and generates FCFF conversion of ~20% of net profit. Other stocks such as Titan and VFL, generate FCF at over 60% of net profit for similar growth. DMart deserves a premium for longer growth runway, good execution and favourable competitive landscape; however, the lower cashflow generation in order to fund owned stores vs rented stores for other retailers, doesn’t seem to be fully captured in the valuation. In order to make valuation multiples comparable, analysts of IIFL Capital Services need to adjust for this. 

Making valuation comparable: 

In order to make valuation comparable, analysts of IIFL Capital Services  assume a sale and lease back of all existing properties as well as future growth only under the lease model. The current market cap, reduced for the sales consideration is divided by the adjusted (i.e. post rental cost) profit of the company. This results in the FCF conversion going up from ~20% to ~60%, (which is comparable to companies such as Titan, VFL), but the lower profit margins result in PE multiple going up from 74x to 95x. The PE premium for comparable cashflow generation is higher than what is prima facie visible. 

Owning has advantages as well as disadvantages: 

DMart owns properties for two reasons: (1) Securing a good location for the long term. (2) Avoiding the possibility of very steep increase in rentals when the lease comes up for renegotiation (typically 12-15 years). However, it is struggling to close more than ~50 deals a year, which is impacting growth. Slower growth impacts DCF value; whether on balance DMart’s decision to own vs lease is the right one, is difficult to say.