DMart is on the road to recovery, but in the slow lane

Avenue Supermarts Ltd, owns and operates the DMart chain of supermarkets, is seeing its business improve gradually. While the June quarter (Q1FY25) results don’t offer much excitement, the worst seems to be over on the gross margin front.

Standalone gross margin expanded year-on-year for the second straight quarter in Q1, increasing by 34 basis points (bps) to 14.9%. The gross margin was aided by a consistent increase in the contribution of the general merchandise and apparel (GM&A) segment, which is discretionary in nature and fetches relatively high margins. The share of revenue from the GM&A segment stood at 22.37% in FY24, compared to 23.04% in FY23.

Last year, while announcing its results for the June quarter of FY24, DMart said lower sales contribution of GM&A had hurt the gross margin. The parameter had dropped 125 bps year-on-year. The segment started performing better from Q3FY24 and the trend has been encouraging so far. Still, DMart’s QIFY25 gross margin is below pre-pandemic levels of 15.6% in Q1FY19 and 16.1% in Q1FY20. Also, gross margin in Q1FY23 stood at 15.8%. This indicates that there’s enough headroom to expand the share of discretionary categories, according to analysts at JM Financial Institutional Securities.

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In the June quarter of FY25, a sharp year-on-year rise in employee costs and other expenses meant the Ebitda margin was flattish at 8.9%, erasing the gross margin gains. DMart said operating costs increased because of efforts to improve its service and build capabilities for the future.

The company added six stores in the quarter, taking the total to 371. Store additions fuelled DMart’s June quarter revenue growth of 18.4% to ₹13,712 crore, a figure that was disclosed earlier this month in an update for the quarter. Analysts were underwhelmed.

Average sales per store grew 4.7% yoy in the quarter. “(This is) broadly within the trend seen in past two to three quarters (5-7% yoy) but still not at par with what we believe the network is capable of delivering, given the strong runway that exists in the sector and DMart’s very compelling customer proposition,” JM’s analysts said in a report on 13 July.

Valuation a sticking point

DMart’s shares gained about 1% on Monday. The stock is up 22% this year, beating the Nifty 50 index’s 13% return, but valuations are a sore spot. “While we believe that the worst is over when it comes to store additions and mix (GM&A), valuation at 90x one-year forward price-to-earnings multiple is at a steep premium to peers and prices in a lot of good news,” said a Jefferies India report dated 14 July.

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The stock’s recent appreciation may cap significant upside in the immediate future as the recovery is expected to be slow amid stiffer competition, especially from quick-commerce firms. Investors will keep a close eye on the pace of store additions in FY25, which may pick up in the second half of the year. Moreover, it is crucial that the improvement in GM&A contribution continues.

“Though there are initial signs of improvement, we believe DMart is likely to take time to improve its overall store matrix in the near term,” said analysts at Axis Securities. According to the brokerage, this is due to a slew of factors such as weak demand in the discretionary category, which is only expected to recover in the second half of FY25. Also, “larger and newer stores have higher gestation periods, thus impacting the overall profitability in the near term,” said Axis analysts.

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