Description

COMERCI

SNAPSHOT

INTRODUCTION

Comerci sold to Soriana their hypermarket operations, in order for this transaction to happen the remaining stake, supermarket operations, will be spun-off and as such a new company will be created; for these paper purposes these remaining assets will be referred as “NewCo”.

We see NewCo as the most attractive investment opportunity in the Mexican retail sector and as a pure investment play through which we can participate in consumption targeted towards middle and upper sectors. It is estimated annual food and beverages expenditures for middle and upper class amounts over MXN$270 billion. In our view NewCo has the pole position in this attractive F&B upper market given the positioning of its supermarket operations as well as other several competitive advantages it boasts.

To better understand NewCo we will briefly explain what is Comerci.

COMERCI OVERVIEW

COMERCI is the ticker for CCM (Controladora Comercial Mexicana). CCM through its subsidiaries operates one Mexico’s biggest supermarkets chain.

One of Comerci’s main competitive advantages is its food and groceries commercialization, as it  represented 68.3% of 2014 Consolidated Revenues. By 2014 the Company had 199 stores and 1.3 million m² of selling floor.

Mexican retail sector has certain particularities, one of them is the existence of several formats. Efforts to increase profitability in a really competitive environment, has led the largest four retail chains (WALMEX, SORIANA, COMERCI and CHEDRAUI) to launch several format that allow them to participate in different segments with a higher level of specialization. Each of these formats is perfectly diferentiated from others in store size, products offered, prices and service level.

COMERCI divides its retail operations in two divisions: Hypermarkets and Supermarkets. This two divisions encompass several formats at the same time.

Hypermarkets: As the name indicates these stores have larger selling space area. Hypermarkets target basically all the segments as they offer a wide variety of products. Comerci’s hypermarkets are divided in 3 formats: Mega Comercial Mexicana are the largest stores and offer the most complete variety of products allowing this format to target all of the socioeconomic spectrum. Comercial Mexicana and Bodega Comercial Mexicana are smaller stores than Mega and the difference between them lies in the segment they provide service to; Comercial Mexicana (medium to medium high) and Bodega (low).

Supermarkets: This smaller formats mainly focus in selling food and groceries. Supermarkets include 4 formats with substantial differences among them. Sumesa attacks medium and lower class clients and its main strentgh is its stores location. Alprecio are small formats whose main focus is price competitiveness with a clear cut focus on lower class clients, Fresko focuses on store location targeting medium to high class customers and City Market which is COMERCI’s upscale format offers gourmet products and is oriented to high classes.

Marketing strategy has  been exceptionally well executed as Comerci has become a household brand in Mexican retail. Marketing efforts have translated into promotions and campaigns that are widely recognized and accepted by customers; some of them are: Julio Regalado (promotional campaign offering substantial discounts in the months of July and August, this promotion has lasted 33 years), Miércoles de Plaza (offers lower prices mainly in fruits and vegetables on Wednesdays, it has lasted 32 years), Monedero Naranja (loyalty card program that allows the client to collect points based on the amount spent which later are redeemable for products such as kitchen utensils among others).

As we have mentioned the brand “Comercial Mexicana” is widely regarded, and its private label “Golden Hills” is not the exception, ranking continously in the top 3 private labels in the country. Comercial Mexicana has as well its own private label of generic drugs under the name “Farmacom”.

Comerci has developed its business mainly in Mexico’s central region as 81.8% of the Company’s consolidated revenues are generated there. We have a positive perception on the Company’s exposure to this region; as Mexico City, Estado de México and Puebla present attractive demographics like high population density and a buoyant economic activity. We believe this elements have allowed the Company to have its stores in premium locations and to own more valuable real estate assets as well as the possibility to sell to clients with high spending power.

2008 CRISIS

Comerci in 2008 was heavily invested in FX derivatives betting on the strength of the Mexican peso with uncovered positions that posed a great risk on its financial stability. This was extremely irresponsible as the Company had all of its operations in Mexico and the only reason behind  investing in that kind of financial instruments was a speculative one. CCM had been betting with relative success on the strength of the Mexican Peso and in october 2008, the mexican peso depreciated against the american dollar Comerci was unable to close its positions and margin calls began. Losses were around US$ 1.1 billion and they left CCM facing a severe liquidity crisis as they had to renegotiate with several banks. This financial and strategical turmoil affected the Company’s ability to invest and ultimately the business competitive position. Fortunately Comerci was able to turn around the situation and the lesson was learned, now the Company has a conservative financial approach with a clear focus on adding value to its shareholders. The Company closed 2Q15 with zero debt and a cash position of MXN$ 4.3 billion.

