Description

June 13, 2024

LONG: Fielmann Group AG (FIE GR)

Share Price: €42.70

Market Cap: €3,587mm

Enterprise Value: €3,942mm

Executive Summary:

We believe an investment in Fielmann represents the opportunity to buy an under-the-radar compounder at a value price. Fielmann is the dominant optical retailer in Germany and surrounding countries, with a 55% market share (by volume) in its home market of Germany, and 44% and 33% share in Switzerland and Austria, respectively. The company has no earnings calls, no investor presentations published on its website, and is not covered by any analysts at bulge bracket firms, despite having a market cap of nearly €3.6bn. The company is refreshingly anti-promotional and makes no adjustments to its IFRS earnings. The business recently passed hands from the founder to his son; while we are generally wary of family-controlled businesses, especially when the founder turns the business over to a child, we believe this transition (and more recent management changes) mark an inflection point in both profitability, investor-friendliness and growth for the business that has so far gone unnoticed by the market.  

We believe the company can compound earnings at 25% per year between now and 2026 as the company executes on multiple "low hanging fruit" margin initiatives to restore historical levels of profitability. Longer-term, we think Fielmann can compound revenues at mid-to-high single digits and earnings at high teens as it fills the void left by its only scaled competitor in Europe, GrandVision, which we believe is prioritizing more expensive owned brand frames and lenses since its purchase by EssilorLuxottica, vs. its and Fielmann’s historical focus on cheaper private label product.

Furthermore, we believe Fielmann has the potential to bring its "category killer" concept outside of its core markets to other markets over time, most of which were previously dominated by GrandVision. We see upside of ~50% to 100% over the next 3 years as the company executes on its plan and the market comes to better appreciate the changes that have occurred at the company.

Why Scale Optical Retailers in Europe are Great Businesses: 

We believe optical retail at scale has historically been perceived as a great business with investors rewarding generous multiples to publicly traded companies like GrandVision, Fielmann, Warby Parker, and National Vision.  Below are historical valuation multiples at IPO for publicly traded optical chains, as well as notable private equity transactions.

Source: Capital IQ data, as of April 2024. €/$ in millions.

We believe the generally accepted thesis on optical retail at scale is that chains can deliver prices well below mom & pop opticians due to scale in purchasing of high-quality private label product and higher throughput per store. Over time, this allows large optical chains to take share from mom & pops while providing a dramatically better value proposition to the consumer. Fielmann benefits from this same dynamic. In Germany, the average Fielmann store sells 13x+ more pairs of glasses per store, per day at 60% lower prices and 70% lower COGS, compared to a local independent optical store. 

Source: Independent German Optician data per ZVA, a German association of opticians and optometrists. Assumes Fielmann operating at normalized (2018) margin levels. EBITDA margin post-capital lease expense.

Optical retail at scale is not an equally good business in all markets – we believe optical retail in the US is a less attractive business than in Europe. While US optical chains enjoy the same benefit vs. independent peers, there are many more “discount chains” at scale in the US, resulting in more competition and lower margins for US vs. European optical discounters. Take the below example of the market structure in the US vs. Germany:

    Source: ZVA, Vision Monday. € and $ in millions.

Within the US market, there are six discount-focused players with revenues over $1bn, while in Germany there are only two players with meaningful scale and an 8x gap between the largest player and the third largest player. We don’t believe any other chains in Fielmann’s markets can compete with them. Mister Spex, the fourth largest optical retailer in Germany, went public in the summer of 2021 at €24.50 per share and was billed as the Warby Parker of Europe. It currently trades at €3.00 per share. More recently, Mister Spex has begun to close stores in Germany and remains roughly EBITDA breakeven.

In additional to greater barriers to entry in Europe, there are several other notable differences between the US and European markets:

Source: Research and public company filings.

We believe the market structure in Europe, value proposition of Fielmann vs. competitors, and structural growth drivers in the market will allow Fielmann to maintain dominant share in its key markets and continue to grow 3-5% as they have for many years:

Source: Fielmann filings. € in millions.

