Description

The Summary

GrandVision is the largest optical retailer in the world. It is intricately linked to the success of the Van der Vorm family, the ‘Warren Buffet of Holland’ (I guess there must be a Warren Buffet of everywhere). The company was formed by the family back in 1994 when they acquired Pearle Vision’s Benelux stores for around EUR 50m. Without putting in a penny more, GrandVision has grown through a series of acquisitions and strong organic growth. The growth is driven by a virtuous circle: its scale-advantages are shared with customers through lower prices. The lower prices lead to constant market share growth, more scale and hence more scale advantages, creating a positive feedback loop. On top of that, it is very easy for GrandVision to purchase small mom & pops and insert its supply chain directly into them, creating tremendous returns on acquisitions.

Today, the company will generate sales of c. EUR 3.9bn and operating profit will be nearly EUR 500m (all based on my 2018 estimates), an increase of around 200-fold since 1994. It owns a top three player in the UK, France, Germany, Italy, Netherlands, Scandinavia, Switzerland, India and a handful of Latin American countries. It has over forty banners across each market.

I will dig into the moat and unit economics in detail, some of the risks and the valuation. But the simple narrative is this is a high-quality, defensive compounder, which has structural growth (think demographics and endless staring at small screens), will benefit from any shift online (its market share over-indexes online), margin expansion and low leverage. It IPO’d in 2015 at EUR 20 per share but HAL retained around 75% of the stock and I’m sure this has depressed the price, despite their great record. Three years after the IPO and the share price is still below its issue price. Meanwhile, net debt has declined from EUR 940m to around EUR 750m today and pro forma operating profit has grown by over 20%. While there are some temporary integration issues, the company trades at 16x earnings despite significant investments, with 5-7% normalised organic growth and excellent returns on acquisitions.

The Moat

Optical retail is a great business at scale. It has made a billion-dollar fortune for a handful of families around the world. There are a few quirks that make it attractive. Most important is that it’s a classic scale-economies-shared business model, which gets better over time. But first, let’s go back in time to help illustrate the key features.

History of the Business Model

The optometrist, like many healthcare professions, is an interesting character in the world of business – they are trained and perceived to give customers the best health advice. But the best health advice is also generally to recommend a high-priced product. Customers trust that advice, just like they trust a dentist or doctor. This makes the customers captive with zero bargaining power.

Most opticians were historically owned and run by a single optometrist. Because spectacles are expensive, they were typically only replaced when necessary – say when the glasses were lost, been sat on or when a prescription needs updating – which led to a replacement cycle of three to four years. When customers did need to replace glasses, they were price insensitive – sight is essential.

Most of an optician’s customers were loyal and would return to the store each time. People had personal relationships with their optometrist, who held their prescriptions in their file. Requesting those prescriptions to take to another store was awkward. If you need a new prescription you could go to a new optician, but the reasons that led you to the original optician (typically location or word of mouth) were normally just as valid. Besides, prices were so opaque (who knows where the cost of the frame comes from?) it was very hard to say if one optician was better or cheaper than another. In some markets the price was covered by insurance, which made people even more price-insensitive and loyal.

Footfall was extremely low for a typical optician, but the price of the spectacles, and the gross margin, was so high that the owner didn’t need many sales in a day to make it an attractive career for an educated individual. In fact, today, independents can survive on selling just one to two spectacles a day.

The supply chain was designed to support this structure. The cost of the frames and the lens were just a fraction of the price the optician sold the lens for. For instance, Essilor sells its lens for an average price of EUR 10, whereas the re-sell price is typically over EUR 100. People were often lured in by the relatively low price of the frame and then the optician made the bulk of the profit from the sale of the lens. All this was necessary to support such a low-volume, high-touch product, run by well-educated people that required a return commensurate with their alternatives. The business had substantial operating leverage – expensive people and premises relative to their sales, with low inventory turnover.

However, over the last two to three decades, chains have emerged to compete with this independent. Some entrepreneurial opticians realised that they could offer significantly lower prices than the competition and such dramatic price differences could lure even price-sensitive buyers to their stores. The increase in footfall and sales density more than made up for the lower gross margin. If an optician goes from selling two spectacles a day at EUR 200 gross profit each to six at EUR 100 each, they have increased their gross profit by 50% and probably doubled their operating profit, all the while lowering the price tremendously for the customer.

Such stores thrived and rolled out across their market. Regional rollouts became national and, in the case of Specsavers, international (although Specsavers is the exception to the rule). Over time, this scale became an advantage with the suppliers who themselves were consolidating and becoming more powerful. Most importantly, chains became big enough to produce own-brand frames and lenses. This allowed the larger ones to offer a high-quality product far cheaper than the independents could. As they got bigger, they got more scale-advantaged and they passed this on to their customers. Over time their relative product became increasingly superior to their independent competitors.

Despite this, the shift to chains has been incredibly gradual, unlike say the grocery market or other retail markets. Most markets are still around 50% independent opticians / chains. Many people remain price insensitive and prices are so opaque many don’t realise they are vastly over-paying at independent opticians (I certainly didn’t until I did my due-diligence here!). But the difference in the offering is so large that chains are overwhelming the independents, who are gradually going out of business. Many independents have an untenable position – having been operating profitably for years, a Vision Express opens nearby and wipes out most of their profits. Despite this, many hang on for years, letting staff go and not replacing old equipment, as they try to eke out a living. Some don’t have an alternative – locked in by a lease or not willing to give up their own independence to work at a chain. But the train has left the station and is not slowing down.

Differences in Unit Economics

It is worth considering the unit economics of two stores – a chain and an independent – to illustrate the stark difference of their competitive positions and business models. I have used an optimistic case for the independent’s unit sales per day. It is unlikely to be as high as 3. But even still it implies GrandVision generates sales and gross profit of more than double that of an independent. Meanwhile, the average price at the chain is 20-30% below the independent. In other words, the chains are passing on its scale advantages to the customer. Still, they generate a higher gross margin than the independent because of the high margins on its own brand and because of their scale in purchasing, although admittedly the gross profit per unit is lower.

How does this translate into the store P&L? This is again a pretty rough estimate but I guess that this higher gross profit translates to a contribution advantage of around 3x on a per store basis. The independent is left with a modest profit of c. EUR 60k before taxes. They don’t have the sales density to invest in marketing or more modern equipment and they end up off the high-street. All these contribute to the lower sales density. The low volume means there is little need of more than part-time staff, although assuming the ophthalmologist is the owner, they do face a genuine challenge of what to do with the store when they’re giving a customer an eye test. Multiple independents I visited had their husband or wife mind the store while they went for eye tests. One was minding their child in the store.

Virtuous Circle

The beautiful thing about this model is that it is reinforcing. The superior offering for customers leads to an increase in market share for each store. The great unit economics make a rollout very attractive. Given the decline in the supply of independents in most markets this doesn’t lead to excessive supply growth. This further increases GrandVision’s market share, which is growing in every market. It also makes acquisitions highly attractive. All this increases GrandVision scale advantages with suppliers – making it the largest customer in the world for its major suppliers in lenses and frames. It sold 16 million spectacles in 2017. Compare that to most opticians which sell less than a thousand spectacles per year. This leads to better unit costs over time, which it passes on to its customers. Customers reciprocate by giving more volume to GrandVision, and the cycle repeats. They can also use this scale to invest in marketing their lower prices, driving further volumes. Growth begets growth.

Meanwhile, its independent competitors are caught in a vicious cycle. As they lose market share the operating leverage in their business model leads to a decline in profits. To offset this, they must increase prices on their most loyal customers. Eventually the elastic band breaks, and even these loyal customers move to a chain, where they are typically pleasantly surprised by how much money they can save.

This shift will take time. The average customer is loyal for about ten years to an individual store. In most cases, they look for a new one only when they move houses or jobs. This makes it a good business to be in. But when you’re taking market share, it also means it can be a slow grind. Nonetheless, a predictable one.

Some markets can support more independents. For example, French people, and many Americans, have the cost of their spectacles reimbursed, so they are not price sensitive. However, even here it is likely that people become more price sensitive, not less. Already the regulation is changing, reducing the amount people can have reimbursed. While this may lead to a decline in sales for everyone (including GrandVision), it will accelerate its increase in market share and is something the company welcomes.

Importantly, GrandVision’s management and key stakeholder understand this dynamic. They have made difficult decisions to lower prices consistently. From 2011 to 2013 this took the form of lowering prices in several markets where they had acquired operations. This was a brave decision. Because customers are price-insensitive and loyal in the short run it must be tempting to increase prices. Longer run however having a reputation as being cheaper makes it the right decision to lower prices. A moat built on low prices and high volumes is much more sustainable.

In recent years rather than pushing prices down GrandVision has been pushing own brands which have a much lower price point, despite being of comparable quality to 3rd party brands. This effect has been quite dramatic. In H1 2015, Exclusive Brands were in the high-50s as a percentage of volumes. Just one year later that had increased to the high-60s. Today it is “well over 70%”. I estimate that the average sales price for spectacles declined by 8% from EUR 190 to EUR 174 from 2014 to 2016 and likely again in 2017. A big driver of this was the shift towards own brands. [Note different to the average sales price above of EUR 200-250. That’s because I’ve included Asia & Americas in here which has prices of around EUR 80 per spectacle.]

GrandVision’s Market Position

GrandVision has a top three position in effectively all its major markets except the US, where it has just entered the market. I estimate its market share is around 14-15% in the UK where it is the #2 player (the UK is the most consolidated market), a 8-9% share in Germany where it is also the #2 (Germany is quite a fragmented market in terms of revenue), a 10-12% share in France (also highly fragmented), an 8% share in Italy where it is the #1 player (a highly fragmented market), a 23% market share in the Benelux where it is the #1 player, a 10-15% market share in Scandinavia where it is the #3 and a 24% market share in Switzerland where it is the #1. I estimate these markets make up at least 75% of sales and most of the operating profit. Most markets have a different banner besides some adjacent markets (Vision Express is in the UK and Ireland, Synoptic is across the Nordics, Peale is in Belgium and the Netherlands, etc.).

It is desirable to be the #1 in each market. The higher GrandVision’s market share, the higher its margins typically. Although some markets are higher margin markets than others – for instance, France is a high-price, high-margin market because of the reimbursements. GrandVision also has a high margin franchise business there. However, the local scale advantages are mostly down to brand and logistics (increased store density improves efficiencies on labs for instance). But these are just part of the story. Purchasing is a major part of the scale-advantages and GrandVision conducts its purchasing from a central procurement team. It buys nearly EUR 1bn from its key suppliers, making it is by far their biggest customer. It tenders out its lens contract every three years and has lowered the cost per lens over time. This gives it an advantage over its competitors even when they are larger than it in the market.

GrandVision’s strong economics can be seen in its returns on capital. Its lease-adjusted return on net operating assets is 24% (post-tax) despite loss-making operations in several countries. The unit economics look much better in its developed markets. Its average operating margins of 12-13% are depressed by these loss-making operations – in its “G4 countries”, which are its biggest markets, it has operating margins of nearly 20% and significantly higher returns. Its lease-adjusted post-tax return on capital is around 13% but that includes some revalued goodwill that was created as part of its IPO. Its ROE is around 35-40%, again including this revalued goodwill.

