2013 | 2014 | ||||||
Price: | 140.00 | EPS | $9.81 | $11.30 | |||
Shares Out. (in M): | 41 | P/E | 14.3x | 12.4x | |||
Market Cap (in $M): | 1,052 | P/FCF | 0.0x | 0.0x | |||
Net Debt (in $M): | 317 | EBIT | 582 | 647 | |||
TEV (in $M): | 1,369 | TEV/EBIT | 12.8x | 11.5x |
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Investment Thesis
Matas is the largest health and beauty retailer in Denmark with a powerful brand, strong market share, stable free cash flow, high quality management and a cheap valuation, trading at 11.2x our 2015 (CY) earnings. Matas is substantially undervalued given its consistent mid-single digits top-line growth, 15% annual EPS growth, 100%+ return on tangible invested capital and two free options that could substantially add to its earning power.
Business Overview
With 295 stores across Denmark (266 owned/operated and 29 associate stores), Matas is the dominant retailer of health and beauty products. For the American audience, Matas is a high quality drug store (think Walgreens) without pharmaceuticals or food but with a stronger focus on cosmetics (think a more affordable Sephora). Matas has been around for 64 years and is known by every Dane. Revenue mix is heavily weighted toward cosmetics with 41% of revenue from mass beauty (make-up, hair-care, skincare and toiletries) and 33% from high-end beauty (selective fragrances/skincare/etc from brand names such as Chanel), 10% from vitamins, 9% from household goods and 6% from OTC drugs.
Industry Overview
Matas commands 38% share of the total beauty market in Denmark and 62% share in high-end beauty. In Vitamins and OTC drugs, Matas commands 26% and 15% market share, respectively. Matas has more than twice the share of its next biggest competitor in mass beauty, and more than 3x the share of its nearest competitor in vitamins. Its private label “Stripes” brand accounts for 17% of revenue and is the #1 beauty/personal care brand in Denmark. Matas has continued to take market share with an incremental 900bps gain in the total beauty market over the last decade. Matas has consistently outperformed the broader health and beauty market, which grew at a CAGR of 3.6% over the last ten years while Matas grew at a 5.8% CAGR. Over the next four years, the overall H&B market is projected to grow at a 3.0%-4.0% CAGR and we believe that Matas will continue to outperform the market growth by 1-2% annually. Our proprietary survey of ~500 Danish women proves the strength of the business. 45% of Danish women visit a Matas store at least once per month, making it the second most frequently visited store after Netto (a large grocer); 93% would recommend that a friend shop there; and Matas has the highest overall score of any retailer in Denmark.40
Management
Since CVC’s buy-out in late 2006, the Matas management team has successfully transformed Matas from a cooperative structure with 180 store owners, each of whom owned/operated their own stores but used the Matas name, into a professionally managed and cohesive company. Our reference checks revealed that CEO, Terje List, is a world-class leader, salesman and operator with one of his biggest supplier stating that “you couldn’t find anyone better than Terje [to run Matas]”. We calculate that the CEO has over $4mm of equity value (stock and options) in Matas which equates to over 5x his base salary and a significant portion of his net worth. This is definitely on the higher end of management ownership in Europe. When we met with Terje, his passion about the business was evident and he jokingly explained that if he is not successful in continuing to build Matas, he will be forced to leave Denmark as the entire business community associates him with the company.
Key Investment Factors:
Market leader in attractive industry with great unit economics:
As stated above, Matas is the market leader in an attractive and growing industry. This understates its strong unit economics with over $1,000 sales per sq-ft (in US terms), 17% EBIT margins and low capex (~1.5% of sales). Operating margins are partially higher than most retail peers due to the nearly 50% gross margins in the beauty category as well as leveraging rental and labor expenses due to its outstanding sales productivity. Additionally, lease agreements are attractively structured because rent is indexed to inflation and only Matas (not the landlord) has the right to terminate a lease. Matas also leverages marketing expenses across the country (very homogenous population) and receives substantial marketing subsidies (>1.5% of sales) due to co-sponsoring by suppliers, such as L’Oreal, who aim to promote certain products through Matas’ leaflets and stores.
