Fish Where The Fish Are: International IPOs
To generate superior returns, we need to do two things:
- Look where nobody else is looking
- Fish where the fish are
Let’s flesh these ideas out through the lens of the world’s best investor, Warren Buffett:
“It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”…would you say the same thing today?”
Buffett spent most of his early Partnership days buying and selling undervalued micro-cap stocks. Most times, these stocks had little liquidity and a nonexistent following.
That’s what we’re all about at Macro Ops. Our global, no-limits approach allows us to find ponds with tons of fish and no fishermen. One such setting is the International IPO market.
International IPO markets are ripe with misunderstood and underfollowed businesses. Here’s an example of the power in finding underfollowed International IPOs.
80% Returns In Less Than Six Months
In December 2020, we issued an investment report on Companhia Brasileira de Distribuição (CBD). CBD is Latin America’s second-largest retailing company with a consortium of supermarkets, hypermarkets, general stores, and warehouses.
CBD’s golden egg was its 76% market share domination in online food commerce, much of which catalyzed by COVID-19. The company possessed clear scale advantages and used them in its Direct-To-Consumer e-commerce marketplace.
Despite its competitive advantages and massive footprint, the company traded for 0.5x sales and <8x current EBITDA.
Mr. Market’s Price Didn’t Make Sense
The numbers didn’t make sense. Either we were wrong about the future, or Mr. Market was wrong about his expectations.
Five months after we sent the report, we had our answer. The stock is up over 88% for an annualized 211% IRR.
It’s our job to find these ideas every week, month, and quarter for our Collective members. And while we can’t guarantee 80% returns in less than six months, we can ensure we’ll follow this repeatable strategy of fishing where the fish are.
You can read that entire report below.
Companhia Brasileira de Distribuição (CBD): Hypermarkets, Cash and Retail
CBD is the largest Brazilian company engaged in business retailing of food, general merchandise, electronic goods, home appliances, and other products from its supermarkets, hypermarkets, and home appliance stores and second-largest retail company in Latin America.
The company was founded in 1948 by Valentim Diniz. At age 16, Valentim immigrated to Brazil. Nineteen years later, Valentim opened his own pastry shop in 1948. He named the shop Pão de Açúcar. It was the birth of what CBD is today.
Pão de Açúcar: The Largest Food Retailer in South America
What was formally Pão de Açúcar’s is now Grupo Pão de Açúcar (GPA). But the company trades under the name Companhia Brasileira de Distribuição (ticker CBD) on the NYSE.
CBD owns and operates over 1,500 retail stores throughout Brazil, Colombia, Uruguay, and Argentina. There are three types of stores:
- Premium: Pão de Açúcar, Minuto, Carulla Fresh Market, Devoto and Mini Libertad
- Mainstream: Mercado Extra, Exito, Geant, Libertad
- Cash & Carry (self-service, bulk items): Assai, Supre Inter, SurtiMAX
The company owns 462 premium stores, 691 mainstream stores, and 353 cash & carries. CBD commands 16% market share in Brazil, 29% share in Colombia, 41% share in Uruguay, and 14% share in Argentina.
The majority (65%) of CBD’s stores are located in Brazil. In fact, there’s a CBD store in every district and state.
Breaking Down Sales
CBD has two primary sales engines: Multivarejo and Cash & Carry. Multivarejo includes supermarkets, hypermarkets, proximity markets (corner stores), and pharmacy/gas stations. The Multivarejo segment generates 42% of CBD’s sales.
That means its Cash and Carry business, Assai, generates 58% of its total sales. For us non-Latam investors, it’s best to think of Assai like Sam’s Club or Costco. And CBD’s Multivarejo businesses as Whole Foods, Target, or Wegmans.
The company is actually planning to spin off its Assai business into its own public company. CBD shareholders will receive shares of the spin-co upon a successful spin-off. We’ll cover that later.
Long Live Brazilian Brick & Mortar (Multivarejos)
Nearly every brick-and-mortar brand grew double-digit same-store-sales (SSS) QoQ. Pão de Açúcar grew its stores 30% SSS. Mercado Extra and Compre Bem grew SSS 18% and 36% respectively. The Minuto collection of stores grew SSS 37%. Extra Hiper stores grew SSS 7%.
Let’s dive into each of the Multivarejo brands.
Mercado Extra benefited from store revitalizations, higher private-label sales, and an increased number of customers. Mercado continues to take market share in its regions as the company saw 580bps improvement in customer satisfaction.
CBD plans to renovate another 30 stores in Q4 2020, bolster sales, and increasing market share.
Compre Bem caters to lower-income shoppers (B & C income segments) with regional locations and lower-than-average prices.
Think of Compre Bem like an Aldi’s or Lidl. Compre Bem stores offer >7,000 products focusing on butchery, produce, and bakery. They operate a low-cost logistical model with perishable food items delivered straight to the store. The company also started an online store where consumers can buy online pick-up in-store (BOPIS).
