Investors of Avenue Supermarts Ltd have had a roller-coaster ride over the past nine months. The stock first fell from the highs of about 1,650 last August to 1,135 in October 2018, and then made a rapid recovery back to the 1,650 levels by the end of December. It has given up most of the gains this year, and is now trading at 1,250 apiece.

Concerns about competition, high valuations and declining profit margins are some reasons that have weighed on the stock. The company’s March quarter results announced on 11 May show that Ebitda (earnings before interest, tax, depreciation and amortization) margin has declined again. On a year-on-year basis, the Ebitda margin has contracted by 25 basis points to 7.48%, as other expenses and input costs increased at a higher-than-expected rate.

The big worry for investors is that the outlook on margin remains bleak, especially given the company’s commitment to provide the lowest price to its customers daily, a strategy known as EDLP (everyday low price). “Given the intense competition from Reliance Retail, Big Bazaar, Big Basket, and lately Amazon and Flipkart, DMart’s gross margin is likely to remain under pressure since EDLP continues to be its mainstay," point out analysts from Edelweiss Securities Ltd in a report on 11 May.

Note that the March quarter is the third consecutive quarter of year-on-year margin contraction.

Apart from the drop in margins, investors also need to content with the fact that store additions haven’t been exceptional. DMart added 12 stores last quarter and 21 stores in FY19, taking its total store count to 176.

“Store additions (last fiscal) were below our expectations; we could have done better," said Neville Noronha, chief executive officer and managing director of Avenue Supermarts, in a press statement.

Overall, DMart’s revenue and net profit for the March quarter increased by 32% and 21%, respectively, year-on-year.

While that may look like pretty decent growth, expectations are running very high. The DMart stock currently trades at 62 times estimated earnings for FY20, based on Bloomberg data. Earnings growth is way lower than where it should have been to justify those valuations.

Sure, same-store sales growth at 17.8% for FY19 is encouraging. However, with profit margin outlook remaining muted, investors would need more assurance for valuations to expand from hereon.

The company plans to do a qualified institution placement of 25 million shares. While this could dilute earnings per share in the near term, the funds raised could lead to a faster pace of store additions. While this should help investor sentiment, much also depends on DMart’s margin trajectory.

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