Proven competitive advantage as numerous foreign players have tried and failed to take market share from Matas:
Over the last ten years, three foreign competitor chains (German market leader Douglas, German discount drugstore Scheker, and Norwegian beauty retailer Esthetique) all entered the Danish market with plans to take significant share of this attractive market. All failed miserably as Douglas closed is last store in 2010, 6 years after it first entered, Scheker closed its last store in 2009, 5 years after it first entered, and Esthetique sold its final 9 locations to Matas in 2013 after having as many as 20 locations at its peak. We believe there are numerous reasons as to why Matas has thrived, including its structurally advantaged retail locations, national advertising scale (75% of all Danish households receive Matas’ bimonthly leaflet) and captive Danish consumer mindshare that would be impossible for any entrant to replicate. A former Matas employee explained to us that “it’s all about location in this business and Matas has the best locations in small towns and brilliant locations in the big cities.”
Consolidating the retail network and optimizing new central warehouse:
Matas plans to continue to expand its operated retail square footage by opening a very select number of new retail stores and by buying associate stores. This allows Matas to optimize best-in-class practices, product assortments and capture incremental retail margin (17% wholesale gross margins vs. 48.5% retail gross margins). There are 29 associate stores today and management believes that 10-15 would be attractive acquisitions candidates. Matas has the right of first refusal and recently bought in 6 stores at a valuation of 1.0x revenue, which translates to 7-8x pro-forma earnings. Matas has also recently transitioned to a new central warehouse for high-end beauty products which we estimate will have a long-term positive impact on overall gross margins by 50-100bps.
Full roll-out of loyalty program and growing online sales:
Launched in August 2010, Club Matas is already the second largest loyalty program in Denmark. Its 1.35mm members include over 60% of all Danish women aged 18 to 65. Around 60% of revenue is generated from Club Matas members as they visit stores roughly 50% more than non-club members. Members earn points on each transaction that then can be used for purchases at Matas’ online Pointshop. For the first time ever, targeted marketing programs are set to begin soon and we believe could boost SSS by 1%. A large current supplier told us that they are very excited about the use of data and “understand the value of working with Club Matas to really focus on their target audience.” Although, not a big part of sales (<1% of total), Matas is also the leading health and beauty website with DKK 30mm of online sales that is growing 50% so far this year.
Benefiting from a macroeconomic recovery:
Recent 3% like-for-like growth has come even as the overall Danish economy has not yet recovered from the financial crisis. In 2012, Danish real GDP growth was negative 0.35% and total retail spend declined 2% YoY. Recently, we have observed that Danish Consumer Confidence has massively turned positive (June-Nov 2013) and is back to pre-crisis levels after years of negative to flat readings. While total retail sales and GDP are still stagnating, we believe that the worst is over and the Danish consumer is recovering.
Discussion of Two Free Options
StyleBox Option:
Matas is planning to leverage its extensive market and consumer knowledge to open StyleBox, a Danish retail chain concept combining hair, nail and make-up treatments with the sale of selective beauty products. Stores will be located in large cities and in shopping malls. The new concept will sell a selection of high-end products that are unavailable in Matas stores. Matas has launched five stores and will end the year with 7 locations in prime areas. Management believes that Matas could open up to 50 stores if the concept is successful. Our proprietary survey suggests that over a third of Danish women would be interested in shopping at StyleBox. We believe that StyleBox could add DKK 1.00-2.00 in EPS (10-20% increase from current year consensus EPS).
Pharmacy Option:
Denmark is the only remaining Scandinavian country that has yet to liberalize the sale of prescription drugs. Currently, Danish law dictates that only pharmacists can own and operate pharmacy stores and these owner/operators currently have a monopoly on prescriptions sales to the general public. No dominant incumbents exist because pharmacists can only own a maximum of 4 pharmacy stores (of the 314 national pharmacies). The Danish Competition Authority and Danish Productivity Commission have both recommended the liberalization of prescription drugs and the government is scheduled to discuss this matter in March 2014. Matas management has explicitly stated that it’s prepared to act if the law changes as its larger stores could easily add a prescription counter without expanding square footage. Although the low gross margins on prescription (Danish pharmacy gross margins are 22.9%) would be a negative mix shift for Matas, it would be very positive on gross profit dollars, which is what really counts. Basically, this would drive higher profits per store and the increased traffic would also be beneficial to core health and beauty sales. Our survey revealed that almost 40% of women would be interested in buying prescriptions from Matas. If liberalized, we expect that Matas could gain 10%-20% share of the pharmacy market (has 15% share in the OTC market) which would translate into an additional DKK 2.25-5.75 in EPS (23%-60% increase current year consensus EPS).
