Description

B&M European Value Retail

Summary: I recommend a long position in B&M European Value Retail, the general merchandise discount retailer primarily operating in the UK with a small presence in France and a German segment that will likely be sold. We believe an investment in B&M represents attractive value, Brexit or not, and the opportunity to back a growing, competitively advantaged, and recession-proof business with runway to grow EBITDA double digits while generating a 5%+ LFCF yield, the cash from which will be returned via dividend or repurchase over time. We believe the time is now before the company cleans up its German business, formally announces a well-hinted capital return, and the upcoming UK election (potentially shorting some challenged retailers as a hedge). Our target price is ~5.70 per share based on 18.5x 3/2022 earnings per share (50%+ upside to 3/2021) – a discount to comparable businesses in developed markets despite faster growth.

Background

B&M went public in 2014 with an innovative model for retail that was rapidly expanding in the UK with a toe-hold position in Germany, raising capital at 270p per share. B&M offers absolute value to customers through its model of buying a narrow range of 5500 SKUs deeply across Home, Seasonal, Garden, FMCG, Toys, Electronics, ambient food, and other categories. B&M drew quckly comparisons to the dollar stores in North America, which had gained investor favor, for the high unit level returns, recession-resilient discounter positioning, and Amazon-proof value proposition. B&M continued opening stores in the UK and provided the market with more color on its expansion in Germany in summer of 2016. There was also, a market rumor that ASDA explored acquiring B&M during the summer of 2017. Shares reached 430 per share in early 2018. 

At the end of 2018, B&M announced the acquisition of Babou, a French retailer with 95 stores. B&M said that they had been following the concept for a long time and the price was too attractive to ignore despite ongoing challenges in the Europe operation. B&M announced a strategic review of the German business on the company’s H1 earnings call, highlighting the difference in model between Germany and the UK. Despite the disappointment in Germany, shares have been a decent performer through 2019, but trail US / global peers as and have performed in line with the FTSE 250 over the last 2 years. We believe shares have been held back by moderating LFL sales, challenges in the European business, and the lack of a catalyst. Investors now question see B&M’s core business approaching saturation and question whether the company has missed the boat in the European market. 

Investment Thesis: 

1. B&M’s core UK business segment will sustain high returns 

2. Significant runway for expansion in the UK

3. Valuation supported by UK business but there is a call option to build a European presence

4. Near term catalyst in upcoming capital return, opportunistic M&A, and a smooth German exit  

B&M’s UK core business generates high returns driven by advantages in buying, site selection, and local economies of scale

• B&M’s 9 month pre-inventory and 15 month post-inventory store level returns are among the best across all publicly traded retailers

• Existing retailers cannot pivot to the B&M model because their exist estate, product offering, supply chain, and brand does not support it

• B&M’s model allows the company to operate with attractive financial returns while causing competitors to earn below their WACC or marginal cost (competitive exit of Poundworld, Wilkinson suffering, etc.)

• High SKU Density: B&M’s high sales base over a low SKU count drives a number of advantages vs. competitors 

• Buying Power: B&M’s revenue / SKU and COGS / SKU is 300%+ higher than mainline competitors and 20%+ greater than discounter competition (Poundland and Home Bargains) 

• Direct Supply and Owned Label: Mainline retailers, even those with larger aggregate volume, lack the SKU density to justify building the required infrastructure to source from suppliers directly and invest in product development for owned label programs

• Owned-label products limit price comparison and benchmarking

• Site selection: B&M has proven strong economics in stores ranging from 10-30k sqft, giving the company a wider selection of store options to optimize its estate vs. other concepts that are geared towards the high street or car parks. 

• B&M’s low prices drive traffic and the company can seek sites with very low occupancy costs in contrast to other concepts seeking high traffic areas

• Local economies of scale: B&M’s small basket size make the concept uneconomic to disrupt through ecommerce i.e. a ‘bring to me’ model. 

• Average transaction value is 12gbp with an average quantity of ~3 items and 34% gross margins making the total value extracted per visit just 4gbp for the entire transaction and simple-buying experience

• B&M replaces 100 of its 5500 SKUs per week which drive newness to the shopping experience and promote traffic with 70% of customers visiting their stores every 2 weeks

B&M has sufficient runway to achieve its 950 unit target in the UK with potential for more expansion through its convenience format B&M foods

• B&M is 66% penetrated in the UK in its core, B&M Fascia and at most 56% penetrated on a sqftage basis including Heron Foods, the company’s small, convenience food concept

• Similar concepts, such as the NAM dollar stores, have comparable expansion potential but trade on much higher multiples

• DG, DLTR and Dollarama trade at 20x+ earnings but are 58-70% penetrated in their core markets

• Despite growing to £3bn+ sales in the UK B&M remains a small percentage of retail sales and achieves only a HSD share of spending in core categories ex: 7% in toys

• In aggregate, UK General Merchandise discounter sales are still only ~3% of the food and non-food markets

• Mainline retailers and disadvantaged discounters are suffering as a result of UK consumer pressure with over 2,500 shops closed on a net basis from the top 500 UK high streets in 2018. Companies facing distress that have benefitted B&M include: Poundworld, Toys R Us, HomeBase, Debenhams, Office Outlet, Boots, and MKS

• Despite continued growth from B&M, Home Bargains and the Range total general merchandise (i.e. not Aldi/Lidl) discounter square footage will decelerate from 2.5mn sqft added per year between 2009 to 2018 to 1.7mn sqft between 2018 and 2021 (9.6% vs. 4% CAGR)

• Store targets will continue to rise as mainline retailers and poorly positioned discounters exit the market

• On the company’s most recent conference call, Management indicated that they will likely raise the 950 target in the future and has included “at least” in front of its 950 store target in its annual report

• Aldi has plans to reach 1,200 stores by 2025 and smash its 1,000 store target by 2022 vs. 775 stores at the end of 2018, which seems to justify B&M’s target of 950 stores (~600 FYE19) over the same period.

• Southeastern UK is the major driver of expansion and is a geography where B&M’s stores have performed strongly: Average store contribution in South East is £826k vs £791k for rest of estate

• Management highlighted the success in the South East on the most recent conference call indicating that these were the company’s most profitable stores

• Flexible assortment with local buying mitigates impact of competition from nearby store openings as B&M and competitors can re-optimize merchandise and reduce overlapping product

Valuation supported by the UK business but there is significant upside if B&M’s France business is successful

• France Better Positioned than Germany: Babou, the company’s acquisition in France, is better positioned to repeat B&M success than Jawoll in Germany with management commentary more bullish in recent months (although this is likely to offset the German disappointment)

• B&M’s German acquisition, Jawoll, kept the original management team as operators for 5 years after taking control, whereas B&M put in country leader Cedric Mahieu immediately after acquisition

• France: Cedric Mahieu the previous trading director La Foir'Fouille, a discount concept in France with 240 units and 600mn of revenues

• Jawoll was originally a close-out discounter, similar to Olli, and did not have the requisite infrastructure to ingest large quantities of stock, which is integral to B&M model

• Ultimately, while we believe Europe is important for the multiple and would drive a 20x+ earnings bull case, our forecast is for Europe to grow to just 7% of group EBITDA. 

• Assuming no contribution from Europe, we still see the potential to grow EBITDA double digits through FY23 at high incremental returns

• We believe the investment can generate decent returns if the European expansion continues to stumble

Near term catalysts to drive shareholder return via capital return, acquisition of Home Base stores, and completion of exit from Germany

• Capital Return: Management have signaled the sale / leaseback of their new distribution center upon completion and have hinted at significant demand for the asset

• We see potential for 150mn+ for the sale of the business that will likely be returned to shareholders through M&A or buyback

• With the exit of the german business, we expect the UK business to start generating significant amounts of FCF, averaging >200mn through FY23

• UK Acceleration through Opportunistic M&A: We believe management is highly opportunistic and has been rumored to explore M&A and leases in dying mainline retailers. 

• With the larger number of UK retail closures, we see significant scope to accelerate expansion in the UK through opportunistic M&A

• German Exit: German exit likely to refocus investors on the attractive UK story as German challenges have dominated investment discussion despite having a slightly negative impact to profits 

• Analysts have said that Germany was the focus of 80% of conversations with investors over the last year; we believe a shift in focus to the UK will be a positive for the stock 

• We believe that B&M will be able to exit German with limited cash costs 

Financials:

B&M will continue to grow units in the UK at a rate of 40+ per year with an additional 15 units open in FY21 through the acquisition of stores. France will turn profitable in FY21 and unit growth will accelerate from 5 units in FY20 to 10-15 units in FY21 and 20-30 beyond. Ultimately, as the geography scales, B&M will earn a HSD margin driving group margins to the high single digits.

We believe at the UK moves past Brexit - B&M will be recognized by the market as a retail concept with attractive returns and runway for growth. Shares will re-rate in line with US peers DG and DLTR at 18-20x earnings. In the downside scenario, shares will fall to LDD PE on earnings that normalize, in line with Scandinavian peers Europris and Tokmanni on a pre-IFRS 16 basis.

Catalyst

Clarity on Brexit / Election

Better than expected earnings

Capital return

Exit from Germany

Opportunistic M&A

Progress in Europe