Description

Boil down: China is re-opening and it is worth pausing and asking the question: how intense must the pent-up buying pressure be following two-plus years of house arrest? Imagine being a wealthy, coastal Chinese citizen forced to twiddle your thumbs for over two years while the rest of the world re-opened? Given the size of the population in question, the impact of this pivot could prove monumental for businesses in the travel ecosystem. Add to this cocktail an enduring global bid for experiences, evidenced recently by airlines adding flights, and we believe travel is the rare theme worth underwriting for 2023.

We believe the best way to express this idea is Dufry, a pure-play travel investment that is not only a top-down winner, but has idiosyncratic catalysts including a management upgrade, an underappreciated merger with Autogrill, cheap valuation, and inflecting cash flow. We have crystal clear reasons for the opportunity – it got hammered on Covid, staged a comeback, only to get smoked on Russia/Ukraine – and believe that is in the rearview mirror now. The skew is sufficiently asymmetric, with a base case of 60 (+60%) and a plausible up case of 70 (+80%). As for the downside, we believe that fundamentally the lows should be in given what this company faced in 2022; at its worst, the stock hit 30 twice this year, representing a trough valuation of 6x on pre-COVID EBITDA, which corresponds to -20% downside.

In the interest of presenting a 'fair and balanced view', we would note a) leverage cuts both ways and can lead to big moves lower, b) China could pivot again and re-close the economy, or c) the macro slowdown could hit them harder than expected. The risks are enumerated in more detail towards the end of the writeup. In short, losses are entirely possible, so do your own diligence.

Key points:

1. China reopening play (growing demand for international travel)
2. Autogrill (AGL IM) merger is more accretive than initial impressions
3. Leadership turnover with a new financially focused CEO
4. Inflecting cash flow with high operating and financial leverage
5. Fatigue in equity story starting to improve

Note: All figures are pro forma for pending Autogrill (AGL IM) acquisition and stated in Swiss Francs (CHF). All math shown is EBITDA (fully lease burdened) vs. TEV excluding leases.

Description: Premier operator of airport duty-free (brands include Dufry & World Duty Free) and convenience retail stores (Hudson) as well as food and beverage locations (Autogrill acquisition will bring franchises like Starbucks, McDonalds, Dunkin, Chick-fil-A, Burger King, etc.). Dufry is the largest global airport retailer, with a total market share of ~30% (including Autogrill), and is generally a bellwether for total passenger travel and consumer willingness to spend. The combined business has 5,500 stores in 350 airports in 75 countries, 60k employees, a 2.3bn passenger TAM, CHF 13.6bn in sales, and CHF 1.4bn in EBITDA as of 2019.

2019 Revenue Mix (Pro Forma for Autogrill acquisition)

Source: Dufry 2022 Capital Markets Day

Why it’s cheap: In 2020, COVID decimated global airline travel and Dufry’s results got hammered and Dufry was forced to raise equity for liquidity. As the business slowly recovered in late 2020 and early 2021, concerns emerged about Dufry’s overall leverage level and management’s ability to realize an ambitious CHF 400mm OpEx cost save plan. As the business was regaining its footing in early 2022, Russia invaded Ukraine and Dufry sold off on concerns regarding exposure to wealthy Russian travelers (~3% of sales) and general European travel sentiment. Since then, Dufry has seen steady resumption in international travel despite rising ticket prices and recession fears. Management turnover and the Autogrill acquisition have further muddied the waters and left the stock somewhat adrift as of late.

Source: Bloomberg

Thesis:

1. China reopening play (growing demand for international travel): Pre-COVID, Chinese consumers accounted for ~7% of total Dufry sales. Due to China’s Zero-COVID policy, sales from these consumers are effectively at 0. 80% of Chinese travel is to APAC area, where Dufry has seen the slowest recovery in sales by any region. As China loosens COVID restrictions and reinstates international flights, we expect a significant tailwind to Dufry sales from Chinese “revenge travel”.

Source: Dufry 2022 1H Results Presentation

Source: https://www.bloomberg.com/news/articles/2022-12-13/china-air-travel-demand-surges-as-covid-zero-rules-dismantled

Source: https://www.cnbc.com/2022/12/13/china-axes-travel-tracking-app-in-latest-easing-of-covid-curbs.html

Source: https://www.cnbc.com/2022/10/12/united-airlines-grows-summer-europe-travel-schedule.html

2. Autogrill (AGL IM) merger is more accretive than initial impressions: Early investor perception of the Autogrill acquisition was not the most positive. Investors thought Autogrill was primarily on highway restaurants and eateries in Italy, with limited natural synergies with the rest of Dufry’s portfolio. However, Autogrill’s 2019 business mix was 67% airports, and only 25% Motorways, and is 50% North America which is a nice complement to Dufry’s existing portfolio.

