Description

Overview:

Assai Atacadista is the second largest operator of cash and carry stores (i.e. wholesale grocery) in Brazil with 293 locations. The company was formerly a subsidiary of GPA, a large Latam supermarket operator controlled by Casino Group, but separated into a standalone company to go public in March 2021 at $15.13 per share. Casino Group has since fully exited its 40.90% ownership. Both the cash and carry format, and Assai’s dominance in the market have grown exponentially over the last decade. Since 2011, the group has increased its unit count by 5x and increased its gross sales by nearly 20x, or a ~27% revenue CAGR in Reais (~16% USD CAGR). Today, Assai has an~11% market share of the R$700 billion Brazilian food retail market, and a 30% market share of the cash and carry segment. Atacadao, owned by Carrefour, is the largest cash and carry operator in Brazil with a 35% market share. 

Extra Hiper Acquisition:

In October 2021, Assai announced that it had reached an agreement to acquire ~70 Extra Hiper hypermarkets from GPA for R$4.0 billion. This was a highly material transaction. Assai had previously completed >20 hypermarket conversions as a subsidiary of GPA, and it felt it had a strong grasp on the economics of a cash and carry conversion. These ~70 stores collectively produced R$ 8.7 billion in sales, and the company’s track record of conversions indicated a ~3x uplift in gross sales, and adj. EBITDA margins that are 25% higher than a typical Assai store given the locations are generally in more densely populated areas. The group budgeted R$ 45 million per store in capex for the conversion, so all in approximately R$ 7.2 billion in capex for post conversion economics of R$ 25 billion in sales and R$ 1.9 billion in adj. EBITDA. This is both highly attractive in absolute terms, and compared to the unit economics of a new Assai store that cost R$ 70 million to build and ramps to R$ 270 million in sales with R$ 16 million in adj. EBITDA.  Assai expected that a conversion unit would reach maturity by the end of year 2, whereas greenfield units require 5 years to mature. 

This conversion project created a very elevated period of capex, and while the group incurred a significant amount of leverage up front, the growth in EBITDA is just beginning to flow through. Today, the hypermarket conversion project is finished, and the cohort of 47 conversions that were completed in 2022 are now in their second year of maturing. These stores are currently operating at a monthly sales run rate of R$ 26 million, which is a 2.6x increase from pre-conversion. In addition, they are operating in line with the company average adj. EBITDA margin of 5.5%. As these units continue to mature, as well as the 17 conversions that occurred in 2023 and  the ~60 greenfield Assai stores built over the last 3 years, the group should benefit from significant embedded growth. Consider that over the last 3 years Assai has spent nearly R$ 11 billion to build ~120 stores. On a run rate basis, assuming a normalized growth of 20 stores per year, capex inclusive of maintenance capex should be at a level of R$ 1.5-2.0 billion per annum, or roughly half the level of the last 3 years. 

Growth / Unit Economics:

As touched on briefly above, Assai has grown with highly attractive unit economics. The average Assai store costs R$ 70 million to build, and ramps to $R 270 million in sales with R$ 16 million in EBITDA, or a pretax ROIC in excess of 20%. Moreover, while Assai already holds 30% market share of the cash and carry market, there is still significant room for growth. Consider that there are 91 cities in Brazil in excess of 150K in population that do not yet have an Assai store. In addition, Atacadao, which is currently at 371 locations, is still planning to grow by 15+ units per year and plans to reach 470 units in time. This growth is supported by the growing adoption of the cash and carry format, which has risen to the top for consumers as the format of choice given that prices are often ~15% cheaper than a supermarket. Beyond that, there are 2,000+ existing smaller cash and carry stores throughout Brazil where Assai and Atacadao are likely to continue outcompeting and gaining share as they have significant relative procurement advantages. 

Management Incentives:

Assai has been led by Belmiro Gomes since 2011. Prior to joining Assai, Belmiro was the commercial director at Atacadao for 22 years. Given that Assai was a subsidiary of GPA, the company had a long way to come in aligning its executives, which were long tenured but owned very little shares, with that of the new shareholders. On that front, earlier this year Assai passed a management compensation scheme which I believe is highly attractive, and gives shareholders a good sense of management’s own internal views on the growth potential of Assai. The program was granted to the CEO, as well as the two VPs of Operations and Commercial & Logistics, who had been with the company for more than 12 years each. The program consisted of a one off share grant of up to 2% of the outstanding common stock. 0.4% of the grant is for executive retention, of which 30% vests over 5 years, and the remaining 70% vests in 7 years. 1.6% of the grant is performance based, where the executives only begin receiving shares if EPS grows at a minimum of inflation + 20% p.a., and they receive ~14bps for each 1% CAGR in excess of the minimum threshold. In other words, to receive the maxim of 1.6% performance shares, Assai must compound EPS at nearly 40% p.a. (IPCA + 20% p.a. + 12%).

Valuation:

Assai is trading at a highly attractive valuation on today’s run rate metrics, and is exceptionally attractive when considering how economics are likely to evolve over the coming three years. 

FY2024

Gross Revenue R$ 85,000

Net Revenue R$ 77,350

EBITDA R$ 4,254

Interest Cost (R$ 1,750)

Mtn CAPEX (R$ 600)

Tax (R$ 665)

FCF R$ 1,238

Thus, against the current $2.3bn USD market cap, Assai currently generates ~$225m USD in FCF, or nearly a 10% yield using very conservative assumptions. For instance management estimates that maintenance capex per unit is ~R$ 1m and I assume double that above. 

Here is what economics could look like in 3-4 years time given the maturation of the ~120 recently built units, including conversions, normalization of organic grow rates, and utilization of excess FCF to pay down debt

FY2027

Gross Revenue R$ 119,500

Net Revenue R$ 108,745

EBITDA R$ 6,524

Interest Cost (R$ 1,350)

Mtn CAPEX (R$ 740)

Tax (R$ 1,551)

FCF R$ 2,882

It of course depends on how exchange rates evolve over this time, but at prevailing rates I believe there is a clear path to reaching a ~20% FCF yield in the next several years with significant growth remaining thereafter. This also implies that Assai reaches < 2x net debt to EBITDA by 2027. 

Risks:

Beyond operating in Brazil, the primary risk here is that the business is quite levered. As part of the spinoff, GPA gave Assai the generous gift of assuming ~R$ 9 billion in debt. Then to add to this, the leverage incurred for the Extra Hiper acquisition and conversion project has brought Assai to ~R$15 billion in gross debt. While high, I believe this is very manageable given the embedded economic growth from maturing stores. If the company needed to stop building new organic units,  it could start chipping away 10-15% of its debt load each year fairly quickly. 

Catalyst

- deleveraging