SECTOR

Mexican retail sector is pulverized and extremely competitive, on the one hand we have really big players with substantial financial resources, and on the other hand informal sector serves a great part of the population. Super market chains make up the formal sector, while the informal sector is conformed by mom-and-pop stores and street markets. There has been customer shift towards traditional market basically on the basis of better prices, a more convenient shopping experience and a better and wider credit offer. COMERCI’s main competitors are: WALMEX, SORIANA, CHEDRAUI and in minor extent HEB and Casa Ley

There has been consolidation in the industry as big acquisition have been made recently. In 2007 Chedraui acquired Carrefour, in 2010 Soriana acquired Gigante’s supermarket operation and more recently Soriana acquired certain assets from Comerci. This consolidation has changed the competitive landscape as retail companies have gained more negotiating power that translate into more competitive prices and larger scale. As a result margins have contracted and growth has become more challenging for all the players in the sector.

In 2013 a fiscal reform was approved. The effects of this reform affected negatively consumption in Mexico as supermarket SSS decreased in 2013 and practically remained flat in 2014. Through 1Q15 SSS pace has picked up, showing recovery in consumption.

TRANSACTION

On January 28th, 2015,  SORIANA purchased from COMERCI the operation of  its hypermarkets and the Alprecio format, we will mention the highlights of this transaction:

• Purchase of 160 stored under the Mega, Comercial Mexicana, Bodega CM and Alprecio formats. Of the 160 stores, 142 will be owned and 18 will be leased.

• The transaction includes 3 distribution centers, equipment & inventory, its logistics platform and 51 additional real estate assets which include land bank properties and commercial venues rented to third parties.

• Soriana will get to keep the right of use of the “Comercial Mexicana” brand for 2 years.

• For all these assets Soriana payed MXN$ 39.2 billion, this amount implies a multiple of 12.5x 2014 EBITDA.

• In order to perform the transaction the remaining assets will be spun off to create a new Company.  

NEW COMPANY

As mentioned the assets not included in the Soriana deal will be spun off. This assets consist mostly of the Supermarket stores and will be owned by this so called “NewCo”. We will mention some of NewCo’s highlights:

• NEWCO will keep the ownership and operation of 40 stores under the following formats: City Market (high end), Fresko (medium to high end), Sumesa (low end) and some stores that later will be converted to Freskos or City Markets.

• Main focus will be in developing the Fresko brand, as there lies the greatest potential as it now only alligns with their interest to focus on a high class segment, but it also fits with the core competences of the management team of selling only food and groceries.

• Company will continue with a discipline growth as management will mainly focus on Mexico’s central region, a market which they know well and allows them to lever on their existing distribution centers.

• It will get to keep as well 1 distribution center and 2 land banks.

• NEWCO formats have better margins than peers at 9.3%, yet we expect margin contraction mostly coming from the lost of operational leverage mostly in SG&A and in some minor extent from lose of scale and negotiating power, all in all margins would still  be higher than peers as margin contraction of 150 bps is expected at the most

• Managements expects NEWCO to double its size in the next 5 – 7 years. This would imply anual growth rates in Revenues and EBITDA of 15 and 17% respectively  

NEWCO FINANCIALS

NEWCO vs PEERS

As we mentioned before, the assets NewCo will get to keep, post better margins than the operations sold. EBITDA margin stands at 9.3% and as a result of lower scale SG&A will hurt profitability on the short term, eventually margins will pick up and we believe they will normalize at current levels of ≈9%.

PEERS VALUATION

NEWCO VALUATION

NewCo is a top notch asset with  higher margin than its peers. In our opinion Newco belongs in a different asset class than its retail competitors mostly because of its exposure to clients with higher spending power. We also believe it is less prone  to be affected by  consumption cycles and it faces a less intense competitive landscape as most supermarket chains have focused on lower segments.  

Soriana’s transaction would enable us to buy NewCo at a significant discount to peers at only 4.9x EBITDA, comparable companies trade at 10.7x. We believe this investement opportunity is extremely attractive, not only from a valuation perpective but also we would be buying a great company with more attractive growth rates. Growth in the retail sector has stagnated mainly because of tough economic conditions and a more aggresive competitve landscape. As we mentioned NewCo would be able to weather this headwinds due to its exposure to higher socioeconomic segments.

COMERCI VALUATION

Catalyst

Spinoff of newco this month