Source: Dufry / Autogrill 2022 Merger Presentation

The merger gives Dufry considerably more scale with existing landlords, and allows for hybrid retail / dining concepts which have demonstrated good traction with passengers in early test concepts. While cost synergies are only CHF 85mm, this feels conservative and Dufry delivered synergies 30% ahead of initial guidance with the acquisition of World Duty Free in 2015 (also acquired from Edizione, the largest owner of Autogrill). Dufry has highlighted further revenue synergy opportunities from the merger, but has yet to quantify the opportunity.

3. Leadership turnover with a new financially focused CEO: In June 2022, Xavier Rossinyol was brought in as CEO of Dufry, replacing Julián Díaz who had led the business for over two decades after its acquisition by Advent in 2004. Xavier had previously been with Dufry from 2004-2015, serving as CFO until 2012 and then COO of EMEA and Asia until 2015 before leaving to be the CEO of Gategroup. In 2020, as part of emergency equity raises and the financing of the Hudson acquisition, Advent invested CHF 415mm and elected another board member, Ranjan Sen, giving Advent 2 board seats including the Chairman position held by Juan Carlos Torres Carretero. With Advent’s increased board role they wanted a more financially disciplined and focused CEO and brought in Xavier who was well known within the company and had the financial focus from his time as CFO. In our conversations with Xavier, we’ve found him to be a focused and experienced operator with a clear strategic vision who is acutely aware of the financial implications and tradeoffs of the current strategy.
4. Inflecting cash flow with high operating and financial leverage: With ~$5bn of net debt and $5bn of operating leases, Dufry has considerable financial leverage which should be a strong tailwind to FCF generation as Asia sales return to pre-pandemic levels. And with a store base of ~5,500 locations, there is considerable fixed cost in the business which Dufry has tried to flex down during the pandemic. However this provides further leverage to a recovery in the missing sales, which we believe can drive Dufry to a ~10% FCF yield.
5. Fatigue in equity story starting to improve: Per our conversation with Xavier, one of his key priorities is improving the equity story perception with investors. A few key issues he highlighted with us were:
   1. Autogrill perception (mentioned in Point #2). Investors thought Dufry was buying an Italian highway food businesses. Investors didn’t understand the logic. Clarified that this was primarily a North American airports business; attracting some interest from large funds as a larger scale pure play travel food and retail play.
   2. EBITDA reporting. Complete mess based on IFRS 16 and lease/interest expense. New cleaner reporting (CORE EBITDA) will report fully cash lease burdened EBITDA that is more familiar to most US investors.
   3. Consecutive headwinds of COVID, leverage levels, Russia/Ukraine & European weakness starting to abate as results improve. Leverage getting to a point (especially pro forma) where more European investors are comfortable with it.
   4. Legacy management team had a history of underdelivering on guidance and promises. New guidance appears appropriately conservative and Xavier is focused on rebuilding credibility with the investor base. At the most recent IR day and on the NDR, management has insisted that rebuilding credibility with investors by delivering on guidance targets was critical.

Anecdotally, we heard from IR that roadshow interest for the deal was “off the charts”. The level of interest appears to have caught the management team a little by surprise. The new team, the merger with Autogrill, and the resumption of international travel have resulted in the clearest and most articulate strategic vision for the company in years.

Financials & Valuation: We think the business is comfortably worth CHF 60 at 9x ’24 EBITDA, with upside to CHF 70 at 10x EBITDA.

Historical Multiples:

Comparable Transactions: Median travel retail acquisition multiple of ~9.6x EV/EBITDA over the last 10+ years.

Source: Goldman Sachs Research

Risks:

• AGL IM deal close: Autogrill acquisition is not yet closed, however it was approved by Dufry shareholders in August ’22 and the Edizione stake is expected to close by end of Q1 ’23. Since Edizione has a controlling stake, Dufry will then be able to launch a mandatory tender offer (MTO) for the remaining Autogrill shares, closing of which is expected by Q2 ’23. We do not expect there to be any anti-trust barriers to the deal.
• Consumer airport habits are changing: Dufry has highlighted increasing WiFi penetration as a competitor to its duty free locations. Consumers spend more time on their phones entertaining themselves (watching content, shopping, communicating) instead of browsing duty free stores and shopping. We believe that the merger with Autogrill addresses this risk by integrating the food and beverage and shopping experiences. Consumers need to eat at airports, and we believe and integrated offering and opportunity for cross-sell or promotion should more than offset the marginal substitution from consumers spending time on their phones.
• Airport concession compression: Airports have been increasing rents (concession fees) which is a potential longer term headwind to Dufry’s margins. However, airports have been trying to make the consumer experience more pleasant to induce more shopping and dwell time as an improved revenue source. We see Dufry as a key component in helping airports realize this vision and believe they can structure contracts that will be accretive as they held drive traffic and conversion.
• Recession: So far, travel spending has been very resilient despite inflation, rising rates, and a wobbly macro. If there was a significant recession, either in the US, Europe, or globally, this would likely impact travel demand and ultimately Dufry sales.
• China reopening: China reopening represents a material tailwind for the business and the apparent relaxation of restrictions would be a powerful boost to results. If China were to stick with Zero-COVID indefinitely this would be a continued headwind.

Catalyst

China reopening, Autogrill acquisition closing, fundamental inflection.