Douglas - It's that time - Positioning
All,
Please find our updated analysis of Douglas here.
It is that time when the bet has worked out and you still believe in the upside, only your instruments will no longer participate in it as much as they used to. 11% YTM is nice, but for a PIK coming from the 50s, the opportunity is rather to take some chips off the table. After all, our bet was that Douglas would recover, not that it would IPO. The latter seems well within grasp, but not for the first time and it would be quite a different bet - one for which we would want to earn more than 11% anyway. All that said, we remain convinced of the strength of the franchise, current management’s strategy and the unshakeable demand for beauty products.
Investment Rationale:
- At 91.5 c/€ bid, for a PIK coming from the 50s, we are taking half of our now 6% position off. We see the company achieve its seemingly ambitious goal of growing to €5bn sales and €500m EBITDA and that the back-to-basics strategy of Van der Laan is the right one for the business now. We are merely managing risk at this stage and we may be selling the other half soon.
- COGS inflation turned out to be milder, with only 6.5% increase vs. 10% and more than we had feared, and the flip to disinflation looks smoother now too, paving the way for a softer landing on supplier pass-throughs. Douglas have managed to raise prices to protect margins without dropping proportionate volume and thus to raise revenue, Gross Profit and EBITDA despite the recessionary environment.
Current Trading:
- We had anticipated a marked drop in gross margin in Q2 and Q3 '23 on the assumption that the new stock negotiated in calendar Q323 would begin rolling through the P&L at over 10% inflation. This effect took place but was not visible for lack of volume figures. Management quoted the cost increase closer to 6.5% and the consumer environment allowed for higher price increases than we anticipated last year. This effect was already visible in Q2 and lead to a beat in revenue and Gross Margin on only slightly lower volumes, which in turn were based on lower conversion and smaller basket sizes.
- Eastern Europe carried the results, growing at all levels.
- Because the CEO is new, we are half expecting him to take some provisions in Q4 of this year, which would then lead to better earnings growth in 2024.
- Douglas have created a "Pureplays" division containing the stores of Parfumerie Akzente, DisApo (-intment) and Niche Beauty. One business unit for the on- and offline remains of Perfume Dreams after most of it was merged into Douglas, an online prescription drugstore (the rest may be moved into skincare) and 51% in a scouting and import platform for a collection of foreign niche brands seems an unlikely project. We agree with comments made on the call that this looks like a non-core basket.
- Douglas are experimenting with a mix of Douglas/Nocibé format of which four stores will be piloted in France.
- Format Standardisation: The company is going to differentiate between a "Luxury" format for ca. 10% of store network and "Premium" for the normal 90% of the stores.
- Elevation of Hair Care and Accessories to "Category" level alongside the three existing ones: Fragrance, Make-Up and Skin Care. So five categories going forward.
- Douglas has entered Belgium with a first store.
Model:
- Q3 saw the merchandise inflation come through as expected. At the same time, footfall was up across the regions except in the south, whereas basket sizes were largely the inverse of that - mostly reflecting a cautious consumer faced with higher prices. Southern Europe was the only exception with lower footfall (also due to fewer stores - measured on a gross basis), but larger baskets instead. Eastern Europe carried the results with higher footfall, higher conversion and bigger baskets. As consumer caution is likely a trend, we have reflected that in lower sales going forward at better margins.
- Marketing income has been disappointing this season.
- Overall, we were disappointed with revenue but may have been too bullish about Germany in particular. The company has raised prices and is wearing the lower volume. This would explain the higher inventory at the end of Q3, which is not met with higher payables as we would have expected if - as management profess - the higher inventory is due to pre-purchases for the AW season. Never mind.
- In a higher inflation environment, we are not bothered with Douglas running a larger inventory, even if that does not seem to be the reason for it. Inventory bought a year earlier captures a better Gross Margin and the market multiplies the incremental EBITDA with perhaps 8x, which should be double the value of the capital bound by the incremental inventory.
- Total NWC, however, came in lower than we had expected. The company must have bought more cautious volumes in the first place. Well done. Extraordinary items have also come down. Here we have dropped our forecast, but remain cautious about Q4, which could be a good opportunity to provision for a lot of things that will help keep next year cleaner. After all Douglas have a new CEO.
- CapEx was light in Q3, but we are not changing our outlook. Management hinted at higher CapEx during the call and we think that is a good idea. We have not changed our expectations.
- Cash is therefore significantly better than expected and we think that will remain so.
Inflation:
- Douglas have more than passed on the merchandise inflation to consumers, who dropped volumes / bought smaller baskets, but not by enough to offset the rise. As a result, Gross Profit has risen.
- The results are further evidence that stabilised by the lipstick effect and continued household liquidity (albeit in a recession), consumers will pay up for a slightly smaller basket of goods.
- Because of the cycle with which Douglas negotiate their annual purchasing contracts in the second half of the calendar year we had originally foreseen a marked drop in gross margin in Q2 and Q3 202. This has been offset with higher prices at lower volumes, resulting in a drop in Sales, but neither in %age Gross Margin nor in total Gross Profit.
- Labour cost increased in Q323, but not by as much as we had anticipated, as there was a catch-up payment involved following negotiations last year. Labour costs are under admirable control so far.
Competition:
- With the return of customers to the high street, Douglas' online business has gone sideways in 2022/23, while its largest pure-play competitor, Notino, has been growing to almost the same size now.
- As a result, Douglas are showing good margins and earnings, but it will have cost the company the online lead in Europe.
- Notably, Notino and Flaconi are achieving their growth without an in-house store chain to draw captive existing customers from. Overall Notino and Flaconi are growing as fast as Douglas online and together amount to some 2/3 of Douglas. This explains how Douglas have managed to grow, while remaining profitable while competition has been having less pressure to show profits in the short term.
- 2022 does not seem to have gone well for Flaconi. 2021 Pro-7 put Flaconi up for sale, but instead, we seem to be observing a change in strategy, as we can think of no other explanation for the poor results the company has posted (little disclosure). P7S1 reacted with switching out the CEO, so we stay tuned.
- Note that the differences in reporting period have a bearing on the shape of each curve at any time.
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk