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Value Investing Contest Winning Entry #2: V-Mart Retail

This report was prepared by JK, as part of the Safal Niveshak Value Investing Contest. None of the facts herein have been validated by Safal Niveshak. Also, please DO NOT treat this report as a “recommendation” from either the author or Safal Niveshak. Do your own homework.


The Big Picture
Understanding the big picture, foreseeing the structural trends and sector tailwinds play a critical role in identifying and developing conviction on ideas that go on to become multi-baggers creating huge wealth for investors in the long run.

So what are the current structural trends going on in the Indian economy?

I can clearly identify two –

1. Switch from Unorganized players to Organized players: Organized players are gaining market share from the unorganized players. This structural shift is happening in every consumer facing sector, be it jewellery, bathroom solutions, plumbing solutions, kitchen appliances, shoes, apparels and inner-wears, restaurants, or retail.

Why this switch? Because of rising income levels, customers’ aspirations are increasing and organized players are considered to be providing higher quality products.

Social proof, advertisements, Pavlovian association (to associate ‘I have heard of this product’ to ‘I like this product’) are the psychological reasons which are making sure that this switch is here to stay.

2. Increase in Purchasing Power of Tier-II & III cities’ population: With high rental costs and space constraints, many organizations are moving out of Metro and Tier-I cities and launching operations in smaller cities. With some of the village population moving to smaller cities for want of better lifestyle, the target population is also growing in smaller cities and it makes all the more sense for organizations to expand in Tier-II and Tier-III cities. Consequently, these cities are growing and expected to grow much faster than metro and Tier-I cities.

This is precisely the reason why some of the Tier-II & III focussed companies are growing much faster than the industry. For example – Emami, Cera, Kewal Kiran, Atul Auto are growing faster than their industry.

Now, how about a company which allows an investor to play both these themes simultaneously?

A company focussed on Tier-II and III cities and where organized players’ share is not even 10% of the total market size?

V-Mart Retail is one such company.

Company Business & History
V-Mart is in the business of Organized Retail. It is one of the pioneers in setting up retail stores across various small Indian towns and cities. V-Mart primarily operates in Tier-II & III cities and offers –

  • Apparels (Men, women and infants);
  • General Merchandise (Non-apparels i.e., footwear, fashion jewellery, books, games, home furnishing, kitchenware, crockery and gifts); and
  • Kirana (FMCG products, food items, personal care and home care).

As on date, the company has 88 stores across 12 Indian states with a total area of 7.1 lakh sq feet.

V-Mart was incorporated as Varin Commercial Pvt. Ltd. in 2002. It opened its first retail store in Gujarat in 2003. In 2006, the name was changed to V Mart Retail Pvt. Ltd. and in 2008, it was made a public limited company. V-Mart came with IPO in the beginning of 2013 and got listed on 20th Feb. 2013.

Financials
Over the past 6 years (2008 to 2014E), V-Mart’s revenues have grown at a CAGR (compounded annual growth rate) of 33% while EBIT (earnings before interest and tax) has grown at 34% and PAT (profit after tax) has grown at an impressive CAGR of 40%.


So what’s the reason for this high growth?

A big part of this growth (26%) has come from increase in stores. About 6% growth has come from same store sales growth, and a part of PAT growth can be attributed to margin expansion.


Management Quality
V-Mart has a return oriented management handling the company. What makes me conclude that?

  • Management’s aim is not store expansion but Sales and Profits growth. They keep mentioning this in their con-calls and annual report. “At V-Mart, we would rather grow 30% compounded across ten years supported by revenue growth in every single year as opposed to 50% compounded with three down years in ten” writes the management in its annual report .
  • Management evaluates each store on Profitability basis. And if any store fails to perform as per expectations, the management isn’t hesitant to close it. Recent closure of three stores including one in Delhi is a good example of this. Read here.
  • Management follows a Regional cluster-based store expansion strategy. Every new store they open is within 150-200 kms from an existing store. This strategy helps the company in efficient brand spending, superior inventory turns and better human resource management.
  • Management keeps a good check on costs. The company’s rental costs and selling & distribution expenses are the lowest in the industry. They have also stopped offering Kirana products (being lower margin products) in their new stores.
  • Management has outlined a policy of keeping debt to equity ratio below 0.75.

As a result of all these measures, the ROE (return on equity) stands at around 18% now.

Competition
V-Mart faces competition from Pantaloon, Trent, and Future Lifestyle from the listed space. However, all these retail chains focus mainly on Metros and Tier- I cities, while V-Mart’s sole focus area is Tier-II and III cities. The company faces nil to minimum competition from listed players in these cities.

Major competition in V-Mart’s target cities comes from local and niche players. However, as the company’s brand image and value proposition grows, it is bound to snatch market share from the local players.

Bullish Viewpoints

  • Low penetration: The Indian retail industry has grown from Rs 14,574 billion in FY07 to Rs 28,840 billion in FY12, at a CAGR of 14.3%. During the same period (FY07 to FY12), organized retail has grown from Rs 598 billion to Rs 1,932 billion, at a CAGR of 26.4%. As a result, share of organized retail has grown from 4.1% in FY07 to 6.7% in FY12. Compared to the US and the UK where organized retail share is 80-85%, Indian figure of not even 7% is very small and provides ample growth opportunities for India’s organized retailers.
  • Tier-II & III focus: Tier-II and Tier-III cities are growing and expected to grow faster than Metros and Tier-I cities. The growth in Tier-II and Tier III cities is aided by increasing disposable income that has created immense opportunities for companies looking out for new markets to grow. More and more companies are moving to these cities due to availability of talent pool at a lower cost, more affordable real estate prices and stable business environment. As a result of this trend, players with focus on smaller cities are doing well. Out of a total of 88 stores, V-Mart has more than 85% of its stores in Tier-II and Tier-III cities.
  • Big opportunity size: As on date, V-Mart has 88 stores in 76 cities across 12 states, out of a total 1,600 cities (all tiers) in India spread across 35 states and union Territories. So, there is huge opportunity size that V-Mart can potentially cater to.
  • First mover advantage: The retail industry has low entry barriers. However, being a first mover will help V-Mart in not just gaining better knowledge on customer needs and supply chain management but will also deter potential competitors from entering in these small markets, some of which may not be profitable for two retail chains.

So, we can see that V-Mart has a huge opportunity to grow. But how will this growth be funded?

  • Ability to fund growth: At the end of December 2013, V-Mart had a surplus cash of 36.5 crore from its IPO & pre-IPO placement. The company opens new store with a total area of approx 8,000 sq foot and incurs capex of about Rs 1,300/sq foot for opening a new store. So, V-Mart can open 35 new stores before this cash runs out. It has opened 20-25 stores in FY14. So, this cash is enough to fund capex plans for next 1.5 years. The company’s has a healthy debt to equity ratio of 0.32 (as on Dec 13 end). It has a policy to keep debt to equity ratio below 0.75. So, internal accruals and some debt will be able to fund growth beyond 1.5 years also. There will be no need for raising cash through fresh equity. The management has also guided on the same in the con-calls.
  • Sensible return-focussed management: Already discussed.
  • Same store growth and margin expansion: Over the past 6 years (2008 to 2014E), the company has been able to grow its income per store at a CAGR of 6%. The growth has been higher in the recent years. The company achieved same store sales (stores operating for more than 1 year) growth of 20% in FY13 and 9% in 9mFY14. As it gains more popularity, this growth is expected to continue in the future as well. Its net profit margins have expanded from 3.6% in FY08 to 4.7% in FY13 due to economies of scale, effective utilization of ads & promotions, better bargaining power with suppliers, better inventory management and focus on better margin products (apparel and general merchandise).
  • Good & improving ROE: For a new store, IRR calculations are as under:


So, a new store has IRR of 17.4% once it achieves efficient sales level (which generally happens in about 3 months).

Then with same store growth and margin expansion, it will improve in next few years and with efficient use of debt, the company should be able to improve ROE to 20%+.

Risks

  • E-retailing: There is an increasing trend among Indian buyers to buy online due to higher discounts. Substantial increase in e-retailing can provide a challenge to V-Mart’s business model and its growth prospects. However, low internet penetration in India especially among V-Mart’s target customers (i.e., customers residing in Tier-II & III cities with annual income range between Rs 1 lakh to Rs 10 lakh) and tendency among Indian buyers to see and feel the product before buying should act as a hindrance for the growth of e-retailing.
  • Competition and low entry barriers: The company faces competition not just from organized players like Pantaloon and Trent but also local niche players. Competition can intensify from multi-brand FDI which may eat into V-Mart’s margins. The industry has low entry barriers. It’s not tough to open retail stores. However, understanding customer needs, managing supply chain, and learning curve should act as a source of competitive advantage for a retail company like V-Mart.
  • Inability to understand and adjust with fashion trends: The company is in the business of apparel and general merchandise wherein customers’ demands change with fashion trends. In case the management fails to understand and adjust its inventory based on fashion trends, the company may be left with unsold inventories. Hence, it’s important to monitor the company’s inventory holding days. At FY13-end, its inventory holding days were 94 (decreased from 103 days in FY12).
  • Institutional exit: Foreign shareholding (shareholding with FIIs & NRIs) reached its maximum allowed limit of 24% in V-Mart recently. See here. DIIs also hold 7.5% of total shares. Exit by some of them even due to non-fundamental reasons may cause volatility in the stock price.

