DMart’s private label business

There is always lots to learn when visiting DMART stores. This morning my wife pulled me along to their large store in Andheri East. We are DMART-ready (their online venture) customers and seldom go to their physical stores given how crowded they are at most times. To avoid the rush, we landed at the store at 8.30 am. The store timings for most DMART stores are 7 am to 11 pm – a retailer won’t extend its timings unless he is confident of footfalls coming in all day long.

What struck me was how much DMART’s private label strategy has scaled up. There is a DMART private label product now available in almost every category. A few examples are – home care (toilet and surface cleaners, dish wash gels, room fresheners), personal care (hair oil, bar soaps – there’s a Pears lookalike, toothbrushes), foods (green tea, coffee, biscuits, cereal), home décor (tableware, cookware, small consumer appliances). Most of these have prices sharply lower than their branded counterparts – often the differential would be easily 30-40%. Some of these categories have distinct brands such as D’Homes for home décor and Le Café for Coffee. In some cases, like the former, the customer knows it’s from the house of DMART while in the latter it is not so obvious. Either way, the quality seems acceptable (having tried a few) and the pricing is aggressive (relative to the branded alternative). The above list is by no means exhaustive but anecdotal observation over time suggests that the range and SKU count have been steadily going up.

Traditionally, consumer brands in India have thrived on a few strong competitive advantages

1. branding and marketing which reduced ‘search costs’ in the minds of the consumer
2. distribution – it has always been expensive to build distribution in India for reaching the millions of retail outlets
3. consistent consumer insight is possible simply because of the feedback generated from the distribution channel allowing sharp incremental innovation

DMART can make a mark on all these three parameters

1. search costs – here DMART itself is a strong brand; consumers know that once inside a DMART, any product on its shelf, whether from a known brand, a relatively unknown brand, or from DMART’s label, comes with a certain quality standard. Note that poor products which won’t sell will automatically get ditched in a high-volume environment. This belief of getting a certain decent quality is re-informed over time from being a repeat customer. DMART thus does not have to spend crazy ad spend and marketing dollars to reduce ‘search’ costs. Walking into a DMART store itself reduces this cost for the customer.
2. Distribution – DMART does not need to build separate distribution rails for its private label. They are already the best way for any consumer brand to capitalize on the growth in modern retail. Modern retail in India is growing at double the rate of traditional channels and can grow its share by 3-4x in the coming decades. Any developed market study would drive home this point. So, the two major issues of branding/ marketing to reduce search costs and distribution are already solved for DMART given their otherwise strong engine of footfall generation (led by every day low pricing).
3. Consumer insight – DMART knows what sells at a very micro level and also which way the winds are blowing. I’d argue their feedback mechanism is way faster and more accurate than HUL. The latter does not have a complete direct retail coverage yet and even for the direct route, a distributor is sitting in between. Moreover, does HUL have real-time insight into what its largest competitors are selling? DMART does and can simply piggyback on this data and see what the best private label products are to launch – what categories, what price points, and what variants would best work. This is kind of the Amazon Basics playback.

In many ways, DMART is breaking through the existing moats of some of the largest consumer brands whose products they are selling. The management is conservative and never makes a lot of noise around its private label play. Neither do they give any concrete numbers on current private label share. But let’s do some rough-cut math here. Let’s assume currently private label share is 15% (they will always underplay the real figures). It is probably growing faster than DMART’s overall revenues so keep that in mind when you value this stream. Given the sharper price points, let’s assume gross margins of 30% (we need to know the sales mix to be very accurate here but keeping it simple). Most consumer brands outsource manufacturing and DMART does the same (there is no secret sauce in manufacturing or procurement in most consumer categories). DMART’s opex is ~7-8% of sales (Gross margin less EBITDA margin). Remember, unlike the consumer companies DMART private label does not have to bear advertising and distribution costs. But let’s be conservative and assume 10% of sales to the opex. That leaves us with ~20% EBITDA margins for private label. Let’s knock it down again for the sake of conservativeness and we get to 15% EBITDA margins. The operation is capital light in the sense that everything is outsourced and working capital would be flat to negative (DMART can squeeze private label suppliers more than it squeezes suppliers like HUL). But let’s assume a 10-day working capital cycle. We will assume fixed asset turns of 4x (same as for overall operations) which takes care of the investment physical stores. If you plug this all in, you will end up with post-tax ROCEs of 35-40% at the minimum. The question is how you would value a 25-30% growing profit stream with such attractive economics and in a branded consumer business (DMART is the brand here). For context, Britannia which does similar margins but is a single category company and grows at one-third the pace is valued at 55x FY23E.

Annualizing June-22 nos., my rough-cut estimate is that DMART’s private label PAT is ~Rs600-700cr and growing at 25-30%. Almost one-fourth of DMART’s current profits may be coming from its private labels. Would this mean DMART’s margins would expand going forward? Not necessarily – this management will likely recoup all excess gains back into driving sharper pricing to keep their mojo of ‘every low prices’ intact. (Presume you would have read Nick Sleep’s letters on Costco.) Remember that at current EBITDA margins of 10%, DMART already has a 20% ROCE engine in place – thus driving sustainable growth becomes more value accretive and taking near-term margins higher and testing customer loyalty.

Another subtle observation is that the rise of DMART and modern trade is fast-breaking distribution-led moats of consumer brands. For example – any successful D2C brand which is riding a high wave of consumer awareness can quickly access shelf space in DMART stores (and on Amazon, Nykaa, JIO Mart). Not only have they begun matching HUL in brand recall but also negated their distribution edge at least in tier one markets which matter for such brands. In return to give them this privileged access, DMART will take its pound of flesh by extracting higher margins from such brands. I noticed that Wipro Consumer Care is selling its ‘Surf Excel Matic’ lookalike in DMART at 30% lower prices. While ten years back it would have struggled for visibility, today it sits right next to Ariel, Tide, and Surf Excel. You can see consumers picking up this product for two reasons 1) sharply lower pricing 2) A Wipro product sold under DMART roof substantially reduces ‘search costs’ and increases the likelihood of experimentation. Again, no surprise that Wipro probably pays higher margins to DMART than does HUL. These are additional margin accretive trends for a retailer like DMART. Finally, remember that this is not DMART versus HUL (or so many other top-notch brands across categories). For the more discerning customers like us who have more loyalties to the market leaders, DMART sells a lot of Surf Excel too, probably its single largest seller in the country.

Disclaimer: Note that this note is purely for educational purposes and not a stock recommendation of any kind.