Description

Background

Hudson Ltd is the dominant operator in a unique niche within the North American retail sector: airport travel retailing. HUD generated $1.9 billion annual turnover, $238 million Adj. EBITDA last year, with over 1,000 retail locations covering 1.1mm sq. ft. The company operates a diverse range of duty-free and duty-paid goods in travel/convenience stores, bookstores, dedicated duty-free stores, specialty stores, electronic stores, QSRs, and beverage stores, using both proprietary (Hudson, Dufry, etc.) and licensed third-party brands (Dunkin’ Donuts, Coach, Tumi, etc.).

HUD is controlled by Dufry (58% economic/90% voting), the Swiss-based global leader in travel retail with CHF 8B in annual sales. Dufry completed a partial IPO of Hudson shares in February 2018 to improve its own liquidity situation, as Dufry had been levered at 3.5x. Dufry raised over $700 million and no primary shares were issued. 

Setup

HUD shares have not been well received by the public markets. Shares have only briefly traded above the $19 IPO price ($1.75B equity value), and after the recent declines, now sit nearly 40% underwater. Shares trade at just ~6x EBITDA and 12x FCF after NCI. 

I believe there are several, mostly non-fundamental or temporary factors depressing HUD’s share price:

-Broken IPO, Dufry control overhang, no obvious buyers

-Abrupt departure of longtime CEO at the start of this year sent shares down double-digits

-Negative “retail stock” sentiment: With no good public (US) comps and limited coverage, I think Dufry is being viewed as a traditional brick-and-mortar retailer--based on the current price--despite a more favorable business model and  secular trends.

-Risk of being “Amazoned”: Late last year, news broke that Amazon was exploring taking its checkoutless Go stores to airports. 

-Tariff war; macro/China risk: Recent sales trends have been affected by reduced Chinese traveler spend. 

Contrarian View

Attractive LT Fundamentals: 

Unlike traditional retail, HUD has captive traffic with arguably LT, secular growth tailwinds: HUD operations are levered to NA airport passenger spend. Passenger volume has averaged 3% per year since the recession, while per-passenger spend has been growing at 4%. HUD’s organic sales growth has actually averaged 8%+ since 2010, driven up by square footage growth/market share.

The travel retail business has different conditions than traditional retail, which can limit competition: Bidding process, other regulations (e.g ABCDE program), unique operational know-how, etc. HUD is relatively immune to e-commerce risk, brand erosion (vast portfolio and ability to repurpose sq footage over time), sales deleveraging (esp. with variable rent structures), fashion/taste risk, etc.

HUD also has economies of scale, particularly around purchasing, with up to ~40% share of non-F&B retail space in 24 of the top 25 NA airports. F&B represents attractive white space for the Company, already up to 40% of sales but with <20% overall retail market share including F&B. Regional airports also offer some room for market expansion.

The Amazon Go risk remains out there, technically, but there has been no new news flow. I think airports are not likely to be a target anytime soon given the regulations and the limitations on taking in the customer traffic necessary to justify the high cost of the stores, among other reasons. 

HUD’s financial returns are actually quite attractive for a retailer.

2018 Returns:

Recent Slowdown: Sales growth has decelerated materially from HSD trends in prior years, starting in 2H 2018, to a current cycle low of +1.2% in 2Q 2019. The slowdown reflects lower net new business (contract) wins as well as a marked decline in Chinese traveler spend. Duty-free sales represent a little over 20% of HUD’s total sales, but Chinese travelers make up 40-50% of this spend. The latter slowdow is clearly visible in recent quarterly sales trends:

Q218 - Q219

Total 3.8% 4.2% 2.5% 3.2% 1.2% 

Duty-paid 3.9% 5.0% 3.2% 4.2% 3.4% 

Duty-free 3.4% 2.1% 0.3% 0.5% (5.4%)

The Chinese traveler headwind will likely continue at least until we have a new president, but at only ~10% of sales, I see it as manageable. Likewise the recent contract losses, following several years of outsized (4-5%) annual sq. footage growth. 

Also note, HUD’s sales profile compares to >60% duty free sales at Dufry. These sales are more volatile as they are more discretionary and are driven by international traveler volume and currency fluctuations as well as the Chinese traveler.

HUD is certainly not immune to the broader impact of a recession, but passenger volume only dropped ~3% in 2009, for reference. Variable rent agreements also limit the sales de-leveraging risk somewhat. 

Looking beyond the current environment, +4% medium- to long-term organic growth seems achievable without lofty assumptions: +2% passenger volume growth, +2% spend per passenger, zero net market share gains. The market looks to be pricing 0-2% LT growth, depending on your discount rate and near-term assumptions.

Valuation:

At ~6.5x EBITDA and 12x FCF after NCI (actually 5.5x based on reported EBITDA), HUD trades at all-time lows versus its brief historical range as well as versus Dufry’s trading range. Also of note, HUD’s NI is understated relative to FCF due to non-cash amortization and minimal cash taxes, including ~$175mm (gross) NOLs.

Precedent comps average ~12x EBITDA, though I put limited weight here as many of them involved Dufry and the subsidiary is not likely to be put for sale.

Based on a blended trading multiple (9x forward EV/EBITDA ) and DCF valuation (3.5% terminal EFCF growth), I value HUD shares at $18-19 looking out to 2020. The stock will be beholden to near-term results, which will push out the return horizon, but I see limited downside at the current valuation barring a serious recession/global air travel disruption. This risk could be partially hedgeable through businesses with more leveraged exposure (airlines, hotel operators, etc.) 

Other key risks: Contract win/loss cadence; Dufry control; destructive M&A/capital allocation decisions; Amazon Go; more drastic duty-free sales declines. 

Capital Deployment Opportunity

Hudson has de-levered to just 1x net debt to EBITDA, including $300 million in cash, yet the co. currently has no capital return policy. The company is under-levered and should be buying back stock here, IMO. Dufry’s control may be an impediment, and the cash build also reflects mgmt’s interest in M&A, but at this valuation I see capital deployment as a  also remains a top priority for mgmt. While M&A brings obvious valuation risks, HUD has significant synergies from prior acquisitions, principally from purchasing power. At the current price share, I think capital deployment offers a favorable risk/reward.

Catalyst

Return of capital program initiation

Normalization (eventual) of duty-free sales