Valuation
At the current market cap of Rs 500 crore, V-Mart is trading at about 19x FY14 PAT. So what is market expecting at this price?

Assuming opportunity cost of 12% per year and terminal growth rate of 2% per year, market is pricing in 18% growth rate for the next 5 years.


So can V-Mart achieve 18% growth for next 5 years?

Yes in my view, with 5% same store sales growth and 13% annual increase in stores. For this, the company will need to have 162 stores by 2019 end. With more than 1,600 cities, that should not be a problem.

For opening 74 new stores, V-Mart will need capital of Rs 148 crore at current costs (Rs 1 crore per store for capex and Rs 1 crore per store for working capital). This growth can easily be funded by current cash (Rs 32 crore) and internal accruals over the next 5 years (NPV of PAT for 2015-19 is Rs 152 crore).

Also, V-Mart’s high growth period has a probability to last more than 5 yrs due to big opportunity size and economies of scale.

So, in nutshell, V-Mart is a good and improving business with huge opportunity size and is priced attractively.

Disclosure: I, JK, am invested in the stock.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Pranshu Khandelwal says:

    Hi Jk,

    Good article. What is their EPS CAGR for last 5 years?

    Thanks,
    Pranshu.

  2. Nelson Christian says:

    A very good report with top down research which focuses on the big broader structural changes and then moves on to identify the right company. I was not aware about this company and its business model. Very lucidly written and very well explained.

  3. Vary clear and simple style to explain an investment case which is very good. Kudos for great articulation. In retail, everything boils down to inventory management. It is a very tough business with very fragile or fleeting moat and those that keep the cost to bare bones (low cost providers) are the only ones that can make it. The management of Vmart do sound conservative in their approach but one need to see whether they are going to to walk the talk after becoming a public company. The opportunity size is definitely bigger but that is the same reason why people have invested huge sums in all other retail businesses and lost their money. Growing efficiently is not easy but at the same time not impossible. There is no public retail business in india that has really added any shareholder value. Please note I mean shareholder value and not how much it went up in price from the initial investment price. They all grew to big size but only by only destroying shareholder value. As charlie munger quoted, they have have made lot of profits which are either sitting in the warehouses as inventory or as a owned retail space but not as cash that has been returned to the shareholder.
    For a compounding machine of 20% (if all goes well and they execute as per plan) i would not be willing to pay 20 times current earnings as it provides low margin of safety. I would have loved to do this for non capital intensive businesses that need to throw only few more paisas for getting 1 rupee additional revenue but not for this business which needs constant reinvestment if it needs to grow.
    Regards
    Ravi

  4. Hey ,
    Very well written.

    I atleast expected disclosure of past debacle of promoters.

    I have full faith in intentions of the management.

    Thanks.

  5. Crisp well written note. I had not heard of them so your article helped me get aware of this company.
    Retail is all about inventory turnover (cost is sunk in real estate and people), so buy goods and sell quickly. The faster you can turn goods for sale into actual sale the more you earn. That is the way the kirana shop operates.
    Overtime some get in to the trap of holding large dud inventory and that proves to be their nemesis.
    Inventory is one (of the many) factor to watch in a retail model.
    How much inventory do they hold ? or is it on consignment basis (which is still better) ?

    • Yes, inventory mgt is very important.
      They have managed it well so far.

      As per FY13 AR, they hold 111 crs of inventory while have trade payable of 40 crs.

  6. Just a few words of caution for everyone-

    This is not a Buy & Forget Stock. There are things which can go wrong here.

    An investor needs to monitor-

    1) Sales/ sq foot — A declining trend here means they are struggling to grow in their existing stores / growing too fast for confort.
    2) PAT margins — A declining trend here means they are giving too high discounts to attract customers may be due to increased competition or due to lack of customer interest.
    3) Inventory Days — A declining trend here means they are not able to sell inventory fast enough & run the risk of obsolescence.
    4) Payable Days — A declining trend here means suppliers are taking better terms from the company.