Despite the US market being more competitive, we do believe there is opportunity for Fielman to have success in the US, especially given their more consumer-centric model with higher customer satisfaction.  Warby Parker has generally been successful penetrating the US with a similar model, taking share from both mom & pop’s and less consumer-friendly discounters.  Fielmann has recently entered the US via 2 acquisitions in the Midwest.  Unlike the coasts, which are much more competitive, Fielmann’s chosen markets have what we view as weaker competitors in Nation Visional, Visionworks, and Walmart Optical, which while offering low prices generally have very poor customer reviews.  We estimate Fielmann’s new combined banners are #1 or #2 in states representing more than 65% of their store count (MI, WI, MN).

Why the Opportunity Exists: 

Fielmann has historically traded at a premium valuation given its dominant market position and long history of execution. We believe investors have recently soured on the name for several reasons:

Growth at the Expense of Margin

Gunther Fielmann founded the retailer in 1972 and was CEO until late 2019 when his son, Marc Fielmann, took over. When Marc became CEO, he changed the strategy to focus more on revenue growth and expansion outside of Fielmann’s core markets. This strategy shift came at the expense of margins, as expansion markets were less profitable and the company decided not to raise price to take more share while the industry saw significant cost inflation in 2021 and 2022. As a result, EBITDA margin pre-capital lease expense went from 26.0% in 2018 to 19.3% in 2022, when the company had to issue two profit warnings and cut the dividend. 

Lack of Investor Relations

As a family-owned business (72% ownership), Fielmann makes little effort to engage with investors. Since IPO, the IR effort has been headed by a long-time finance executive with minimal interest in following public markets conventions like hosting earnings calls, producing investor materials, and courting investors. Recently, under a new CFO, the company hosted their first ever webcast earnings call in late April. It wasn’t hard to get involved in the Q&A section of the call as we were given two opportunities to ask questions and only four questions were asked (including ours). In typical Fielmann fashion, no archived recording or copy of the presentation is available on the website. We believe this behavior is likely to change under the new CFO.

Lack of Sellside & Buyside Coverage

Fielmann is covered almost entirely by local German brokerages.  Only two Pan European brokers (HSBC and Kepler) continue to cover the stock after BofA and Berenberg recently dropped coverage. With regards to buyside interest, Fielmann has never been written up on Value Investors Club, Savant, X / Twitter or Substack.

Consumer Confidence in Germany

Consumer confidence in Germany was near the worst on record in ’22, and even worse than in ’08 / ’09. It bounced back slightly in ’23 but is still low relative to history. We believe weak consumer confidence has weighed on ASP and volumes in Fielmann’s largest market.

Source: Bloomberg data, as of March 2024.

Why Now:

Change in Management Focus & Investor Communication

After a challenging 2022, management has shifted their focus to profitability and margin restoration. Here’s a slide from their first ever earnings call in April ’24:

Source: Fielmann presentation.

In January ’24, the company hired a new CFO, Steffen Baetjer. Steffen brings notable experience to Fielmann having spent 14 years in three CFO roles of private equity owned German companies. We believe he is a major upgrade over the prior CFO who had been in the role since 2004 and was much less focused on controlling store level operating expenses, which we believe are bloated. We spoke with several former colleagues of Steffen who had the following to say about him: 

Former Colleague: “I’ve worked for a lot of CFOs and by far Steffen was the best. Just a different level of smart, very sharp. Can read a situation very well and comprehend the big picture.”

Former Colleague: “He was able to keep the business afloat during COVID because he was a very demanding and tough boss, but also very fair.”

Former Colleague: “Steffen came into APCOA and his first major projects were opex, capex and net working capital improvement programs. He has extensive experience in cost reduction and improving margins.”

Low Hanging Fruit to Improve Margins

During their recent earnings call, the CEO called out his levers to improve margins, many of which we confirmed in our independent diligence.

