Description

I think DUFRY is a 3 year double. Asymmetry is more to the upside than the downside from 1) motivated and concentrated holders (Advent, Baba, Qatar) that could take DUFRY private, 2) more upside than downside to China JV, 3) probably faster upside to consensus on both recovery timeline / cost cuts.

1. DUFRY generates a ~13% EFCF / ~10% UFCF on normalized 2019 earnings (assuming modest discounts haircuts to management’s cost cut expectations)

1. While the company increased their share count by ~70%, their cost cut plan should double equity FCF

2. DUFRY should breakeven on equity FCF when revenue is 60-70% of 2019 levels. However, I doubt DUFRY will burn meaningful FCF in 2021 (albeit the key question is what minimum lease payments will be on their airport contracts in 2021. Management has indicated long-term lease payments of ~30% of revenue is still reasonable). 

3. While core airport retail business has had a shaky growth, it does organically grow LSD over time. I don’t think a 5-6% unlevered FCF yield for the core business is unreasonable. Thus, core business alone gets you to DUFRY as a ~3 year double.

4. There is clearly lots of optionality around China / Hainan. While I do think it will be a challenge for DUFRY/Baba JV to take huge share. There is a lot of opportunity and I think there could be at least 10 CHF/share of value today from the JV (20% upside to stock). 

Risks

1. Obviously, macro matters and I’m a little nervous about business travel recovery. However, its only ~30% of DUFN customers.

2. Cost cuts, as I outlined below, are tough to verify. I only underwrite CHF250mm in my base case

3. Company is hated. Stock has been horrible for many years before covid and murky European duty free trends.

A. Revenue Organic Growth – not a disaster but very hard to model (I can’t cleanly explain pre-Covid revenue trends) / clear deceleration / LSD LT organic growth the most I would underwrite

DUFRY has seen its organic growth average ~2.5% per year. This is worse than the ~6% global travel average. 

As you can see below, retail spend per passenger peaked in 2013/2014. There is no clear single reason for the trend. Reasons for deceleration include: 

1) Rise of low cost carriers (low cost carrier passengers spend less than international travel)

2) DUFRY under exposure to Asia which is the fastest growing air travel region. 

3) Fx

1. Low cost carriers have taken share of global travel. This is a headwind to duty free sales

2. DUFY is under exposed to Asia / Middle East, which are the fastest growing markets

3. FX headwinds have driven part of the negative growth as DUFRY stores are priced in USD. That trend of weakening fx doesn’t look like its getting much better from 2019 level.

B. DUFRY is mostly leisure oriented - ~65-70% of DUFN customers are leisure/family visiting customers

C. Management has articulated a big cost cut plan. 400mm CHF of cost cuts. While these cost cuts could be huge relative to the ~346mm of equity FCF the business generated in 2019, I am skeptical the cost cuts will come to fruition cleanly in the financials.

DUFY is guiding to ~400mmCHF of cost savings permanently post Covid. ~300CHF mm from personnel cuts and ~100CHF mm from other/SG&A. It’s pretty impossible to verify this. DUFY management claims they cut a bunch of middle managers they don’t need anymore. Based on management’s guidance on cost cuts, personnel expenses would drop from ~14.1% of 2019 sales to ~10.7% of 2019 sales. I’m a little skeptical based on the fact that 1) their personnel expense as  % of opex is lower than for peer businesses and personnel expenses have never gone below 12.5%. 

Similarly, Dufry selling expenses / rent has been straight up cost inflationary. Airports have historically increased rents every year that have hurt DUFRY incremental margins. Most airport concessions have minimum annual guarantee payments (“MAGs”); however, DUFRY successfully renegotiated many of these agreements. While we are not privy to the agreements, DUFRY management claims that they don’t expect rent payments as % of sales to exceed 30%. We can’t really verify this but I am skeptical.

D. Stock is cheap on normalized 2019 FCF yield. If you believe their cost cuts (I’m a little skeptical), then stock trades at an unlevered ~11.5% FCF yield. 

E. China JV is an opportunity 

China has shown a strong desire to dramatically expand duty free sales in Hainan. In June 2020, Hainan expanded its duty free spend ceiling from 30k RMB to 100k and is allowing unused quota to be spent within 180 days. China is targeting ~$40bn of spend on Hainan in 2030 vs $2bn in 2019.

While China Duty Free Group (majority owned by an SOE) has 100% share on Hainan today, China clearly has a desire to develop Hainan / expand beyond just CDFG. Chinese government has awarded two additional licenses for duty free sales in Hainan earlier this year. Both these players are new ventures with no experience in duty free. 

The opportunity for Hainan is large given Chinese residents spend ~$250bn in travel retail mostly in airports that DUFRY doesn’t have a presence in. 

DUFRY/BABA do not have a licenses to operate in Hainan. However, given their expertise in sales, they do appear well positioned to at least assist license holders. Management says they are working on opportunities. Notably, on 1/5/2021, Dufry signed an agreement with HDH to supply goods / provide advisory services to Mova Mall. This covers 13% of estimate 2025 Hainan retail space; however, wholesale margins should be weak. 

Catalyst

Earnings, BABA JV