Competitive intensity a major risk for DMart, analysts say after company misses Street’s Q3 forecast

• Post Q3 earnings from DMart operator Avenue supermarketsanalysts have expressed concerns due to increasing competition from players with big pockets.
• Shares of Avenue Supermarts are down more than 9% so far in 2023 and are down 19.8% from their 52-week high of ₹4,609.
• For now, analysts recommend that investors take a wait-and-see approach, insisting they have confidence in the company’s business moat and see a huge runway for growth.

Increasing competition from big-sock players has become a major concern for DMart operator Avenue Supermarts after the company reported lower-than-expected quarterly profits despite an unbroken festival season.

“The multi-year low margins in Q3 FY23 reflect a number of serious challenges, which may be due to the heightened competitive intensity over the past two years and the inflationary stress still prevalent in the discretionary value segment,” said a report. from ICICI Direct.

On Saturday (Jan 14), Avenue Supermarts reported a 6.6% year-on-year increase in its consolidated net profit to ₹590 crore in the third quarter, while analysts had estimated it will rise to ₹672 crore.

Even gross margins remained under pressure, falling short of analyst estimates — at 14.3%, the company’s gross margins were 60 basis points lower year-over-year and below analyst expectations of 15%.

On Monday, the first trading day after the results were announced, the company’s shares plunged more than 4%. Shares of Avenue Supermarts are down more than 9% so far in 2023 and are down 19.8% from their 52-week high of ₹4,609.

However, since 2020, Avenue Supermarts stock is up 92%.

Explaining the decline, Marcel Noronha, CEO and General Manager, Avenue Supermarts, said: “The FMCG and commodities segment continued to outperform the general merchandise and apparel segments. The gross margin percentage decline in the corresponding quarter of last year is a reflection of this mix change. Discretionary non-FMCG sales did not perform as well as expected this quarter.”

The company also reported sales density below pre-pandemic levels of ₹35,900 per square foot, compared to ₹38,700 per square foot in Q3 FY20. It also added just four stores in Q3, below analyst expectations at HDFC Securities, bringing the total number of stores to 306.

Increasing competition is a concern

One of DMart’s entrenched competitors is Trust Retailwhich as of Q2 FY23 had a network of 16,617 operating stores.

According to HDFC Securities analysts, DMart’s weak performance is due to multiple factors, such as increased competition and increased inflation.

“Channel audits suggest that DMart’s weaker unit economy (than usual) is not only a function of high inflation keeping discretionary buying in check, but also a result of a fair challenge to DMart’s value proposition by deep-pocketed peers in its top districts,” said a report from HDFC Securities.

DMart is also relatively under-represented in the online space — its e-commerce business currently operates in just 22 cities, according to the company’s Q3 report. Reliance’s JioMart service, on the other hand, is present in 260 cities.

To add more value to its brick-and-mortar network, Avenue Supermarts announced that it is in the process of launching a pilot pharmacy shop-in-shop at one of its stores.

Wait and watch for now, analysts say

Despite the company’s disappointing performance in the third quarter and the resulting cuts in earnings expectations, analysts recommend that investors hold off for now.

“We recommend a wait-and-see approach as we look for demand triggers to recover,” said an Axis Securities report. The brokerage expects Avenue Supermarts to benefit from cooling inflation, but has cut net profit estimates by 17% for FY23 and 7% for FY24.

“We believe the company’s overall sales quality and margin profile are likely to recover in FY24 as the company passes on the RM (raw material) benefits through price reduction and grammage increases, as well as the intervention of the RBI to contain overall inflation. will lead to an overall improvement in throughput,” said the Axis Securities report, cutting the price target by 8.75% to ₹4,000 while maintaining the “hold” rating for the stock.

On Tuesday, the stock traded 0.3% higher at ₹3,691.

Analysts at Prabhudas Lilladher maintained a buy rating on the stock, despite lowering earnings per share (EPS) estimates by 4.2% for FY23 and 4.3% for FY24.

“We believe DMart has a huge runway to grow with more than 1,500 stores (current stores 306) in a consolidated market and scale into DMart Ready,” the brokerage said in its report.

Lingering concerns about demand and the lack of any trigger for a rise in Avenue Supermarts shares have led brokers to cut target prices for the shares. Analysts at Prabhudas Lilladher say a “meaningful correction” from here will be a good starting point to invest in the company.

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