The first and largest lever is their ability to raise the ASP of their glasses, predominately by increasing the proportion of high value lenses as a percentage of their sales mix. Unlike in the US, eye exams in Germany are typically free at Fielmann and 10-30 euros at independent optical stores. After getting their prescription, customers spend most of their time shopping for and trying on frames, which are lower priced & lower margin. Fielmann and other optical chains make most of their margin on the lenses, which at Fielmann can vary from a few euros to as much as a couple hundred euros. The lens package is often recommended by an optometrist, who generally can upsell the customer to higher value features like thinner lenses, blue light filters, progressive lenses, etc. Due to the lack of price transparency and comparability of lenses across chains, the lens purchase being the last step in the process (after you’ve selected your frame), and the heavy use of the product (you literally see the waking world through the lenses) customers typically don’t price shop lenses.  We believe these dynamics make it relatively easy for Fielmann to increase its ASP by upselling higher priced lenses and/or increasing lens prices. Several industry executives we spoke to echoed this point, with one going so far as to suggest that Fielmann’s value proposition to their customers is so strong and price transparency so opaque that they could “raise price 20% on their lenses and probably not lose any customers”.

The second lever for margin improvement is the ability to standardize and centralize the lens glazing process. Lens glazing is the act of grinding and shaping lenses to fit a specific pair of frames. According to management, ~50% of Fielmann’s lenses are glazed at their individual retail stores by high-cost optometrists, vs. National Vision and GrandVision who do this entirely in centralized labs. Glazing at the retail store is a highly inefficient process since it requires equipment at the stores and consumes time of the optician. Fielmann has invested significant capex over recent years to build more glazing capacity in their Rathenow, Germany facility, which should contribute to margin expansion over time as they shift more glazing out of the stores and into cheaper centralized operations.

GrandVision Strategy Shift Creates Room for Fielmann to Take Share and Expand into New Markets

GrandVision is Fielmann’s largest competitor in Europe and has significant market presence in all Fielmann’s markets. Historically, GrandVision has focused on the value end of the market, much like Fielmann, but in the summer of ’21 the company was acquired by EssilorLuxottica, who is the largest lens and frame manufacturer in the world. EssilorLuxottica’s brands and lenses cater to the medium to high of the market. We spoke with the former CEO of the second largest German Optical retailer who had the following to say about GrandVision’s strategy after it was acquired by EssilorLuxottica:

 “[GrandVision] has been taken over by EssilorLuxottica. They are obviously trying to position the brand a bit higher, more branded products and branded lenses which then leads to the fact that they open up a bit more the market on the lower end of the prices where some of the competitors step in. Fielmann is one of those.”

This shift in GrandVision’s strategy presents significant opportunity for Fielmann in its core markets, but also in new potential expansion markets where GrandVision is currently the leader.

Global Expansion Strategy Could Help Drive Long-Term Growth in Revenues and Earnings

Since 2019, Fielmann has expanded into Southern Italy, Slovenia, Spain and, most recently, the Midwestern United States. While the company has faced some challenges in their Italian expansion, we believe management has learned from their mistakes and has found more success in entering new markets through M&A and retaining the acquired banner, as they did in Spain. We believe Fielmann can make accretive acquisitions of smaller regional chains by leveraging their purchasing power, balance sheet and scale to improve margins and expand the local brand through new store openings.  The ability to gain share in these new markets as they did over-time in their core markets provide a multi-year runway for growth.

Trough Multiple on Trough Earnings

Fielmann had EBITDA margins pre-capital lease expense of 20.8% in 2023 compared to a consistent 26.0-27.0% pre-2020. Even on these bottomed out figures, Fielmann is trading near the cheapest valuation in its history. Pre-COVID, Fielmann generally traded between 15.0x - 20.0x EV/NTM EBITDA and 25.0x - 35.0x P/E.  

