We’re adding Dufry (DUFN-CH, ADR=DUFRY) as a new Long Idea. Most people know this company’s brands, but few understand the business, and even fewer understand and appreciate the stock – particularly in the US (it’s covered by European analysts, and generally not well liked). We first called out this name in our research on October 6th, when a deal with Alibaba piqued our interest as it related to accelerating growth in the all-important Chinese market. While we’ve been researching the name, the stock has risen by 34% vs 4% for the S&P – not ideal -- but even at its current price of CHf 52, we think it is a 2-year double. And then likely another 2-3-year double from there. This is an extremely powerful TAIL call with ‘Best Idea’ written all over it, though DUFN will occupy real estate on our ‘Long Bias’ list while we complete our research in the coming weeks, which we’ll present in a Black Book. But we definitely know enough today to go Long as the earnings recovery is likely to happen well ahead of the consensus for reasons beyond a simple ‘travel rebound’, which we don’t think is represented in a CHf 52 stock. With accelerating organic growth coming from the luxury goods section of the travel retail market on top of a leaner cost structure with top notch strategic and financial partners and a diminishing debt burden, we think this name will retest peak multiples on new (higher) peak earnings – that is, if it’s not acquired first.
The primary business here is Duty Free retail in airports, which accounts for about 90% of total sales. Taking a 10,000 foot view…find me any other brick & mortar retailer where customers are literally locked in the store for an hour, have ZERO Amazon competition, and is a globally diversified monopolist in each market in which it operates across multiple retail formats (Duty and tax-free, brand boutiques and concept stores). Simple answer…a comparable does not exist.
We think there’s a confluence of trends that are happening right now in the market that will allow DUFN to consolidate a fragmented industry from a position of strength, with the partners and funding that less-capitalized competition does not have. It is likely to come out of the pandemic as a better company than it went in – leaner, more profitable, with greater market share, much higher returns, which should – at a minimum – allow it to retest its prior peak 18x p/e and 12x EBITDA multiple vs 9x depressed EBITDA today.
A few key points…
- Big Share Gainer. The company has 10% share of the duty free industry today, with the remainder in the hands of small regional concessionaires. These concessions generally carry 20-30 year terms with airport operators, but with the travel economy comping down ~80% there is a general trend towards the retailer wanting to exit early – opening up the opportunity for DUFN to step in at attractive terms. We think that ‘recovery sales’ will beat pre-pandemic levels in 2022 as a result of new concessions acquired during the slowdown.
- Airport Operators Are Going Upstream. There’s an accelerating trend globally for airports to exit the hands of local municipalities and into the hands of private operators that have a vested interest in taking the airport shopping experience from being a place to buy smokes and cheap booze to actually being a boutique luxury shopping experience. The US is easily a decade behind Europe in this trend, so it might not be apparent to people that are stuck inside US borders. But it’s a secular trend that is a solid tailwind for anyone that sells luxury products to travelers.
- Luxury-esque Geographic Diversification. Europe and Africa account for about 40% of total sales in 660 locations. North America is about 25% of sales across 1,103 locations. Central and South America make up 20% of sales through 535 stores, while Asia Pacific and the Middle East is about 15% of the total in 221 locations. Over a TAIL duration, we think the recent partnership with Alibaba will aggressively expand the business in AsiaPac – particularly given that the Chinese consumer accounts for ~40% of total Duty Free spending globally. Nonetheless, this is the kind of global diversification that luxury companies strive for, and DUFN’s got it.
- Strong Acquisition Target. This business is becoming increasingly luxury, and the company’s profile in its Duty Free business is going upscale in the same way that we think Restoration Hardware has taken its brand and unit growth upstream. While pure luxury goods accounts for about 15% of the portfolio today, we think it’s headed closer to 25%-30% over a TAIL duration – particularly as boutique’s grow as a percent of the mix. Worth noting that another 32% of the portfolio is fragrances, which caters to an upscale customer. All in, combined with global diversification, this makes it an ideal acquisition candidate for the likes of LVMH or Kering, both of whom we think are likely to accelerate acquisition activity out of the pandemic.
- Premium Partners Funding Growth. The stakeholder list here is impressive. In Sept 2020 Advent International bought 11.4% of the company, which funded DUFN buying the portion of Hudson that it did not already own. Just a month later the company did a deal with Alibaba alongside a rights offering for BABA to own up to 9.99% of the company as a partner to accelerate the growth in the Asia Pacific market – the most important luxury goods market on the planet. In addition, the State of Qatar owns 6.9% of the company. Our sense is that Advent would like for its stake to be much larger (it holds a Board seat) – and will serve as the ultimate partner to fund concession opportunities that come along during the pandemic/recovery at a time when DUFN’s balance sheet is otherwise stretched due to the lack of near-term cash flow.
The Elephant in the Room
Current financials for DUFN look simply atrocious. After all, this is a travel-centric stock and travel has come to a standstill. 2020 sales are tracking (not reported yet) to be down ~75%. Given that occupancy costs are booked as SG&A, Gross Margins held in reasonably well – down only 250bp. But the company severely deleveraged its SG&A infrastructure and is likely to lose about CHf1.2bn for the year, or about CHf 23.33 per share – not good when you’re sitting on CHf 4.5bn in debt (recently restructured debt covenants so absolutely deminimis near-term default risk). Clearly anyone investing in DUFN today has to look through a lot of turmoil in the numbers as they exist today.
Recovery Financials
- We think that the company will emerge from the pandemic stronger than it went in.
- First off are the new concessions as duty free shopping retail switches hands from the desperate players and upscales to DUFN’s sweet spot.
- Second, there’s the outsized growth in China led by the BABA partnership.
- We could paint a bear case that the business traveler will never return to pre-pandemic levels of activity. We have that factored in to our Hudson forecasts. But the reality is that the more-resilient Leisure consumer is the driving force behind high-end shopping that is the crux of the DUFN financial model.
- On the cost side, the company is cutting CHf400mm from its cost structure. Another factor that US investors don’t appreciate is that with 40% of the business in Europe, the company is subject to significant restrictions around laying off employees under virtually any circumstances. But with the pandemic, most of Europe relaxed employment standards allowing companies like DUFN to adjust costs to match revenues. This is a company that was largely built through a series of acquisitions and is anything but lean. This cost-cutting program is good for 400-500bps in margin – notable given that it was a 3%-5% margin business pre-pandemic.
- By 2022, we think that people will see that the ‘new normal’ is 7-8% EBIT margins vs the 3-5% DUFN has been putting up over the past 5-years. That gets us to CHf9.00 in EPS power by 2023 vs the Street at 6.56 (we're closer to 12.00 by 2025). This also puts the company at a net cash balance of 4.5bn -- at parity with its debt levels by YE2023 – notable with 800mm in maturities that come due in 2024.
With the company revisiting prior peak margins, as a healthier company with a better organic growth profile, we think it’s reasonable to assume that DUFN should retest a historical peak multiple of 18x EPS x CHf9.00 = 158. That’s 3x the current share price over 2-3 years.
Needless to say, we’re buyers.
More research to come…
McGough