The optical industry has some great businesses. I don’t believe this is accidental – I think, at scale, there are many reasons why it is an attractive market to operate in. And perhaps Fielmann, Specsavers and Luxottica have stronger business models than GrandVision. Fielmann is the market leader in Germany and has a great brand and operates almost exclusively with own brands. Incredibly, in prescription frames, it has a revenue market share of 20% but a volume market share of 50%, implying a price of one-quarter the market’s average. Yet its gross margins are nearly 80% and its operating margins are 19% because of its incredibly high volume per store. Yet Fielmann is lower growth and more mature – at half the market in volumes it gets harder for market share gains to make as much a difference. It doesn’t have GrandVision’s attractive acquisition model. And (until recently) it traded at four times sales compared to GrandVision’s 1.4 times sales.

Specsavers has tremendous economics and is one of the few optical chains whose brand is transferring to other markets. The company operates with a franchise model. With a market share of around 40% of the UK, it’s a wonderful business. Sadly, it remains family-owned.

And then there’s Luxottica, one of the best businesses in the world. It operates with quite a different business model and makes most of its operating profit from its wholesale business. It owns its brands (e.g. RayBan, Oakley, etc.), and it operates with a high-margin, high-priced model with significant marketing. Its retail chains (LensCrafter, David Clulow, Sunglass Hut, etc.) are largely high-end and designed to host their brands in the most exclusive way possible. Its main threat is the consolidation of the retail market – it generates a disproportionate amount of its sales from independents.

But in some ways GrandVision is more attractive than all of them. Its unmatched purchasing power, strong market positions and excellent capital allocation gives it higher growth and returns than most of them. It doesn’t face challenges from the shift to own brands – in fact, its leading this shift. Besides, they can all co-exist.

Growth Levers

Industry Level Growth

The demand for optical products is growing faster than population growth. This is because of:

1.      Demographics: older people are more likely to require glasses. 60% of the global population is estimated to require glasses. This increases to over 70% for people aged 45 and 95% for people aged 70.

2.      Declining replacement rate: there is evidence that as a country becomes wealthier, they purchase glasses more frequently. In the US, the replacement cycle has declined from roughly 4 years to around 2.5 years.

3.      Increasing complexity and value-added products: Older people also require more complex, progressive glasses. There is an increasing adoption of more advanced lenses, with value-added products such as thinner lenses, scratch-proof and other coatings. These all have a higher average selling price and higher gross margin.

4.   Under-penetration: in some parts of the world there are a lot of people without glasses that need it. Indeed, some estimates say that 57% of people around the world don’t have access to proper eye care. As people start to get richer in emerging markets, these under-served people are expected to get glasses.

5.   Greater contact lens attachment rates: if a customer buys contact lenses they tend to be far more valuable. GrandVision estimates that their customers that buy contact lenses are 3-4 times more valuable than those that just buy spectacles. More people are buying contact lenses over time – it is growing faster than spectacles. This is expanding the size of the market.

6.   Declining replacement cycle: there is some evidence that the replacement cycle declines when an economy gets richer. The US has gone from a replacement cycle of 3-4 years to 2 years over time.

Offsetting this growth is a shift towards chains. This is important as chains operate with lower ASPs. So value growth of 4% might be made up of volume growth of 2%, LFL price increases of 1-2%, product mix growth (shift towards contact lenses and complex glasses) of 2% and chain/independent mix shift of -2%. This is all educated guesswork.

How do I estimate the chain/independent mix impact? If we assume chains have a 50% value share in a market. Say chains have a volume growth of 2% above the market volume growth (say 4%) and independents’ volume growth is 2% below (say 0%). Assume also that ASPs for chains are 1/3 below independents. Combining these factors and the shift towards chains would have a negative impact of 2% for the market.

Overall, the global market grew at a CAGR of 4.5% from 2005 to 2013 in Euro, not much more than global GDP growth. But segmenting that between independents and chains shows that chains are growing significantly faster.

The market is not particularly cyclical, although data is hard to get. The French and German markets grew in 2008 and 2009 according to the Prospectus. The demand for spectacles is typically needs-based, often driven by diminishing eye sight and lost or broken glasses.

GrandVision’s Revenue Growth Drivers

The company’s target is to grow sales by around 5% every year excluding large strategic acquisitions, which pushes the growth up to around 7-8% on average. It generates margin expansion on top of this, getting to high single-digit operating profit growth excluding strategic acquisitions. The strategic acquisitions push the operating profit growth into the double digits. The company has achieved this going back many years.

There are four main revenue growth levers – LFL sales growth, store network growth, bolt-on acquisitions and strategic acquisitions. I go through each in turn.

1.      LFL sales growth has averaged around 2.5%. This is driven by several steady drivers. Chains are taking market share because of their superior price offering. This drives volume growth above the market average. The market volume growth exceeds population growth because of demographic factors. GrandVision doesn’t increase prices – indeed it has been lowering prices – but the average selling price is likely to increase going forward driven by mix factors. As people get older, they’re more likely to get progressive or complex glasses, which carry a higher price. GrandVision also underindexes on contact lenses and sunglasses, which are growing at a higher rate than spectacles.

2.      GrandVision grows the network by around 1-2% pa. This cannibalises some existing stores somewhat (and hurts the LFL store growth) but nonetheless carries attractive returns. GrandVision takes market share in a growing market. Store growth is part of this, especially given people typically don’t travel far for their glasses.

3.      Optical retail is full of independents that, when they retire, don’t have an easy way to sell. GrandVision buys many of these each year. It can massively boost returns by using its buying power to reduce the COGS. It can reduce the prices driving better volume in each store and further enhancing margins. Re-branding to an established market leading brand is typically part of the reorganisation.

4.      GrandVision has been buying large chains consistently for over twenty years. In 2017 it bought Tesco Opticians (#4 in the UK) and Visilab (number one player in Switzerland). In 2015 it bought For Eyes in the US. These companies had EUR 80m+ sales but typically generate margins below GrandVision’s.

Margin Expansion

There is a lot of operating leverage in the system, although low-margin acquisitions hide the extent of it. Group operating margins have expanded from 10.3% in 2011 to 12.4% in 2016. However, its organic incremental margins have been over 30% over the last three years. This can be seen in its G4 segment (57% of sales), which has had fewer acquisitions. There EBITDA margins have expanded from 19.0% to 21.5% from 2011 to 2016, despite a few acquisitions.

There are several drivers of this. Part of it is just a natural part of the model – LFLs grow faster than wages and rent. It is, funnily enough, a beneficiary of the weakness in high-street retail: rent inflation is low. Most marketing is national and so doesn’t need to be increased just because the store network grows.

Then there have been operational changes which have helped improve margins. The company has been centralising the cutting of lenses to TechLabs. This is more efficient: store staff no longer need to spend 30-90 minutes preparing a pair of spectacles. It means the stores can be smaller, with the same amount of selling space. It means the equipment can be stored centrally in a lower rent-per-square foot location and the equipment has higher utilisation. This move has led to a c. 200bps improvement in margins and there is a lot more to go here.

I also believe there may be opportunities on gross margin. There are several mix things going on here – the shift to Exclusive Brands boosts gross margins and the shift towards contact lenses and sunglasses lowers them. However, the ASP has come down significantly over the last few years as GrandVision aligned some acquired chains to every-day-low-prices. This is unlikely to be as extreme in the next few years and so you might see improved supplier prices drop to the bottom line.

Valuation

GrandVision trades at a ~6% FCF yield. This FCF is after capex to add around 1-2% to the store network. It is also after tremendous investments in the Americas division, which generates around 15% of sales but no margin. Within that division are business with margins in the high-teens and others where they are investing a tonne or have the wrong cost structure. It could certainly operate with double-digit margins in this region, adding around 10% to the operating profits. It also has de-levered significantly below its long-term target of 2x. You could easily see it add another 20% to operating profit by doing another couple of strategic acquisitions in the next couple of years.