Source: Capital IQ data, as of April ’24.

Fielmann’s is also cheap relative to peers. From early 2014 to the beginning of COVID, Fielmann traded at a premium to its peer group, typically 5.0+ turns to GrandVision and 2-5.0x above EssilorLuxottica on an EV/NTM EBITDA basis. From March ’20 until now, Fielmann’s multiple has declined and it now trades at a material discount to competitors and private equity transactions.

Source: Capital IQ data, as of April 2024.

Valuation & Price Targets 

Trading Comparables

If we assume more normalized margins for Fielmann (25% EBITDA margin pre-capital lease expense), the business is trading at 8.2x FY25 EBITDA and 12.5x FY25 EPS, or a roughly 60% discount to EssilorLuxottica.  Historically, Fielmann has actually traded at a slight premium to EssilorLuxottica:

Source: Capital IQ data, as of June 2024. € in millions except per share data. EBITDA post-capital lease expense.

Compounding Math

Over the next three years we expect revenues to compound at 8% and EBITDA to compound at 15% as a combination of pricing, margin recovery, and new store openings drive stronger growth than historical growth in both revenues and margins. Longer term, we think the business can compound revenues closer to 6% and EBITDA closer to low teens. Combining low teens EBITDA growth with a mid-single digit free cash flow yield, we think Fielmann can compound share value in the high teens for many years.

Short Term Price Target

In a more traditional analysis in our base case, we estimate ’25 EBITDA of ~€445mm (23.0% EBITDA margin pre-capital lease) at an NTM multiple of 12.3x to arrive at a share price of ~€63, or a 47% premium to the current price. In our bull case, we assume the company reaches achieves EBITDA margin of 24.1% and a 14.75x multiple (~23.6x P/E), which implies a near double. Given the trough-on-trough dynamics and high-quality nature of the business, we view downside as limited at around ~20%.

Source:  Internal estimates. € in millions. EBITDA post capital lease expense.

Risks:

Revert to Growth at the Expense of Margins

The main reason why this opportunity exists is because Fielmann is a controlled company with a CEO who proactively decided to degrade margin. There is a risk that the CEO doesn’t care about profitability and continues to pursue a growth at all costs strategy. Given our conversations with the company, new CFO, and public statements, we view this as unlikely but nonetheless a risk.

Challenge Replicating the Model in Other Markets

While we view international expansion as a major opportunity and believe in management’s ability to execute, there is a risk that the model isn’t replicable in other markets. For instance, Fielmann attempted to expand organically into Southern Italy with the Fielmann brand but has struggled and closed 10 of their 54 stores in January ’24. After conversations with experts and the company, we believe management has learned from their mistakes in Italy and can pursue international expansion successfully by entering new markets through M&A and retaining the acquired banner, as they did in Spain.  As mentioned previously, the US is also a more competitive market and one where we view execution risk as above average.

High Operating Leverage

As mentioned above, 75% of the cost base is fixed and therefore if same store sales were to begin declining, margins would erode quickly. Fielmann operates mostly in the discount / value portion of the market and the purchases are non-discretionary so there is some insulation from a macro downturn, but consumers can still delay their purchases of glasses if there are no issues with their current pair.

Important Disclaimer:

Although, as of the publication date of this report, the author has long positions in Fielmann and stands to realize gains in the event the stock price increases. Following publication of the report, the author may transact in securities of Fielmann. This report does not constitute advice on whether the recipient should buy or sell Fielmann now or in the future. The author’s decision to invest or divest – in whole or in part – of its investment in Fielmann are based on numerous considerations not discussed herein, including but not limited to the composition of its entire portfolio and the portfolio’s specific investment objectives and limits. All content in this report represents the opinions of the author who has obtained all information within this report from sources they believe to be accurate and reliable. However, such information is presented “as is,” without warranty of any kind – whether express or implied.

I do not hold a position with the issuer such as employment, directorship, or consultancy.

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Margin Normalization