    Regards,
    JK

    • And another thing which can be done in retail is to just spend some time inside or outside the store and see what no. of people going out are carrying goods purchased in the store.
      While that is also a function of what is sold in the store. However if most buyers are buying daily needs stuff (which is cost sensitive) the store may not have much profitability in which case it has to build more and more volumes.
      So a chain which has popular in-house brands especially apparel may be more profitable vs other retail chains. I see this in big bazaar, where after selling off pantaloon, they have opened big fbb (fashion at big bazaar) stores and they seem to be popular.
      Another point in retail (and for that matter many establishments like restaurants which deal in cash) is that a lot of customers pay in cash and some (or lots) of that may not find its way to the accounting books (siphoning) which is a big corporate governance issue.

  7. vinvestor2010 says:

    You’ve not spoken about several key issues in your analysis. Hence I would like to suggest some things to be included
    1) The first time failure of the VMart team under Mr Agarwal and how they plan to improve
    2) Corporate Governance is an issue.. as the promoter has issued shares to his son at a discounted price the company is falling
    3) The company is following a cluster approach as per you. How? One store in Jharkhand , another in Himachal Pradesh… please explain in detail
    4) How will they tackle companies like Big Bazar, Reliance Retail with deep pockets of thousands of crores

    • 1) When VMart Failed? I think you are talking about Vishal’s failure. VMart’s head was CEO of Vishal Retail till 2002 & then he left. Vishal failed much later. Correct me if I am wrong?
      2) Need to see this.
      3) Read AR for details. New store are within 150- 200 kms of existing stores.
      4) Focus area is different. VMart is focusing on Tier 2,3 cities.

  8. Maheswar Reddy says:

    Nicely written report and easy to follow. Interesting to read about their focus on tier-II and III cities. Had never looked in much detail into this company. This report gave a good summary of the business. Thanks.

  9. Sudhanshu says:

    Hi JK,

    Very good write-up. Very crisp. I liked your same store sales and sales per square foot analysis, which are key to retail industry. Overall, Management appears to be conservative in opening new stores, which is good. The organic growth/same store sales is attractive from the retail industry perspective. However, there is no FCF. What are your thoughts on whether they’ll be able to achieve positive FCF in the near future? Also, it appears the company is diluting shares each year, which is a little concerning. Further, what are your thoughts on whether a special dividend is expected sometime soon given they have so much of cash and their current dividend yield is very low. Also, how much margin of safety do you think we have on current market price?

    Thanks!

  10. Positive FCF may take time as they are in growth phase. I don’t think we should worry too much about positive FCF for growing companies as long as they are able to fund their growth. Refer Prof Bakshi’s lecture on Relaxo for details.
    No special dividend will come. Cash will be used for capex.
    MOS comes from growth here & not price paid. Its not cheap at 19x earnings & without growth, there is no MOS. I am positive on growth.

  11. Punit S says:

    Hi JK,
    Sorry for my naive question, but how did you determine “market is pricing in 18% growth rate for the next 5 years” based on the current MCap and opportunity cost/ terminal growth rate assumptions?

    As you may have already determined, I’m a newbie trying to learn my way through basics of valuation approaches.

    Thanks!

  12. ValueInvestorGuy says:

    Great article. But I think you overlook the basic problem in retail growth stocks like this. High store growth alone is not enough. Profit margin improvement has to continue along with that. Otherwise, on a increasingly higher PAT base, PAT growth as a % starts looking worse and worse. This results in investors de-rating the stock by reducing its PE. Thus revenue continues to increase and even PAT, but because the PE reduces, the market cap doesn’t go anywhere. In this scenario, the management expands the share base even further, then the per share value actually declines and hurts the investor.

    In this particular co, PAT growth has decelerates as follows in the last 5 years.
    130.0% 173.9% 74.6% 63.6% 38.9%

    The PE is presently 22.4, ie a PEG of 0.58. That may look cheap but it is not, if the co. does not improve its profit margin, notwithstanding its growth.

    I modeled the following # stores over the next 5 years
    Stores 107 122.6 135.8 147.8 159.8
    Revenue 695.5 796.9 882.7 960.7 1038.7
    PAT 28.5 31.9 35.3 38.4 41.5

    Looks like a fast growth co, but the PAT margin is still at 4-4.1%.
    This, the market does not like. The store growth does not count. The PE gets de-rated to possibly 18, then 15, then 10, and 5 years later, possibly below 10.

    What will that do to the stock price?

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