After muted Q2 show, DMart's sales may gain traction in third quarter

Margin trajectory, however, depends on festival season discounts, share of general merchandise

Aided by a gradual recovery following the easing of lockdown restrictions, retail chain Avenue Supermarts (DMart) reported a sequential uptick in the second-quarter performance. Sales in the quarter were up 37 per cent over the June quarter, though they were down 12 per cent from the year-ago levels.

Most sales were still for essentials (staples and fast-moving consumer goods or FMCG), even as there was some uptrend in general merchandise and apparel. 

The company highlighted that the recovery in mature stores or units, which are at least two years old, is 87.5 per cent in September, with regards to the year-ago period. Though footfall has increased when compared with the June quarter, social distancing norms and customers preference for e-commerce channels could explain the lower than optimum volumes/revenues. 

Though the sales numbers were below estimates, brokerages highlighted that the recovery for grocery-led retailers was faster and the trend should improve led by growth across segments. Analysts at Motilal Oswal Research said: “Unlike other retailers, grocery retailers catering to essentials have seen swift recovery from Covid-19. We believe the gradual unlocking of the nation will lead to positive sales from Q3FY21, supported by improving sales from the general merchandise and apparel category.” 

Grocery/FMCG sales accounted for three-fourths of DMart’s revenues in the September quarter. Despite a muted Q2, hopes of recovery helped the stock gain 6 per cent in trade on Monday.

Despite unfavourable conditions and sales yet to hit last year’s levels (same-store sales down 12 per cent YoY), the company continues to expand, adding six stores in the September quarter. The company has closed two of its stores for walk-in customers and converted them to e-fulfilment centres for its e-commerce business. Total store count at the end of the quarter was 220, against 189 in the year-ago period. 

While the sales of FMCG and staples have recovered as shopping continued to be needs-based, the scale of recovery in the general merchandise segment would be the key for both revenues and margins. For Q2, gross margin improved by 30 basis points to 14.5 per cent on a sequential basis, but was down 90 basis points over the year-ago quarter. Though the higher contribution of the grocery segment in Q2 led to the weaker margin profile, improving sales of the more profitable general merchandise and apparel should help in margin recovery. Muted gross margin and weak operating leverage led to a 240-basis point dip in the operating profit margin to 6.2 per cent in Q2.

Though DMart Ready or e-commerce business has more than doubled to Rs 88 crore, it accounts for a minuscule 2 per cent of the company's consolidated revenues. Analysts at Prabhudas Lilladher highlighted the company’s increasing focus on e-commerce, given the rise in digital footprint in the Mumbai region and Pune and the conversion of existing stores into e-fulfilment centres. 

While the ongoing festival season may improve the sales momentum of the company, especially in the general merchandise category, the rise in competitive intensity from retailers, such as Reliance Retail, as well as e-commerce players (Amazon, Flipkart) can have implications for Avenue’s profitability. 

The sharp gains on Monday have erased some of the underperformance in the stock (had shed 11 per cent since its August highs), though the valuation at 80x its FY22 earnings estimates is on the higher side. 

Given the pandemic uncertainty and lack of clarity on lockdown relaxation, investors should await further correction and stability in volume trends across segments before considering the stock.