Combined, Mercado Extra and Compre Bem make up 6% of CBD’s revenues.
Extra Hiper (17.6% of Revenues)
Extra Hiper stores have everything a consumer needs:
- Food (Perishable/Non-perishable)
- Home appliances
- Automotive supplies
- And more
Extra Hiper is like a Walmart. It’s got everything you need. Yet you probably don’t want to spend your entire weekend there.
CBD has 104 Extra Hiper stores across 16 Brazilian states. Extra Hiper breaks its stores into “high profit” and “low profit” stores. There are ~75% high-profit stores in operation and 25% low-profit stores.
High-profit stores have unique characteristics like:
- High traffic locations
- High repeat purchases of perishables
- Simplified operating processes
- Optimized assortment of products
With the low-profit stores, the company either closes down or converts Extra Hipers into Assai shops.
Pao de Acucar (10.7% of Revenues)
CBD’s Pao de Acucar stores are in the middle of complete renovation. This includes remodeling the physical stores and giving them an online presence/grocery delivery service.
So far, the facelift is working. Refurbished stores generated 900bps more sales, 700bps greater volume,—refurbished, and 500bps more customers.
The 46 renovated stores account for 41% of sales and 66% of EBITDA.
Proximity Stores (2.8% of Revenues)
CBD’s Proximity Stores include:
- 86 Minuto Pão de Açúcars
- 153 Mini Extras
- 104 drugstores
- 74 gas stations
- Two smaller general stores
CBD saw solid growth from this consortium of stores in 2019. Revenues increased 15% on 3% customer growth while gaining 100bps in market share.
How can CBD’s proximity stores generate 15% sales increases while growing customers by 3%? Private label branding. The company sold 30% more private-label products through its proximity stores YoY.
Multivarejo Growth Levers
According to the company’s latest Investor Presentation, there are a few ways to grow sales and profits. On the sales side, CBD can expand stores into greenfield locations and rehab its existing stores. There’s also e-commerce and food delivery which the company is just starting to implement. Finally, CBD’s Multivarejo stores can sell more private-label products. 20% of their sales came from private-label last year. They should do >23% this year.
CBD can pull a few levers to grow profit margins, including:
- Converting/Remodeling old stores (+30bps increase)
- Reducing assortment of goods and optimize supply chain practices (+50bps)
- Close underperforming stores or convert those into Assai stores
Cash & Carry Business: Assai Spin-off Potential
The company announced a proposed spin-off of its Cash & Carry Business, Assai, in September 2020.
Before we dive into the spin-off specifics, let’s look at Assai’s business economics.
Put simply, Assai is a tremendous business. The company needs little capital to grow, generates high-profit margins, and has a long runway to reinvest in its business at above-average rates of return.
Assai had grown sales 3.4x from 9B Real in 2014 to 30.3B Real in 2019. During that time, they’ve expanded EBITDA margins from 4.2% to 6.3% and grow market share 740bps to 28.4%
What makes Assai a great business is that their stores get better as they age. For example, mature stores generate nearly 200bps more EBITDA margin. Couple this with CBD’s new model design for the store, and you have a twin-engine of growth. New mature model stores generate 5.5M Real more per month in revenue than old model stores.
Assai wants to build another 60 stores in the next three years. They’ll have ~196 stores by the end of 2020. So another 60 puts us at 256 stores throughout Brazil.
In doing so, Assai expects to reach 50B Real in revenue by 2022 (or $9B).
If all goes well, CBD investors will receive shares of Assai in Q1 2021.
A Call Option on Digital Retail Transformation
CBD was one of the first companies to introduce food delivery (1995) and loyalty programs (2000) in Brazilian retail. Thanks to COVID, the company’s reaping the rewards of its digital-first strategy. CBD uses a 1P (first-party) and 3P (third-party) strategy:
- 1P: E-commerce via Multivarejo stores (Pao De Acucar & Clue Extra)
- 3P: GPA Marketplace
First Shot on Goal: 1P E-commerce
CBD has an excellent direct-to-consumer E-commerce business. They provide shoppers with next-day, same-day, BOPIS, and next-hour food delivery. The company’s E-commerce business accounts for 76.6% of Brazil’s self-service market share. They’ve seen 240% YTD growth in E-commerce with a 202% increase in the number of new customers.
What’s interesting about their 1P E-commerce business is the James app. James is Brazil’s UberEats, DoorDash and GrubHub. James’ vertical retail business has experienced massive COVID-growth, including:
- 1,238% GMV growth QoQ
- 689% increase in the number of orders QoQ
- 70% growth in average ticket value
Second Shot on Goal: Apps
CBD has 14.5M downloads, and 170M visits on its apps Cliente Mais and Clube Extra. This gives them a tremendous competitive advantage in the D2C E-commerce business as other food retailers can’t match their customer base.
As exciting as their food e-commerce and app businesses are, they’re not as exciting as CBD’s 3P Platform.
Third Shot on Goal: The GPA Marketplace
GPA’s Marketplace message is simple: “We have the greatest number of active and engaged customers in retail and you can sell more of your product if you partner with us on our platform.”
The company wants to create a one-stop-shop platform for customers to purchase food and non-food items. Here’s the CEO of Multivarejas segment, Jorge Faical, on the platform (emphasis mine):
“We have already signed more than a dozen contracts with leaders in the Brazilian retail market, especially in terms of vertical categories, baby care, for example, automotive products, furniture, kitchen utensils, bed, bath and more. And this, of course, will complement our proposal for food. So the marketplace will become a very strong center of gravity, and we are going to invite you for a presentation of our marketplace and how this will be impacting GPA going forward.”
The platform will combine specialty and generalist product desires. You can buy tires as quickly as baby food—all in one place.
The glue that will hold this platform together is GPA’s My Rewards loyalty program. It’s all about creating positive virtuous cycles. GPA’s Marketplace virtuous cycle looks like this:
Greater number of customers on platform → greater number of partnered retailers → greater assortment of products → greater number of customers on the platform
The company expects the platform to start at 240M visits. They’ll have 10x more sellers on the platform in 2021 than they’ll have in 2020. Finally, the company’s estimating >400K products offered over the next 12 months.
Launching a 3P platform marketplace when you have a 76% market share in digital food commerce is a good idea. The company has minimal customer acquisition costs, which means increased profits and more significant margins than their competitors.
Culture & Leadership
GPA has a 3.7/5 rating on Glassdoor. 77% of employees would recommend the company to their friends. More importantly, 97% of employees approve of CEO Peter Estermann.
Estermann is a retail whiz with a passion for digital transformation. For example, Estermann became CEO of Via Varejo in 2015. The company was on the verge of losing billions. Estermann brought a digital-first mindset and prioritized e-commerce.
Over the next three years, Estermann took the stock from 1.03BRL/share to 8.81BRL/share for a 700% return.
Financials (September 2020) & Valuation
The company’s revenue grew from 48.26% YoY to 79B Real. They did 21.45% Gross Margins for 16.95B Real with 3.37B Real in Operating profit (4.2% margin).
The last three quarters have seen LTM YoY revenue growth of 48.26%, 37%, and 25.33%. We don’t think they’ll maintain these growth rates as COVID-related adoptions subside.
Let’s look at the balance sheet. GPA has 7B Real in Cash, 11B Real in long-term debt, and another 9B Real in lease obligations. This gets them ~13B Real in Net Debt and 3x Net Debt/EBITDA.
This is a good business. Is it leveraged higher than I’d like? Yes. But the company also has the most prominent food retail business in Brazil, millions of customers, and great insights into purchasing frequency. Given they not only survived but thrived through COVID, their balance sheet seems safe.
That’s why I was pleasantly surprised to find this business trading for 0.5 EV/Sales and 7.6x EV/EBITDA. It’s surprising to see the largest food retailer with a 76% market share in online food commerce trade for 0.5x sales.
Viewed another way, you can buy GPA’s Multivarejo business segment (generating 33.34B Real in revenue) for 1.29 EV/Sales. That means you get the Assai business for free. It’s a free call option on GPA’s Cash and Carry business.
The most significant risk with the long CBD thesis is that the Assai spin-off will be net-negative to shareholders. James Cherry wrote an excellent short pitch on Seeking Alpha. He suggested the combined corporate expense of both separate companies will be higher than the current co’s corporate expenses. Thus, shareholders lose in the end. While this may be true, the fact is shareholders will have two ways to play two dominant brands in Brazil.
Another risk related to the spin-off includes cannibalization of sales. GPA already has a plan in place to turn its failing Extra Hiper stores into Assai stores. What’s to stop the separate Assai company from taking greater market share from Multivarejo’s collection of brands?
Finally, there’s country risk. A bet on CBD is a bet on Brazil’s economy. The company generates nearly 75% of its revenue from Brazil. The remaining 25% is split between Colombia (19%), Argentina (2%), and Uruguay (5%).
CBD is Brazil’s largest retailer and the second-largest retailer in South America. The company has over 14M customers using its digital apps. It plans to roll out a unique 3rd party omnichannel commerce platform with 400K SKUs. The company has a 76% market share in digital commerce and has a footprint in every state and district in Brazil.
CBD is led by digital-first e-commerce specialist Peter Estermann. He’s created an environment where 77% of employees would recommend their business, and 97% of them favor the executive officer.
The company has higher-than-average leverage, but we believe shareholders are compensated for that risk at the current 0.5x EV/Sales and 7x EV/EBITDA valuation. You can buy CBD’s Multivarejo businesses for 1.29x sales at the current market price and get the Assai business (one of the best Cash and Carry operations in Brazil) for free.