Goldman Sachs, recently, recommended Avenue Supermarts as a buy and set its target at Rs.1,586; it currently trades at Rs.1,086 per share. That's an upside of 46%; want it?
The stock was priced at Rs.299 per share when it was offered for public listing in March 2017; but the euphoria was evident as it closed the day at Rs.641.60. Well, the exuberance has not evaporated, yet.
At the time of the offering, the company was priced at Rs.187 b. At the listing date, it was priced at Rs.400 b. As of now, the market price of the company is Rs.678 b. And now, Goldman is pricing it at Rs.990 b ($15 b).
When EBIT grows 13 times, and EPS grows 30% annually over 10 years, magic happens. Euphoria combines with exuberance.
Let's do the math. EPS for the year ended March 2017 was Rs.7.67. I don't buy the shit about weighted average number of shares, and Rs.8.48 EPS as reported in the financial statements; those are as per the accounting standards.
When EPS grows 30% over the decade, it will be Rs.105.75 in 2027. So, if we expect 12% return on investment, the stock has to trade 32 times its earnings in 2027 as compared to 141 times now. But who wants 12%? Let's ask for 15%; for that, the stock should trade at 42 times. For 20% expected return, the multiple rises to more than 63 times. For 18%, it is 54 times. We are nearly there; in a decade, the stock will have to trade at 54 to 63 times its then earnings in order for the investor to earn a decent return.
It's a simple math; but where's the catch? Retail is a tough business. We have seen in the past how Walmart killed other retailers, and how the current times are so testing for its own business. Online retailing, and ecommerce are set to takeover in future. Can d-mart survive it? Nobody can tell now, but with some rationality, one can say that over 50 times earnings is too much to ask from a retail business.
D-mart reinvested Rs.20 b in the last three years. If it has to keep pace with its growth estimates, reinvestment has to continue. When stories about the Indian demography, consumption, low base, high growth and so forth are told, the growth story has to be matched with the reinvestment story. During the last six years, the company has not had positive free cash flows to the firm; in fact, it had a cumulative negative FCFF of Rs.12 b during the period. Is that a surprise? If you want to open stores, you got to put the cash back. And if you fall short of internal cash earnings, you got to look outside for cash; and if that happens for too long, it is not going to be good.
So how do we value d-mart based on its cash flows? As of March 2017, d-mart had Rs.19 b cash and Rs.15 b debt. Let's assume its after-tax EBIT (March 2017) is free cash flows; wishful thinking, but hold on. Some more wishful thinking: Let's say FCFF grows 30% annually over the next decade; and let's assume that it would reach to Rs.75 b in 2027. We will then have to value it based on an expected rate of return.
If we use these high cash flows over the decade, and then apply a perpetual growth rate set equal to the stable growth rate, and discount them at 15% rate of return, we get a value of Rs.314 b for the entire equity. At 18%, it is Rs.217 b; and at 20%, Rs.177 b.
Instead of using the perpetual growth route, if we apply a multiple to the 2027 free cash flows, we get a value of Rs.400 b for the equity when expected rate of return is 15%. At 18%, it is Rs.318 b; and at 20%, Rs.275 b.
Now compare the values to the Goldman's value of Rs.990 b. Also remember that we have had a fair dose of wishful thinking. We have plucked cash flows from nowhere. We have assumed high growth rates in cash flows for a long time. These two assumptions are quite powerful, and quite exuberant. And I have not even considered dilution through options, for d-mart has some options outstanding.
Will they all hold? I mean, come on...
But then again...if the stock can trade at 141 times earnings now, it can also trade at that multiple ten years later. So there is a strong case for the stock to trade close to Rs.15,000 per share in 2027. How about that? All the stupid men and women, hurry up, the stock is a screaming buy now...
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