Douglas - A little known fact

All,

Please find our updated analysis of Douglas here.

We still own 2.5% of NAV in the PIKs, holding on to which was clearly a mistake. However, we see a good opportunity to keep those on the books until February. A little-known fact is that for the vast majority of products Douglas negotiate in-take prices only once a year: in calendar Q4 / Douglas Q1. Prices then change around January. This means that the upcoming Christmas season - Douglas’ all-important Q1 - Douglas will be selling merchandise at inflation prices, which it buys at in-take prices it negotiated pre-inflation. In a winter with likely less travel and where warm socks may be the gift of choice, that should allow Douglas to generate good gross profit. It should also hold approx 3 months of pre-inflation inventory on the books at the end of December.

Q123:

- Douglas will eventually be subject to inflation like any other retailer. However, we are foreseeing a markedly different first year of it. Because Douglas can buy most inventory through calendar year-end at prices negotiated in 2021 but find themselves competing for share of wallet with goods that are already subject to inflation, we are foreseeing a strong competitive advantage for the company - at least relative to other types of consumer goods.

- We expect the new (higher) in-take prices to trickle through from Q2 onwards, really hitting margins only in Q3 and Q4. So taking into account the heavy weighting of the Christmas season, we think that 3/4 of the year’s EBITDA will see strong margins. That should stand in stark contrast to anything else retail will have to report.

- Douglas tend to report their September Q4 around 20th of December and report on the important December quarter in mid-February. So depending on how we think about risk by then, that would be an interesting time to hear a company report good numbers.

Gas and Electricity:

- Germany in particular, but across Europe we are concerned about reserves of gas and the price of energy, which could result in anything from black-outs to rationing, which in turn would require a slow-down in production and ripple through the economy. Douglas should feel no particular direct effect, but indirectly its strong exposure to Italy and Germany will likely impact results.

Inflation in the Long-Term:

- From H223 onwards, Douglas would be as exposed to inflation as any other retailer.

- We think that the affordable luxury segment it retails in should provide some protection, compared to mid-market retail for instance, but there will still be an impact.

- Having modelled for elasticity, it is simply too early to conclude how large the impact is and how long it will last, but despite leverage being lower then than it is now, we are modelling a period around early 2024 where the PIKs are effectively all out of the money.

We think of this as a “period”, a transitory effect and we may have much more information well before that time comes.

Positioning:

- We are holding on to our position in Douglas into what we think will be a surprisingly strong Q1 (half of annual EBITDA - perhaps even more in 2023). We are then considering selling our position on those news and buy back lower later.

- Douglas are grappling with online migration, but have made rather a virtue of it and so despite its high leverage / big balance sheet, the company is good and - market circumstances aside - that is where we fundamentally want to be.

Wolfgang

E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk