This DUFRY print is exactly what we wanted to see, and outlined in our note over the weekend. We’re buyers of this name in a big way at CHF50 ($5 US ADR). Based on the long-term upside – which we see as nearly 5 to 1 upside/downside, we’d even be buying the stock higher from where it is today. 1H net income came in significantly better than consensus – (CHF348M) vs consensus (CHF605M) – a huge cost-driven beat, with revenue in line, and management stood by the revenue scenario for the year outlined last quarter. Sequential progress on revenue, better than expected cost cuts, materially improved liquidity (we weren’t expecting this much progress here), and as another added bonus, management teased the Street with a 2023 recovery at a 12% margin – exactly what we’re modeling (though the market still doubting). Hainan squarely on plan. This management team is simply firing on all cylinders in optimizing this business model to emerge a stronger, leaner, and more dominant company with more dominant share, double pre-covid margins, and twice the return profile. Despite management teasing a 2023 recovery, we think the Street (and the current price) is still too conservative in not expecting a full recovery for another 5-years – particularly the European investment community. We think we’ll see a full recovery by 2023, on an EBIT margin double pre-pandemic rates. There’s your first paycheck. Then you get your second paycheck on the Hainan JV with Alibaba, which we think is running ahead of schedule (management is keeping people grounded here with expectations). That gets you paid by another CHf165mm, (1.50 per share) once the JV kicks into high gear in 2023. With the meaningfully higher margin profile comes the cash…and we think that the company will take out 15-20% of its share count over a TAIL duration – that is, unless it continues to consolidate the 88% of the industry it does not control. But at today’s price, I think that the only acquisition that matters is an acquisition by LVMH or KER of DUFRY. If it’s a standalone company at this price (or lower) on a year’s time I’ll be surprised if it is not acquired. Ultimately by year 5 we’re looking at CHf14 in earnings power. Give that a 20x multiple (prev peak was 18x, but now it will be a more profitable, higher margin and better capitalized company with higher returns) and you get a stock that’s CHf280 that compares to its current price of CHf50. That’s a 5-bagger for you, at a time when we’re at peak variant ‘freak out’ sentiment. If you own the ADR, you’re talking a $5 stock going to $25. A BIG idea, to say the least. This name at ~CHF50 ($5 US ADR) is the most compelling risk/reward right now on our Best Ideas Long list.
Key Callouts of the Quarter
- Dufry revenue continues to improve on a month-by-month basis. The main driver of the improvement monthly is the vaccination and reopening cadence in the EMEA region. Vs 2019 April revenue was -71%, May -68%, June -60% and July -50.4% (not included in HY results) with commentary around August positive as well. The company plans to have 85% sales capacity online by the end of August.
- While Hainan is a long term driver of the thesis, the company reported that the project is currently on schedule with the opening of 33,000 sq meters of shopping space scheduled for Q3. The final phase of the project which is an additional of 6,000 sq meters is scheduled to be completed in Q1 2022. We think this is worth CHF1.50 in EPS by 2025.
- Financially the company is in a very strong position with over CHF2bn in total liquidity consisting of CHF640mm in cash, CHF1.5bn in credit of which the main CHF1.3bn facility is undrawn, a weighted average maturity of 4.6 years and the extension of the 5x leverage ratio covenants to 2022.
- Average Free Cash Flow, or Equity Free Cash Flow as defined by the company, came in at a better-than-planned CHF-45.8mm (vs the original CHF-60mm scenario) with the company achieving positive cash flow in May and June which is expected to continue into Q3. Q4, due to normal business activities, is expected to be a cash outflow again.
- Cost savings are ahead of schedule to the tune of CHF1.2bn in cost savings vs 2019 instead of the originally planned CHF530-670mm while sustainable cost cuts remain at 400mm. On the call management implied that given a return to 2019 levels in 2023, the operating margin should be in the ballpark of 12%.
- Passenger forecasts shared with investors on the call from leading data providers show that recovery to 2019 level is now expected in 2023—something we have been arguing all along.
- The 2021 revenue/cash flow scenario analysis remains the same in terms of revenue levels, but now is updated to reflect better expense and cash management (below).
- The QA session was largely focused on the cost savings the company is reporting with analysts unsure of where the long-term cost cut level should be given the strong cost cuts now coupled with the return of store labor. This is a question we plan on asking management personally as well. Additionally, analysts asked management to paint a picture of what 2023 could look like with a full recovery to which the CFO painted in broad strokes what the puts and takes could be (yes CHF400mm in cost cuts but other issues like rising wages, minority interest payments, etc.). At the end of the question the analyst put forth a 12% operating margin target to which the CFO responded “Look, we don’t give guidance of that kind, but potentially yes.”
Source: Dufry HY 2021 Investor Presentation
Source: Dufry HY 2021 Investor Presentation