How does this FCF yield compare to the organic growth potential? I believe a continuation of the past is likely – these are long-term trends in their favour, after all. That means 2-3% LFL growth, 3-5% organic growth after network expansion and 5%+ growth with bolt-ons (which are sort of like organic openings). There is plenty more to do to drive margin expansion as GrandVision moves to smaller stores and centralises its lens cutting. Given the operating leverage and high incremental margins, mid-to-high single digit FCF growth is likely before strategic acquisitions.

The person on the other side of the coin is likely perturbed by the lower LFLs in the last couple of quarters (largely due to temporary reasons). They may be worried about lower margins, which largely come on the back of a reorganisation in the US and the integration of Tesco. They may be specifically worried about the US, which has turned out to be more difficult than management expected. All in all, these are issues that have struck the company in the last few months and coincide with the share price decline from EUR 25 to EUR 19. I can look past these issues.

Key Risks

Operational

Operating leverage: GrandVision has experienced expanding margins for the last few years, driven by solid LFLs and the operating leverage in the business model. But this operating leverage works in the opposite direction of course. Fixed costs are nearly 2/3 of the cost base. If LFLs were to go negative for cyclical or competitive reasons, the decline in operating profit could be substantial. It helps that the demand for optical products is defensive and GrandVision does benefit from people trading down from more expensive chains. But it typically does face trading down in its own stores as well and when LFLs fell 1-2% in 2009, the decline in operating profits was 13%. 2009 was obviously a severe downturn but perhaps the next downturn would be met along with some competitive pressures and the decline would be more severe. Longer term the company may be able to readdress these issues but it remains a cause for concern.

GrandVision helps reduce its operating leverage by signing very short leases. Its average lease outstanding is just 2.5 years.

Online business model becoming more accepted: There are several challenges for a pure-play online optician. Most people need a new prescription to get a pair of spectacles and this can’t be done at home (yet). People also want to try on multiple pairs and want to get the glasses fitted once they’ve been bought. The replacement cycle is so long that it is tough to acquire valuable customers through advertising.

So far around 4-5% of optical sales in GrandVision’s key markets is done through pure-play ecommerce sites. The vast majority of this is contact lenses and sunglasses. Contact lenses have naturally migrated online. The repurchase cycle is in the months rather than years and a prescription usually works for a few years. Retailers also originally made the mistake of charging high prices for contact lenses and so people could save money buying them online. Now many offer subscription models where people buy a pair of glasses and a subscription to contact lenses all at a discount. The majority of sunglasses, especially high-priced sunglasses, remains through stores. Almost all of prescription glasses come through a store.

Nonetheless the high price of the products, driven by the expensive store network, could make the model ripe for disruption. This is what Warby Parker bet on and they have indeed been relatively successful with sales over $100m. Despite developing a great brand, Warby Parker has so far struggled to make the model work. It is expensive to send many pairs to a consumer and inconvenient for them to return them. Many find their prescription is not up to date and so have to go to store to get one anyway. Indeed, they have now themselves moved to a omni-channel model, heading towards 100 stores. Other internet opticians are following suit. Investors recently partially wrote down their investments in the company. Surprisingly, it is moving towards an expensive retail network, with huge stores in Soho and locations next to Apple stores in Greenwich, Connecticut.

In fact, a better way at looking at GrandVision is that Warby Parker is following its business model. Warby Parker is all about offering low prices by using own branded glasses and having high sales density. They both offer great omni-channel experiences. And both will benefit from superior models to most of the industry. But Warby Parker lacks the scale of Grandvision, with around 2-3% of its unit sales, so it can’t generate the economics GrandVision can.

A potential game changer would be if we could do eye tests at home. This combined with the Warby Parker model could grow the model. But online will hit the independents far more. GrandVision actually over-indexes its market share online – it’s one of the largest online optical retailers in Europe.

