Douglas - In search for a revolution
All,
Please find our updated analysis of Douglas here.
Long lead-time retailers can be a risky bet, but as long as consumers remain flush enough to afford your product, the stronger the rise in inflation, the better. Fortunately, continental consumers haven’t spent all their savings following the Pandemic and cosmetics are sticky affordable luxury. So far so good. Going forward we are also looking in good shape: Inflation is to stay higher for longer, government spending knows no bounds, minimum wages are catching up and Douglas are looking to be settling into a new groove. With most interest fixed and caps on the €675m floater, Inflation is helping the company grow into its balance sheet, instead of representing a headwind.
Investment Rationale:
- We are holding on to our 5% position in the PIKs. We’ve been thinking about de-risking the position following its recent appreciation, as we are concerned that the bonds will trade off on the usual Q2 WC outflow. But the spread is too wide to make sense, forcing us to wear some volatility on the return into the 90s.
- As per above, the rise in inflation and the slower return to lower levels that we anticipate going forward has resulted in a tailwind for the retailer due to European consumer savings carried from the pandemic.
COGS:
- As previously flagged Douglas negotiate their prices once per year, even as oftentimes the sit down with their suppliers up to once in the interim to negotiate any adjustments. Cost increases negotiated with suppliers at the end of 2021 were minimal (inflation was still low) and the raw material and even labour cost inflation underlying the perfume and cosmetics business did not justify a major adjustment in H222.
- As per calendar Q4 22 price rises negotiated for 2023 were 5-6% only, a cost increase that should be well outpaced by competing gift products in the apparel business and elsewhere. This will allow for healthy margins going forward. What van der Lean described as a one-off effect should not just be one-off for Q123, although it may have been most pronounced in this important quarter, but it will be a one-off for the year 2023.
Uptrading:
- We find our above theory evidenced in the comparatively low price competition in the perfume market. There are no reports of the annual price battle taking place this year - even now, after Christmas. Consumers are mostly able to pay up and if anything, are buying smaller baskets at higher prices / are uptrading.
- As long as upgrading remains the dominant trend, margins are under no pressure and we are unlikely to see major price battles. Downgrading will come when consumer savings are exhausted and their outlook darkens. So we will stay tuned to the language retail management teams are using when describing their quarterly tradings.
Revolution:
- Even though we are expecting Douglas earnings to improve significantly this year and are forecasting PIK leverage to drop below 5x by this time next year, we feel concerned about CVC’s prospects. The sponsor is invested with over €1.3bn - never mind the accrued minimum IRR over the last seven years.
- CVC’s best chance of a however profitable exit is an IPO, a burden owed to its disastrously expensive idea of buying shop chains in Italy and Spain, only to have to downsize them while battling online migration in its cash-cow home market.
- Over the last years however, through no further fault of CVC, the Pandemic and now the exit from it have consumed a string of equity stories championed by its recent (and overall successful) CEO Tina Müller. Douglas had bought and integrated Parfumerie Akzente and further invested in its IT and competitive pricing capabilities, which has ensured the unique profitability of its online channel. That channel then became the new value proposition when The Hut Group went public. But CVC took too long to follow suit, choosing to be stingy when it was time to be generous, and the window closed.
- Other recent strategies remain nascent, including DisApo and the market place experiment.
- Aside from cost cutting, Douglas therefore finds itself without a great equity story to sell to the public. New CEO Sander van der Lean’s “Reshaping” strategy has not yet been finalised, but sounds a lot like “evolution", rather than “revolution". His profile is international, that might help, but as per above, to put CVC back in the money in this market we think they need more “revolution".
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk