We couldn’t be more pumped about what DUFRY reported this morning with its interim sales release. As we outlined in our Black Book yesterday, the business is getting better on the margin, though earnings and cash flow (due to management coming in WAY ahead on cost cuts) are far better than we expected. There’s definitely a structural change to the profitability part of the equation as travel recovers – which is largely driven by a more collaborative approach to setting concession pricing with the airport operators. Both parties know that they need each other to make money, and the terms of the agreements are being renegotiated to be more variable in nature – which is a MAJOR change to economic balance between the two sides. We continue to think that upside here is in the 3-5-bagger range here over a TAIL duration, and the catalyst calendar is aligning over the near term.
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Key Highlights From The Company’s Report
Recovery is happening, plain and simple. The company has now reopened 1,850 stores which represents 80% of total stores and 84% of total sales capacity which is up from last quarter's 1,600 shops which was 65% of stores and 75% of sales capacity respectively. On a monthly basis sales improved vs 2019 each month by at least 200bps with current October estimates of about -39.4% of 2019 sales. The best performing regions are North America and Mediterranean/Eastern Europe, which coincidentally are the regions that are seeing the most tourists and having the least rigorous travel restrictions. Management also provided passenger recovery forecasts for 2021 and beyond with all major data providers placing 2021 levels between -40 to -50% of 2019 levels, 2022 between -10% and -25% of 2019 levels and 2023 at even to +5% of 2019 levels. All the data is positive.
The ‘It Can’t Cut Costs Because It’s European’ Narrative Just Got Blown Up. At the beginning of this year Dufry expected to have ~CHF 970mm in cost savings vs. 2019 with CHF 400 of those being permanent cost cuts. Last quarter the temporary cost savings forecast was upped to CHF 1.2bn, this quarter it was upped to CHF 1.9bn. The principal driver in the target increase is increased MAG relief, but management also called out some additional personnel cost savings in the form of government assistance in Europe as well as OpEx costs coming back slower than expected. All in the company still expects CHF 400mm in permanent costs, but we think it will come in better than CHF 450.
Cash Flow Looking Solid. As a follow up to the cost cutting point, the company delivered Equity Free Cash Flow of CHF +253.7mm, which is similar to the Q3-2019 (i.e. pre-COVID) number of CHF +266.2mm. With that positive cash flow, the company paid down CHF 266mm in debt taking net debt to a pre-COVID level CHF 3.1bn.
Hainan On Track. Lastly, the Hainan project continues to be on schedule. Nothing is consolidated on the company's P&L at the moment due to the Chinese foreign direct investment rules, but the company now has 33,000 square meters of retail space on the Island where it houses over 200 brands including a significant number of first-time entrants to the Hainan market. Management is playing its cards close to the chest, but both we and the company know that the call option to get paid big time both in Hainan as well as gaining share from China Duty Free elsewhere in China (with Alibaba JV) is very material longer-term.