Valuation and Why It’s Cheap
Absolute valuation:
On our numbers, Matas trades at 11.2x 2015CY earnings with no credit given for either of the two significant options outlined above. We expect revenue and earnings growth of 4-6% and 15% per year, respectively. Management has committed to paying out 60% of Adj. Earnings through dividends or share buyback until it de-levers to 2.0x Net Debt / EBITDA from 2.8x today. We believe that Matas will institute a healthy dividend and then use incremental cash flow, especially after it reaches its target leverage ratio, for buybacks. The tremendous stability of the company’s cash flows makes it a perfect business to leverage (under CVC ownership it had >6.0x leverage during the financial crisis) such that management could easily maintain a 2.0x leverage ratio and uses the incremental cash flow for buybacks and special dividends much like DSV A/S, another great Danish company.
Relative valuation:
Matas trades at 11.2x our 2015CY earnings estimates versus comps that trade at a median of 15.7x EPS for 2015:
• Nordic retailers (Axfood, H&M, Mekonomen): 14x-20x
• Global cosmetic (Bonjour, L’occitane, Sa Sa): 14x-18x
• US beauty retailers and pharmacies (CVS, Walgreen, Sally Beauty): 13-15x
• Beauty and personal care (Estee Lauder and L’Oreal): 20-21x
Indiscriminant selling:
Prior to the IPO, CVC (private equity firm) and former store owners (“M Invest”) collectively owned 69% and 30%, respectively, and now own 19.4% and 8.5%, respectively. CVC has recently moved to exit Denmark entirely as a result of a recent change in tax law that eliminates the interest tax shield on highly levered companies, impairing the ability to do LBOs. Danish pension and retail investors have also been far less interested in the private equity backed IPOs since the epic failures of Pandora and TDC in late 2010, which have both massively underperformed in the year following their IPOs. Additionally, Matas will not be paying a dividend until mid-2014 so many dividend-seeking investors are on hold until then.
Illiquidity from small float:
Since the IPO, average daily volume has averaged just $7.5m/day and about half of that in the last 2-3 months. The lockup on CVC’s and M Invest’s remaining stake expires in December 11th and a sale of all their shares could free up a significant amount of liquidity, potentially increasing the current float by 45%+.
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# | AUTHOR DATE SUBJECT |
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25 | |
congrats piggybanker - That was quite a situation.
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23 | |
Daily volume is not a good perspective in this case. The daily trading volume of 6 million shares implies that the company turns over ownership once every 40 days. I don’t think that is the timeframe or mindset of most owners of Safeway stock. If you believe what they say about high frequency traders then 70% of the daily volume is just the same few shares going back and forth between 2 computers in New Jersey. Even those computers are going to start to notice something when 1 out of every 20 shares traded doesn’t come back around. A better perspective is that the scope of this buy back is large enough to buy every share from the top 49 institutional holders of the stock. Maybe some will sell but they’ve held this stinker up until now so why not just go down with the ship. Anyway, that’s what makes a market. It looks good to me but high short interest scares me so I appreciate everyone’s input. I tend to get overly excited about buybacks to my own detriment sometimes. | |
22 | |
I don't see the big problem here with being short through the buyback. If they complete the buyback over a year then they need to buy $2bn over ~252 trading days or $7.9mm per day. At the current share price, that's 326k shs per day vs avg daily volume of 6.1 million shares or about 5% of the daily volume. What's wrong with this perspective? | |
21 | |
If that's all you were getting when you bought SWY stock then those estimates would be relevant (and very alarming!) to the thesis here.
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20 | |
Why do you think what's left of Safeway is a stable business? Here are UBS's estimates for Safeway's US business EBIT from FY08 through FY12 (ex-Blackhawk and Real Estate) -
FY08: $1,507 million
FY09: $934 million
FY10: $790 million
FY11: $633 million
FY12: $551 million
If you prefer US EBITDA, here are CSFB's numbers for Safeway's US EBITDA compared to Kroger's:
FY08: $2.6 billion (KR: $4.1 billion)
FY09: $1.9 billion (KR: $3.8 billion)
FY10: $1.8 billion (KR: $3.8 billion)
FY11: $1.69 billion (KR: 4 billion)
FY12: $1.6 billion (KR: 4.3 billion)
At the very least, these numbers beg the question of what Kroger has done differently (might be helpful to compare KR versus SWY's basket prices) and whether Safeway can stabilize its US business. | |
19 | |
On my 2nd point, sorry I made a discounting mistake (thus proving that pension accounting is tricky and should be thrown in "too difficult pile, move on to the next")...
