Avenue Supermarts : Reliance Retail brings forward the competitive risk here and now :: Credit Suisse

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The key risk to Avenue Supermarts is a rise in competitive intensity from a well-resourced competitor. In the past, this risk was from ecommerce or opening up of retailing for global companies. However, we believe the bigger risk is the rapid expansion of Reliance Retail. ▪ Reliance's grocery revenues are now 1.7x Avenue's estimated grocery revenue . Even after netting off cash and carry revenues, it is likely that B2C revenues of Reliance will exceed Avenue's. Reliance's grocery sales grew 65% in FY19 compared to ~33% for Avenue. ▪ Avenue's core geographies of Maharashtra and Gujarat are not large for Reliance as of now, and that could be a future threat. However, Reliance is large in the states where Avenue is trying to expand, which will likely make it tougher for Avenue and dilute margins. ▪ We believe Avenue's steep valuation at 67x FY20E P/E could be justified if FCF were to post a CAGR of over 25% over the next 20 years. The risk to such a long-term view on high earnings growth is brought alive by the rapid expansion of a large player like Reliance.

Competitive risk not from E-commerce or FDI in retail but from Reliance Retail: Competition in brick and mortar retailing was limited to Indian companies, most of whom, other than Reliance, had high leverage. Foreign direct investment was not permitted which kept away global majors. E-commerce is a future risk and is not playing out at present. Instead, we believe Reliance is the main source of competitive risk. Reliance Retail's grocery sales were 1.7x Avenue's estimated grocery sales for FY19 (grocery is ~75% of Avenues's revenues). Reliance Retail grocery grew 65% in FY19 vs Avenue's overall growth of 31% in 9MFY19. Reliance retail grocery sales include cash and carry, and so are not strictly comparable with Avenue which has only B2C sales. However, even after netting off the cash and carry sales, Reliance Retail's scale is likely larger than Avenue's and growing faster.


Not a great overlap of Avenue's core geographies with Reliance, but lot of overlap in geographies where Avenue targets expansion: We looked at the store footprint of Reliance's grocery business vs that of Avenue. Avenue's core geography is Maharashtra and Gujarat where over 60% of the stores are located.
However, Avenue has added 83% stores in FY18 outside the core states. These states are AP, Telangana and Tamil Nadu where Reliance Retail's grocery business has a sizable presence in terms of existing stores

Avenue's new geography expansion will likely dilute financial metrics: In our initiation "Taking a rain check" we stated that financial metrics of the business could worsen as Avenue expands beyond its core states. This is because of (1) the need to establish credentials in a new state by greater discounting, (2) the learning curve in getting the right assortment and pricing, and (3) higher costs of overheads compared to earlier dense store clusters. With Reliance Retail grocery business rapidly expanding, we see greater pressure on new stores as there will be strong existing and incoming competition to these new states. Retail is a difficult business to run in the long term, but not difficult to disrupt in the short term: We believe Avenue's everyday low price model is a very tough business to run profitably in the long run and needs excellence in execution. However, in the short term, it is not difficult to disrupt as for the consumer the low price is the reason for the loyalty. Thus, if a large player at the cost of profitability offers lower prices, the entry barriers are not high.