More on Douglas results - leverage back up

All,

The short is paying off. The results were overall weak - if slightly better than model - and investors can expect restructuring costs, price and It investments to offset any gains from the newly initiated cost and store review program for some time. As expected, leverage is back to where it was in September. 

Good news: Douglas - as previously observed - is broadly able to defend and grow its market share at competitive prices, while making more money than its competitors. Note that this is a mom observation and not yoy.

Other news:

  1. Competition remains intense in Germany, where the company has come under the attack of “a major pure-play competitor” - presumably Flaconi - owned by Prosieben. This explains the further margin contraction in Germany, however it does not explain the slow growth of its online store.

  2. Its online store has been growing at a lacklustre 16% yoy while Flaconi are out posting 40% growth (from a smaller base). Flaconi spent E22m on TV spots (see shareholder) in 2017, on under E100m of turnover. While that means that Flaconi produce no significant profit, the marketing expenses go straight to its shareholder. Thus we are no longer convinced that Flaconi will scale back its aggressive discounting any time soon. The argument made by CEO Tina Mueller that every company needs to make a profit at some point mirrors our thoughts per our last analysis - but our thoughts are changing on this topic.

  3. Douglas are stepping on the cost break. Measures to begin paying off in Autumn include: 

    1. Review of the German store base. In contrast to previous comments, the company is now looking to move “quickly” and pre-empt further margin erosion. The company declined to give any estimates of cost, except that it would reduce costs elsewhere and attempt to live within its current cashflow profile.

    2. Hiring freeze

    3. Operational efficiencies - this sounds like personnel cuts

    4. Reduction of travel, marketing agency and consultancy fees. We are somewhat surprised by the idea to reduce marketing agency expenses. Surely the overall marketing budget will remain at least constant (irrespective of parts of the e-commerce platform strategy ramp-up expenses being booked under marketing).

  4. Marketing expenses have remained elevated, although less so than in Q1. The company has guided to remaining within the same context as last year.

  5. The company has alluded to significant further investments in:

    1. IT and online backbone

    2. Price (lower gross margin)

    3. E-commerce platform

  6. Finally: Douglas will roll-out a platform strategy (see our piece on “the future of retail" in our analysis). To that end it has recently bought Welmoa. We think this is the right direction and rolling out a separate service is probably the right idea. But the roll-out is likely slow with the first trial stores / services to open for Christmas. The costs for the initial roll-out are limited, but might add-up significantly when the test-phase is over (2020 and beyond).

Newish Risks:

  • Price Investments in other parts of Europe. So far similar price reductions have not been required in France for instance. This could still ensue. 

  • Continued aggressiveness from Flaconi. So far nothing suggests that Prosieben are about to turn the tap off at Flaconi. The company is held within the Nucom group, which specialises in “new commerce” business models.

  • Slow expansion of online store. For Douglas to protect its market share and ensure that Flaconi are making no money, the online business has to grow at a high rate. In contrast to management’s portrayal we do not agree with the statement that this business is growing in line with pure play competitors. 

  • Significant additional restructuring and OPEX costs will likely prevent the company from posting any net reduction in its cost base for some time. Thus it will have to produce additional gross margin to cover its debt. At the moment there is nothing under way that looks likely to achieve that before winter 2019. 

Newish Opportunities:

  •  The platform strategy does not require holding inventory (on Douglas’ balance sheet). The company has some 350m on NWC most of the time, parts of which could unwind. That seems a long way off however. 

In summary we believe that the company is probably more stable now than the market perceives, since today’s news were largely anticipated - at least on this desk. I.e. we believe EBITDA should pretty much begin to stabilise from here. But the threat of yet to be detailed operating efficiencies being eaten up by potential further price investments, expenses on IT, platform roll-out, German store base review and expenses incurred to produce future operating efficiencies leave us with only a lukewarm outlook.

We will update our model and view in due course.

Wolfgang

Wolfgang FelixDOUGLAS