Secondary market position in several key markets: in several key markets GrandVision is second or third to a bigger player. In Germany, it is second to Fielmann. In France, it is third to Krys Group. In the UK, it is second to Specsavers. It is certainly more attractive to be the dominant player in each market. Yet it remains a great business, not least because its global scale gives it more purchasing power than even the leading players in those markets. Moreover, chains are taking market share from independents and this is the key driver. For instance, in the UK it has been Vision Express (GrandVision) and Specsavers that have been taking market share from all the other players.

Consolidated supply chain (getting more consolidated with Essilor/Luxottica merger): The top two or three players dominate in the contact lenses market, prescription frames market and the lenses market. This gives them some power with GrandVision. GrandVision has offset this by developing its own brands. It has also power with most of these suppliers. Even Essilor, which controls 40-50% of the lens market, must offer a better price to win GrandVision’s lens tender. The switching costs are low for GrandVision in lenses. These suppliers also need a “friendly middleman” to sell their products at a high gross margins. Finally, the suppliers have more bargaining power with GrandVision’s competitors than it does with GrandVision. This actually makes having a consolidated supplier market somewhat attractive.

Luxottica is something of an exception here. It, along with Safilo, controls most of the key brands. While GrandVision is not dependent on Luxottica, it struggles to get a large discount versus independents. If GrandVision wants to sell RayBan or Tom Ford branded glasses, it doesn’t have much of a choice. This is again why GrandVision has pushed its exclusive brands so much.

This market power may get worse when Essilor merges with Luxottica. Of course it will probably hurt independents more. But it may also see more of the economics flow from GrandVision to Essilor Luxottica.

Tight ophthalmologist market: This market can be tight and this can drive wage inflation. Fielmann describes it as a major issue in Germany. This again reinforces the danger of the business model were LFLs to turn negative for some time.

Negative impact from regulation: Some markets are reimburse-led. This leads to high prices and margins. It also keeps independents in business. So regulations that remove reimbursements can hurt GrandVision in the short-term but are unlikely to be huge issues in the long run.

Entering lower-margin markets in the Americas and Asia: GrandVision has been aggressively entering this market. Its Asia & Americas division has grown its sales from EUR 200m in 2012 to over EUR 500m this year. Its operating margins are in the low single digits compared to high-teens for the rest of the group. As these are the faster growing markets it may be that margins are diluted. On the other hand, it may be that this division has margin potential. Besides the margins are depressed because of investments that are driving double-digit organic growth.

Threat of new well-funded players entering the market with extremely low prices: Fielmann estimates its unit costs are EUR 35 per spectacle. It can offer prices of around EUR 180, way below the market average, by having incredibly high sales volume. If it enters new markets (it’s already trying in Italy) with this model, it could hurt the incumbents. Other start-ups are trying it in France with apparently even lower prices (EUR 50) and they are well-financed. While this may drive business away from independents, it may also take market share from GrandVision too, which averages significantly higher prices (e.g. EUR 200-250 in Europe). Part of the high prices is because GrandVision’s stores over-index to an older customer which is more likely to have complex lens needs and so actually its LFL prices are close to Fielmann’s. But the average price remains high and it would be a threat if people can under-price it.

Financial

Lease-adjusted leverage: again a reminder that the business is quite operationally levered. It has around 2x net debt to operating profit (slightly less on a proforma basis). Capitalising leases this is around 3.5x. Given the defensiveness of the demand and its competitive position, the structural growth in the market and its high cash conversion, I’m not overly worried about this leverage.

Management

The CEO is new and something of an unknown entity. I really like the corporate culture, handed down from HAL, but nonetheless there is a risk that the new CEO convinces the board to do some strange things and makes mistakes.

The optical retail industry is evenly split between chains and independents, although chains have been taking market share for many years. GrandVision is the largest of these chains. Its business model, along with many other chains, is to use its scale to offer lower-priced products and services. In return, it expects to generate more volume per store than the independents and more than compensate for its lower gross profit per unit.

Catalyst

Who knows?