Douglas - Of Forests and Trees - Positioning

All, 

Please find our updated analysis here.

Please also note the update in format: To make it easier for you to find the updated sections from time to time, we are re-arranging our write-ups to differentiate between content that is universally valid for the name and content that requires more regular updating or is situational. The latter is reflected in the emails as well, but it’s worth referring to the analysis for context. Please let us know your thoughts on this format.

Now to the credit:

We’ve been bullish on this name for some time. As the business is overcoming the series of shocks it endured since CVC bought their stake - Online migration in home-market Germany, the pandemic or now the steep rise in inflation, it feels like Douglas might be in for some normalisation over the coming year. That’s exactly what new CEO van der Lean is aiming for with his back-to-basics strategy and we find management's growth targets quite easy to model. Our fear that Q1 margins were a one-off have not materialised in Q2 and overall the concept of disinflation seems to move in more slowly than we thought, which gives the company scope for a softer landing on COGS pass-throughs, which are also coming more slowly than we feared. 

Investment Rationale:

- We had muddled our communication on the last write-up and are finding ourselves still holding the 5% PIK position we had at least considered de-risking into Q2. (Our model had said we were de-risking 50% into the SSNs, but the email said that we weren’t doing it after all.) We are holding on to this position as we see the company achieve its seemingly ambitious goal of growing to €5bn sales and €500m EBITDA, which should see the PIKs drop below 5x pre-IFRS16 leverage by this time next year. We think the back-to-basics strategy of Van der Laan is the right one for the business now.

- 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 smoother landing on supplier pass-throughs.

Model:

- We have archived our very detailed and complex driver by which we used to forecast the company along regions and separately by on- and offline. Although we can still approximate earnings in this way (no more disclosure of pre-ifrs16 segment EBITDAs), we no longer think it is worth it and all the detail would have us miss the wood from the trees. You can still find the old driver in the back of the file. 

- Like Van der Laan's overall plan, the new driver is very simple and focuses on the core elements that make a successful retailer: stores, growth and costs, inflation etc. 

- Douglas have the chance to rebuild their margins now that online migration, pandemic and inflation seem to be under control. Van der Laan's strategy aims at investing in sales growth in the stores while focusing on margins and customer satisfaction. The more balanced omnichannel focus also makes better use of Douglas' unique store chain as a strategic asset vis a vis its online pure-play competitors.

- On a very modest store roll-out we have modelled zero LfL growth except for inflation itself and labour cost to outpace sales with 10% p.a. for over a year. We have increased CapEx, because we cannot see how this would be achieved with the promised reduction and NWC represents a mild outflow - mostly due to inflation. Even so, we arrive at a smooth return to normality for a retailer of this type, which results in a deleveraging of the PIKs to below 5x by the end of next year (before the Q125 deleveraging).  

Inflation:

- The record results Douglas have achieved in Q123 demonstrate that stabilised by the lipstick effect and continued household liquidity, consumers will pay up for a slightly smaller basket of goods. 

- However, because of the cycle with which Douglas negotiate their annual purchasing contracts in the second half of the calendar year, we assumed Q223 would show a marked drop in gross margin as the old inventory negotiated on 2021 prices (pre-inflation) would make way for new inventory negotiated in calendar H222. But we have not seen any of it. As a result, we are no longer as negative on Q3 either. 

- We understand that the price uplift to Douglas has been on average as little as 6.5%, not the 10%+ we had previously modelled. Douglas' and other retailers' negotiating power vis-a-vis beauty brands suppliers is visible in the latters' results around the globe. Also, the shift from inflation to deflation will probably be slower than we anticipated, affording Douglas a softer landing from eventual supplier pass-throughs. Van der Laan has assured us of it...

- As regards inflation of its main cost items: Labour and Rent, Douglas have been actively re-negotiating much of their rental portfolio in the last years. We expect costs to increase inside the shops, however, before overall labour cost inflation drives up consumer salaries.

Strategy and current trading:

- Sander van der Laan's vision for Douglas is much simpler than his predecessor's. With Tina Müller's strategies exhausted, Sander van der Laan's more international image could raise Douglas' profile with international investors ahead of the long-sought IPO. He is cost conscious and likely to take the axe to anything that isn't profitable or immediately promising returns. CVC's strategy, therefore, seems to have shifted from IPO-ing on a great Online- / DisApo-fuelled equity story back to a focus on results, which we find much in tune with the market. 

- He believes in good execution along the basic principles of retail and we think that may be just what the doctor ordered now for the company. He formulates his strategy in four (vague) categories:

Pillar #1: No1 Beauty Destination: Update brand positioning, improve execution and "increase spending". Develop a Social Media plan and buy a listening tool. ESG. 

Pillar #2: Most Relevant and Distinctive Brands: More early brand sourcing. Not just perfumes - communicate to customers. Double own-brand sales. Specify assortment, pricing and promo. strategies.

Pillar #3: Friendliest Omnichannel: Methodical customer journey on and offline. CRM 2.0. One customer support for all channels and countries. Social commerce. Modularise store elements. More stores.

Pillar #4: Focussed and Efficient Operations: Define, standardise and simplify processes, systems, KPIs across stores, geographies and channels. Warehouse roll-out. Reduction targets for CapEx and NWC.

- We agree with company guidance of 2026 revenues of more than €5bn and pre-IFRS 16 EBITDA of up to €500m by 2026, if not earlier even. However, the investment is now 7 years old and for CVC to get their money back, turn a profit even, not much more must go wrong.

Warehousing:

- Under Sander van der Laan the commentary surrounding the remaining warehouses had initially softened. In the Q123 call, management only said they might need another warehouse for Eastern Europe. No mention of Italy or France.  

- During Q223, however, the roll-out of "a network of omnichannel warehouses" found its way back into strategy pillar #4: "Build focussed and efficient operating model". We do believe that the Italian and French warehouses will be built. By contrast, the Spanish presence is now so reduced that perhaps that investment makes less sense now than it did when first announced. 

- Four more such migrations remain.   

- The additional inventory required to operate old and new warehouses in parallel has been less pronounced than we had anticipated. 

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, Notitno, 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 by 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