Undiscounted obligations over next 10 years are $1.54 billion, and undiscounted obligations 10+ years out are $2 billion. So you'd need $1.38 billion earning 2% to meet obligations over next 10 years, and $771 million earning 10% to meet obligations 10+ years out... for a total of $2.1 billion (vs. $1.8 billion plan assets). Still 1/3 the number on the balance sheet.
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18 | |
Point #1: Walmart and Whole Foods are taking market share but SWY’s topline has been stable and their profit margins are solid. On a sales/share basis SWY is a turbocharged growth stock and Whole Foods is a shrinking turd. Regardless of that distraction, the original thesis here was about free cashflow and “how long can Safeway pay their dividend?” and the answer is now “a very, very long time.” My twist on the thesis is you’re going to have $2 billion new buyers of stock and it will be hard to find $2 billion in sellers given who is likely owning SWY stock (coupon clippers)… $1+ billion already short and the whole market cap is only $5.8 billion. Something has to give. Point #2: How much money would you set aside to meet $1.2 billion in obligations spread evenly over the next 10 years and then $1.4 billion in obligations that occur 10+ years out? I’d say put money for the obligations that are 10+ years out in the future into the stock market and hope for 10%. That works out to be $539 million. I’d put the money needed in the next 10 years in fixed income and hope for 2%... that works out to be $1.38 billion. Thus, a reasonable person could argue that $1.9 billion would work. As of the end of the year, Safeway had $1.8 billion set aside to meet their obligations. So, do they really have a pension problem? Most investors do indeed throw companies with large pension obligations into Warren Buffett’s “too difficult for me” pile because of earnings and cashflow distortions – caused by assumptions and smoothing affects about rates of return on plan assets. Investors who are really concerned with the true, long term situation and not just trying to predict earnings should focus on the relationship between the PBO and the pile of assets they have to satisfy that PBO… and to me Safeway looks good in that area. Point #3: I don’t know about the 3rd point about having underinvested in their stores. Seems like a weak thesis. Maybe they should short Berkshire Hathaway as I heard the same thing about them. | |
16 | |
for the record, not involved either way (grocers are way too crowded short but the shorts aren't dumb), but short case goes something like:
1) traditional grocers are losing share to WMT, TGT, discounters on low end and whole foods, wegman's, on high end.
2) large pension expense where the CFOs have played a lot of games with the accounting
3) underinvested in stores/pricing for years so FCF artificially high. need to reinvest in capex and lower pricing to compete, which will reduce NT FCF
just throwing it out there | |
15 | |
Are you guys really quibbling over ebitda multiples as if this was some sort of acquisition candidate?
Take a step back and ponder this:
A profitable, non-cyclical $5.8 billion company with no liquidity or solvency issues is about to get $4+ billion in cash. They promise to buy back $2 billion in stock after having already bought back 1/2 the stock outstanding in the last few years.
Who will they be buying those shares from? Most current owners of Safeway stock own it because it is a friggin grocery store and it pays 3.5% dividend. Those people aren't going to sell. The dividend is more secure now than it has been in ages and it is likely only going up. So, who's going to sell? You can't have $2 billion in buyers without $2 billion in sellers.
Meanwhile, you have all these clever short sellers who shop at whole foods and make the keen observation that traditional grocers are dead. Safeway's topline & margins look pretty stable for a dead business! Those clever short sellers have already sold over $1 billion of the market cap. Are they going to sell more to the company? They're likely the same clever individuals who are paying 2x sales for grocery stores like NGVC vs. (.1x sales for Safeway).
So I'm not exactly sure how you put all this together but you have a $5.8 billion pie and what looks to me like an upcoming supply & demand imbalance between the various buyers and sellers of the stock. | |
9 | |
What do you think its worth post the sale? What do you think the market it missing now? | |
8 | |
Congrats!
Too much cash and a dwindling number of shares to buy back! Not a bad problem to have... | |
7 | |
proceeds used to pay down $2B in debt and buy back stock.
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1 | |
How do you explain the difference in performance over the years between Kroger and Safeway? How do Safeway's price points compare to others in the industry, both in grocery and outside? Thanks. |
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