India's Avenue Supermarts opens $280m IPO

The company behind D-Mart supermarkets kicks off bookbuilding for what could be India’s largest IPO so far this year.

One of India’s most profitable retailers is ready to go public as Avenue Supermarts kicks off its Rs18.7 billion ($280 million) initial public offering on Wednesday.

Avenue Supermarts will no doubt hog the attention of stock market investors because it is the operating entity behind D-Mart, a well-recognised supermarket chain that operates 118 stores across nine Indian states.

Investors will also be keen to see how the stock performs after its listing since it is set to be the nation’s largest IPO this year, beating Bombay Stock Exchange's $182 million deal in January.

D-Mart is the country’s third largest retail chain by revenue, only trailing behind Reliance Retail, the retail flagship of Indian conglomerate Reliance Industries, and Mumbai-listed Future Retail, which runs supermarkets under the Big Bazaar brand.

In a broader sense, the IPO could be seen as a gauge of investor sentiment towards India’s retail sector, which has been growing exponentially in recent years amid the country’s rapid economic growth.

India’s total private consumption expenditure of $1.12 trillion was the main force behind the economy's 7.6% growth in the 2015/16 financial year — although this figure has raised some eyebrows among sceptical economists.

Total private consumption made up around 58% of gross domestic product for the 12 months ended March last year. That is already high by emerging Asia standards; the same figure in China was 37% in 2015, according to World Bank data. 

But it seems likely that consumption will only become a bigger part of India's growth story in the years to come. In a 2014 report, the United Nations said that India had the world's highest population of 10 to 24 year olds, boasting a whopping 356 million.

Unsuprisingly, analysts are expecting a short-term boom in India's workforce. Ernst and Young estimates that the ranks of Indian workers will grow to 900 million by 2020, equivalent to nearly three times the US population last year.  

There are some black marks. Analysts think consumption spending will weaken — at least in the short-term — after the government’s effort to demonetise 500 and 1,000 Rupee banknotes late last year, a move which wiped out about 86% of the total value of currency in circulation.

The move is a direct hit to retailers, since electronic and digital payments are not common, particularly in less-developed regions where cash remains the main form of payment.

It also remains to be seen how overall retail sales could be affected by the nationwide goods and services tax set to be implemented later in July. From then on, daily necessities will be levied a goods and services tax of 5%, while luxury goods could be taxed as much as 28%.

Small but well-formed

Avenue Supermarts will be selling approximately 10% of its stake through the IPO at a fairly tight range of between Rs295 and Rs299 per share. Based on the indicative terms, Avenue Supermarts could command a post-money valuation of about Rs18.7 billion ($280 million).

This valuation implies Avenue Supermarts is aiming for a market size of about 1.5 times Future Retail, despite running a smaller business. For the nine months to December 2016, Avenue Supermarts booked total sales of Rs88 billion, around 71% of Future Retail’s Rs123.4 billion sales in the same period.

But the company is more profitable despite — or perhaps because of — its smaller scale. In the 2015/2016 financial year, Avenue Supermarts’ pre-tax profit margin was 5.7% compared with Future Retail’s 3.2%, while its 3.7% net profit margin was also much higher than Future Retail’s 2.2%. In its red herring prospectus, the company claimed it was the most profitable food and grocery retailer in India.

Avenue Supermarts attributed this high level of profitability to the strategy of owning most of its stores. While this means it needs more capital for each additional store, it also means that ballooning rents do not hurt its profitability.

Facing uncertainties in consumer spending and difficulty in expanding into rural areas, some supermarket operators have been closing down stores. Reliance Retail, the country’s largest supermarket chain operator, shut down 60 loss-making stores last year.

But Avenue Supermarts is still expanding, albeit rather slowly. The company added 11 stores in the last financial year and plans to continue expanding with a focus in India’s southern and western regions. It has never closed a store since its founding in 2002.

"While it is remarkable that Avenue Supermarts have never closed any store, what makes it even more astounding is that it comes in a backdrop of competitors who have been right-sizing, closing brands and changing their product offering in order to find any mix that might work," Sumeet Singh, an equity analyst at independent research firm Smartkarma, told FinanceAsia.

About 63% of the company's overall sales value comes from Maharashtra, the central western state that has the highest GDP among India’s 29 states. It will continue to focus on expanding in densely-populated residential areas with a majority of middle class consumers, according to its red herring prospectus.

Foreign restriction

Avenue Supermarts’ implied market value is about 36.2 times its net earnings on a trailing twelve-month basis, putting it at a slight premium to Future Retail’s 34 times price-to-earnings. V-Mart, a medium-sized hypermarket chain, is trading at a similar level of about 35.3 times earnings.

According to the indicative terms, half of the IPO will be reserved for qualified institutional buyers, 15% for non-institutional funds and 35% for retail investors. Bookbuilding will run until Friday, March 10.

In any case, the IPO is likely to be a largely domestic issue since the company is restricted to sell a maximum of 24% of post-issue paid-up capital to foreign investors. For that reason, the company has not picked any foreign investment bank to manage the share sale.

Kotak Investment is the global coordinator of the IPO. The bookrunning lead managers of the deal are Axis Capital, Edelweiss, HDFC, ICICI Securities, Inga Capital, JM Financial, Motilal Oswal Financial and SBI Capital.

¬ Haymarket Media Limited. All rights reserved.

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