Competition worries post Future deal weigh on Avenue Supermarts stock

With the combined entity more than twice its size in grocery, pricing pressures could hit profitability

The Avenue Supermarts stock has shed 3 per cent on worries that the acquisition of Future Group’s retail and backend assets, by Reliance Retail, will weigh on prospects. The impact could be significant in the Mumbai market.

While Avenue has 216 stores across the country, 36 per cent or 76 of them are in Maharashtra. Of these, 32 are in the Mumbai region alone. The merged entity, which will combine the network of Reliance Smart and Big Bazaar, will take Reliance Retail’s total store count to 39.

In addition to large-format stores, Avenue also has 220 DMart Ready stores in Mumbai.
 

Analysts at Credit Suisse believe Avenue will now rank a distant second in the large two-player market, with grocery revenues of Reliance Retail now at 2.5x that of Avenue following the transaction. Food and FMCG products account for 52 per cent and 20 per cent of Avenue Supermarts’ revenues, respectively. According to analysts, the deal could lead to higher competitive pressure for Avenue. Given the scale of the combined operations, Reliance Retail could negotiate better deals with suppliers, which could be passed on to customers.

 

 

Reliance will likely get more favourable terms of trade and a higher share of brand-funded promotions, thereby improving its competitive position, says Credit Suisse. Given that the merger process and approvals will take at least a couple of quarters, the pricing pressure could reflect on the retail segment from CY21.

Avenue had closed FY20 with an operating profit margin of 8.6 per cent, which is expected to slip 150-200 basis points in FY21, given Covid-19 restrictions and weak operating leverage. This, coupled with a lower share of the general merchandise segment (which is more profitable), led to the sharp dip in operating profit margins to 2.9 per cent in the June quarter.

Some analysts, however, believe the retail segment is quite large and expect well-run retail chains with a strong balance sheet, such as Avenue Supermarts, to post strong growth rates. Despite being asset-heavy (owns most of the stores), it has consistently been able to achieve higher growth, margins, and return on capital employed vis-à-vis the sector.

Vikas Jain of Reliance Securities believes the Future deal will not be a setback for Avenue Supermarts, given it remains one of the most profitable retailers in organised retailing. The industry, according to him, is large enough to accommodate multiple players.